Overhead
Content
OVERHEADS
An overhead is the amount which is not identified with any product. The name overhead might have come due to the reason of over
and above the normal heads of expenditure. It is the aggregate of indirect material, indirect labour and indirect expenditure. The
generic term used to denote indirect material, indirect labour and indirect expenses. Thus overheads forms a class of cost that
cannot be allocated or absorbed but can only be apportioned to cost units.
In earlier days, overheads were not given much importance, because the prime cost constitutes 50-80% of the total cost. However,
with the modern trend towards the mechanisation, automation, and mass production, overhead costs have grown considerably in
size and in many undertakings the proportion of overhead costs to the total costs of products is appreciably high. High overheads do
not indicate inefficiency if the increase in overheads is due to the following likely causes:
(a) Improved methods of managerial control like Accountancy, Production Control, Work Study, Cost and Management
Accountancy...etc. In the process of reducing costs of other elements, viz. direct material and direct labour, overhead costs are likely
to increase.
(b) Large scale production or mass production.
(c) Use of costly machines and equipments increases the amounts of depreciation, maintenance expenditure and similar other items
of overhead costs.
(d) Less human efforts are necessary with automatic machines. A major portion of the cost is allocated direct to machines, thus
increasing the machine overhead costs.
(e) Increased efficiency and productivity of labour has the effect of pushing up the overhead to direct labour ratio.
Overhead Accounting
The ultimate aim of Overhead Accounting is to absorb them in the product units produced by the firm. Absorption of overhead
means charging each unit of a product with an equitable share of overhead expenses. In other words, as overheads are all indirect
costs, it becomes difficult to charge them to the product units. In view of this, it becomes necessary to charge them to the product
units on some equitably basis which is called as ‘Absorption’ of overheads. The important steps involved in Overhead Accounting are
as follows:(a) Collection, Classification and Codification of Overheads.
(b) Allocation, Apportionment and Reapportionment of overheads.
(c) Absorption of Overheads.
(a) Collection, Classification and Codification of Overheads: These concepts are discussed below:Collection of Overheads:
Document
Stores Issue note, purchase voucher
Overhead Costs
Indirect material
Nature
Consumables, lubricants etc.
Payroll sheets, time sheets
Indirect labour
Cash books
Indirect material, Indirect labour &
indirect expenses
Indirect material, Indirect labour &
indirect expenses
Indirect expenses
Wages, salaries, contribution to
statutory
benefits,
bonus,
incentives, idele time
All type of costs
Subsidiary records – journal
Other reports
For provisions of costs that are not
actually paid for
Depreciation, scrap, wastage etc.
The following are the source documents for collection of overheads:(i) Stores Requisition
(ii) Wages Sheet
(iii) Cash Book
(iv) Purchase Orders and Invoices
(v) Journal Entries
(vi) Other Registers and Records
Source document and the nature of overheads are enumerated as below.
For the purpose of overhead accounting, collection of overheads is very important. It is necessary to identify the indirect expenses
and the above mentioned source documents are used for this. Proper collection of overhead expenses will help to understand
accurately the total overhead expenses.
Classification of Overheads
Classification is defined by CIMA as, ‘the arrangement of items in logical groups having regard to their nature (subjective
classification) or the purpose to be fulfilled (Objective classification). In other words, classification is the process of arranging items
into groups according to their degree of similarity. Accurate classification of all items is actually a prerequisite to any form of cost
analysis and control system. Classification is made according to the following basis:
Based on Elements: Indirect Materials, Indirect labour and indirect expenses.
Based on Functions of the organisation: Manufacturing overheads, Administrative overheads, Selling and Distribution overheads,
and Research & Development overheads.
Based on the Behaviour: Fixed Overheads, Variable Overheads & Semi variable overheads.
Classification according to Elements
According to this classification overheads are divided according to their elements. The classification is done as per the following
details:Indirect Materials
Materials which cannot be identified with the given product unit of cost centre is called as indirect materials. As per CAS-3 indirect
material cost is defined as ‘Materials, the cost of which cannot be directly attributed to a particular cost object’. For example,
lubricants used in a machine is an indirect material, similarly thread used to stitch clothes is also indirect material. Small nuts and
bolts are also examples of indirect materials.
Indirect Labour
As per CAS-3, indirect employee cost is the employee cost, which cannot be directly attributed to a particular cost object. Wages and
salaries paid to indirect workers, i.e. workers who are not directly engaged on the production are examples of indirect wages.
Indirect Expenses
As per CAS-3, Indirect Expenses are expenses, which cannot be directly attributed to a particular cost object. Expenses such as rent
and taxes, printing and stationery, power, insurance, electricity, marketing and selling expenses etc. are the examples of indirect
expenses.
