Factory overhead definition
/What is Factory Overhead?
Factory overhead is the costs incurred during the manufacturing process, not including the costs of direct labor and direct materials. Factory overhead is normally aggregated into cost pools and allocated to units produced during the period. It is charged to expense when the produced units are later sold as finished goods or written off. The allocation of factory overhead to units produced is avoided under the direct costing methodology, but is mandated under absorption costing. The allocation of factory overhead is required when producing financial statements under the dictates of the major accounting frameworks.
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Examples of Factory Overhead
Examples of factory overhead costs are noted below:
Production supervisor salaries
Quality assurance salaries
Materials management salaries
Factory rent
Factory utilities
Factory building insurance
Fringe benefits
Equipment setup costs
Equipment maintenance
Factory supplies
Factory small tools charged to expense
Insurance on production facilities and equipment
Property taxes on production facilities
The range of possible factory overhead costs can be quite extensive, depending upon the size and complexity of a factory operation and the level of detail at which costs are recorded.
Factory Overhead Variances
After factory overhead is allocated to inventory, the amount actually allocated will vary from the standard amount that had been budgeted to be allocated. This difference is caused by either a spending variance or an efficiency variance. The spending variance occurs because the actual amount of factory overhead expenditure incurred in the period was different from the standard amount that had been budgeted at some point in the past. The efficiency variance occurs because the the amount of units to which the factory overhead was allocated varied from the standard amount of production that had been expected when the allocation rate was set up.
FAQs
How is factory overhead applied to production?
Factory overhead is applied to production using a predetermined overhead rate, which is calculated by dividing estimated total manufacturing overhead by an estimated allocation base such as direct labor hours, direct labor cost, or machine hours. As production occurs, overhead is assigned to work in process by multiplying the actual quantity of the allocation base used by the predetermined rate. This approach ensures consistent cost assignment throughout the period, rather than waiting for actual overhead costs to be known.