Everything you need to know about classification of overheads. Classification of overheads refers to the process of grouping costs according to their common characteristics.
The overhead costs are incurred not for any particular job, work-order, process or unit but for the business as a whole and include all costs other than direct material costs, direct wages and direct expenses.
Overhead costs are also denoted by ‘supplementary costs’ ‘non-productive costs’, ‘indirect costs’, ‘on cost’, ‘burden’ etc. Of all the terms, ‘overhead’ is the most common and the Institute of Cost and Management Accountants, London, does not recommend the use of the terms ‘on cost’ and ‘burden’.
Overhead expenses, unlike chargeable expenses, are indirect expenses which cannot be identified with particular products, job, processes or work orders and hence cannot be allocated. These costs do not relate to any one specific cost centre.
However, for proper cost ascertainment, accounting as well as control of overhead costs is essential.
Classification means determination of categories, classes or groups in which overhead costs may be subdivided. CIMA has defined classification as “the arrangement of items in logical groups having regard to their nature (subjective classification) or the purpose to be fulfilled (objective classification)”.
The overheads can be classified under the following heads:- 1. Element 2. Behaviour 3. Function 4. Control 5. Nature 7. Selling and Distribution 8. Office 9. Production.
Element wise classification of overheads includes:- 1. Indirect Materials 2. Indirect Labour 3. Indirect Expenses.
Behaviour wise classification of overheads includes:- 1. Fixed Overheads 2. Variable Overheads 3. Semi-Variable or Semi-Fixed Overheads 4. Step Overheads.
Function wise classification of overheads includes:- 1. Factory Overheads 2. Administration Overheads 3. Selling Overheads 4. Distribution Overheads 5. Manufacturing Overheads 6. Research and Development Overheads.
Control wise classification of overheads includes:- 1. Controllable Overheads 2. Uncontrollable Overheads.
Nature wise classification of overheads includes:- 1. Normal Overheads 2. Abnormal Overheads.
Classification of Overheads Based on Element, Behaviour, Function, Control, Nature, Selling and Distribution and Other Details
Classification of Overheads – Element-Wise and Behaviour-Wise Classifications
Classification of overheads refers to the process of grouping costs according to their common characteristics.
Overheads may be grouped according to:
This method of classification follows the definition of overheads. In this method, overheads are divided into three elements, viz. indirect materials, indirect labour and indirect expenses.
(a) Indirect Materials:
They are a part of material cost that cannot be allocated to a particular job or production but is absorbed by the cost centres or cost units indirectly. Some examples are—fuel, lubricating oil, stores consumed for repair and maintenance, cotton waste, etc.
(b) Indirect Labour:
This includes such types of wages that cannot be allocated, but can only be apportioned to cost centres or cost units. Some examples are—wages for maintenance workers, salary of storekeeper and foreman, overtime and night shift bonus, employer’s contribution to funds, holiday pay, leave pay, etc.
(c) Indirect Expenses:
The expenses that cannot be allocated directly but can only be apportioned to or absorbed by cost centres or cost units are known as indirect expenses. The common examples are—rent, insurance, taxes, telephone expenses, canteen and welfare expenses, lighting and heating, depreciation, etc.
It should be noted that this method of classification is usually followed for classifying factory overheads but not overheads in general.
This classification is made on the basis of behaviour or nature of the overhead costs. The nature of expenses is such that some change with the level of activity of an enterprise, while others remain constant. Thus, behaviour-wise overhead costs could be classified into fixed, variable and semi-variable overheads.
(a) Fixed Overheads:
These are expenses that remain unchanged in total for a given period despite fluctuations in volume of production. Examples are—rent and rates, managerial salaries, building depreciation, postage, stationery, legal expenses, etc.
(b) Variable Overheads:
They represent those costs that vary in direct proportion to the volume of output. Examples are—fuel, power, commission paid to selling agents, indirect materials (supplies), indirect labour, etc.
