The key difference is that manufacturing overhead is part of product costs, while operating expenses are period costs expensed as incurred. The method of cost allocation is up to the individual company – common allocation methods are based on the labor content of a product or the square footage used by production equipment. Manufacturing overhead is all indirect costs incurred during the production process. Variable costs fluctuate with production levels and are typically small compared to fixed overhead. For example, DEF Toy is a toy manufacturer and\u00a0has total variable overhead costs of $15,000 when the company produces\u00a010,000 units per month.<\/p>\n
Let’s assume a company has overhead expenses that total $20 million for the period. Direct costs typically are direct labor, direct machine costs, or direct material costs\u2014all expressed in dollar amounts. Costs must thus be estimated based on an overhead rate for each cost driver or activity. In more complicated cases, a combination of several cost drivers may be used to approximate overhead costs. The manufacturing overhead budget is prepared depending on how the company allocates overhead.<\/p>\n
Pay rent and property taxes regardless of production levels, which makes them fixed overhead costs. You can break down manufacturing overhead costs into several categories, each contributing to the overall production environment. During low-production months, fixed overhead costs must be absorbed by fewer units, artificially inflating the per-unit cost, while high-production periods may show unusually low overhead per unit.<\/p>\n
For Beta Company, the Variable OH rate per machine hour is $2 (calculated above) and actual variable overhead was $46,000 for 22,000 actual machine hours. For product costing purposes, Beta must estimate the expected level of activity in advance and set a rate based on that level. Direct labor is the cost of hourly wages of production workers who assemble manufactured goods. Multiply the overhead rate by the activity hours related to each product.<\/p>\n