For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. He is the sole author of all the materials on AccountingCoach.com.
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Nonmanufacturing Overhead Costs
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, and manufacturing overhead.) Nonmanufacturing costs are reported on a company’s income statement as expenses in the accounting period in which they are incurred. Expressed another way, nonmanufacturing costs are not allocated to products via overhead rates since they are not included in the amounts reported as inventory on the balance sheet or in the cost of goods sold that is reported on the income statement.
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. In other words, selling prices must be large enough to cover SG&A expenses, interest expense, manufacturing overhead, direct labor, direct materials, and profit.
Some of the costs that would typically be included in nonmanufacturing costs include:
Salaries and fringe benefits of selling, general and administrative personnel. This would include the company president, vice presidents, managers, and other employees in the nonmanufacturing functions of the company.
Rent, property taxes, utilities for the space used by the nonmanufacturing functions of the company.
Insurance for areas outside of the factory.
Interest on business loans.
Marketing and advertising.
Depreciation and maintenance of equipment and buildings outside of manufacturing.
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Financial Reporting vs. Individual Products and Customers
As mentioned above, nonmanufacturing costs cannot be included in inventory or the cost of goods sold; rather, nonmanufacturing costs are reported as SG&A expenses and Interest Expense in the accounting period in which they occur.
However, if management wants to determine the profitability of a specific product or customer, it is necessary to allocate or assign nonmanufacturing costs to the products and/or customers outside of the financial statements. This information stays within the company—it is only used internally to assist management with decisions such as pricing; choosing which products to promote or to phase out; choosing which products to review for possible production processing changes; etc. In the end, management should know whether each product’s selling price is adequate to cover the product’s manufacturing costs, nonmanufacturing costs, and required profit.
If management does not allocate the nonmanufacturing costs to specific products, a product that requires a significant amount of sales support and administrative costs may actually be unprofitable even though its gross profit (sales minus manufacturing costs) indicates that it is very profitable. On the other hand, a product with a low gross profit may actually be very profitable, if it uses only a minimal amount of administrative and selling expense.
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Methods of Allocating Nonmanufacturing Overhead Costs
As mentioned previously, nonmanufacturing costs are allocated internally to products and customers for the purpose of giving management information that is useful for decision-making, but not for the purpose of financial reporting. When doing the internal allocation of nonmanufacturing costs it is logical to follow these four steps: (1) identify the activities that cause the nonmanufacturing costs, (2) measure the cost of those activities, (3) identify the products and customers requiring the activities, and (4) assign the cost of the activities to those products and customers. In short, the best way to allocate nonmanufacturing costs is to use activity based costing (ABC).
Some activities involving nonmanufacturing expenses include:
Servicing existing accounts (product designs and other needs)
Invoicing customers for shipments of products
Processing payments from customers
Maintaining the company’s computer information system
Financing the inventories and other business assets
Prospecting for new accounts
Preparing financial statements and reports to government agencies
Overall management of the company
It is likely that you will have to estimate the cost of these activities. Next, you will need to allocate the cost of the activities to the individual products. Estimates and allocations based on logical assumptions are better than precise amounts based on faulty assumptions.
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Recap
Allocations are, by definition, arbitrary. Allocations of manufacturing overhead to inventory and the cost of goods sold are required by generally accepted accounting principles (GAAP). However, for financial reporting under GAAP, nonmanufacturing costs are not allocated to products; rather, they are expensed when they occur.
Information provided to management on the profitability of specific products and customers will require the allocation of nonmanufacturing costs in addition to the allocation of manufacturing overhead.
Allocations based on a single factor—such as direct labor hours or machine hours—are too simplistic for today’s complex manufacturing environment. Hence, activity based costing (ABC) came into existence. ABC can be used for allocating both manufacturing overhead and nonmanufacturing costs.
Where to Go From Here
We recommend taking our Practice Quiz next, and then continuing with the rest of our Nonmanufacturing Overhead materials (see the full outline below).
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Also referred to as SG&A. For a manufacturer these are expenses outside of the manufacturing function. (However, interest expense and other nonoperating expenses are not included; they are reported separately.) These expenses are not considered to be product costs and are not allocated to items in inventory or to cost of goods sold. Instead these expenses are reported on the income statement of the period in which they occur. These expenses are sometimes referred to as operating expenses.
This account is a non-operating or “other” expense for the cost of borrowed money or other credit. The amount of interest expense appearing on the income statement is the cost of the money that was used during the time interval shown in the heading of the income statement, not the amount of interest paid during that period of time.