An overhead is the amount which is not identified with any product. The name overhead might have come due to the reason of over
and above the normal heads of expenditure. It is the aggregate of indirect material, indirect labour and indirect expenditure. The
generic term used to denote indirect material, indirect labour and indirect expenses. Thus overheads forms a class of cost that
cannot be allocated or absorbed but can only be apportioned to cost units.
In earlier days, overheads were not given much importance, because the prime cost constitutes 50-80% of the total cost. However,
with the modern trend towards the mechanisation, automation, and mass production, overhead costs have grown considerably in
size and in many undertakings the proportion of overhead costs to the total costs of products is appreciably high. High overheads do
not indicate inefficiency if the increase in overheads is due to the following likely causes:
(a) Improved methods of managerial control like Accountancy, Production Control, Work Study, Cost and Management
Accountancy...etc. In the process of reducing costs of other elements, viz. direct material and direct labour, overhead costs are likely
to increase.
(b) Large scale production or mass production.
(c) Use of costly machines and equipments increases the amounts of depreciation, maintenance expenditure and similar other items
of overhead costs.
(d) Less human efforts are necessary with automatic machines. A major portion of the cost is allocated direct to machines, thus
increasing the machine overhead costs.
(e) Increased efficiency and productivity of labour has the effect of pushing up the overhead to direct labour ratio.
Overhead Accounting
The ultimate aim of Overhead Accounting is to absorb them in the product units produced by the firm. Absorption of overhead
means charging each unit of a product with an equitable share of overhead expenses. In other words, as overheads are all indirect
costs, it becomes difficult to charge them to the product units. In view of this, it becomes necessary to charge them to the product
units on some equitably basis which is called as ‘Absorption’ of overheads. The important steps involved in Overhead Accounting are
as follows:(a) Collection, Classification and Codification of Overheads.
(b) Allocation, Apportionment and Reapportionment of overheads.
(c) Absorption of Overheads.
(a) Collection, Classification and Codification of Overheads: These concepts are discussed below:Collection of Overheads:
Document
Stores Issue note, purchase voucher
Overhead Costs
Indirect material
Nature
Consumables, lubricants etc.
Payroll sheets, time sheets
Indirect labour
Cash books
Indirect material, Indirect labour &
indirect expenses
Indirect material, Indirect labour &
indirect expenses
Indirect expenses
Wages, salaries, contribution to
statutory
benefits,
bonus,
incentives, idele time
All type of costs
Subsidiary records – journal
Other reports
For provisions of costs that are not
actually paid for
Depreciation, scrap, wastage etc.
The following are the source documents for collection of overheads:(i) Stores Requisition
(ii) Wages Sheet
(iii) Cash Book
(iv) Purchase Orders and Invoices
(v) Journal Entries
(vi) Other Registers and Records
Source document and the nature of overheads are enumerated as below.
For the purpose of overhead accounting, collection of overheads is very important. It is necessary to identify the indirect expenses
and the above mentioned source documents are used for this. Proper collection of overhead expenses will help to understand
accurately the total overhead expenses.
Classification of Overheads
Classification is defined by CIMA as, ‘the arrangement of items in logical groups having regard to their nature (subjective
classification) or the purpose to be fulfilled (Objective classification). In other words, classification is the process of arranging items
into groups according to their degree of similarity. Accurate classification of all items is actually a prerequisite to any form of cost
analysis and control system. Classification is made according to the following basis:
Based on Elements: Indirect Materials, Indirect labour and indirect expenses.
Based on Functions of the organisation: Manufacturing overheads, Administrative overheads, Selling and Distribution overheads,
and Research & Development overheads.
Based on the Behaviour: Fixed Overheads, Variable Overheads & Semi variable overheads.
Classification according to Elements
According to this classification overheads are divided according to their elements. The classification is done as per the following
details:Indirect Materials
Materials which cannot be identified with the given product unit of cost centre is called as indirect materials. As per CAS-3 indirect
material cost is defined as ‘Materials, the cost of which cannot be directly attributed to a particular cost object’. For example,
lubricants used in a machine is an indirect material, similarly thread used to stitch clothes is also indirect material. Small nuts and
bolts are also examples of indirect materials.
Indirect Labour
As per CAS-3, indirect employee cost is the employee cost, which cannot be directly attributed to a particular cost object. Wages and
salaries paid to indirect workers, i.e. workers who are not directly engaged on the production are examples of indirect wages.
Indirect Expenses
As per CAS-3, Indirect Expenses are expenses, which cannot be directly attributed to a particular cost object. Expenses such as rent
and taxes, printing and stationery, power, insurance, electricity, marketing and selling expenses etc. are the examples of indirect
expenses.
