Overheads

Overhead is the aggregate of indirect material
costs, indirect labor costs and indirect
expenses. These are those costs which cannot
be allocated accurately but can be apportioned
and absorbed to the cost centers or cost units.
Overheads costs are also known as ‘
Supplementary costs’, ‘Non-productive costs’,
‘indirect costs’ etc.
ACCORDING TO BLOCKER AND WELMER
“Overhead costs are the operating cost of a
business enterprise which cannot be traced
directly to a particular unit of output.”

CLASSIFICATION
OF OVERHEADS
ON THE BASIS
OF FUNCTION
ON THE BASIS
OF ELEMENTS
ON THE BASIS
OF BEHAVIOUR

FACTORY OVERHEAD
ADMINISTRATION
OVERHEAD
SELLING AND
DISTRIBUTION OVERHEADS

• It includes all the indirect costs incurred in
factory in respect of manufacturing operations. It
includes the cost of indirect materials and
indirect labor.
FACTORY
OVERHEADS
• It refers to the general expenses and expenses of
administration and control of business. It includes all
the indirect costs relating to direction, guidance,
management, control and administration of business
concern.
OFFICE &
ADMINISTRATIVE
EXPENSES
• These include all the indirect costs which are incurred
for
• Promoting the sales
• Retaining the customers
• Providing after sale services to the consumers
SELLING AND
DISTRIBUTION
EXPENSES

INDIRECT MATERIAL
COST
INDIRECT LABOR
COST
INDIRECT EXPENSES

• It is the cost which is not directly attributable to the
finished product. These costs are not absorbed or
apportioned by the cost units or cost centers
directly.
INDIRECT
MATERIAL
COST
• It refers to that part of labor cost which is not
directly attributable to the cost centers or cost
units. These are not apportioned to or absorbed by
the cost centers or cost units.
INDIRECT
LABOR
COST
• Expenses which cannot be allocated to the cost
centers or units but can be apportioned by them
are known as overheads or indirect expenses.
INDIRECT
EXPENSES

SEMI-VARIABLE
OVERHEADS
FIXED OVERHEADS
VARIABLE OVERHEADS

FIXED OVERHEADS: A fixed
cost is a cost which is incurred
for a particular period of time
and which, within certain
activity levels, is unaffected by
changes in the level of activity.
These costs mainly depends
upon the effluxion of time and
do not vary directly with the
changes in the volume or
output or sales.

VARIABLE OVERHEADS: A
variable cost is a cost which
tends to vary with the level of
activity. These costs tend to
increase or decrease with
the rise and fall in the
production or sales. These
costs vary in total but per
unit cost remains the same.
Example: cost of raw
material used in producing
finished product.

SEMI VARIABLE
OVERHEADS: This is the
cost that contains both a fixed
cost and a variable cost
component. The part of semi-
variable costs remains
constant in spite of changes in
the volume of output or sales,
while the other part varies in
proportion to changes in
volume of output or sales.

METHODS OF
SEGREGATING SEMI-
VARIABLE COSTS
COMPARISON METHOD
RANGE METHOD
EQUATION METHOD
GRAPHICAL METHOD
LEAST SQUARE METHOD
AVERAGE METHOD

The comparison method is followed to
segregate the semi-variable overheads into
fixed overheads and variable overheads. Under
this method the quantity of output at two
different levels is compared with the
corresponding amount of expense. The amount
of fixed overhead remains same and the
amount of variable overhead is calculated as
follows:
Variable cost per unit= Change in amount of
expense/ Change in quantity or output

This method is also known as High and Low
Points method. Under this method, the amount
of expense at the highest and lowest levels are
compared and related to output attained at
those levels. As the amount of fixed overheads
remains the same, the change in indirect cost is
due to the variable portion.
VARIABLE COST PER UNIT= Change in
amount of expense/ Change in output.

Under this method, variable and fixed portions
of overhead are ascertained by means of
straight line equation. The straight line equation
is:
Y= mx+ C
Where Y= Total semi-variable cost
C= Fixed costs included in semi-variable costs
m= Variable cost per unit
x= Output or number of units.

Under this method of segregation
of fixed and variable elements is
made by first taking the average of
two selected groups and then
applying the range method or
equation method, as the case may
be.

Under the graphical method, volume of output
is drawn on horizontal axis and semi-variable
expenses on vertical-axis. Expenses
corresponding to each volume are plotted on
the graph paper and a straight line, ‘the line of
best fit’ is drawn through the points plotted.
This straight line represents the ‘total cost line.’
The point where the straight line intersects the
vertical-axis is taken to be the amount of fixed
expenses. A parallel line from the intersecting
point to the amount of fixed expenses. A
parallel line from the intersection point to the
horizontal axis gives the ‘fixed cost line’.

Under this method, segregation of fixed and
variable elements of semi-variable overhead is
made by finding out a ‘line of best fit’ for a
number of observations with the help of
statistical methods:
Y= mx+ C
Where Y= Total semi-variable cost
C= Fixed costs included in semi-variable costs
m= Variable cost per unit
x= Output or number of units.

EFFECTIVE
COST
CONTROL
HELPFUL IN
DECISION
MAKING
FIXATION OF
SELLING
PRICE:
MARGINAL
COSTING AND
COST-VOLUME
ANALYSIS:
HELPFUL IN
BUDGETARY
CONTROL
ABSORPTION
OF OVERHEAD

EFFECTIVE COST CONTROL
To exercise the effective cost control, proper classification of
overhead into fixed or variable is required. Fixed expenses are
incurred by management decision and as such can be
controlled by the top management while variable expenses can
be controlled by lower management.
HELPFUL IN DECISION MAKING
The classification of fixed or variable overheads helps in taking
the following decisions by management:
•Make or buy decision
•Selection of suitable sales mix
•Operate or shut down decisions

FIXATION OF SELLING PRICE
The classification of overheads into fixed or variable is very helpful
in determining the selling price of the products or services.
Sometimes, a manufacturer charges different prices for the same
articles in different markets to meet varying degrees of competition.
However, the lowest selling price of any product should at least
cover prime cost plus variable overhead. This classification also
helps in determining the price during trade depression or in a special
market.
MARGINAL COSTING AND COST-VOLUME ANALYSIS
The classification of fixed or variable overhead elements is very
essential for the technique of marginal costing and break-even
analysis. It helps in ascertaining the marginal cost i.e. the total
variable cost attributable to one unit of output. Further, it assists in
determining the break-even point i.e. the volume of output where
there is no profit and no loss.

HELPFUL IN BUDGETARY CONTROL
Classification of fixed or variable overhead is very
helpful in preparation of flexible budgets. A flexible
budget is a budget which is designed to change in
accordance with the level of activity actually attained.
Flexible budget for various levels of activity can be
prepared with the help of this classification.
ABSORPTION OF OVERHEAD
This classification helps in the proper absorption of
the different items of overhead. This method to be
adopted for determining the absorption rates
depends on the nature of overhead.

Overheads

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Overheads