Fixed Manufacturing Overhead

Definition

Fixed manufacturing overhead refers to the indirect costs associated with the manufacturing process that do not vary with changes in production volume. These costs remain constant regardless of the number of units produced, and they must be incurred to maintain the manufacturing facility and support the overall production operations.

5 Must Know Facts For Your Next Test

1. Fixed manufacturing overhead costs are incurred regardless of the number of units produced, such as rent, property taxes, insurance, and depreciation on manufacturing equipment.
2. These fixed costs must be accounted for in the total cost of a product under absorption costing, which is required for external financial reporting.
3. Fixed manufacturing overhead is a key component in calculating the break-even point, as it represents a portion of the fixed costs that must be covered by sales revenue.
4. Accurately estimating and managing fixed manufacturing overhead is crucial for effective cost control and pricing decisions in a manufacturing environment.
5. The ratio of fixed manufacturing overhead to total manufacturing cost is an important metric that can provide insights into a company's operating leverage and sensitivity to changes in production volume.

Review Questions

• Explain how fixed manufacturing overhead is used in the calculation of a break-even point in units and dollars.
  • Fixed manufacturing overhead is a critical factor in calculating the break-even point, which is the level of sales or production at which total revenue equals total cost. To determine the break-even point in units, the fixed manufacturing overhead is divided by the contribution margin per unit (selling price per unit minus variable cost per unit). To calculate the break-even point in dollars, the fixed manufacturing overhead is divided by the contribution margin ratio (contribution margin per unit divided by selling price per unit). The break-even point represents the minimum level of sales required to cover all fixed costs, including the fixed manufacturing overhead, without generating a profit or loss.
• Compare and contrast the role of fixed manufacturing overhead in variable costing and absorption costing.
  • Under variable costing, fixed manufacturing overhead is treated as a period cost and is expensed in the current period, rather than being included in the cost of inventory. In contrast, absorption costing requires that both variable and fixed manufacturing overhead be included in the cost of a product. This means that fixed manufacturing overhead is allocated to units produced and carried forward as part of the inventory cost. The inclusion of fixed manufacturing overhead in the product cost under absorption costing has implications for inventory valuation, cost of goods sold, and profitability reporting, as it can result in different net income figures compared to variable costing.
• Evaluate the importance of accurately estimating and managing fixed manufacturing overhead for a manufacturing company's overall financial performance and decision-making.
  • Accurate estimation and effective management of fixed manufacturing overhead are crucial for a manufacturing company's financial performance and decision-making. Underestimating fixed manufacturing overhead can lead to underpricing of products, resulting in lower profitability. Conversely, overestimating these costs can result in higher product prices, potentially making the company less competitive. Additionally, fixed manufacturing overhead plays a significant role in the company's operating leverage, which determines its sensitivity to changes in production volume. Careful monitoring and control of fixed manufacturing overhead can help the company optimize its cost structure, improve profitability, and make informed decisions regarding pricing, product mix, and capacity utilization.

Related terms

Variable Manufacturing Overhead: Variable manufacturing overhead are indirect manufacturing costs that fluctuate in direct proportion to changes in the level of production activity.

Absorption Costing: Absorption costing is a method of inventory valuation that includes both variable and fixed manufacturing overhead costs in the cost of a product.

Break-Even Point: The break-even point is the level of sales or production at which total revenue equals total cost, and the company neither makes a profit nor incurs a loss.