Factory Overheads

True Tamplin

Written by True Tamplin, BSc, CEPF®
Updated on September 4, 2021

Definition of Factory Overheads

Factory overheads are the aggregate of indirect materials, labor, and other costs that cannot be identified conveniently with the articles produced or services rendered.

The benefits arising from these costs cannot be associated with a specific cost unit. Instead, they are apportioned across the cost units on an equitable basis.

Overheads are an element of cost but they are a supplementary cost and cannot be directly added to a particular job.

Explanation

The main cost of a product consists of direct materials, direct labor, and direct expenses.

Besides these expenses, there are certain indirect expenditures that cannot be conveniently identified with the article produced. These expenditures cannot be allocated to a particular job, process, or item of production. Such expenditures are known as factory overheads.

The factory overhead is the total of all costs (other than direct costs) incurred to maintain and run the production facility or factory. These are also referred to as production overheads or works overheads.

Examples of Factory Overheads

Examples of items included in factory overheads include:

  • Factory expenses (e.g., rent, rates, insurance, water, heat, and electricity)
  • Factory maintenance (e.g., cleaning, servicing, repairs, oiling, and greasing)
  • Depreciation of factory plant and machinery and buildings
  • Wages and salaries (other than direct labor) of persons engaged in the factory (e.g., foremen, supervisors, maintenance staff, factory administrative or clerical staff, testers, and examiners)
  • Consumable stores and all forms of indirect material (i.e., material that cannot be traced as part of the finished product, such as oils and greases, small tools, cleaning materials, and minor spare parts for repairs)

Steps Needed for Proper Accounting of Factory Overheads

Since overheads cannot be allocated to cost units directly, the following steps are necessary for its proper accounting:

  • Allocation of expenses to production
  • Allocation of expenses to service departments
  • Appropriation of expenses to the production unit(s) and service departments that cannot be conveniently allocated
  • Re-appropriation of expenses related to service departments so as to include them in the production cost
  • Absorption of expenses of each department over the job, process, or product completed during the period in the department concerned

Problems With Factory Overheads

Several problems associated with factory overheads are stated as follows:

  • Factory overheads cannot be conveniently allocated to cost units, which gives rise to the apportioning problem
  • It is not possible to decide whether a cost incurred is beneficial or detrimental
  • It is not possible to know whether a certain overhead can help in achieving better value for money, which is because the benefits achieved cannot be measured easily
  • It is not possible to reduce or eliminate such a cost that has been incurred; an extension is undertaken and the step cannot easily be re-traced
  • Factory overheads have a tendency to grow with increasing business complexity

Expenses Usually Included in Factory Overheads

  • Wages of indirect workers (e.g., repairmen, labor used on cleaning shop floor, men employed in moving work-in-progress and financial goods)
  • Salaries and allowances for work manager and supervisory staff
  • Workers welfare, canteen expenses, medical charges, and compensation
  • Contribution to social security schemes, educational schemes, and old-age pension contributions
  • Carriage inward on purchased materials
  • Indirect materials and materials of small value
  • Buying and store-keeping expenses
  • Normal losses of time and materials
  • Factory rent and rates, property tax, and so on
  • Power, oil, and gas expenses
  • Factory lighting
  • Insurance of factory premises, plant, and machinery
  • Depreciation
  • Stationery, telephone, and clerical salaries.
  • Repair and maintenance expenses
  • Time-keeping expenses
  • Factory transport expenses
  • Expenses of service departments (e.g., boiler room, electricity supply, water supply, inspections, and tool room)
  • Other miscellaneous expenses related to production shops not listed above

Classification of Factory Overheads

Factory overheads may be classified based on the following:

By Nature

  • Indirect materials
  • Indirect labor
  • Indirect expenses

By Normality

  • Normal factory overheads
  • Abnormal factory overheads

By Controllability

  • Controllable
  • Uncontrollable

By Variability

  • Fixed
  • Variable
  • Semi-variable

List of Possible Expenditures Treated as Factory Overheads

Under normal circumstances, the following expenditures are included in and treated as factory overheads:

Indirect Materials

  • Cost of consumable stores
  • Cost of stationery used in the factory

Indirect Labor

  • Salary paid to the factory manager
  • Salary paid to other officers of the company who are involved in some form of manufacturing
  • Proportionate salary of the director(s) devoting time to factory problems
  • Holiday pay for workers
  • Paid sickness leave for workers
  • Storekeeper salary and salaries of other staff in the stores department
  • Contribution to provident fund of the factory employees
  • Contribution to social welfare activities
  • Expenditures, other than contributions, to social and other welfare activities
  • Contribution to social security scheme (e.g., premiums for group insurance, state insurance corporation, and so on)
  • Overtime wages
  • Wages for normal idle time (if not charged directly)

Indirect Expenses

  • Rent of factory land and buildings
  • Insurance of factory buildings, plant and machinery, stock of raw materials, and so on
  • Municipal taxes and rates
  • Expenses of canteen, educational facilities, and recreation clubs
  • Experimental and research expenditure
  • Design expenditure
  • Power and fuel
  • Stores handling expenditure
  • Factory lighting and heating charges
  • Carriage inward
  • Factory telephone expenditures

Other Chargeable Items

  • Depreciation on plant and machinery
  • Expenses on removal and erection of machinery
  • Provision for obsolescence
  • Cost of defective work
  • Interest on capital
  • Development costs
  • Royalties and patent fees
  • Maintenance and repairs
  • Annual bonuses
  • Benefits (e.g., prizes)
  • Training expenses
  • Township maintenance costs

4 thoughts on “Factory Overheads”

    • Thanks! Let us know what other kinds of information you’d like to see and we’ll try to add it in the future. Best of luck!

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