Overhead cost estimation for The Saudi Transformers Company Ltd

Project principle investigators: Moath Al-Swaidan, Abdullah Dehwah, Mohammed Al-Harbi

Supervisor: Dr Muhammad Al-Salamah

Course: ISE-304 Principles of Industrial Costing

Institution: King Fahd University of Petroleum and Minerals

Background

Cost estimation is essential for the manufacturing industry because of its direct impact on the financial performance of the organization. One general definition of the overhead cost is the charges associated with manufacturing that cannot be clearly linked to particular operations, products, or projects. Overhead costs are extremely important in manufacturing estimation because they can be easily overlooked. Moreover, overhead costs have forced some manufacturers out of business because overhead costs contribute to a significant portion of total manufacturing costs. In the same way, total overhead costs vary from 8% to 30% of the sum of materials, labor, and equipment costs. So, it is clearly that overhead cost should not be under estimated in order to survive in a competitive market.

To apply the overhead principle we studied the case of a Saudi manufacturing company, which is chosen to be The Saudi Transformers Company Ltd.

The Saudi Transformers Company Ltd. is a major manufacturer of electric transformers. It has experienced a steady growth since its inception twenty years ago. The growth trend is projected to increase.

Problem statement

The STC uses the direct labor cost as a basis of calculating the overhead rate and we want to investigate whether this method is the best for estimating overhead cost or they should consider taking other basis.

Data collection

The STC has 285 direct workers working on the production line. It has 69 indirect workers divided as follows:

12 production managers.
32 workers in the maintenance department.
25 workers in the warehouse.

The workers work for 8 hours shift with a total of 240 days yearly. The company produces 500 transformers yearly, with a direct material cost of 15,000 riyals per transformer.

The direct labor cost can be broken down in to the following:

DESCRIPTION	Direct labor (estimated)
BASIC SALARIES	2,000,000
OVERTIME	213,750
HOUSING ALLOWANCES	18,000
TRANSPORTATION ALLOWANCES	68,400
BOUNCES ETC.	30,000
MEDICAL EXPENSES	102,600
SERVICE REWARD	15,000
LEAVE TICKETS	18,000
ELECTRICITY EMPL.RESIDENT	26,000
RECRUITMENT EXPENSES	14,250
PASSPORT & VISA EXPENSES	171,000
TRAINING EXPENSES	45,000
TRAINING EXP. (SAUDI EMPL. /WORKERS)	5,000
OTHER BENEFITS	0
OTHER EMPLOYEE RELATED EXPENSES	27,500
EMPLOYEE RELATED PREVIOUS PERIOD	32,000
TOTAL	2,786,500

The overhead cost can be broken down in to the following:

DESCRIPTION	Overhead (estimated)
BASIC SALARIES	600,000
OVERTIME	181,000
HOUSING ALLOWANCES	19,000
TRANSPORTATION ALLOWANCES	43,000
BOUNCES ETC.	25,000
MEDICAL EXPENSES	92,000
SERVICE REWARD	50,000
LEAVE TICKETS	8,000
ELECTRICITY EMPL.RESIDENT	0
RECRUITMENT EXPENSES	10,000
PASSPORT & VISA EXPENSES	21,000
TRAINING EXPENSES	20,000
TRAINING EXP. (SAUDI EMPL. /WORKERS)	60,000
OTHER BENEFITS	0
OTHER EMPLOYEE RELATED EXPENSES	33,000
EMPLOYEE RELATED PREVIOUS PERIOD	18,200
MAINTENANCE MATERIAL	100,500
MAINTENANCE LABOR	52,000
MAINTENANCE EXP (CONSTRUCTION JOBS)	60,000
OUTSIDE MAINTENANCE	72,000
REGISTRATION FEES	15,000
AUDITING FEES	3,500
LEGAL FEES	120,000
CONSULTATION FEES	230,000
OUTSIDE SERVICES (AUDIT AND TEST)	81,000
PRINTING, STATIONARY AND SUP.	23,000
INSURANCE	1,000,000
EQUIPMENT & EQPT. RENTAL	52,000
TRANSPORTATION EXPENSES	73,100
INTERNAL TRANSPORTATION	31,000
FREE SAMPLE OF PROD.MATL	7,000
SOFTWARE EXPENSES (ERP)	23,000
LAND RENT	600,000
POWER [OFFICE &FACTORY]	250,000
TELEPHONES	22,000
WASTE DISPOSAL SERVICES	41,000
OTHER RENTS	46,000
AIR TICKETS	32,000
TRANSPORT & CAR RENTAL	20,000
TRAVELING ALLOWANCE	48,500
SUBSCRIPTIONS	17,000
ADVERTISEMENT & MARKETING	130,000
CLEARING ACCOUNT	240,900
DONATION	689,000
PREVIOUS PERIOD EXPENSES	380,000
DEVELOPMENT PROJECTS	247,000
DEPRECIATION	280,000
PHYSICAL INVENTORY ADJUSTMENT	3,000
FINES	201,000
TOTAL	6,370,700
INDIRECT MATERIALS	420,000
GRAND TOTAL	6,790,700

Data analysis

The total direct material cost = 500 * 15,000 = 7,500,000 riyals per year

The total direct labor hours = 285 * 240 * 8 = 547,200 hours per year

The Prime cost = 2,786,500 + 7,500,000 = 10,286,500 riyals

The overhead rate by taking direct labor cost as a basis is as follows:

Overhead rate = budgeted overhead / direct labor cost = 6,790,700 / 2,786,500 = 2.437 riyal per riyal of direct labor cost

The overhead rate by taking direct labor hours as a basis is as follows:

Overhead rate = budgeted overhead / direct labor hours = 6,790,700 / 547,200 = 12.41 riyal per labor hour

The overhead rate by taking prime cost as a basis is as follows:

Overhead rate = budgeted overhead / prime cost

Here the prime cost = direct material cost + direct labor cost

So, the overhead rate = 6,790,700 / 10,286,500 = 0.66 riyal per prime riyal

Conclusion

After analyzing each case of overhead rate with different basis, and by using our industrial engineering background we conclude that taking the prime cost as a basis for calculating the overhead cost for the STC Company, is more suitable and more convenient than taking the other two basis, because the prime cost is the cost driver in this production line and the STC company is producing only one kind of standard product.