What is Overhead?
Overhead is the cost of material, labour and expenses, which cannot be easily identified with any, job or process.
The costs, which cannot be identified or linked or attributed or allocated to the cost, centre or cost unit are termed as overhead. Therefore, overhead is the aggregate of indirect material cost, indirect wages and costs of indirect service.
Small amounts can be traced into a specific units of production included in the overhead. The treatment of costs as overhead is the purely judgment of the management.
In nutshell, overhead is the mix of indirect materials, indirect wages and expenses.
Importance of Overhead
After the industrial revolution, most of the companies prefer to produce the products in mass production. For which, the companies bought expensive machinery and equipment. It led to increase in indirect expenses rather than direct expenses. In the case of handicraft methods of production also, the costs, which can be traced directly to the product, may be only material and labour.
Moreover, there is a need of appointing some more persons other than workers to carry on the production operation. They are supervisors, engineers, clerks, accountants, maintenance men and the like.
In some companies, modern methods of production may be followed. If so, they may appoint staff specialists for economic operation of production. As a result, the cost of product is reduced. Whenever new methods of production followed and increased the production level, automatically the proportion of overhead cost may be increased.
In India, many large companies have established automatic and semi-automatic plants for the purpose of mass production. In these industries, certainly, the overheads are considerably increased. This is undesirable in developing countries like India. If these industries are producing basic materials, which are necessary for agriculture or products of household, there is a possibility of increasing cost of production.
Hence, such increasing cost of production should be controlled through well-devised cost accounting system and cost control system.
Classification of Overhead
The cost of direct material and direct labour is easily classified and allocated to specified cost centre or cost unit. But, this is not possible in the case of overhead. Moreover, there is a need of finding cost of production and profitability. Hence, classification of overhead is necessary one classification is the process of arranging items into groups according to the amount of similarity.
CIMA defines 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 may be classified in the following manner.
1. Function wise classification of overhead
The overheads can be classified into in the following ways on the basis of function.
1. Administration Overhead
2. Production Overhead
3. Selling Overhead
4. Research and Development Overhead
5. Distribution Overhead
2. Behaviour wise Classification of Overhead
The overheads can be classified into in the following ways on the basis of behaviour.
1. Fixed Overhead.
2. Variable Overhead.
3. Semi-Variable Overhead.
3. Element wise classification of overhead
The overheads can be classified into in the following ways on the basis of Element.
1. Indirect Material.
2. Indirect labour.
3. Indirect Expenses.
4. Control wise classification of overhead
The overheads can be classified into in the following ways on the basis of Control.
1. Controllable overhead.
2. Uncontrollable overhead.