(c) Semi-Variable or Semi-Fixed Overheads:
There are certain expenses that neither fall in the category of fixed costs nor variable costs. Such expenses are known as semi-variable or semi-fixed overheads. They remain fixed at certain levels of output, while they vary at other levels but not in proportion to die output. For example, in telephone charges, the rental element is a fixed cost whereas charges for calls made are variable costs.
Classification of Overheads – Function-Wise, Element-Wise and Behaviour-Wise Classifications
The indirect portion of the total cost constitutes the overhead cost. Overhead cost is defined as “the aggregate of indirect material costs, indirect wages and indirect expenses.” The term ‘indirect’ denotes that which cannot be allocated but which can be apportioned to cost centres or absorbed by cost units. The overhead costs are also sometimes allocated to cost centres.
The overhead costs are incurred not for any particular job, work-order, process or unit but for the business as a whole and include all costs other than direct material costs, direct wages and direct expenses. Overhead costs are also denoted by ‘supplementary costs’ ‘non-productive costs’, ‘indirect costs’, ‘oncost’, ‘burden’ etc. Of all the terms, ‘overhead’ is the most common and the Institute of Cost and Management Accountants, London, does not recommend the use of the terms ‘oncost’ and ‘burden’.
Classification of Overheads:
Classification of costs refers to the process of grouping costs according to their common characteristics.
Overhead costs may be grouped according to:
2. Elements, and
1. Function-Wise Classification:
It refers to the classification of overhead costs with reference to the various major activity divisions of a concern.
The main groups of overhead on the basis of functions are:
(a) Factory Overhead;
(b) Office and Administration Overhead;
(c) Selling Overhead; and
(d) Distribution Overhead.
(a) Factory Overhead:
Factory overhead refers to all expenses other than direct material costs, direct wages and direct expenses incurred in a factory in connection with manufacturing operations.
Examples of factory overhead are – Rent of factory building, municipal taxes and insurance of factory building, depreciation of factory building, depreciation and insurance of factory plant and machinery, repairs and maintenance of factory buildings and machinery, salary of factory manager and other factory staff, factory power and lighting, cost of small tools, consumable stores, lubricating oil, cotton waste, salary of store-keeper, expenses of store-keeping, fuel, gas, water, drawing office salaries, factory stationery, cost of idle time, overtime wages (if not treated as direct cost), telephone charges of factory, cost of training of new workers, labour welfare expenses etc.
(b) Administration Overhead:
Administration overhead refers to all expenses relating to the direction, control and administration (not connected directly with production, sales or distribution) of an undertaking.
Examples of administration overhead are – General management salaries, salaries of general office staff, office rent, depreciation of office building, rates and insurance of office building, office lighting and air-conditioning, depreciation of office furniture and office machinery, repairs and maintenance of office building, office furniture and office machinery, audit fees, legal charges, office stationery, telephone charges of office, bank charges, directors’ fees, counting office salaries etc.
(c) Selling Overhead:
Selling overhead refers to all costs of seeking to create and stimulate demand or of securing orders.
Examples of selling overhead are – Sales office expenses, advertisement, salary of sales manager, salaries of other selling staff, commission on sales, travelling expenses, expenses of travelling agents, cost of price lists, catalogues and samples, bad debts, rent of show-room, depreciation of showroom, rates and insurance of show-room, lighting and cleaning of show-room, expenses of branch establishments, expenses of sales and publicity department, cost of training to salesmen, postal expenses relating to sales, legal expenses for recovery of bad debts, cost of entertainment of customers, market research expenses, cost of preparation of tenders etc.
Distribution overhead refers to all expenses incurred from the time the product is finished in the factory till its delivery to ultimate customers or consumers.
Examples of distribution overhead are – Rent of warehouse, depreciation of warehouse, insurance, rates and lighting of warehouse, depreciation, running and maintenance of delivery vans, salary of van men, carriage on sales, packing materials and packing charges, cost of after-sales service, salary of warehouse- keeper, and the like.
It refers to the classification of overhead with reference to the various elements on which costs are incurred.
The main groups of overhead on the basis of elements are:
(a) Indirect material costs,
(b) Indirect wages, and
(c) Indirect expenses.
