By Nancy Orben, CPA, Senior Manager at Blue & Co.
Manufacturers typically incorporate overhead and labor costs into their bill of materials, regardless of the costing system used.
It’s crucial to annually assess several factors:
- Raw Material Costs: Have they changed (in a standard cost system)?
- Labor Rates: Have they altered?
- Alternate Labor Sources: Is the company using temporary labor or another source with a different cost structure?
- Raw Materials: Have they been updated in your bill of materials?
- New Indirect Cost Components: Are there any new elements, such as new machinery, a change in energy provider, or the addition of energy or water-saving devices?
Significant changes in production levels can impact the cost per unit for overhead costs by distributing the costs over more or fewer units.
When calculating overhead, compare your actual costs to the applied overhead amount to identify over or under application of overhead. This involves comparing the actual general ledger account balances or the percentage of the balances used in the initial overhead calculation to the applied overhead amount. If there’s a significant difference, you may need to recalculate your overhead rate.
In a standard cost system, monitor your variance accounts. Large price variances may indicate a need to adjust your standard costs. Large usage variances may suggest a need to review your bill of material quantities or investigate production issues.
Overhead, labor, and standard costs should be updated at least annually, and standard costs may need more frequent updates, especially when there are significant changes in raw material costs.
Other options include:
- Quarterly review of all costs.
- Quarterly review of the top 20 percent cost items and annual review of the remaining 80 percent.
- Evaluation of a change when raw material or other costs increase during the year by more than a certain percentage set by the company.
If the company conducts an annual cost review, it might be beneficial to examine these costs in the fall when preparing the next year’s budget or early in the year when the previous year’s results are available.
If you need assistance reviewing your overhead or standard costs, please contact your Blue & Co. advisor or a member of our Manufacturing team.
