UNIT – IV

OVERHEAD

Definition: Overhead is defined as ―the aggregate of indirect Material cost, Indirect

Overhead = Indirect material + Indirect wages + Indirect expenses

ICMA defines overhead as total cost of indirect materials, wages and expenses.
Overheads costs cannot be allocated but it can be apportioned
and absorbed on-an equitable basis.
It is also known as "On cost", "burden'', indirect expenses.
Cost Allocation and Apportionment
Cost Allocation: It means the allotment of whole items of cost to cost centre or cost units.
Cost Apportionment: It involves allotment of proportion of items of cost to cost centres or
cost units.
CLASSIFY OVERHEAD
OVERHEAD CLASSIFICATION

OVERHEAD

FUNCTION WISE ELEMENTS WISE BEHAVIOUR WISE

1. Factory Overhead
2. Administration 1. Indirect materials 1. Fixed
Overhead 2. Indirect Labour 2. Variables
3. Selling Overhead 3. Indirect Expenses 3. Semi- VAriable
4. Distribution
Overhead
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Function Wise Classification: This classification is made on the basis of four major
function in a concern. i) Factory Overhead ii) Administration Overhead
iii) Selling Overhead iv) Distribution Overhead.
I. Factory Overhead: It is all indirect expenditure incurred in connection with
manufacturing operations. It consists of indirect material, indirect labour and
indirect expenses incurred in producing an article.
Examples: Power, Factory rent, Lighting & Heating Foreman Salary, Depreciation
on Plant & Machinery.
II. Administration Overhead: It includes all those costs which are incurred in general
and financial management of a concern.
Examples: Audit fees, legal charges, postage/ telegrams and telephone] printing &
stationery, Depreciation, of office building, Director's fee, office rent, salary to
office staff.
III. Selling Overhead: It refers to those indirect costs which are associated with
marketing and selling activities.
Examples: Advertisement costs, Bad debts, sales office expenses, sho room
expenses, salesman salaries.
IV. Distribution Overhead: It means the expenses incurred from the stage of product is
completed in the works till the product reaches its distribution. Examples: Packing,
godown rent, Depreciation, on delivery van, carriage outwards.
Element Wise Classification: On this basis, overheads are classified under three groups.
i) Indirect Material ii) Indirect labour iii) Indirect expenses
I. Indirect Material: are those material its cost cannot be allocated to specific cost
unit but which can be apportioned to or absorbed by and does not form a part of
finished goods.
Examples: Lubricants, cotton waste, consumable stores.
II. Indirect Labour: The wages of Indirect labour which cannot be allocated but which
can be apportioned to or absorbed by cost centre or cost unit is known as indirect
labour.
Examples: salary of supervisor, wages for maintenance workers overtime, holiday
pay, employee's contribution to provident fund.
III. Indirect Expenses: are those expenses which cannot be allocated but which can be
apportioned to or absorbed by cost centres or cost units.
Examples: Rent, rates, insurance, taxes, welfare expenses, lighting and heating,
Depreciation an plant Sc. machinery printing, stationery, telephone, telegram etc.
Behaviour Wise Classification:
According to his behaviour, overheads are grouped into i) Fixed ii) Variable iii)
Semi variable.
I. Fixed Costs: These costs remain fixed in total and do not increase or decrease when
the volume of production increases or decreases. But the fixed cost per unit increases
when the volume of production decreases and fixed cost per unit decreases when the
volume of production increases. It is also known as period cost.
Examples: Rent, insurance on building, salary to staff, Depreciation of plant and
machinery postage, stationery.
Example:
For 10000 output
Total Fixed overhead Rs. 1,00,000

Fixed cost per unit = 1,00,000 / 10,000 units = Rs.10 per unit
suppose output is increased to = 20,000 units
Total Fixed overhead = 1,00,000
Fixed cost perunit = 1,00,000 / 20000 units = Rs. 5 per unit
II. Variable Costs: These cost will change in proportion to the volume of production
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(ie) when volume of production increases total variable cost also increases and when
volume of production decreases total variable cost also decreases. But variable cost
per unit remains fixed.

Examples: Direct Material Cost, Direct Wages, Power, Royalties, Royalities, Fuel,
Spoilage, Indirect Material, Indirect Labour, Idle Time etc.
Example:
Output 10000 units
Variable overhead = Rs.1,00,000
Per unit = Rs. 1,00,000 /10000 units = Rs.10 If the
output increases to 20,000 units
Variable overhead = 1,00,000 / 10,000 units x 20,000 = Rs.200000
Variable overhead per unit = 2,00,000 / 20,000 units = Rs. 10
Variable Cost = Prime cost + All variable-overheads
III. Semi-variable Costs: These are certain items of cost which are part fixed and partly
variable. These are called semi variable costs.
Examples: Telephone, compensation to salesman, repairs
and maintenance, depreciation of plant & machinery.

Bases of Apportionment:
The following are main bases of overhead apportionment:
I. Direct Allocation: Overheads are directly allocated to various depart- ments on the
basis of expenses for each department respectively.
E.g.: Indirect Material, Indirect Wages. Power & Light (when separate metres ate
installed)
II. Direct Labour: Under this basis the overhead expenses are distributed to various
dept, in the ratio of a total number of labour / hours worked in each Debt.
E.g.: Salary of supervisor, Administrative expenses.
III. Direct Wages: According to this basis, expenses are distributed amongst the
departments in the ratio of direct wages.
E.g.: Contribution to provident fund workers compensation workers insurance.
IV. Electric Light - Number, of light points
V. Electric Power - Kilowatt hours.
VI. Floor Area: This basis is adopted for the apportionment of certain expenses like
rent, rates on building lighting and heating.
VII. Capital Values: In this method the Capital value of certain assets like machinery
and building are used for the apportionment of certain expenses. E.g.: Rent taxes of
building, Depreciation of plant.
Cost Classification:
This is the process of grouping costs according to the common characteristics.
Cost may be classified accounting to various characteristics nature, functions, variability
etc.
Departmentalisation of Overhead Expenses:
In a factory there are two types of departments a) production department
b) service department.
Manufacturing processes carried out m the product. A service department provides
service for the benefit of other departments.
Departmentalisation of overhead expenses refers to the apportionment of overhead
between production and service departments and the reapportionment of all service,
department overheads to the production departments.
Primary distribution of overhead
Common expenses have to be apportioned or distributed between production and service
department on some equitable basis. The process of distribution is usually known as primary