Material costs which cannot be allocated but which are to be apportioned to or absorbed by cost centres or cost units, are known as ‘Indirect Material Costs’. Examples of indirect material costs are – Consumable stores, cotton waste, small tools, lubricating oil, coal, fuel etc.
Indirect wages refer to the labour cost or wages which cannot be allocated but which are to be apportioned to or absorbed by cost centres or cost units. Examples of indirect wages are – Salary of foreman, salary of supervisory staff, salary of factory manager, salary of time-keeper, salary of store-keeper, idle time wages, leave pay etc.
Indirect expenses refer to expenses (other than indirect material costs and indirect wages) which cannot be allocated but which can be apportioned to or absorbed by cost centres or cost units. Examples of indirect expenses are – Factory rent and rates, depreciation of factory building, insurance of factory building, depreciation of plant and machinery, factory lighting, repairs and maintenance etc.
By ‘behaviour’, we mean the reaction of the expenditure for changes in the volume of output. Some overhead costs increase with the increase in the volume of output, some remain constant irrespective of the changes in the level of output, whereas some others do not vary upto a certain volume but vary after that.
The main groups on the basis of behaviour or variability are:
(a) Fixed Overhead;
(b) Variable Overhead; and
(c) Semi-variable or Semi-fixed Overhead.
(a) Fixed Overhead:
Fixed overhead refers to expenses which tend to remain constant or unaffected (in aggregate) by changes in the volume of output. For example, if the monthly salary of the Works Manager is Rs.2,000 and the monthly output is 10,000 units and in a particular month the production falls down to 8,000 units, we cannot make a corresponding cut in the works manager’s salary.
The monthly expenditure of Rs.2,000 thus remains constant and is not affected by the fall in output. Similarly, when the output increases, there is no increase in the monthly salary of the works manager. The other examples of fixed overhead are- Rates and taxes on building, insurance of building, factory rent, supervisor’s salary, etc.
The fixed overhead costs will continue to be incurred even when production completely ceases in a particular period and are, therefore, also known as ‘Period Costs’, ‘Shut-down Costs’ or ‘Stand-by Costs’.
Fixed overhead costs are not always wholly fixed in native. Tins is because over a long period of time, if the concern decides to go in for additional equipments and buildings and appoints some additional staff to cope with the increase in production, these result in a permanent change in the level of production and the fixed charges which were constant within a certain range of plant capacity do also increase now. Thus, the total fixed overhead costs remain constant only within the limits of plant capacity and any appreciable change in the latter affects the fixed overheads.
Another important feature of fixed overhead costs is that since the amount of such costs for an accounting period is constant, the cost per unit decreases with increase in output and increases with decrease in output.
(b) Variable Overhead:
Variable overhead refers to expenses which tend to change (in aggregate) directly with changes in volume of output. Such expenses increase in aggregate as the output goes up and decrease proportionately when the output falls. However, there may not always be a perfect mathematical relation. The examples of variable overhead are- Indirect materials, fuel and power, carriage outward, packing materials, lighting, internal transport, store losses, idle time etc.
(c) Semi-Variable Overhead:
Semi-variable or semi-fixed overhead costs refer to expenses which are partly fixed and partly variable. These costs are fixed upto a certain volume of output. If, however, the output rises beyond that limit, these costs shall increase in aggregate although the increase in the expenditure will not be proportionate to the increase in output. Examples of semi-variable overhead costs are- Depreciation of plant and machinery, repairs and maintenance, cost of supervision, service department wages, postage and stationery etc.
Classification of Overheads – Production, Office, Selling and Distribution Overheads
1. Production Overheads:
It includes indirect materials, indirect wages and indirect expenses as under:
(a) Indirect Materials – Apart from direct materials which is a part of prime cost indirect materials are also included in it, such as oil, coal, stationery, cotton waste etc.
(b) Indirect Labour – Workers, manager salary, watchmen salary, office staff etc., are included in indirect labour.
