Updated July 13, 2023
Definition of Overhead Budget
The Overhead Budget can be defined as the budget which is prepared to forecast or show all the future costs that are expected to be incurred during the manufacturing of the goods or services of the company.
It does not include the direct material cost and the direct labor cost along with all other costs which form part of the cost of goods sold, i.e., which generally forms part of other master budget prepared by the company.
Explanation
The company prepares various budgets to understand future incomes and expenses. For example, manufacturing companies prepare overhead budgets to estimate the company’s overhead expenses. In Overhead budgets, direct labor and direct material expenses are not considered because they already form part of the other master budgets in calculating the cost of goods sold. Therefore, overhead budgets help the management and employees of the company in the future estimation of profitability and the understanding of their limitations in terms of expenses.
Example of Overhead Budget
Let’s consider Company ABC Ltd, which is the manufacturing company. It has prepared the list of all the overhead expenses for the upcoming year, December 2021, and is planning to prepare the overhead budget.
According to the company, its expected employee costs for the next year for Q1, Q2, Q3 &Q4 would be $13,000, $11,000, $14,000 & $12,000, respectively. Its expected utility charges and income tax charges for the next year for Q1, Q2, Q3 & Q4 would be $4,000, $3,000, $6,000 & $5,000, and $10,000, $11,000,$9,000 & $12,000, respectively. It has forecasted some fixed expenses which will remain unchanged during the next year, like Depreciation expenses, insurance expenses, and the rent expense of the factory. These expenses will remain $13,000, $12,000 & $15,000 per quarter.
Now, its Overhead budget will be presented as follows:
| Overhead Budget of ABC Ltd | ||||
| For the year ended Dec 2021 | ||||
| Particulars | Q 1 | Q 2 | Q 3 | Q 4 |
| Variable Overheads | ||||
| Employee Cost | $13,000 | $11,000 | $14,000 | $12,000 |
| Utility Charges | $ 4,000 | $ 3,000 | $ 6,000 | $ 5,000 |
| Income Tax | $10,000 | $11,000 | $ 9,000 | $12,000 |
| Total Variable overheads(A) | $27,000 | $25,000 | $29,000 | $29,000 |
| Fixed Overheads | ||||
| Depreciation Expenses | $13,000 | $13,000 | $13,000 | $13,000 |
| Insurance Expenses | $12,000 | $12,000 | $12,000 | $12,000 |
| Rent Expenses | $15,000 | $15,000 | $15,000 | $15,000 |
| Total Fixed Overheads(B) | $40,000 | $40,000 | $40,000 | $40,000 |
| Total Overhead Expenses(A+B) | $67,000 | $65,000 | $69,000 | $69,000 |
In the above, we can see the variable overheads are shown separately, and below that, the fixed overheads are presented. Total overhead expenses are the sum of variable and fixed overheads.
Overhead Budget Format
In preparing the overhead budget, the variable overheads are shown separately, and they are calculated as the product of total units of production and the rate per unit. Then, below variable overheads, fixed overheads expenses are presented, and last total variable overhead expenses are shown as the sum of variable and fixed overhead expenses.
The Overhead Budget is presented in the below format:
| Company XXX | ||||
| Particulars | Q 1 | Q 2 | Q 3 | Q 4 |
| Variable Overheads | ||||
| Units(a) | XXX | XXX | XXX | XXX |
| Rate(b) | XXX | XXX | XXX | XXX |
| Total Variable Overheads(A)(a*b) | XXX | XXX | XXX | XXX |
| Fixed Overheads | ||||
| Rent [c] | XXX | XXX | XXX | XXX |
| Depreciation (d) | XXX | XXX | XXX | XXX |
| Total Factory Overheads (B)(c+d) | XXX | XXX | XXX | XXX |
| Total Overhead Expenses (A+B) | XXX | XXX | XXX | XXX |
Why is Overhead Budget Important?
Overhead budgets are important for companies because they give the company’s management and employees an idea of all the future expenses to be incurred by it. With the help of this, the management and employees of the company understand their limitations and can make strategies to control those expenses. The company’s management and employees can systematically allocate their business resources according to the priority of the expenses.
Advantages of Overhead Budgets
The following are the advantages of the Overhead Budget:
- First, the Overhead Budget gives the company’s management and employees all the expected future expenses to be incurred by it. Hence, the company’s employees and management can control all expenses that they find irrelevant and allocate the funds to other areas to achieve the desired results.
- With the help of Overhead budgets, the business resources can be allocated to the different areas of the business efficiently and effectively. This improves the future profitability of the business of the company.
Disadvantages of Overhead Budget
The following are the disadvantages of the Overhead Budget:
- First, the preparation of the overhead budget is a time-consuming activity. The company’s management has to invest much of their time and efforts to prepare the same. Hence, they get less time to invest in other company activities.
- The preparation of the Overhead budget is based on the management’s estimates and their judgment. However, the management estimate and their judgment are subjective, which can differ from person to person and change because of the unpredicted conditions of the market. Hence, the overhead budget does not give realistic results for future expenses; it just estimates the company’s management.
Conclusion
The Overhead budget forecasts all indirect expenses or overhead expenses to be incurred by the company in the future. Hence, the management and the company’s employees understand future expected expenses. Therefore, it gives them the way to make proper strategies to control those expenses and increase profitability in the future. Moreover, all the limitations are well known to the employees in the present for future expenses. Therefore, the company’s management and employees can differentiate which expenses are important and which are not. Hence, by doing this, the company’s management and employees can avoid irrelevant future expenses. The preparation of the overhead budget is mainly prepared in the manufacturing industries.
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