When any expenditure which cannot be directly charged to any job, operation or process, such expenditure is called overhead. Thus indirect expenditure of any kind is indicated by overhead. Indirect materials, indirect wages & indirect expenses are included in overhead.
Therefore, those expenses which although cannot be allocated to any product or service (as direct cost) but can be apportioned to, or absorbed by, the products or services are called overhead.
Overhead is defined by different authors in different languages, but the same sense is carried by each definition.
Overhead is constituted by the aggregate of indirect materials, indirect wages & indirect expenses. Where, indirect materials are those material cost although which cannot be allocated to any process or job but can be apportioned to or absorbed by processes or jobs. Wages other than direct wages are referred to as indirect wages. Also expenses other than direct expenses are referred to as indirect expenses.
In many cases, what is a direct cost & what is an item of overhead are matters of judgment. For example, during a given period, from the electric meter of a department, the cost of electricity consumed by the department is known; but detailed technical arrangements are required if it is needed to know each cost centre or cost unit wise, cost of consumption of electricity. In the circumstances stated above, arrangement may be made by the management of one factory at some cost, while because of the amount of cost involved; another factory’s management may consider it undesirable. Thus, in the former factory, cost of electricity can be treated as direct cost; the same shall be treated by the later factory as indirect cost, i.e. overhead. Thus, generally it can be said that depending upon the decision, on the basis of economic & other considerations, some items of cost may be treated in one organization as direct cost & in another organization as indirect cost.
Thus, in many cases, distinction between direct cost & indirect cost is not possible. The expense is treated as overhead, where in relation to a cost centre or cost unit, the process of making direct measurement of an expense is considered wasteful or where no acceptable method of such measurement is there.
Different names of Overhead:
Overhead are called by various names. Sometimes between the different terms, distinctions are drawn which are not consistently observed. In fact, for the purpose of explaining the same thing i.e. overhead, all the different terms are used.
Classification of Overhead:
In various ways as mentioned below, overhead may be classified:
- Function wise Classification:
Three distinct functions are there in every manufacturing company, namely:
(i)Production function; (ii) Administrative function; & (iii) Selling & distribution function.
All indirect expenses which are incurred
in relation with production function are production overhead or factory overhead
or works overhead.Examples of production overhead are expenses relating to stores;
supplies for factory; cost incurred for supervision; expenses with respect to personnel
department; charges formaintenance & repair; cost of insurance; depreciation;
canteen expenses; payment made for rent, rates & taxes; expenses relating
to payroll department, indirect labour, internal transport cost etc.
Administrative or office overhead is all expenses which are incurred in connection with the general administration of the organization. With formulation of policies, these expenses relate to but are not directly connected with production, sales or distribution. Examples of Administrative overhead are-salary paid for the staff office which is connected with the general administration; expenses paid for office; payment of rent, rates & taxes for administrative building; remuneration paid to directors; expenses incurred with respect of telegram, telephone; postage & stationery charges; depreciation in respect of office equipment & of building ; bank charges etc.
Selling overhead are all those expenses which are incurred in connection with the sales functions & distribution overhead are those expenses which are connected with distribution function (i.e. delivery of products sold) . These two are normally treated alike. Examples of selling overhead are salary & commission paid to salesmen; expenses incurred for the purpose of advertisement which includes free gifts, samples, exhibition etc.; expenses incurred for market research; after sales services cost’s; commission of travelers; normal bad debt, etc. Whereas examples of distribution expenses are godown expenses incurred for the purpose of finished product’s storing; charges incurred for the purpose of packaging; expenses incurred in respect of freight, when customers are not charged for it; expenses incurred for loading & unloading of goods & materials, expenses incurred for the delivery vans’ maintenance & repair; salary paid to deliverymen etc.
Since the selling & distribution overhead are incurred after the completion of the production of goods & materials, these expenses are often known as ‘after production costs’.
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