Factory Overhead

Definition: Factory overhead is the costs incurred during the manufacturing process, not including
the costs of direct labor and 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 costingmethodology, but is mandated under absorption
costing.
Examples of factory overhead costs are:

Production supervisor salaries

Quality assurance salaries

Materials management salaries

Factory rent

Factory utilities

Factory building insurance

Fringe benefits

Depreciation

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.
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.
The use of factory overhead is mandated by accounting standards, but does not bring real value to
the understanding of overhead costs, so a best practice is to minimize the complexity of the
factory overhead allocation methodology. Ideally, there should be a small number of highly
aggregated factory overhead accounts that are pooled into a single cost pool, and then allocated
using a simple methodology. Also, the amount of factory overhead analysis and recordation work
can be mitigated by charging all immaterial factory costs to expense as incurred.
Similar Terms
Factory overhead is also known as manufactu