Manufacturing Overhead Budget

Absorption costing is used by manufacturers according to generally accepted accounting principles. Under absorption costing, manufacturing overhead is a product cost. Product costs are inventoried and expensed as cost of goods sold along with other product costs only when the units they are attached to are sold.

Manufacturing overhead costs are allocated (also called “applied” or “attached”) to the units produced during the period according to a predetermined rate.

Under the traditional method of applying manufacturing overhead costs to units produced, usually either the machine hours allowed per unit or the direct labor hours allowed per unit are used as the basis of the allocation. The budgeted total fixed overhead costs and the budgeted total variable overhead costs are determined. Those totals are then each divided by the number of hours of the allocation base allowed for the budgeted production volume to calculate the predetermined fixed and variable manufacturing overhead application rates per hour allowed for the budgeted production. Those amounts of manufacturing overhead are applied to each unit produced during the period.