## How to Calculate Factory Overhead

BUDGET 5  -  DEVELOPING THE MANUFACTURING FACTORY OVERHEAD

After the Direct Manufacturing Labor Budget has been developed, the next step is to Develop Your Manufacturing Factory Overhead Budget. As the name implies, the Manufacturing Factory Overhead Budget, is used ONLY by Manufacturing companies. Therefore, you may omit this Budget if your business is NOT considered a manufacturing company. If, on the other hand, your business involves manipulating raw materials into finished products, you will be required to develop a Manufacturing Factory Overhead Budget.

Since Murray does NOT plan to manufacture his product (IE the diskette, listing the organizations who provide scholarships to University Students), he can omit this Budget.

Factory overhead expenditures are costs that are directly associated with operating the production facility or manufacturing plant (excluding raw material costs and direct labor costs). Examples of factory overhead costs include electricity, heat, utilities, maintenance, and repairs of the production facility. Other examples would include insurance on the manufacturing plant and equipment, factory supplies, insurance on raw materials and on work in process, property taxes on the building, payroll taxes on the wages of factory workers, worker's compensation insurance for factory workers, and repairs to the manufacturing plant and equipment.

Factory overhead does NOT include marketing and administrative expenses. Marketing and administrative expenses are not considered factory overhead simply because they are not incurred in the manufacturing process.

The Manufacturing Factory Overhead Budget attempts to determine two things:

To determine your Total Manufacturing Factory Overhead Costs for each forecasted business year, you are required to estimate all the costs that are expected to arise in your manufacturing facility only. In other words, what costs will arise as a direct result of producing the products in which you plan to sell. Lets assume, the XYZ Company is planning to produce (make) 10,000 products in 200X. Also assume, the XYZ Company predicts the following factory overhead costs for 200X.

 FORECASTED COST OR EXPENSE 200X Utilities of the Production Facility \$6,000 Electricity of the Production Facility \$5,500 Maintenance to the Production Facility \$9,500 Repairs to the Production Facility \$9,500 Insurance on Production Facility \$3,500 Worker Compensation Insurance on Factory Workers \$4,500 Insurance on Raw Materials \$5,000 Payroll Taxes on Factory Worker's Wages \$9,000 General Factory Supplies \$7,500 Total Factory Overhead Budget \$60,000

As you can see, the XYZ Company is forecasting its Total Factory Overhead at \$60,000 in 200X. In other words, to produce 10,000 units in 200X, the XYZ Company expects its Manufacturing Plant Expenses will be \$60,000.

Part 2 -  Determine Your Manufacturing Factory Overhead Cost On A Per Unit Basis:
The company would now calculate the cost of Factory Overhead for each unit produced. To do this, the company would simply divide its total forecasted factory overhead cost (\$60,000) BY the number of units it plans to produce in 200X (10,000 units). Below charts these calculations:

 YEAR Total Forecasted Cost of Factory Overhead Number of Units to be produced Factory Overhead Cost per unit 200X \$60,000 10,000 units \$6.00 per unit

Therefore, for every unit the XYZ Company makes, it will spend \$6.00 on factory overhead. If the company plans to produce 12,000 units in the year 200Y, then they can easily estimate their total manufacturing factory overhead at \$72,000 (12,000 units to be produced x \$6.00 of factory overhead per unit = \$72,000 in Manufacturing Factory Overhead for the year 200Y). The same procedure can also be performed to estimate its total factory overhead for year 3.

Knowing how much factory overhead (in dollar) goes into producing each finished product is extremely important to a manufacturer. It assists them in determining its total cost to produce each product, and ultimately assists in setting their product's price(s). Furthermore, a manufacturer will consider three cost items when determining its total cost to produce one finished product (IE Total Product Cost). These cost items include:

1.    The Raw Materials needed to make one finished unit (Budget 1);

2.    Direct Labor Costs needed to produce one finished unit; (Budget 4);

3.    Factory Overhead used to produce one finished unit (Budget 5)

The sum of these three costs, on a per unit basis, tells a manufacturer how much it will cost them to produce or make one finished unit or product. For instance, lets assume the XYZ Company determines the following costs are needed to produce one unit of finished product:

• \$154.00 worth of raw materials are needed to make one finished product;
• 2 hours of labor, at \$20 per hour, ( IE \$40) is needed to make one finished product;
• \$6.00 of factory overhead is required to produce one finished product.

Therefore, the company's Total Product Cost or total cost to produce one finished unit is \$200  (IE \$154.00 + \$40.00 + \$6.00 = \$200 per unit).

Categories: Forecasting