## Overheads — Definition
Overheads are expenses that cannot be directly attributed to any specific cost unit or work order. They are incurred for the overall output of the organisation, not for a particular job or product.
Key Points:
- In some industries, overhead costs can exceed the combined cost of direct labour and materials
- Includes costs of auxiliary facilities that enable production (e.g., boiler house providing steam) but are not part of the final product
- Incurred across all functions: production, administration, selling, and distribution
- Ignoring overheads leads to inaccurate cost estimates and poor expenditure control
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## Classification of Overheads
### 1. By Function
| Type | Definition | Examples |
|---|---|---|
| Factory / Manufacturing Overhead | Indirect costs from material procurement to finished product | Stock keeping, machine repairs & maintenance, factory building depreciation, indirect labour, primary packing, factory insurance |
| Office & Administrative Overhead | Costs of general management and administration (not production/selling/distribution) | Office staff salaries, office building depreciation, postage & stationery, audit fees, operating lease rentals |
| Selling Overhead | Costs of promoting and making sales | Salesmen's commission, advertising, sales office expenses |
| Distribution Overhead | Costs of making product available in the market after production | Delivery van expenses, transit insurance, warehouse costs, secondary packing |
> Manufacturing overhead also includes administration costs relating to production/factory/works.
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### 2. By Nature (Behaviour)
| Type | Behaviour | Examples |
|---|---|---|
| Fixed Overhead | Unaffected by output level within a relevant range | Permanent staff salaries, building & plant depreciation, interest on capital, insurance |
| Variable Overhead | Varies proportionally with activity level | Indirect materials, power & fuel, lubricants, tools & spares |
| Semi-Variable Overhead | Contains BOTH fixed and variable components | Electricity bills, water charges, telephone & internet expenses |
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### 3. By Element
| Type | Definition | Examples |
|---|---|---|
| Indirect Materials | Materials not forming part of the finished product | Lubricants, cotton waste (machine maintenance); stores for boiler house, canteen |
| Indirect Employee Cost | Employee costs that cannot be allocated to specific cost units | Foreman salary, supervisor salary, admin staff salary |
| Indirect Expenses | All other overhead expenses (not materials or labour) | Rates & taxes, insurance, depreciation, advertising |
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### 4. By Controllability
| Type | Definition | Examples |
|---|---|---|
| Controllable Costs | Can be influenced by management action | Materials cost, wages & salary, power & fuel |
| Uncontrollable Costs | Cannot be controlled by management | Rates & taxes, depreciation, interest on borrowings |
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## Why Fixed vs. Variable Classification Matters
1. Cost Control: Variable costs can be managed by adjusting output; fixed (policy) costs are harder to reduce
2. Flexible Budgeting: Enables meaningful estimates at different activity levels
3. Decision Making: Essential for make-or-buy, shutdown decisions, export pricing
4. Marginal Costing & CVP Analysis: Segregation is a prerequisite for break-even analysis and contribution margin calculations