How to Calculate Manufacturing Overhead Costs?

To calculate manufacturing overhead costs, divide your overhead costs by your labor costs to see how efficiently you use your resources. Multiply this by a hundred (100%) to calculate the percentage of overhead that is ‘used’ per employee. This percentage represents the percentage of all costs that consist of overhead costs. The lower this percentage, the higher the profit.
Manufacturing costs are the part of production costs that are not directly related to materials or administration and sales.

Formula:  Indirect costs / direct costs X one hundred (100%).

The manufacturing costs are broken down into

  • Direct manufacturing costs
  • Manufacturing overhead
  • Special direct production costs

Direct material

costs + overhead costs for the material

= material

costs

+ direct production costs + overhead costs for production

= manufacturing costs

+ special costs for manufacturing

= manufacturing costs

+ overhead costs for administration

+ overhead costs for sales

+ special direct costs for sales

= prime costs

This article also covers:

Which costs can you consider as overhead costs?

Below you will find an overview of overhead cost examples:

Personnel costs

  • wages and salaries
  • staff training and allowances

Administration costs

  • insurances
  • liability insurance
  • Vehicle insurance

Vehicle costs

  • motor vehicle tax
  • fuels

ICT costs

  • software costs
  • hardware costs

Building costs such as

  • energy
  • rental costs
  • license fees

Other general costs

  • printed matter
  • automation
  • telephone costs

Benefits of Recording and Calculation of Overhead Costs

Having an interest in recording and calculating overhead costs certainly has valuable benefits in business. Here are some benefits of recording and calculating overhead costs :

Know the Cost Allocation details; you can find out in detail what the costs are in the business and where these costs are incurred. This will also help you make a budget for future overhead costs to be better planned and avoid excessive expenditure.

  • Determine Prices More Accurately

Knowing how much overhead you have can also influence determining the right product price. Calculations regarding overhead costs need to be included in the pricing, not even to suffer losses. Moreover, overhead costs must still be incurred regardless of whether business production is high or not.

  • Oversee Expenses

Recording and calculating overhead costs help you to oversee expenses in the business as a whole. You can see whether the expenditure has been done efficiently, or even overhead costs are too significant compared to other costs. 

Allocation of manufacturing costs overhead

While manufacturing equipment, product cost calculation will be inaccurate unless the manufacturing overhead is allocated rationally. In order to perform accurate costing, it is necessary to allocate the cost using the manufacturing overhead cost account properly.
Allocating manufacturing overhead costs is done by transferring manufacturing overhead costs to work in the process. The journal will look like this:

DebitAmount CreditAmount
Work in professXXXManufacturing overheadXXX

Production overhead distribution flow

Allocate the manufacturing overhead cost according to the following flow.

  1. Allocation rate calculation
  2. Calculate the allocation amount
  • Calculation of allocation rate

The following formula calculates the allocation rate.

Allocation rate = total manufacturing overhead costs / total allocation standard numerical value.

For example, a factory that makes tennis and bats considers the electricity bill that makes both tennis and bats.

The monthly electricity bill is S10000. And suppose a reasonable allocation criterion is machine usage time. Suppose the machine has been used for 400 hours in tennis and 700 hours in bats.

In this case, the manufacturing overhead is $100,0, and the total allocation standard value is (400 hours + 700 hours) = 1100 hours. Using the above formula, it becomes as follows.

Allocation rate = S10000 / 1100 hours = $9/hour

The allocation rate shows how much electricity was spent per hour on the machine. As with all industrial bookkeeping, it is important not to memorize the formula but to practice calculations while being aware of what you are looking for.

  • Calculate the allocation amount

The following formula calculates the allocation amount.

Allocation amount = Allocation standard value of the product x Allocation rate

Consider the continuation of the same example.

The allocation rate (electricity bill of the machine per hour) is $9 per hour. You have run this machine for 400 hours to make tennis. The allocation base number is 400 hours. Therefore, the electricity bill allocated to tennis is as follows.

400 hours x $9 /hour = $3600

This is the allocation amount.

You also run this machine for 700 hours to make bats. The allocation base number is 700 hours. Therefore, the electricity bill allocated to bats is as follows.

700 hours x $9/hour = $6300

This completes the allocation of manufacturing overhead costs.

Finally, the total amount of electricity ($9900) is allocated to the tennis ($3600) and bats ($6300).

How to Calculate Manufacturing Overhead Costs ?

Having a reliable overhead record will help set a better price for your product or service, showing where you can save money, and streamlining your business model. But these benefits only come from careful records, so read on to find out the best way to calculate your manufacturing overhead costs. 

Overhead costs are not related to company income.

If the company has seasonal expenses, it will be easy to influence the manufacturing overhead costs. These expenses must be written in as much detail as possible so that the calculations are clearer. An example of yearly expenditure is the addition of air conditioning during the dry season.

Overhead costs are incurred with the cost of goods and services.

To categorize factory overhead costs is to ask whether these costs are directly related to producing products or services. Any costs cannot be categorized as manufacturing overhead costs. Other costs besides production are classified as manufacturing overhead costs.

If it has been classified correctly, then you can also find out the percentage of business overhead. You do this by adding up all the manufacturing overhead costs, divided by month, and then dividing the total by all monthly sales.

For example, a company has a factory overhead cost of $ 120,00 and generates $80000 for its monthly sales. The percentage of overhead that can be generated is $120,00 divided by $80000 so that the figure becomes 0.15.

Manufacturing Overhead Rate = Overhead CostsSales x 100

Manufacturing Overhead Rate = 1200080000 x 100

After that, multiply by 100 so that the percentage is 15% of all sales. This calculation can describe the amount of money spent on manufacturing overhead costs. For example, in this case, for every payment generated by the company, 15 percent must be devoted to manufacturing overhead costs.

Another benefit is labor costs. Monthly manufacturing overhead costs divided by monthly labor costs and then multiplied by 100. For all manufacturing overhead costs cases, the lower the percentage, the more effective the business is in utilizing resources. Business value can be measured by various factors, including the calculation of profitability and the percentage of manufacturing overhead costs.

The most accurate way so far is to track costs and revenues that allow business owners to measure the magnitude of business efficiency. Manufacturing overhead costs are also related to the purchase and financing of equipment.

How to Make a Manufacturing Overhead Budget?

The most elaborate process, in developing the operating budget, is to calculate the manufacturing overhead rates to be applied to the finished products.

Example:

Manufacturing Overhead Budget
Fixed $Variable $ Total $
Indirect Labor400002200062000
Utility Bills20002600028000
Maintenance 250001040035400
Property Tax 50%40004000
Factory Insurance50005000
Manager Salary60006000
Various 230001730040300
Total amount payable except supplies10500075700180700
Manufacturing Supplies300005500085000
Amount to pay 135000130700265700
Depreciation- Building (60%)50005000
Depreciation Machinery 2000020000
Total160000130700290700

General Manufacturing Cost 

Fixed =       $160000

Variable =   $130700

Total =        $290700

Calculation of the cost rate for manufacturing overheads against direct labor cost.

Formula:  General manufacturing cost of direct labor x 100%

                   290700 350000 x 100 =  83.05%

It means that the goods or products being manufactured will be debited with 83.05 for every $100 of direct labor. 

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