Overheads refer to the indirect costs that are not directly attributable to a specific product or job. They include expenses like rent, utilities, and salaries of support staff. Efficient management of overheads is crucial for accurate costing, budgeting, and pricing decisions.
Collection of Overheads
Overhead collection involves identifying, recording, and accumulating indirect costs. These costs are gathered from various sources within the organization. The process typically:
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Primary Source Documents:
Overheads are first collected from invoices, receipts, salary registers, and utility bills. These documents provide details of the costs incurred.
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Expense Allocation Sheets:
Costs are categorized based on departments or cost centers. For example, factory rent is allocated to the manufacturing cost center, while office rent is allocated to the administrative cost center.
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Voucher Records:
Vouchers are used to record various expenses, ensuring each overhead cost is captured systematically.
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Ledger Accounts:
All overhead costs are transferred to overhead ledger accounts, where they are grouped by categories such as manufacturing, administrative, and selling expenses.
Classification of Overheads:
Overheads are classified into different categories based on their nature, behavior, and function. The classification helps in better analysis, control, and allocation of overheads. Here’s an overview of how overheads are typically classified:
Classification by Nature:
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Indirect Materials:
These include materials that cannot be directly traced to a specific product, such as lubricants, cleaning supplies, and small tools.
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Indirect Labor:
The wages of employees who do not directly contribute to production, such as supervisors, maintenance staff, and security personnel.
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Indirect Expenses:
Costs other than indirect materials and labor. Examples include factory rent, utilities, insurance, and depreciation.
Classification by Function:
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Manufacturing Overheads:
Costs associated with the production process, including indirect materials, indirect labor, and factory-related expenses like machine maintenance and factory utilities.
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Administrative Overheads:
Costs related to the general management and administration of the business, such as office rent, salaries of administrative staff, and legal expenses.
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Selling and Distribution Overheads:
Costs incurred in promoting, selling, and delivering products to customers. These include advertising, sales commissions, packaging, and transportation costs.
Classification by Behavior:
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Fixed Overheads:
Costs that remain constant regardless of production levels, like rent, insurance, and salaries of permanent staff. These costs do not change with the volume of production.
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Variable Overheads:
Costs that vary directly with production levels, such as power consumption, indirect materials, and commission on sales.
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Semi-Variable Overheads:
Costs that contain both fixed and variable components. Examples include telephone bills (with a fixed line rental and variable usage charges) and maintenance costs.
Classification by Controllability:
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Controllable Overheads:
Costs that can be regulated or influenced by a manager at a specific level of the organization. For example, a factory manager can control indirect material usage and overtime pay.
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Uncontrollable Overheads:
Costs that cannot be easily regulated by a manager, such as rent or depreciation.
Classification by Normality:
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Normal Overheads:
Regular, expected costs necessary for business operations. These are usually included in product costs.
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Abnormal Overheads:
Unexpected costs, like excessive wastage or abnormal idle time, that are not included in product costs and are charged directly to the profit and loss account.