When determining the economic viability of a business operation, it’s vital to calculate manufacturing costs. Unfortunately, general manufacturing costs don’t reflect the true cost of producing goods. Using the general manufacturing costs exclusively gives you an incorrect and incomplete view of your business.
Aside from direct manufacturing costs, you must know how to calculate manufacturing overhead. Manufacturing overhead costs enable you to calculate the total cost of producing a specific good.
Let’s take a look at some manufacturing overhead examples and how to calculate manufacturing overhead.
Manufacturing overhead refers to the indirect costs of creating a product. There’s more to manufacturing than the men and women handling raw materials and making a product out of them. There are also maintenance workers, janitors, and quality control staff who all play crucial roles in enabling those employees to complete their assignments. These indirect manufacturing costs are known as overhead.
If you’re wondering how to find manufacturing overhead, let’s take a look at some examples of overhead costs:
None of these expenses is directly tied to the actual manufacturing process. However, it would be impossible for the business to manufacture its products to a high standard without these. This is why they’re considered indirect costs and part of your organization’s overhead.
You also need to take into account applied overhead costs and how to find manufacturing overhead applied. An applied cost is a fixed cost applied to the cost of the project. If you need to know how to calculate manufacturing overhead applied costs, you first need to know what would count as an applied cost. Some examples include insurance and depreciation.
Calculating manufacturing overhead is simpler than you might think. The first step is to identify the overhead costs that enable your production lines to run efficiently. These are any costs that don’t relate to the direct manufacture of a product.
Add all these indirect costs together. That is your manufacturing overhead cost formula. Now, you need to figure out your overhead rate.
Once you’ve added all your overhead costs together, you need to figure out the manufacturing overhead rate. This is different from the manufacturing overhead applied formula because it’s expressed as a percentage. The manufacturing overhead rate formula is:
Manufacturing Overhead Rate = Overhead Costs / Sales x 100
For this example, let’s use a printing factory called Graphix International. The manager has identified the following major overhead expenses:
Graphix International’s overhead costs are $250,000 per year. The depreciation on the office building wouldn’t be added to overhead costs because it has no direct or indirect involvement in the production of the product.
In 2020, Graphix International made $674,000 in sales. So, let’s calculate its overhead rate.
$250,000 / $674,000 x 100 = 37.09%
This means that 37% of the company’s revenue goes towards covering the company’s manufacturing overheads. A higher overhead rate can indicate a company’s production process is lagging and inefficient.
Generally Accepted Accounting Principles (GAAP) indicate that manufacturing overhead should be added to the cost of direct materials and labor when determining the Cost of Goods Sold (COGS) and the value of the inventory. Each of these figures must be reported on both the balance sheet and income statement.
To achieve full GAAP compliance, a portion of overhead must be allocated to every item produced by an organization.
This may sound complex, but businesses must file their accounts according to GAAP standards. For this reason, a professional accountant can be invaluable in this process.
Knowing how to calculate manufacturing overhead provides valuable insights into the quality and efficiency of your business. Regular monitoring of overhead costs and overhead rates tells you whether your business is reaching its potential.
Get help with calculating these figures, monitoring them, and acting on them by contacting Porte Brown, a trusted Chicago CPA firm, to learn more about our accountancy and advisory services.
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