Basics of Cost Accounting - 8: Overheads

Overheads

                  Costs may be classified into direct of indirect cost:

        Direct cost can be conveniently traced into or identified with the product manufactures. Direct costs which are also called “Prime Cost” or “Basic Cost which represent, the cost which can be easily and directly identified with the cost centers or cost units. 

But indirect cost represents the costs which are not directly identifiable with the cost centers with the cost centers. These indirect cost are called "Overhead Expenses”

Meaning:

Overheads is the aggregate of indirect material cost, indirect labour cost and indirect expenses which cannot be conveniently identified with and directly allocated to a particular cost center or cost object in an economically feasible way. It is also known as indirect cost or burden or on cost. 

Overheads = Indirect Material + Indirect Wages + Indirect Expenses.

Definition:

1. Certified Institute of Management Accountants, London:

    “Overhead is an aggregate of indirect materials, indirect wages and indirect expenses”

2. Wheldon: 

“Overheads are the cost of indirect materials, indirect labour and such other expenses, including service department expenses as it cannot be conveniently charged directly to specific cost units. Alternatively, overheads are all expenses other than direct expenses”.

Classification of Overheads:

Classification is the process of grouping like facts under a common designation on the basis of similarities of nature, attributes or relations. Classification of overheads is the process of grouping of indirect costs on the basis of common characteristics and clear objectives.

All overhead expenses are grouped together under common heads and further classified according to their fundamental difference.

A. Functional wise Classification:

1. 1. Factory Overheads: These are the indirect costs incurred in the manufacturing process. They include expenses such as factory rent, utilities, depreciation on factory equipment, and indirect labor costs associated with production.

2. 2. Administration Overheads: These are the indirect costs associated with the general administration of a business. They include expenses such as salaries of administrative staff, office supplies, utilities for administrative buildings, and other general administrative expenses.

3. 3. Selling Overheads: These are the indirect costs incurred in the process of selling goods or services. They include expenses related to advertising, sales commissions, marketing campaigns, packaging, and distribution of sales literature.

4. 4. Distribution Overheads: These are the indirect costs associated with the distribution of goods to customers. They include expenses such as warehousing costs, transportation costs, packing expenses, and distribution network maintenance costs.

B. Element wise Classification:

1. 1. Indirect Material: These are materials that cannot be conveniently traced to specific cost objects. Examples include lubricants, cleaning supplies, and small tools used in production.

2. 2. Indirect Labour: This refers to labor costs that cannot be attributed directly to specific cost objects. It includes wages of maintenance staff, supervisors, and other support personnel who are not directly involved in production.

3. 3. Indirect Expenses: These are expenses that cannot be directly allocated to specific cost objects. They include items such as depreciation on machinery, factory rent, and utilities.

C. Behaviourwise Classification:

1. 1. Fixed Overheads: These are overhead costs that remain constant regardless of the level of production or sales. Examples include rent, salaries of permanent staff, and insurance premiums.

2. 2. Variable Overheads: These are overhead costs that vary in direct proportion to changes in the level of production or sales. Examples include raw materials, direct labor, and utilities.

3. 3. Semi-variable Overheads: These overhead costs have both fixed and variable components. Examples include utilities where there is a fixed base rate plus a variable component based on usage.

D. Controllability wise Classification:

1. 1. Controllable Overheads: These are overhead costs that can be influenced or controlled by management decisions or actions. Examples include discretionary spending on advertising or training programs.

2. 2. Uncontrollable Overheads: These are overhead costs that cannot be directly influenced or controlled by management. Examples include rent increases due to external factors or changes in tax rates.

E. Normality wise classification:

1. 1. Normal Overheads: These are overhead costs that are incurred under normal operating conditions and are expected to occur regularly. Examples include routine maintenance expenses or standard administrative costs.

2. 2. Abnormal Overheads: These are overhead costs that occur infrequently and are not part of regular operations. Examples include costs associated with unexpected events like equipment breakdowns, natural disasters, or legal expenses.