We have several articles in this blog on the background for calculating manufacturing overhead. Recall that this is really the catch-all term for all the miscellaneous costs that a factory must account for. The costs to acquire the raw materials (direct materials) and to transform the raw material into the finished goods (direct labor) are easy to obtain and allocate on a per-unit basis. However it is the indirect costs that may be hard to track and allocate. Here is a very good list of examples of what indirect costs go into manufacturing overhead costs and here is another list of manufacturing overhead items.
The simplest way to account for manufacturing overhead (MO) is of course would be to wait until the end of the financial year, sum the actual total indirect costs and divide by the actual total units produced. Clearly this is impractical, because if you are a business owner, you want to be on top of your costs and how they fluctuate on a monthly or even weekly basis.
But you could also sum the actual indirect costs on a more frequent basis, such as monthly. However this has the problem that the calculated MO will exhibit wild swings. For example, if your annual property tax is due in March your MO costs will shoot up for March alone and this would not be indicative of an average cost. A similar problem would manifest itself due to seasonal variations (high utility bills in peak winter and peak summer months).
Both of these issues can be avoided if we use estimated costs at the beginning of the year based on our historical expenses. This is the point of this interesting video lecture on manufacturing overhead allocation. If you are a specialized job shop that does not mass produce and have smaller operations, you can use this simple "predetermined overhead rate" method to allocate manufacturing overhead costs.
No matter which type of manufacturing business you are, real time analytics for tracking MO costs are going to be very valuable to you. Dashboards to display these analytics can be set up using a set of straightforward rules.
Predetermined manufacturing overhead rate (PMOR) is calculated using this simple formula
PMOR = Total indirect costs/cost driver
Here is a scheme for setting up a dashboard for calculating and tracking manufacturing overhead costs at or near real-time.
- Extract all indirect costs from your existing databases, for example, an Access database. The sum of these indirect costs goes into the numerator of the above formula.
- In some cases, manufacturing supervisory labor data may be collected on an hourly basis. To arrive at the cost from this indirect labor, you may need to input assumptions for your management rate on the dashboard
- Allow for any other unexpected one-time costs which cannot be allocated to any direct labor or materials. One of our customers calls this the "X-factor"
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