Learning Objective of the article:

1. Define and explain manufacturing overhead budget.
2. Prepare a manufacturing overhead budget.

The manufacturing overhead budget provides a schedule for all costs of production other than direct materials and direct labor.

## Example of a Manufacturing Overhead Budget:

Following is the manufacturing overhead budget of Hampton Freeze Inc. (See explanation of this manufacturing overhead budget for Hampton Freeze Inc.)

 Hampton Freeze Inc. Manufacturing Overhead Budget For the Year Ended December 31, 2003 Quarters 1 2 3 4 Year Budgeted direct labor hours (see direct labor budget) 5,600 12,800 14,400 7,600 40,400 Variable overhead rate \$4.00 \$4.00 \$4.00 \$4.00 \$4.00 ——— ——— ——— ——— ——— Variable manufacturing overhead \$22,400 \$51,200 \$57,600 \$30,400 \$161,600 Fixed manufacturing overhead 60,600 60,600 60,600 60,600 242,400 ——— ——— ——— ——— ——— Total manufacturing overhead 83,000 111,800 118,200 91,000 404,000 Less depreciation 15,000 15,000 15,000 15,000 60,000 ——— ——— ——— ——— ——— Cash disbursement for manufacturing overhead \$68,000 \$96,800 \$103,200 \$76,000 \$344,000 ======= ======= ======= ======= ======= Total manufacturing overhead (a) \$404,000 Budgeted direct labor-hours (b) 40,400 ———— Predetermined overhead rate for the year (a) / (b) \$10.00

### Explanation of the Manufacturing Overhead Budget for Hampton Freeze Inc:

At Hampton Freeze the manufacturing overhead is spread into variable and fixed components. The variable component is \$4 per direct labor-hour and the fixed component is \$60,600 per quarter. Because the variable component of the manufacturing overhead depends on direct labor, the first line in the manufacturing overhead budget consists of the budgeted direct labor hours from the direct labor budget (see direct labor budget). The budgeted direct labor hours in each quarter are multiplied by the variable rate to determine the variable component of the manufacturing overhead. For example, the the variable manufacturing overhead for the first quarter is \$22,400 (5,600 direct labor hours × \$4.00 per direct labor-hour). This is added to the fixed manufacturing overhead for the quarter to determine the total manufacturing overhead for the quarter. The total manufacturing overhead for the first quarter is \$83,000 (\$22,400 + \$60,600).

A few words about fixed costs and the budgeting process are in order. In most cases, fixed costs are the costs of supplying capacity to do things like make products, process purchase orders, handle customer calls, and so on. The amount of capacity that will be required depends on the expected level of activity for the period. If the expected level of activity is greater than the company’s current capacity, then fixed costs may have to be increased. Or, if the expected level of activity is appreciably below the company’s current capacity, then it may be desirable to decrease fixed costs if that is possible. However once the level of fixed cost has been determined in the budget, the costs really are fixed. The time to adjust fixed costs is during the budgeting process. To determine the appropriate level of fixed costs at budget time, an activity based costing system may be very helpful. It can help answer questions like, “How many clerks will we need to hire to process the anticipated the number of purchase orders next year?” For simplicity, we assume in all of the budgeting examples that appropriate fixed costs has already been determined for the budget with the aid of activity based costing system or some other method.