(c) Indirect Expenses – Repair, depreciation, rent, insurance etc. are included in indirect expenses.
2. Office Overheads:
All expenses relating to planning controlling, directing and motivating are included in it. They have no direct connection with production.
It is classified into 3 categories as under:
(a) Indirect Materials – All expenses relating to stationery, printing and of general nature are included in it.
(b) Indirect Labour – Salary of office staff, managing director and other salary relating to office staff is included in it.
(c) Indirect Expenses – Rent of office building, office lighting, legal expenses, telephone etc. are included in it.
3. Selling and Distribution Overheads:
All types of selling and distribution expenses are included in it such as advertising, salary of salesman, samples, gifts etc.
They are grouped as under:
(a) Indirect Materials – Packing, Stationery used in sales office, oil, grease, samples etc. are treated as indirect materials.
(b) Indirect Labour – Salary of drivers, delivery vans, salary of salesmen are known as indirect labour.
(c) Indirect Expenses – Showroom expenses carriage outwards, rent of warehouse, bad debt, insurance are included in it.
Classification of Overheads – Classifications by: Elements, Functions and Behaviour
Classification means determination of categories, classes or groups in which overhead costs may be subdivided. CIMA has defined classification as “the arrangement of items in logical groups having regard to their nature (subjective classification) or the purpose to be fulfilled (objective classification)”. For proper accounting and control, careful classification of overheads is required.
1. Classification by Elements:
(a) Indirect Materials- Indirect material is that material which cannot be traced in the finished product, process or operation, e.g., jute or cotton waste used for cleaning the machinery, cutting oil and lubricants used in machinery, threads and buttons used in stitching clothes, etc. Sometimes indirect materials, e.g., coal, fuel used in the kilns, etc., are considered as direct material. Again direct materials, e.g., gums and threads used in book binding, etc., are considered as indirect material as it is not worth allocating to cost units.
(b) Indirect Labour- Indirect labour is one which is of a general character and cannot be conveniently traced with a particular job, process or product, e.g., salaries and wages paid to foremen, crane operators, cleaner, watch and ward, store keeper, maintenance staff, clerical staff, time keepers, salesmen, quality control, staff etc.
(c) Indirect Expenses- These are expenses which are incurred by an organisation for carrying out various activities and cannot be conveniently allocated to a job, cost unit or process, e.g., rent, insurance, taxes, lighting, depreciation, etc.
Indirect costs or common costs cannot be allocated but they can be apportioned to cost units.
2. Classification by Functions:
(a) Manufacturing Overhead:
It consists of all indirect materials, indirect labour and indirect expenses incurred in connection with manufacturing activities, which begins with the procurement of materials and ends with the primary packing of the product.
Examples of manufacturing or production or factory overheads are- Consumable stores and direct materials of small value; Factory rent, rates, power and fuel, lighting and heating; Depreciation of plant and machinery, factory buildings and other equipments; Insurance of Plant and Machinery, factory building and other assets; Indirect materials such as cotton waste, lubricants, and other factory supplies; Cost of spare parts, repairs and maintenance of plant and machinery, factory building; Salaries and wages of indirect workers, supervisory staff, security staff, maintenance staff, factory clerical staff, store keeper, time keepers, tool room operator, etc.; Canteen and other welfare expenses; Expenses in connection with factory administration, e.g., Telephone, Postage and telegrams, Telex, Fax, Printing and stationery, Computer room expenses, etc.; Remuneration paid to directors and other higher officials associated with production and factory management; Cost of estimating, drawing, quality control, etc. departments; Idle time wages; Fire protection service costs, Carriage inwards, etc.
(b) Administration Overhead:
These are total costs incurred in formulating policies, planning and controlling the operations of an undertaking and motivating its personnel towards attainment of its objectives. These costs are not related directly to production, selling, distribution, research or development activity or function. They are incurred for the business as a whole. These expenses are generally of fixed nature, i.e., they are not affected by any fluctuations in the volume of production or sales activity.
