Definition: Factory overhead is basically the costs of running a business that can’t be directly attributed to a product or service. Factory overhead usually relates to factories or production of goods. So factory overhead is a cost that the business has to incur in order to produce its product, but the cost can’t be traced back to the production of the product. Are you confused yet?
What Does Factory Overhead Mean?
You may have heard business people say in passing, “I need to cover my overhead.” Think about the Gibson guitar factory. They produce guitars and other guitar accessories. Costs that can be attributed to or traced back the guitars are wood and materials. Some costs that can’t be traced directly back to each guitar coming off the assembly line are the utilities.
How much electricity does it take to make one guitar? Who knows! This is a great example of factory overhead because the electric bills can’t be separated and traced back to any specific guitar that was produced. Yet, the overhead costs are unavoidable.
Sometimes factory overhead costs are called indirect costs because they are indirectly related to the products being produced. They are also called conversion costs because these are costs incurred to convert a raw material into a finished good. Some other examples of factory overhead costs are insurance, rent, building maintenance, machine maintenance, and property taxes.