WHAT ARE MANUFACTURING OVERHEAD COSTS? - CULTURE VOCABULARY - 2024

The indirect manufacturing costs are those costs to be covered by a factory for the manufacture of a product, other materials and direct labor. For example, indirect materials necessary for production, indirect labor, rentals, taxes, light or electricity, among others.

They are costs that are related to the entire operation of the company and exceed the manufacturing process of a specific product. For this reason, they are also known as manufacturing overhead, factory overhead, or factory charge.

Recognizing these costs is essential, because they are necessary to be able to identify the real cost of manufacturing a product and in this way establish the price for the consumer and the benefits that are expected to be obtained from marketing.

Some of these costs may be related to raw materials or services required to run the factory. For example public services such as water and electricity, as well as cleaning supplies.

But also, indirect costs that are salary type. For example, the salary of a supervisor is not part of the labor that works in the manufacture of the product, however, it is an indirect expense necessary for the manufacture of the same and therefore must be taken into account.

Classification of manufacturing overhead costs

Indirect costs are classified according to their constancy within production expenses. In this sense, we can speak of three categories: fixed, variable and mixed costs.

Variable indirect costs

They are those that change in proportion to the production of the factory. This means that the larger the production, the higher the value of these costs.

Indirect materials, indirect labor, and some public services are included in this category.

For example, if a company requires a supervisor for every 10 operators, increasing production will also require hiring a new supervisor.

Fixed indirect costs

They are those that remain constant even if production levels rise or fall. This category includes property taxes, property depreciation or building rentals.

For example, if a factory increases its production but maintains the same commercial premises, there will be no increase in rental costs for real estate. Even if the number of stores is increased, these will constitute a new fixed cost.

Mixed indirect costs

They are those that cannot be considered completely variable or completely fixed. Therefore, for its fixation its fixed and variable components must be separated.

This category includes some public services or the leasing of machinery.

In these cases, it is necessary to separate the fixed components and the variable components to plan the expense properly.

Main Indirect Manufacturing Costs

Indirect materials

Indirect materials include cleaning supplies and office supplies that, while necessary for the operation of the factory, cannot be allocated to the cost of a particular product.

These costs are considered variable rate. This is because as the production and operation of the company change, so do the needs for materials.

Indirect labor

Indirect labor costs are those that make the business possible but cannot be assigned to a particular product.

For example, the value of the salary of a manager who manages the operation of the entire company and not just a product line.

In this case, there are also fixed and variable costs. Fixed costs refer to permanent plant wages, while variable costs refer to expenses that change according to production.

Factory supplies

Factory supplies are all those materials that are consumed within the operation of the factory but are not part of the raw materials. This includes oils, greases, lubricants, stationery, etc.

In this case, they are usually variable costs because they always increase as production increases.

Factory consumptions

Factory consumptions refer to all those services that are necessary for the operation of the company. These include expenses for lease, telephone, utilities, equipment maintenance, depreciation, etc.

Calculation of indirect manufacturing costs

Calculating manufacturing overhead is often a complex process. This is because they are very diverse, imprecise and, in most cases, unforeseen. Therefore, it is necessary for each company to design its own method to calculate its costs and distribute them among its products.

Departmentalization

Departmentalization is a strategy used to classify the costs of a company taking into account its different departments.

In general, manufacturing companies can be divided into two large departments: production departments or Production Cost Centers (CCP) and auxiliary departments or Auxiliary Cost Centers (CCA).

Production Cost Centers are those where the manufacturing process is developed. In other words, the part of the company where the productive activity is properly carried out.

On the other hand, the Auxiliary Cost Centers refer to all those that do not carry out productive activity but are necessary for the operation of the companies. This includes the areas of maintenance, quality, general services, etc.

Taking into account that the auxiliary departments do not carry out any productive activity as such, it is necessary that their costs are distributed in the production costs.

Procedures for the distribution of costs

Indirect manufacturing costs are variable according to the characteristics of each company. Therefore, there is no single model for their distribution. However, four key steps can be identified within this process:

1-Identify all indirect manufacturing costs that the company had during a given period.

2-Identify which auxiliary cost center corresponds to each of the indirect costs of the period. This process is known as primary distribution.

3-Distribute the costs of the different auxiliary departments among the production departments according to the size and productive capacity of each department. This process is known as secondary distribution.

4-Distribute all the indirect costs that were assigned to each production department and divide them among all the units that were generated during the period.

References

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3. Arnold, A. (SF). Top 5 Indirect Manufacturing Costs. Recovered from: ganoksin.com.
4. Dharma, L. (2012). Dealing with indirect cost in manufacturing environment. Recovered from: accounting-financial-tax.com.
5. Peavler, R. (2017). Direct and Indirect Costs and Their Effect on Pricing your Product. Recovered from: thebalance.com.