What is manufacturing overhead and what does it include?

Definition of Manufacturing Overhead
Manufacturing overhead (also known as factory overhead, factory burden, production overhead) involves a company's manufacturing operations. It includes the costs incurred in the manufacturing facilities other than the costs of direct materials and direct labor. Hence, manufacturing overhead is referred to as an indirect cost.

Generally accepted accounting principles require that a manufacturer's inventory and the cost of goods sold shall consist of:

  • the cost of direct materials
  • the cost of direct labor
  • the cost of manufacturing overhead

Note: Expenses that are outside of the manufacturing facilities, such as selling, general and administrative expenses, are not product costs and are not inventoriable. They are reported as expenses on the income statement in the accounting period in which they occur.

Examples of Manufacturing Overhead
Some examples of manufacturing overhead costs include the following:

  • depreciation, rent and property taxes on the manufacturing facilities
  • depreciation on the manufacturing equipment
  • managers and supervisors in the manufacturing facilities
  • repairs and maintenance employees in the manufacturing facilities
  • electricity and gas used in the manufacturing facilities
  • indirect factory supplies, and much more

Because manufacturing overhead is an indirect cost, accountants are faced with the task of assigning or allocating overhead costs to each of the units produced. This is a challenging task because there may be no direct relationship. For example, the property taxes and insurance on the manufacturing buildings are based on the assets' value and not on the number of units manufactured. Yet these and other indirect costs must be allocated to the units manufactured.