What Is Considered Factory Overhead?

Factory overhead, also known as manufacturing overhead, is costs related to manufacturing a product. These costs are divided into three categories: indirect labor, indirect materials and factory-related costs. Factory overhead costs cannot be assigned to any one product, so accountants spread them over all units produced. Understanding the individual factory overhead components can help business owners make better managerial and financial decisions.

Indirect labor covers costs for employees not directly involved with manufacturing the product or project. Examples are floor employees such as foremen, area supervisors and quality control inspectors as well as janitorial staff, security guards and night watchmen, forklift drivers and machine repairmen. Factory maintenance workers, materials handlers and warehouse workers also are included in indirect labor. The salaries and wages you pay these employees cannot be traced to any one product or project.

Indirect materials assist in the manufacturing process but are not directly used to manufacture the product. Indirect materials are mostly consumable, and you must frequently replenish the supply -- for example, machinery lubricants such as grease or oil, cleaning products and protective gear are indirect materials. Solder, lightbulbs, tape, glue and janitorial supplies also are considered indirect materials.

Factory-related costs are incurred to keep the factory open and operating. Monthly rent, utilities, insurance, factory and building depreciation and maintenance are all factory-related costs. These indirect costs are broken down into fixed and variable costs.

Fixed factory costs do not change based on how many products you manufacture. Rent, factory and building depreciation, property insurance and indirect labor salaries are fixed costs. Variable costs increase and and decrease directly in proportion to the number of products manufactured. Indirect materials, indirect costs and utilities are considered variable costs.

Because factory overhead costs cannot be assigned to a specific product or project, these costs frequently are allocated based on direct labor hours or direct labor costs. Total the costs of your indirect materials, indirect labor and factory-related costs, and divide the amount either by direct labor hours or direct labor costs. For example, if you have $100,000 in factory overhead costs and used 20,000 direct labor hours, divide the $100,000 by 20,000 to get a $5 per-unit allocation cost. You then add $5 to the cost of each unit produced.