Budgeting Basics and Beyond

Chapter 9. Manufacturing Costs: Sales Forecasts and Realistic Budgets

In a manufacturing firm, costs are divided into two major categories, by the functional activities with which they are associated. These are manufacturing costs and non-manufacturing costs, also called operating expenses.

Manufacturing costs are subdivided into direct materials, direct labor, and factory overhead. Direct materials are all materials that become an integral part of the finished product. Examples are the steel used to make an automobile and the wood to make furniture. Glues, nails, and other minor items are called indirect materials (or supplies) and are classified as part of factory overhead, which is explained below.

Direct labor is the labor directly involved in making the product. Examples of direct labor costs are the wages of workers on an assembly line and the wages of machine tool operators in a machine shop. Indirect labor, such as wages of supervisory personnel and janitors, is classified as part of factory overhead.

Factory overhead includes all costs of manufacturing except direct materials and direct labor. Examples include depreciation, rent, taxes, insurance, fringe benefits, payroll taxes, and cost of idle time. Factory overhead also is called manufacturing overhead, indirect manufacturing expenses, and factory burden.

In order to budget for manufacturing costs, a production budget needs to be established, which in turn requires a sales budget. Exhibit 9.1 illustrates this relationship. ...