Overheads can be classified based on function, behavior, elements and control. They are briefly explained below.
Function wise classification of overheads
The overheads can be classified into in the following ways on the basis of function wise classification.
1. Production Overhead
It is otherwise called as manufacturing overhead, works overhead and factory overhead. All the indirect expenses, which are incurred in the factory premises in connection with the production of any goods and services, are treated as production overhead. Factory rent, rates, lighting, heating, idle time wages, depreciation of factory, building, plant and machinery, canteen expenses and the like are some of the examples of production overhead.
2. Administration Overhead
The term administration refers to the formulation of policy, direction, control and management of affairs. The general functional expenses are included in the administration overhead. In other words, administrative services are necessary for the effective operation of any business. Hence, such service expenses are treated as administration overhead. The printing and stationary for administration, rent, rates, insurance of general office, bank charges, telephone, postage, and the like are the examples of administration overhead.
3. Selling Overhead
The selling overhead refers to the cost of selling function ie the cost of activities relating to create and stimulate demand for company products and to secure orders. Salaries, Commission and traveling expenses of sales representatives and executives, advertising and publicity expenses, samples, printing of price lists, discounts, rebates, bad debts and the like are the examples of selling overhead.
4. Distribution Overhead
The term distribution refers to the activities relating to the sequence of operation starts from making the packed product available for dispatch and ends with making reconditioned returned empty package available for reuse.
Distribution is also one of the functions like manufacturing, administration and selling. Running expenses of delivery van, wages of packers, carriage and freight outwards, rent, rates and insurance of warehouses and the like are some of the examples of distribution overhead.
5. Research and Development Overhead
Research overhead is the cost of searching for new products, new techniques for production or finding new equipment. The development overhead is the cost of implementation of research result on commercial basis. Cost of raw materials used for research, salaries and wages of R and D department staff, subscription to books and journals, subscription to research association, patent feeds and the like are examples of research and development overhead.
Behavior wise classification of overheads
The overheads can be classified on behavior wise basis also. They are presented below:
1. Fixed Overhead
Fixed overhead represents indirect cost, which remains constant for a specific period regardless of changes in volume of production. In other words, the fixed overhead may be increased after a certain level of production. The fixed overheads do not vary in total in a certain level of production.
The fixed overhead cost per unit decreases if the volume of production increases and vice versa. The fixed overhead is otherwise called as period cost, stand-by cost and fixed cost. Rent of building, depreciation of plant and machinery, salaries and remuneration of management executives, legal fees, audit fees and the like are the examples of fixed overhead.
The fixed overhead is not influenced by managerial action. But, it is fully depending on the policy of the management. The management can appoint new staff members on fixed salary even though there are no changes in the volume of production. If so, the fixed overhead increases in the same level of production.
Likewise, the same management can discharge few employees due to various reasons. Now, the fixed overhead decreases in the same level of production. This is the nature of fixed overhead.
Types of fixed overhead
There are three types of fixed overhead. They are briefly explained below.
1. Long Run Capacity Fixed Overhead: These are expired cost of plant and machinery and other facilities used. It means that these expenses are incurred over a long period of time.
2. Operating Fixed Overhead: These types of expenses are incurred to maintain and use the fixed assets. Heat, light, insurance and property taxes are paid in order to maintain and use the fixed assets.
3. Programmed Fixed Overhead: Some special programmes may be approved by the management. For which, the expenses are incurred by the management. The expenses like advertisement is issued to increase the volume of sales and research are carried on to improve the quality of the product. These are examples of programmed fixed overhead.
2. Variable Overhead
Variable overhead is a portion of indirect cost, which varies directly with change in the volume of production. If varies in total but remains constant in per unit, power, fuel, transport expenses, lubricants, tools and spares and the like are the examples of variable overhead.
3. Semi-Variable Overhead
Semi-variable overhead is a portion of indirect cost, which is partly fixed and partly variable. It means that this type of overhead has the characteristics of both fixed overhead and variable overhead. Semi-variable overheads may remain fixed up to a certain level of production and vary after that level of production. In other words, semi-variable overheads do not fluctuate in direct proportion to the volume of production.
Elements wise classification of overheads
The overheads may be classified on the basis of element wise in the following ways.
1. Indirect Materials
Some materials are used in the production process, which cannot be traced in the end product. In other words, materials used in the production process do not form part of end product. This type of material is called indirect material. Moreover, the cost of such material is insignificant and cannot be considered as worth for analyzing. For example: Threads and buttons used in stitching cloths and lubricants used in maintenance of plant and machinery.
2. Indirect Labor
Some laborers are employed for the purpose of helping the workers to produce goods and services. These laborers are not permitted to engage in the production process directly. Moreover, salaries and wages paid to such type of laborers are not included in the salaries and wages paid to workers who are working in the production process directly. This type of labor is called indirect labor.
For example: Salaries and wages paid to store keepers, sales representatives, personnel manager, accountant, supervisors, and the like. These indirect labor costs can not be identified with any particular job, process, cost unit or cost centre.
3. Indirect Expenses
Some expenses are incurred by the organization in order to run the business but not connected with the production of any goods and services. Without incurring such expenses, nothing will be happen. Moreover, these expenses cannot be conveniently allocated to job, process, cost unit or cost centre. Hence, these expenses are treated as indirect expenses. Rent, rates, postage, insurance, light, depreciation and the like are the examples of indirect expenses.
Control wise classification of overheads
Overheads may be classified in the control wise basis in the following ways.
1. Controllable Overhead
Overheads, which can be easily controlled by management through exercising various steps, are called controllable overhead.
2. Uncontrollable Overhead
Overheads, which cannot be, controlled whatever the steps taken by the management are called uncontrollable overhead.