Such expenses are usually non-controllable, particularly at the lower levels of management. Examples of administration overhead are- Office rent, rates and taxes; Office lighting, heating and air-conditioning; Salaries of office and administrative staff; Remuneration of staff directors; Office supplies, printing and stationery, postage and telegrams, telephones, courier service, Fax, Telex, etc.; Audit and legal fees;
Depreciation, Insurance, repair and maintenance of office buildings, furniture, equipments and office machinery; Bank charges and interest; Accounts and Secretariat costs, etc.
(c) Selling Overhead:
It is the cost of promoting and retaining the volume of sales of the company’s products. It mainly includes the following costs-
Salaries, commissions and travelling expenses of salesmen, selling agents, etc.; Advertising and publicity expenses of various media like newspaper, television, radio, handbills, posters, etc.; Market research costs for assessing latest trends in demand and choices of customers; Bad debts and costs incurred for collection of dues from customers or to follow up the old outstanding debts; Discounts, rebates and brokerage; Servicing cost incurred to maintain the ‘After – sales’ service; Cost of catalogues, price lists and samples; Depreciation, insurance, repairs and maintenance of showrooms and sales office; Remuneration of sales director; Administration expenses of sales office and showrooms; etc.
(d) Distribution Overhead:
It comprises of cost of storing the finished products, packing them prior to despatch, despatching them to retailers or customers, reconditioning the empty containers returned by customers for re-use.
Examples of distribution overhead are- Carriage and freight outwards; Cost of secondary packing materials; Wages of packing staff or payments to the packing contractors; Rent, rates and insurance of warehouse; Maintenance and running expenses of delivery vehicles; Godown rent/tax, cost of loading/unloading; Administration cost of distribution outlets; Packing and delivery charges; Cost of reconditioning empty containers returned by customers; etc.
(e) Research and Development Overhead:
It refers to the total indirect cost incurred for the research and development activities of an organisation. Such activities include development of new products and manufacturing processes, improvement of existing products, substitution of materials and processes, etc. Development means implementing the results of research on commercial basis. If the total cost is insignificant, it may be merged with manufacturing or administration overhead.
Examples of these overheads are- Salaries and wages of Research and Development staff; Cost of raw materials used in R & D; Cost of various tests conducted and trial runs; Insurance, depreciation, repairs and maintenance of R & D buildings, plants and equipments; Subscriptions to R & D associations, Books, Journals, etc.; Travelling cost for surveys, patent fees, etc.
3. Classification by Behaviour:
(a) Fixed Overheads:
Fixed overhead expenses tend to remain fixed irrespective of changes in the volume of output or sale within a relevant range and during a defined period of time. Examples of such overheads are rent, rates, insurance, salaries, audit fees, etc. This is also called “period cost” or “policy cost”, as most of the expenditures arise over a period of time and out of the management policy. Certain items of expenses of fixed overheads may increase or decrease, if the activity exceeds or recedes the range.
Fixed overheads also vary with variation of price levels, e.g., prices of indirect materials, salaries, insurance, etc., change with time and hence fixed overhead changes. Such variations do not occur in a short period. Thus fixed overheads remain unaffected with variation of output in a short period, but the fixed overhead cost per unit varies with variation in the level of activity.
Fixed costs may be discretionary, i.e., incurred at the discretion of management, e.g., research and development cost, advertisement and market research cost, etc., or committed, i.e., incurred even when the volume of production fluctuates, e.g., rent, depreciation, salaries of staff, etc.
(b) Variable Overhead:
It is that portion of the total overhead which tends to change directly with changes in the volume of output, i.e., there is a linear relationship between the variable overheads and output. Indirect material, indirect labour, lighting and heating expenses, salesmen’s commission, power and fuel, etc., are examples of variable overheads. Although total variable overhead increases or decreases with increase or decrease of output, variable overhead per unit of output tends to remain fixed at different levels of output. This is, again, true within certain range of output.
