Cost Allocation for Manufacturing Overhead

Accurate cost allocation for manufacturing overhead enables companies to price their items accordingly to produce a profit. To protect your profit margins, you need to understand exactly how much each aspect of your business costs. Manufacturing overhead refers to all of the costs associated with producing a product, over and above direct labour and material costs.

Fully understanding these costs and their impact on profitability enables business owners to make operational adjustments to improve cost-efficiency.  If costs are not properly calculated, businesses run the risk of losing money on the sale of their products. Allocating costs for manufacturing can be a complex process, and some costs may not seem obvious to incorporate into the calculation of overhead.

Examples of manufacturing overhead include:

• Supplies
  • Any supply that is required to make your product, but not directly associated with its creation
  • For example, if you need certain products to run your machines or sanitize your production line, these are considered overhead costs
• Utilities
  • A production line cannot run without deriving power from utilities
  • Any utilities (hydro, Internet, phone and gas) that are required to complete manufacturing operations must also be calculated as overhead
• Indirect Labour
  • Any labour costs that are not directly tied to the manufacturing process are considered overhead
  • Overhead labour costs include the wages (and all other employment costs) paid to:
    • Manufacturing supervisors
    • Staff members employed to maintain manufacturing equipment
    • Administrative staff that contribute to organizing/recording manufacturing processes
    • Any wages or benefits that are paid to any employee involved in, but not directly responsible for manufacturing products should be calculated as overhead costs
• Additional Overhead Costs:
  • Costs associated with keeping plant workers, products and the workplace safe
  • Insurances, licenses, and building and production permits
  • Costs to appease environmental and legal regulations

Manufacturing overhead accounts for a portion of the various costs that business owners must be aware of and control. If you are unsure of what direct and indirect costs are compromising your profit margins, contact our accounting firm for tips on operational management.