Factory Overheads

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Definition of Factory Overheads

Factory Overheads may be defined as the aggregate of indirect materials, labour and other costs which cannot conveniently be identified with the articles produced or services rendered.  The benefits of these cannot be identified with a particular cost unit. Instead, they are apportioned among cost units on an equitable basis.

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

Explanation

Direct materials, direct labour and direct expenses constitute the prime cost of a product. Besides these expenses, there are certain indirect expenditures which 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 overhead are as follows:

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

Steps necessary for proper accounting of Factory Overheads

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

(a). allocation of expenses to production;
(b). allocation of expenses to service departments;
(c). appropriation of expenses to the production unit(s) and service departments which cannot be conveniently allocated;
(d). re-appropriation of expenses related to service departments so as to include them in the production cost; and
(e). absorption of expenses of each department over the job, process product completed during the period in the department concerned.

Problems concerned with Factory Overheads

(1). Factory Overheads cannot be conveniently allocated to cost units. Hence, the apportioning problem is faced.

(2). It is not possible to decide whether a cost incurred is beneficial or detrimental.

(3). It is also not possible to know specifically whether certain overhead can help in achieving the better value of its money’s worth. It is because the benefits achieved cannot be measured easily.

(4). It is not possible to reduce or eliminate such a cost which has been incurred. An extension done is done. The step cannot easily be re-traced.

(5). The factory overheads have a tendency to rise with the business becoming complex.

Classification of Factory Overheads

Factory overheads may be classified according to the following heads:

1. According to Nature:

(a). Indirect materials
(b). Indirect labour
(c).Indirect expenses.

(2). According to Normailty

(a). Normal factory overheads
(b). Abnormal factory overheads

(3). According to Controllability

(a). Controllable
(b). Uncontrollable

(4). According to Variability

(a). Fixed
(b). Variable
(c).Semi-variable

List of Possible Expenditures treated as Factory Overheads

The following expenditures are (in normal circumstances) included in and treated as factory overheads:

(1). Indirect Materials

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

(2). Indirect Labour

  • Salary paid to the Factory Manager.
  • Salary paid to other officers of the company who are involved in manufacturing in some form or the other.
  • Proportionate Salary of the Director(s) devoting time for factory problems etc.
  • Holiday pay of workers
  • Pay paid for sickness to workers.
  • Salary to the storekeeper and other staff of the store department.
  • Contribution to Provident Fund of the factory workers and other factory employees.
  • Contribution to social welfare activities.
  • Expenditure, other than a contribution, on social and other welfare activities.
  • Contribution to social security scheme, e.g. premium for group insurance, State Insurance Corporation etc.
  • Overtime Wages
  • Wages for normal idle time (if not charged directly).

(3). Indirect Expense

  • Rent of factory land and buildings.
  • Insurance of factory buildings, plant and machinery, stock of raw materials etc.
  • Municipal taxes and rates etc.
  • Expenses of Canteen, educational facilities, recreation clubs etc.
  • Experimental and research expenditure.
  • Design expenditure.
  • Power and fuel.
  • Stores handling expenditure.
  • Lighting and heating charges of the factory.
  • Carriage inwards
  • Factory telephone expenditures

(4). 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 Bonus.
  • Fring benefits e.g. prizes etc.
  • Training Expenses.
  • Township Maintenance Costs.

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