The general guidelines and principles, standards and detailed rules, plus industry practices that exist for financial reporting. Often referred to by its acronymn GAAP.
Costs that are matched with revenues on the income statement. For example, Cost of Goods Sold is an expense caused by Sales. Insurance Expense, Wages Expense, Advertising Expense, Interest Expense are expenses matched with the period of time in the heading of the income statement. Under the accrual basis of accounting, the matching is NOT based on the date that the expenses are paid.
Expenses associated with the main activity of the business are referred to as operating expenses. Expenses associated with a peripheral activity are nonoperating or other expenses. For example, a retailer’s interest expense is a nonoperating expense. A bank’s interest expense is an operating expense.
Generally, expenses are debited to a specific expense account and the normal balance of an expense account is a debit balance. When an expense account is debited, the account credited might be Cash (if cash was paid at the time of the expense), Accounts Payable (if cash will be paid after the expense is recorded), or Prepaid Expense (if cash was paid before the expense was recorded.)
One of the main financial statements (along with the balance sheet, the statement of cash flows, and the statement of stockholders’ equity). The income statement is also referred to as the profit and loss statement, P&L, statement of income, and the statement of operations. The income statement reports the revenues, gains, expenses, losses, net income and other totals for the period of time shown in the heading of the statement. If a company’s stock is publicly traded, earnings per share must appear on the face of the income statement.
A word used by accountants to communicate that an expense has occurred and needs to be recognized on the income statement even though no payment was made. The second part of the necessary entry will be a credit to a liability account.
A current asset whose ending balance should report the cost of a merchandiser’s products awaiting to be sold. The inventory of a manufacturer should report the cost of its raw materials, work-in-process, and finished goods. The cost of inventory should include all costs necessary to acquire the items and to get them ready for sale.
When inventory items are acquired or produced at varying costs, the company will need to make an assumption on how to flow the changing costs. See cost flow assumption.
If the net realizable value of the inventory is less than the actual cost of the inventory, it is often necessary to reduce the inventory amount.
One of the main financial statements. The balance sheet reports the assets, liabilities, and owner’s (stockholders’) equity at a specific point in time, such as December 31. The balance sheet is also referred to as the Statement of Financial Position.
Cost of goods sold is usually the largest expense on the income statement of a company selling products or goods. Cost of Goods Sold is a general ledger account under the perpetual inventory system.
Under the periodic inventory system there will not be an account entitled Cost of Goods Sold. Instead, the cost of goods sold is computed as follows: cost of beginning inventory + cost of goods purchased (net of any returns or allowances) + freight-in – cost of ending inventory.
This account balance or this calculated amount will be matched with the sales amount on the income statement.
The systematic allocation of the cost of an asset from the balance sheet to Depreciation Expense on the income statement over the useful life of the asset. (The depreciation journal entry includes a debit to Depreciation Expense and a credit to Accumulated Depreciation, a contra asset account). The purpose is to allocate the cost to expense in order to comply with the matching principle. It is not intended to be a valuation process. In other words, the amount allocated to expense is not indicative of the economic value being consumed. Similarly, the amount not yet allocated is not an indication of its current market value.
Usually financial statements refer to the balance sheet, income statement, statement of cash flows, statement of retained earnings, and statement of stockholders’ equity.
The balance sheet reports information as of a date (a point in time). The income statement, statement of cash flows, statement of retained earnings, and the statement of stockholders’ equity report information for a period of time (or time interval) such as a year, quarter, or month.
A revenue account that reports the sales of merchandise. Sales are reported in the accounting period in which title to the merchandise was transferred from the seller to the buyer.
Net sales revenues minus the cost of goods sold.
Includes the main financial statements (income statement, balance sheet, statement of cash flows, statement of retained earnings, statement of stockholders’ equity) plus other financial information such as annual reports, press releases, etc.
Things that are resources owned by a company and which have future economic value that can be measured and can be expressed in dollars. Examples include cash, investments, accounts receivable, inventory, supplies, land, buildings, equipment, and vehicles.
Assets are reported on the balance sheet usually at cost or lower. Assets are also part of the accounting equation: Assets = Liabilities + Owner’s (Stockholders’) Equity.
Some valuable items that cannot be measured and expressed in dollars include the company’s outstanding reputation, its customer base, the value of successful consumer brands, and its management team. As a result these items are not reported among the assets appearing on the balance sheet.
For the past 52 years, Harold Averkamp (CPA, MBA) has
worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. He is the sole author of all the materials on AccountingCoach.com.
