Overview

Cetec ERP can automate ledger posting to COGS (Cost Of Goods Sold) Overhead as part of Order completion (“Invoicing” an Order), along with other COGS buckets like Labor, Materials, and Outsource costs. COGS Overhead is accumulated on an hourly basis in parallel to COGS Labor. Setting an appropriate rate for COGS Overhead is an important piece in automating ledger activity.

Overhead Types, Expenses, and COGS

Overhead expenses will show up in the General Ledger as an Expense - Utility bills, Payroll, Cleaning Supplies, and the like should all show in various Expense accounts. Some of these expenses are directly related to the production of goods and are reflected in the Revenue -> COGS accounts to more accurately portray their status as costs of production.

Labor is a good analog to overhead here. Payroll is usually posted to an Expense -> Payroll account, and is “moved” to a COGS account (Credit Expense -> Payroll, Debit Revenue -> COGS -> Labor). Any value that is posted in a COGS account reduces Net Income (i.e. taxable income), and is thus governed in the United States of America by the Internal Revenue Service (aka IRS). The IRS notes that COGS is:

Cost of goods sold represented the costs incurred by the corporation in producing the goods or providing the services that generated the corporation’s business receipts. Included were costs of materials used in manufacturing, costs of goods purchased for resale, direct labor, and a share of overhead expenses, such as rent, utilities, supplies, maintenance, and repairs.

So, Overhead can be separated into two categories:

• Manufacturing Overhead (Overhead that is directly related to manufacturing and production of goods, i.e. COGS overhead)
• Non-Manufacturing Overhead (all other overhead expenses)

Only “Manufacturing Overhead” is eligible to be moved to a COGS bucket. Most overhead will need to stay as an expense, including SG&A (expenses related to selling, general, and administrative tasks), facility rent, cleaning costs, security staff, and all other non-production operating expenses.

Manufacturing Overhead As Accumulated With Labor

Both categories of overhead, by default, are represented as an Expense initially. The goal is to move all Manufacturing Overhead to/from Expense accounts to COGS accounts, where it will reduce Net Income (and with the resulting tax benefits).

In Cetec ERP, these costs can be moved manually with Ledger Entries, or they can be moved automatically by accumulating Labor to a Workorder. To do this automatically, an accurate Overhead rate needs to be set.

Note that the advantage of accumulating Overhead automatically with Labor is that any given Order will have a more accurate Cost picture. If Manufacturing Overhead is manually moved from Expenses to COGS, any specific Order will not accurately factor in Overhead costs. Doing so gives the impression of a more profitable build than is actually true. By accumulating Overhead with the Order build, each Order shows a more accurate cost/resale ratio.

Example:

Order Time & Rates
Order Labor Time: 1 hour
Order Labor Rate: $10
Order Overhead Rate: $5

Resulting COGS Postings
COGS Labor: $10
COGS Overhead: $5

Determining the Correct Overhead Rate

To determine an accurate Overhead rate, the average monthly Manufacturing Overhead expenses need to be determined. Note that many of the primary Costs associated with COGS will automatically be posted in COGS by Cetec ERP, including Labor, Materials, and Outsourcing Costs (pulled from Outsourcing POs linked to a Work Order). The remaining items, which are grouped into the COGS Overhead, are the Costs to identify. These can include Labor that is not logged to Work Orders (but is fully related to Production!), Electricity consumed by CNC Machines, Packaging Materials, and Inbound Freight. As these are subject to IRS judgment, a discussion with your CPA is recommended to validate any assumptions.

Once the expenses eligible for COGS posting are identified, summarize them for a prior period. If the expenses that can be considered as Manufacturing Overhead total $1000, and the number of clocked labor hours for that period total 100, then the overhead rate should be set to $10. The goal is to have labor hours accumulate Overhead at a rate that matches the actual Overhead expense. Note that the number of hours should be pulled from clocked Work hours as this will be the driver for Overhead consumption (i.e. overhead will accrue with labor when someone logs time to a job).

Then, on a monthly basis, the goal is to review the actual Overhead accumulated and compare to what was automatically logged to COGS (based on the overhead rate associated with labor), and then to:

• Adjust the COGS Overhead account with a manual post to reflect any deltas
• Adjust the Overhead rate up or down to more accurately predict future overhead accumulation

This will keep the Overhead account accurate, and also help to provide an accurate cost picture for Production. The end goal being accurate margin and profitability per Order.