Manufacturing cost is the combination of expenses incurred in labor, raw material, and indirect expenses known as manufacturing overhead cost. Start-ups often neglect to consider these overhead costs, resulting in unjustified accounting statements.
Without determining the actual cost of production, it becomes difficult for organizations to run their operations smoothly. Let’s discuss what are the inclusions in manufacturing overhead and how to precisely calculate product cost.
Manufacturing overhead is the costs incurred that are traced by businesses as it indirectly influences the manufacturing cost. Raw materials and labor wages are something that directly affects the pricing of the product but utilities such as electricity, water, field, and so on are considered indirect or overhead expenses.
These expenses aren’t usually added while determining the product cost, which causes a huge setback for businesses. Adhering to international accounting standards, you are required to include manufacturing overhead expenses in the reporting statement with the cost of product sold (revenue).
By determining these costs, businesses can efficiently plan their financial goal and correctly forecast their future growth.
Moreover, these manufacturing overhead costs are tax-deductible, by assessing them companies could lower their tax burden. The expenses that are not included in manufacturing overhead but are indirect expenditures for businesses are:
So what do we include in manufacturing overhead cost that justifies the nature of indirect manufacturing cost?
Imagine running a factory and all the possible expenses incurred while producing goods. Simply divide those costs into direct and indirect expenditures. The direct expenses would be:
Apart from these expenses, all other indirect costs levied during the manufacturing are coined under overhead cost. All those indirect expenses that manufacturing overhead include:
Furthermore, the manufacturing overhead expenses are classified into 3 categories:
These expenses have fixed occurring amounts in nature and have to be borne every month or annually. Examples are insurance premiums, property tax, cleaning charges, maintenance fees, fixed-rate depreciation, and renewable license fees.
That expense that varies based on external factors. For example, changes in import duty, sales commission, miscellaneous expenses, and shipping costs in some cases.
As the name suggests, variable overhead expenses are those costs that don’t have a fixed nature. Those include repair charges, accidental aid, energy and fuel costs, and renovation of the building.
It’s worth noting that these overhead charges vary from organization to organization, mainly due to the nature of the product. For example, a company manufacturing automobiles would have higher overhead expenses due to the inclusion of various indirect expenses compared to a cycle manufacturing unit.
Adding overhead expenses into the product cost is a bit complex task due to its dynamic nature. Here’s how to include manufacturing overhead costs in the product:
| Nature of Cost Incurred | Amount |
| Labor Wages | $20,000 |
| Raw Material | $30,000 |
| Utilities (electricity, gas, water, field, and so on) | $5,000 |
| Rent | $3,000 |
| Transportation | $2,000 |
| Packaging | $1,000 |
| Maintenance | $2,000 |
| Total manufacturing cost including overhead expenses | $63,000 |
Now that $63,000 is your total manufacturing cost including manufacturing overhead cost, simply divide this amount by the total number of units produced.
Let’s say the total unit produced is 100,000, per cost of the produced good is:
So, the per-product cost for the company would be $0.63, selling the product below this amount would be a loss for the organization. Moreover, it is also crucial to determine the manufacturing overhead rate to assess the portion of expenses occurring through indirect resources.
First and foremost, you need to determine all the indirect expenses and labor expenses that are contributing to the manufacturing cost of a product. As stated above, these can be categorized into 3 categories: fixed, variable, and semi-variable. Add all those expenditures, which would be your manufacturing overhead costs.
To calculate the overhead rate, add all these up. Then calculate your monthly sales, and put them up in the manufacturing overhead formula:
For example, if the monthly sales of the manufacturing unit are $50,000 and overhead costs turn out to be $10,000, the overhead cost percentage is:
This concludes that 20% of the revenue generated would go to manufacturing overhead costs. Additionally, you can even bifurcate your calculation by categorizing the overhead cost into fixed, semi-variable, and variable costs.
Some examples of fixed overhead costs are:
Semi-variable overhead cost could be:
The variable manufacturing overhead costs may include:
Fixed Manufacturing Overhead Cost + Semi-Variable Overhead Cost + Variable Overhead Cost / Monthly Sales × 100
Now let’s suppose the fixed monthly overhead cost turns out to be $5,000, Semi variable cost $2,000 and the variable cost is $3,000. The monthly sales turn out to be $40,000, let’s put these figures in the overhead formula:
Manufacturing Overhead Rate = $5000+$2000+$3000/$40,000 × 100 = 25%
The majority of small businesses miss out on determining the manufacturing overhead cost and end up wrongly interpreting their balance sheet. Including overhead expenses in manufacturing costs helps you to correctly determine the selling cost of the product and generate appropriate profits.
The negligence in determining the manufacturing overhead cost leads to the collapse of businesses, as they fail to assess precise net profit. By carefully calculating all the incurred manufacturing costs, it becomes easy to make sound financial decisions.
Marketing expenses, labor costs, raw materials, and all the direct costs contributing to manufacturing costs aren’t included in overhead costs.
The cost incurred while selling goods and administration costs aren’t part of manufacturing costs.
It is necessary to calculate the manufacturing overhead costs of a product, as it helps determine the actual cost incurred to produce a good. Moreover, this helps manufacturing units determine the net profit of the product.
Pre-determined overhead cost is an assumed cost by the organization that needs to be borne over a while.
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