Well, we are working through these budgets, but now we got to an interesting one. There is more that goes in to the production of our shoes that just the raw materials and the people working. We have equipment and small supplies, as well as repairs and utilities. These things can get costly, so we need to make sure we are on top of them as we work through this budget.

Manufacturing overhead includes all the costs of production other than labor and raw materials. This can include some variable and some fixed components.

Variable manufacturing overhead is based on direct labor hours. This can include things like electricity, production supplies, such as needles for the machines that sew together the shoe components and other miscellaneous items needed to produce the shoes.

Fixed manufacturing overhead includes depreciation on the equipment, rent or mortgage on the facility and costs to process purchase orders, customer calls and such. There may come a point where the current facility, equipment or customer reps can’t handle the volume. If this occurs, the fixed costs may change. For our purposes, let’s assume that the current facility and equipment can handle the budgeted output!

So let’s assume our variable manufacturing overhead to be $3 per labor hour. Let’s further assume our monthly fixed manufacturing overhead is $2050 per month. So, included in our fixed overhead is $500 of depreciation. Remember depreciation is not a cash outlay, so we can deduct it from our total manufacturing overhead for cash purposes. We will talk more about that when we get to our cash budget in a bit.

So plugging the information above into our manufacturing overhead budget, we can come up with a predetermined overhead rate for the year. We also have figured out the cash outlay, as well as the total manufacturing overhead.

So if you look at our previous budget for direct labor, the hours shown here on our manufacturing overhead budget come directly from that budget. The variable manufacturing overhead total is simply the hours multiplied by the rate. We now have the information needed to continue moving forward in our budgeting process. We also calculated our predetermined overhead rate for the year. Since manufacturing overhead is an indirect cost, we can’t assign it to a particular product or job. Because we are using our direct labor hours as our allocation base, dividing the entire manufacturing overhead by the direct hours, gives us a dollar amount we can use, as an addition to the direct labor cost, for each hour worked.

So, as an example, our direct labor cost per hour is $20 (as you remember from our direct labor budget). We can now add the $11 per hour manufacturing overhead to each hour worked as we price our products. This is a helpful calculation to spread out those costs that we cannot directly tie to a given product. This comes in very handy when more than one product line is manufactured. So if Hupana Running Company had 12 lines of shoes with varying labor and material costs, we could use this standard amount per hour of labor to allocate all of the manufacturing overhead costs.

Okay, so now we can move on. We have all kinds of information now to complete our budgeting tasks.