Allocation of non-manufacturing overhead costs is an important service you can provide to your clients. Although generally accepted accounting principles don’t allow you to assign them to products as manufacturing overhead costs for financial reports, small business owners need this information to accurately determine the costs of their products so they earn a profit.
What Are Non-manufacturing Overhead Costs?
Non-manufacturing overhead costs are expenses that your client’s company must pay but aren’t directly related to making the product. Selling, general, and administrative expenses are all classified as non-manufacturing. For instance, if your client owns Bubbles Bubblegum Company, the cost of ingredients, labour to make the gum, and the machinery that makes the gum are manufacturing overhead costs. Your client’s marketing team works hard to sell the gum, but their salary is a non-manufacturing overhead cost. When your client prices their gum, they need to factor in both the expense of non-manufacturing overhead costs and the manufacturing overhead costs to make a profit and keep a healthy cash flow.
Common non-manufacturing overhead costs include:
- Property taxes
- Interest on business loans
- Office supplies
- Marketing expenses
Clients need this information to make educated business decisions when determining which products are the most profitable. With this in mind, you need to accurately match administrative costs with the products that use them. A product that requires a lot of support and administrative overhead may seem like a big moneymaker when it isn’t, and a product that doesn’t seem very profitable may actually be extremely efficient. You can add value to the services you provide your client by preparing reports that allocate non-manufacturing overhead for their own internal use.
Traditional Method for Allocating Non-manufacturing Overhead Costs
The traditional accounting method develops an average overhead cost rate and applies it to a cost driver, such as units produced, hours worked, or machine hours. The problem with this method is that it uses an average overhead rate, so some costs see over-representation in the product price, making the product seem less profitable. Conversely, this method causes your client to under-report the costs of other products, making those products seem more profitable.
Activity-Based Method for Allocating Non-manufacturing Overhead Costs
Activity-based costing is a method of allocating overhead costs with the activities that lead to these costs. You start by identifying every activity associated with producing an item and allocate a cost to that activity. The cost assigned to the activity is then assigned to products that require the activity for production. The steps for this method are:
- Identify activities related to non-manufacturing costs
- Determine the cost of these activities
- Identify the products associated with these activities
- Assign the cost of the activities to these products and customers
Activity-based costing is more accurate for allocating non-manufacturing costs because it matches costs with the activities that drive them. This keeps your client from assigning overhead costs to products that don’t use them, giving management a better idea of a product’s profitability and helping them decide whether to continue certain products in light of their non-manufacturing costs.
Both methods of allocating overhead have pros and cons. As an accountant, you want to help your clients make the best decisions possible with evidence that make the choices obvious. QuickBooks Online Accountant helps you manage projects, tasks and clients together. Sign up for free.