(c) Semi-Fixed or Semi-Variable Overheads:
It is that portion of the total overhead which is partly fixed and partly variable. All indirect expenses which neither remain fixed for all levels of activity nor vary in constant proportion to change of output, fall in this category. For example, repairs and maintenance costs remain fixed up to a certain range of production. If production exceeds this range, maintenance cost may rise due to overtime, additional labour, etc., which may not be in constant proportion with production.
In telephone charges and electricity, there is a fixed charge as rental as well as variable charge per call or unit. Certain expenses rise in steps, i.e., it remains fixed up to a certain level, and then jumps and remains fixed up to the next level, e.g., supervisory salary. If two supervisors can manage 20 workers and another 5 workers are recruited, then a third supervisor is to be recruited who will be able to manage further 5 workers. Thus supervision cost will increase but it will remain fixed up to 30 workers.
Classification of Overheads – Function-Wise Classification, Element-Wise Classification, Behaviour-Wise Classification, Control-Wise Classification and a Few Others
Total cost of a product involves direct costs and indirect costs. Direct costs can be conveniently traced down to the product manufactured. It includes direct materials, direct wages, and direct expenses. On the other hand, indirect costs cannot be identified with the product manufactured. Indirect costs are referred as overheads.
However, there are other terms, like burden, loading; supplementary costs, and on cost, which are used interchangeably for overhead.
Classification of overheads involves two steps, viz.:
(i) Determination of the classes or groups in which the costs are subdivided.
(ii) Actual process of classification of various items of expenses into groups.
1. Function-Wise Classification:
i. Manufacturing Overheads:
It also known as works overhead, production overhead, or factory overhead. It is the aggregate of all indirect expenses regarding manufacturing division of a concern. In the words of Harper, ‘Overheads incurred in production, i.e., incurred within the four walls of the factory are known as manufacturing overheads.’
It includes all the expenses which are incurred by the factory from the receipt of raw materials until the completion of production (i.e., until finished goods ready for sale are manufactured). For example, consumable stores, factory rent, salary of foremen, depreciation of plant and machinery, light, fuel, power, repair, oil, gas and water, primary packing, etc.
ii. Administrative Overhead:
It is the sum of all the expenses incurred in connection with the formulation and implementation of policy, direction, controlling the operations, which are not related to the production, marketing, or R&D activity. These are the expenses regarding administrative and managerial functions of the organization.
For example, office rent, light, salary, printing and stationery, telephone, depreciation of office building, audit fees, directors’ fees, legal expenses, etc.
iii. Selling Overhead:
CIMA has defined selling overheads as that portion of marketing cost which is incurred in securing orders. This cost is incurred for creation of demand for the product. For example, sales Office expenses, salesmen’s salaries, advertisements, rent, rates and taxes of showroom, samples, free gifts, demonstration, etc. It represents the cost of finding and retaining the customers.
iv. Distribution Overhead:
It is that portion of marketing cost which is incurred in warehousing saleable products and in delivering the products to customers. It includes those expenses which are incurred in dispatching the manufactured goods to the warehouse, and from warehouse to the end- users.
For example, warehousing rent, expenses of delivery van, packing, storage, insurance, loss of warehouse stock, repairing of empties, etc.
Overhead is the aggregate of:
i. Indirect material,
ii. Indirect wages, and
iii. Indirect expenses.
i. Indirect Materials – It is the cost of materials which cannot be directly charged to the product manufactured. It includes stores consumed, repairs and maintenance, small tools of general use, lubricating oil, cotton waste, loss of stores, fuel, etc.
ii. Indirect Labour – It is the cost of labour which cannot be directly identified with the product manufactured. It includes salaries and wages of maintenance workers, overtime, holiday pay, idle time, employer’s contribution to P.F., leave pay, workmen’s compensation, etc.
iii. Indirect Expenses – These are the expenses which are incurred for the business as a whole. For example, rent, taxes, insurance, lighting and heating, depreciation of building, training expenses, salary of factory staff, hospitals and dispensary, canteen, etc.
Behaviour-wise, overheads are classified as:
(i) Fixed overheads,
(ii) Variable overheads,
(iii) Semi-variable overheads, and
(iv) Step overheads.
