Accounting for Overheads

Introduction

Not every cost can be traced to a single product. The factory rent, the manager's salary, the electricity that lights the whole workshop and the depreciation of shared machines are costs that benefit many products at once. These indirect costs are called overheads, and because they cannot be charged directly they have to be shared out fairly among products. This chapter studies what overheads are, how they are classified, and the three step process of allocation, apportionment and absorption.

Meaning of overhead

Overhead is the total of all indirect costs, that is, indirect material, indirect labour and indirect expenses, that cannot be conveniently traced to a particular unit of product. Examples are factory rent, supervisors' salaries, lubricants, power, depreciation and office expenses. Because overheads are shared costs, the central problem of overhead accounting is to distribute them among products in a reasonable way.

Classification of overheads

Overheads are classified along several lines. By function they are factory (works) overhead, office and administrative overhead, and selling and distribution overhead. By element they are indirect material, indirect labour and indirect expenses. By behaviour they are fixed (such as rent, unchanged with output), variable (such as power, changing with output) and semi variable. By control they are controllable or uncontrollable at a given level.