[PDF Notes] Classification of overheads is the process of grouping of the overheads according to their common characteristics

Classification of overheads is the process of grouping of the overheads according to their common characteristics. Overheads are classified on the basis of (i) Elements (ii) Functions and (iii) Behavior.

Overheads can be classified on the basis of elements in three groups as stated below: (i) Indirect material, (ii) Indirect labour and (iii) Indirect Expenses

(i) Indirect Materials: All those materials which do not form a part of the finished product or cannot be identified in the product conveniently are known indirect materials.

The examples are consumable stores, loose tools, wastrel cotton, lubricating oil, fuel, stationery, postages, etc. There are some materials which, even though, form a part of the finished product are treated as indirect I materials because they contribute a very small part of the total expenses. The examples are nuts, bolts, screws, threads, nails, etc.

(ii) Indirect labour: There are several labour costs which are not directly engaged I for production of goods and services. These labour costs come under indirect of labour. Some of the examples are salary of supervisor, works manager; wages to I coolie, watchman, electrician, storekeeper, timekeeper; director’s fees, overtime payments, cost of idle time, etc.

(iii) Indirect expenses: Indirect expenses are those costs other than indirect materials and indirect labour which cannot be directly identified with a job or product.

The examples of indirect expenses are canteen expenses, repairs, depreciation, insurance, rent, rates, taxes, factory telephone, telegram and postage expenses, lighting, heating, advertisement, first aid and hospital expenses.

The above are broadly divided into cash expenses and non-cash expenses. Depreciation on plant, machinery, factory building, notional rent and interest outstanding expenses are the examples of non-cash expenses, whereas amount paid in cash are cash expenses.

Classification by Function

i) Factory or manufacturing overheads

(ii) Administrative or office overheads

(iii) Selling overheads

(iv) Distribution overheads

Overheads can be classified on the basis of the major functions of a business concern as shown below:

(i) Factory or Manufacturing Overheads: This is also known as production overheads or works overheads. Factory overheads represent all the indirect costs, i.e. indirect materials, indirect labour and indirect expenses incurred in connection with production of product or services. Following are the examples:

Indirect Materials: Consumable stores, grease, lubricating oil, cotton waste, loose tools, postages and stationeries used in the production departments, etc.

Indirect labour: Salary of factory supervisor, works manager, store keeper, foreman, etc.

Indirect expenses: Factory rent, factory lighting, factory repairs and maintenance, depreciation of factory building and machines, etc.

(ii) Administrative or Office Overheads: It is the indirect expenditures incurred in formulating poli y, directing the organisation, controlling and managing the operations of an undertaking other than production, selling, distribution, research and development activities.

This represents indirect materials, indirect labour and indirect expenses incurred by the administrative department in the office. Following are the examples of administrative overheads:

Indirect Materials: Cost of printing and stationary used in the office, cleaning materials, water containers, etc.

Indirect labour: Salary of Managing Director, Directors, General Managers, Accountants, Managers, Secretary, other staff of the office, clerks, Legal advisors, etc.

Indirect Expenses: Office rent, lighting, rates and taxes, Repairs, Insurance and depreciation of office building, furniture or equipment’s, telephone expenses, legal charges, bank charges, etc.

(iii) Selling Overheads: Selling overheads represent those costs which are incurred for promoting sales, stimulating demands and facilitating selling of an organisation. In other words, this includes the indirect costs which are associated with marketing and selling and advertising activities. Following are the examples of overheads of sales department and sale management:

Indirect Materials: Printing and stationary used in sales department, catalogue free gifts, etc.

Indirect labour: Salary of sales manager, sales officers, other staff of sales department, commission to agents, etc.

Indirect expenses: Rent, rates and taxes of sales showroom, repair, maintenance, depreciation of sales office building, equipment and furniture, sales office telephone expenses lighting, heating of sales office, advertisement, bad debt, travelling expenses of salesman, etc.

(iv) Distribution Overheads: Distribution overheads represent those costs which are incurred from the time the product is completed in the factory until it reaches ultimate consumers.

It includes packing expenses, storage expenses and transportation expenses. In other words all indirect materials, indirect labour and indirect expenses incurred by distribution departments are known as distribution overheads. Following examples will make it clear.

Indirect material: Printing and stationary used in distribution office, secondary packing materials, etc.

Indirect labour: Salary to staff attached to distribution office, vehicle driver, coolie, etc.

Indirect expenses: Rent, rates, taxes in the ware house go down, repairs, maintenance, insurance, depreciation of warehouse go down, equipment, furniture, delivery van of distribution office, telephone expenses of distribution office, lighting, heating, cleaning of distribution office, etc.

Classification by Behavior / Variability

Overheads can be classified on the basis of their tendency to vary with the volume of production or sales or activity level. Behavior-wise, the overheads are grouped as under:

(i) Fixed overheads.

(ii) Variable overheads.

(iii) Semi-variable overheads.

(i) Fixed Overheads:

Fixed overheads are those indirect costs which do not change inspired of the change in levels of production up to a given range? In other words, if the level of output goes up or comes down these overheads remain constant.

For instance the salary of a manager or the rent of a building does not vary even if we increase or decrease the volume of production.

Fixed overheads are also known as period cost, policy cost; stand by cost or shutdown cost. The examples fixed overheads are rent of building, plant and machinery; depreciation of building, plant and machinery; salary of Directors, Managers, clerks, accountants, office expenses such as postages, printing, stationary, bank charges legal fees, etc.

It is very important to note that the fixed overheads although remain fixed for a particular level of output, they are not wholly fixed in nature. When a business firm increases its capacity, it has to arrange additional fixed costs such as building, plant, machinery, etc. and this will result in more fixed overheads.

The following graph shows the behavior of fixed overheads:

Total Fixed Overheads

Fixed Cot per unit

Units of Production

The specialty of fixed overhead cost is that the total fixed overheads remain same as all levels of output within a certain range. This line is parallel to the ‘X’ axis. But the fixed overhead per unit varies with the level of production. That means when production level increases the unit fixed overhead decreases and vice versa.

(ii) Variable overheads:

Variable overheads are those indirect costs which vary in direct proportion to the’ volume of output. In other words, when the output increases the total variable overheads increases proportionately and vice versa. But the variable overhead per unit remains fixed at different levels of activity.

The examples of variable overheads are fuel, power, maintenance, depreciation, lubricants, idle time cost, commission to sales man, spoilage, etc.

The following graph shows the behavior of the variable overheads:

Total variable overheads

Variable overhead per unit

Units of Production

(iii) Semi-Variable overheads:

Semi-variable overheads are those indirect costs which remain constant to a certain extent and proportionately vary thereafter.

These overheads are partly fixed and partly variable. For instance, telephone expenses include fixed charge plus variable charge according to the number of calls. Some, times the sales representatives are entitled to a fixed salary plus a commission beyond a certain level of sales. This is a semi-variable overhead. The examples of semi variable overheads are repairs, maintenance, depreciation of plant and machinery, telephone charges.

The graph of semi-variable overhead is shown below to indicate its behavior:

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