Indirect Factory Costs
Indirect factory costs, also known as factory overhead or manufacturing overhead, are all the costs associated with manufacturing a product that are not direct labor or direct materials costs. These are costs that are necessary to run the production facility, but cannot be directly tied to a specific product or unit of product.
Here are some examples of indirect factory costs:
- Indirect Labor: These are wages paid to workers who are not directly involved in manufacturing a product but whose services are necessary for the manufacturing process. This could include maintenance staff, supervisors, and quality control inspectors.
- Indirect Materials: These are materials used in the manufacturing process that do not become part of the final product, or it is impractical to trace their cost to specific products. Examples include lubricants for machines, cleaning supplies for the factory, and small parts or supplies that are used throughout the production process.
- Depreciation of Plant and Equipment: Over time, the machinery and equipment used in manufacturing lose value. This decrease in value, called depreciation, is considered an indirect factory cost.
- Utilities: The cost of utilities necessary to run the factory, such as electricity, water, and gas, are considered indirect factory costs.
- Plant Insurance and Property Taxes: The cost of insuring the plant and the property taxes paid on the plant’s property are also considered indirect factory costs.
Indirect factory costs are allocated to the cost of products using a variety of cost allocation methods, often based on direct labor hours, machine hours, or other relevant cost drivers. Understanding indirect factory costs is crucial for accurate cost accounting and for making managerial decisions about pricing, production, and strategy.
Example of Indirect Factory Costs
let’s consider a company that manufactures wooden furniture as an example.
- Direct Costs: The costs directly linked to the manufacturing of each piece of furniture include the wood used (direct materials) and the wages of the carpenters who assemble the furniture (direct labor).
- Indirect Factory Costs (Factory Overhead): These are costs that are necessary for the manufacturing process but cannot be traced directly to specific units of product.
- Indirect Labor: Wages for the factory supervisor, quality control inspectors, and maintenance staff are indirect labor costs. These roles support the manufacturing process but don’t directly contribute to any single piece of furniture.
- Indirect Materials: Items like cleaning supplies for the factory, glue used in the assembly process, or small hardware like nails and screws are indirect materials. They’re used throughout production but can’t be traced to a specific piece of furniture.
- Depreciation: Over time, the saws, drills, and other machinery used in manufacturing lose value. This decrease in value, or depreciation, is an indirect factory cost.
- Utilities: The cost of electricity to run the machinery and heat the factory, and the water used in the factory, are indirect costs.
- Insurance and Property Taxes: The costs of insuring the factory and paying property taxes on the factory’s property are also part of the factory overhead.
To determine the total cost of each piece of furniture, the company would need to allocate these indirect factory costs to each unit produced. One common way to do this is to calculate an overhead rate (for example, overhead cost per direct labor hour or per machine hour) and then apply this rate to the direct labor or machine hours spent on each piece of furniture.
Understanding these indirect costs is crucial for accurate cost accounting, setting product prices, and making other strategic decisions.