We use the term nonmanufacturing overhead costs or nonmanufacturing costs to mean the Selling, General & Administrative (SG&A) expenses and Interest Expense. Under generally accepted accounting principles (GAAP), these expenses are not product costs. (Product costs only include direct material, direct labor, nonmanufacturing costs include and manufacturing overhead.) Nonmanufacturing costs are reported on a company’s income statement as expenses in the accounting period in which they are incurred. Distinguishing between the two categories is critical because the category determines where a cost will appear in the financial statements.
- Though most of these costs are self-evident, indirect material costs are unique because these costs are not essential to the physical production of the product.
- The more valves are
produced, the more parts Friends Company has to acquire.
- If you compare this diagram with
Figure 9.1 (master budget
schedules for a manufacturing company), you will notice that
production and production-related budgets are not applicable to
merchandising organizations.
- However, for management objectives, managers frequently require the assignment of nonmanufacturing costs to goods.
- For accounting purposes, nonmanufacturing costs are expensed periodically (typically in the period they are incurred).
- Even though nonmanufacturing overhead costs are not product costs according to GAAP, these expenses (along with product costs and profit) must be covered by the selling prices of a company’s products.
Manufacturing costs refer to those that are spent to transform materials into finished goods. Manufacturing costs include direct materials, direct labor, and factory overhead. Costs that are not related to the production of goods are called nonmanufacturing costs; they are also referred to as period costs. These costs have two components—selling costs and general and administrative costs—which are described next. Merchandising organizations do not produce
goods, and therefore do not have production or production-related
budgets. Not-for-profit organizations also
use budgets for planning and control purposes.
Selling Costs
Factory overhead – also called manufacturing overhead, refers to all costs other than direct materials and direct labor spent in the production of finished goods. Nonmanufacturing costs are necessary to carry on general business operations but are not part of the physical manufacturing process. These costs are represented during a period of time and are not calculated into the cost of good sold.
Manufacturing overhead includes the indirect materials and indirect labor mentioned previously. Other manufacturing overhead items are factory building rent, maintenance and depreciation for production equipment, factory utilities, and quality control testing. Since nonmanufacturing overhead costs are outside of the manufacturing function, these nonmanufacturing costs are immediately expensed in the accounting period in which they are incurred.
3: Cost Terminology
However, with an understanding
of the budget components used by manufacturing, merchandising, and
service organizations, one can establish a budgeting process for
virtually any not-for-profit organization. For an example of how
one not-for-profit organization goes about the budgeting process,
read Note 9.35 “Business in Action 9.3”. Merchandising organizations typically purchase finished goods
and sell them to retail or wholesale customers.