(i) Fixed Overheads:
Fixed overheads remain unaffected by the fluctuations of turnover or production activity. These costs are incurred in relation to a passage of time. Such costs remain fixed up to the capacity limit irrespective of the output. For example, rent of building, depreciation of plant and machinery, pay and allowances of staff, bank charges, legal expenses, insurance, canteen charges, etc. These are also called period costs.
Fixed overheads remain constant in total within the current period, regardless of changes in the level of activity. This remains valid within certain turnover limits. Fixed overhead does not vary in total. Fixed overhead on unit cost decreases as the production activity increases and vice-versa.
Examples include – rent of building; pay and allowances of managers, secretary, accountants, etc. It should, however, be noted that an expenditure is fixed within a specified limit relating to time and activity. In a progressive organization, no expenditure remains unchanged for all the time.
(ii) Variable Overheads:
Variable costs are those which, in the aggregate, tend to vary in direct proportion to changes in the volume of output or turnover. In other words, these costs change according to the changes in the output. It changes in the same ratio as the output. For example, indirect materials, indirect labour, power and fuel, spoilage, stores handling, overtime, idle time, etc. These are also called product costs.
Variable overhead varies with change in the volume of activity. It varies in total, but its impact on unit cost remains constant, e.g., oil, fuel, tools, and spares.
Variable overhead is further classified into two categories:
a. Variable production overhead – It is that portion of the variable cost which varies in proportion to the changes in the volume or output or production.
b. Variable marketing overhead – It is that portion of the variable cost which varies in proportion to the changes in the volume or turnover of sales.
(iii) Semi-Variable Overheads:
It is neither fixed nor variable overhead. It remains constant up to a certain level and registers change thereafter. A portion of such expense remains fixed and the remaining portion changes with the output. For example, repairs and maintenance, depreciation of plant and machinery, telephone, salary of supervisors, postage and stationery, service department wages, etc.
It is that part of overhead, which is partly fixed and partly variable. Hence, it is also known as semi-fixed overhead or semi-fixed cost. They may remain fixed within a certain activity level, but once that level is exceeded, they vary without or with having a direct relationship with the volume or the changes in activity.
They do not fluctuate in direct proportion to the volume, e.g., telephone charges. There is a minimum rent which has to be paid irrespective of the number of calls made. In addition, there is a variable charge, say Re. 1 per call, for every additional call made, after permitted limit is exceeded.
Semi-variable expenses usually have two parts, i.e., fixed and variable. For example, the amount of depreciation usually depends on two factors – one on time (fixed) and the other on wear and tear (variable). These together make depreciation (as a whole) semi-variable. Semi-variable overheads can be further split up into two parts.
(iv) Step Overheads:
It do not change when there is a small change in the level of activity but change considerably whenever there is a slightly bigger change. In other words, they change by small steps.
For example, instructors cost for an academical institute.
Overheads that change in the same direction as the change in the level of activity, but not in the same proportion.
Fundamentally, there are only two types of expenses-fixed and variable.
Cost can either be:
(i) Controllable or
(i) Controllable Cost – It is that portion of the cost which can be controlled by an efficient management. For example, idle time, wastage, etc.
(ii) Non-controllable Cost – It is that portion of the cost which cannot be controlled by the management. For example, duty or tax imposed by the Government or price hike by authority.
Nature-wise, overheads can be:
(i) Normal or
(i) Normal Overheads – These are the expenses which are expected to be incurred in producing a given output. They cannot be avoided. They are included in production cost.
(ii) Abnormal Overheads – These are the expenses which are not expected to occur in producing a given output. For example, abnormal idle time, abnormal wastage, etc. These expenses are transferred to costing P&L A/c.
Classification of Overheads – 3 Main Classification: Factory Overhead, Office, Administration, Selling and Distribution Overhead
The aggregate of Indirect Material cost, Indirect Labour cost and Indirect Expenses is termed as – ‘Overheads.’
For the proper interpretation and presentation of cost, the term overheads may be further classified as below:
(1) Factory Overheads (Also termed as production/works/manufacturing overheads.)
