How to Calculate Manufacturing Overhead Costs

How to Calculate Manufacturing Overhead Costs

Once you have identified your manufacturing expenses, add them up, or multiply the overhead cost per unit by the number of units you manufacture. So if you produce 500 units a month and spend $50 on each unit in terms of overhead costs, your manufacturing overhead would be around $25,000. To calculate manufacturing overhead, you have to identify all the overhead expenses (like the three types mentioned above).

For example, if you have an office in an area with a high cost of living, look at moving your operations to a more affordable area. A company must pay rent and utility bills no matter how much work its employees perform in a given month. Cost of goods sold is usually the largest expense on the income statement of a company selling products or goods. Cost of Goods Sold is a general ledger account under the perpetual inventory system.

How to Treat Overhead Expenses in Cost Accounting

You also need to closely monitor your production schedule so you can make adjustments as needed. Download our free production schedule template for Excel to monitor production dates, inventory and more. This is because it completely considers the time element in absorbing the overhead expenses. While costs such as utilities are incurred each manufacturing overhead costs include month, the amount varies from month to month, putting them squarely in the semi-variable category. For example, since you manufacture and sell picture frames, you incur shipping costs for each month you ship orders. However, if there’s a month when your business doesn’t sell any picture frames, you will not have any shipping expenses.

For instance, during months of heavy production, the bill goes up; during the off season, it goes down. In order for a manufacturer’s financial statements to be in compliance with GAAP, a portion of the manufacturing overhead must be allocated to each item produced. These costs must be included in the stock valuation of finished goods and work in progress. Both COGS and the inventory value must be reported on the income statement and the balance sheet.

Why is it important to calculate manufacturing overhead?

This not only helps you run your business more effectively but is instrumental in making a budget. Knowing how much money you need to set aside for manufacturing overhead will help you create a more accurate budget. Simply, totaling the Overhead Costs either for the factory or for various divisions for your business is not sufficient. It is important to assign these Overhead Costs to various products, jobs, work orders, etc.

For example, if your company has $80,000 in monthly manufacturing overhead and $500,000 in monthly sales, the overhead percentage would be about 16%. Led by Mohammad Ali (15+ years in inventory management software), the Cash Flow Inventory Content Team empowers SMBs with clear financial strategies. We translate complex financial concepts into clear, actionable strategies through a rigorous editorial process. The distinction between product-level and factory-level overhead is important for several reasons.

Manufacturing Overhead Outline

These include rental expenses (office/factory space), monthly or yearly repairs, and other consistent or “fixed” expenses that mostly remain the same. For example, you have to continue paying the same amount for renting office or factory space even if your company decides to lower production for this quarter. Once you have allocated manufacturing overhead costs to products, you can use this information to calculate the cost of goods sold and to price your products. The manufacturing overhead rate is a key metric that helps businesses allocate indirect manufacturing costs to their products. Therefore, to calculate the labor hour rate, the overhead costs are divided by the total number of direct labor hours. Adding manufacturing overhead expenses to the total costs of products you sell provides a more accurate picture of how to price your goods for consumers.