Factory overhead is the costs incurred during the manufacturing process, not including the costs of direct labor and direct 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 costing methodology, but is mandated under absorption costing. The allocation of factory overhead is required when producing financial statements under the dictates of the major accounting frameworks.
Examples of factory overhead costs are:
- Production supervisor salaries
- Quality assurance salaries
- Materials management salaries
- Factory rent
- Factory utilities
- Factory building insurance
- Fringe benefits
- 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.
Administrative overhead is those costs not involved in the development or production of goods or services. This is essentially all overhead that is not included in manufacturing overhead. Examples of administrative overhead costs are the costs of:
- Front office and sales salaries, wages, and commissions
- Office supplies
- Outside legal and audit fees
- Administration and sales office lease
- Administration and sales utilities
- Administration and sales telephones
- Administration and sales travel and entertainment
Administrative overhead is considered a period cost; that is, the benefit of this type of cost does not carry forward into future periods.