(2) Office and Administration Overheads.
(3) Selling and Distribution Overheads.
1. Factory Overheads:
These overheads consist of all overhead costs incurred from the stage of procurement of material till the stage of production of finished goods.
i. Indirect Material such as – consumable stores, cotton waste, oil and lubricants etc.
ii. Indirect Labour Cost such as – wages paid to foreman/storekeeper, works manager’s salary etc.
iii. Indirect Expenses such as – carriage inward cost, factory lighting/ power expenses, rent /insurance/repairs for factory building/ machinery, depreciation on factory building or machinery etc.
2. Office and Administration Overheads:
These overheads consist of all overheads costs incurred for the overall administration of the organization.
i. Indirect Material such as – stationery items, office supplies etc.
ii. Indirect Labour cost such as – salaries paid to Accounts and Administration staff, Directors’ remuneration etc.
iii. Indirect Expenses such as – postage/telephone, rent/insurance/repairs/ depreciation on office building, general lighting, legal/audit charges, bank charges etc.
3. Selling and Distribution Overheads:
These overheads consist of all overhead costs incurred from the stage of final manufacturing of finished goods till the stage of sale of goods in the market and collection of dues from the customers.
i. Indirect Material such as – packing material, samples etc. Indirect Labour like salaries paid to sales personnel, commission paid to sales manager etc.
ii. Indirect Expenses like carriage outwards, warehouse charges, advertisement, bad debts, repairs and running of distribution van, discount offered to customers etc.
Classification of Overheads – Element-Wise, Function-Wise, Variability-Wise, Controllability-Wise and Normality-Wise Classifications
The term cost can be basically classified as Direct Cost and Indirect Cost. Direct Cost indicates all those costs which can be identified with the individual cost centre and indirect cost indicates all those costs which cannot be identified with the individual cost centre. The total of indirect costs are termed as overheads.
There may be various ways in which the overheads may be classified:
1. Element-Wise Classification:
As the cost can be basically classified as per the Elements of Cost i.e., Material Cost, Labour Cost and Expenses, the indirect cost i.e., overheads may be classified as per the elements of cost.
This classification of overheads takes the form of:
(i) Indirect Material
(ii) Indirect Labour
(iii) Indirect Expenses.
2. Function-Wise Classification:
Under this classification, the overheads are classified according to the functions they perform.
This classification of overheads takes the form of:
(i) Factory Overheads (also termed as production or woks or manufacturing overheads)
(ii) Administration Overheads.
(iii) Selling and Distribution Overheads.
3. Variability-Wise Classification:
(i) Fixed Overheads:
These overheads indicate the costs which remain unaffected by variations in volume of output. E.g., Rent, Insurance on building, salary to administrative staff etc. Per unit cost of overheads may reduce as the volume of output increases but the total overheads remain constant.
(ii) Variable Overheads:
These overheads indicate the costs which vary directly in proportion to volume of output E.g., Consumable stores, nuts/ bolts, loose tools etc. Per unit cost of overheads remains the same but total overheads may increase or decrease as per volume of output.
(iii) Semi-Variable Overheads:
These overheads indicate those which are neither fixed nor variable in nature. These may remain fixed at certain levels of activity while may vary proportionately at other levels of activity E.g., maintenance cost, power, electricity, supervision cost etc.
4. Controllability-Wise Classification:
Under this classification, the overheads are classified according to their controllable nature.
This classification takes the form of:
(i) Controllable overheads
(ii) Uncontrollable overheads.
5. Normality-Wise Classification:
Under this classification, the overheads are classified according to the fact as to whether the overheads are normally incurred at a certain level of output under normal circumstances.
This classification takes the form of:
(i) Normal overheads.
(ii) Abnormal overheads.
It should be observed in this connection, that the above classification refers to the classification of same amount of overheads in different forms to suit the individual requirements.
E.g., For the purpose of preparing the cost statement, overheads may be classified according to functions while for the purpose of marginal costing applications, overheads may be classified according to variability.