The overhead cost chapter in a business or accounting context typically deals with expenses that are incurred in the operation of a business but cannot be directly attributed to specific products or services.

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COST
ACCOUNTING
UNIT-4
OVERHEADS

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OVERHEAD COST

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Meaning of Overhead
• Overhead refers to indirect costs that are not
directly tied to the production of a specific
product or service.
• These costs are incurred in the overall operation
of a business and are essential for its
functioning, but they cannot be easily traced to
a specific product, service, or cost center.
• Overhead costs are typically allocated or
apportioned to products or services based on
predetermined methods.

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1.Indirect Labor Costs: Wages and salaries of employees who are not
directly involved in the production process, such as supervisors, maintenance
staff, and quality control personnel.
2.Indirect Material Costs: The cost of materials that are necessary for the
production process but are not directly incorporated into the final product.
This can include items like lubricants, cleaning supplies, or small tools.
3.Utilities: Costs associated with the use of facilities, such as electricity,
water, and heating.
4.Depreciation: The allocation of the cost of tangible assets (e.g., machinery,
buildings) over their useful life.
EXAMPLES OF OVERHEAD COST

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5. Rent: The cost of leasing or renting facilities used in production or
administrative activities.
6. Insurance: Costs associated with insuring business assets, employees, or
against specific risks.
7. Taxes: Certain taxes, such as property taxes on facilities, may be
considered overhead costs.
8. Maintenance and Repairs: Costs associated with maintaining and
repairing equipment and facilities.
9. Administrative Costs: Salaries and expenses related to administrative
functions, such as management, finance, and human resources.
10. Depreciation: The systematic allocation of the cost of long-term assets
over time.
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CLASSIFICATION OF OVERHEAD
1.Manufacturing Overhead:
a. Indirect Materials: Materials that are necessary for the production process but are
not directly traceable to a specific product. Examples include lubricants, cleaning
supplies, and small tools.
b. Indirect Labor: Labor costs associated with employees who are not directly
involved in the production of goods. This includes salaries of supervisors, janitors,
and maintenance personnel.
2.Administrative Overhead:
a. Office Supplies: Costs associated with consumable items used in administrative
activities, such as pens, paper, and printer cartridges.
b. Salaries and Wages: Compensation for employees working in administrative roles,
including executives, accounting staff, and human resources personnel.

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3. Selling Overhead:
a. Sales and Marketing Expenses: Costs related to promoting and selling products or
services, such as advertising, sales commissions, and marketing campaigns.
b. Distribution Costs: Expenses associated with delivering products to customers,
including shipping, warehousing, and distribution.
4. Fixed Overhead:
a. Rent and Utilities: Costs for facilities and utilities that remain relatively constant
regardless of the level of production or sales.
b. Insurance: Premiums paid to cover various types of insurance, including property
insurance and liability insurance.
5. Variable Overhead:
a. Utilities: Costs related to the consumption of utilities that may vary with the level
of production, such as electricity and water.
b. Overtime Pay: Additional labor costs incurred during periods of increased
production.
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6. Research and Development (R&D) Overhead:
a. R&D Expenses: Costs associated with research and development activities,
including salaries of R&D personnel, laboratory supplies, and equipment.
7. Depreciation:
a. Depreciation Expenses: The allocation of the cost of long-term assets over their
useful life. It represents the wear and tear of assets used in the business.
8. Taxes and Licenses:
a. Property Taxes: Taxes levied on business properties.
b. Business Licenses: Costs associated with obtaining and renewing licenses required
for business operations.
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Accounting and Control of Manufacturing
Overheads
1.Collection of Manufacturing Overheads:
This involves gathering information about all indirect costs incurred
during the manufacturing process. This can include both variable and
fixed overhead costs.
2.Allocation of Manufacturing Overheads:
After collecting the overhead costs, they need to be directly assigned or
allocated to specific cost centers or production departments. For example,
rent and utilities may be allocated based on the square footage used by
each department.
3. Apportionment of Manufacturing Overheads:
Some overhead costs are common and cannot be directly attributed to a specific
department. Apportionment is the process of dividing these common costs among
different departments or cost centers. This is typically done using a suitable basis,
such as machine hours, labor hours, or production volume.
4. Re-apportionment of Manufacturing Overheads:
In some cases, after the initial apportionment, it may be necessary to re-allocate
certain overhead costs among departments to reflect more accurate usage. This is
known as re-apportionment and is done to ensure that each department bears a fair
share of the common overhead costs.
5. Absorption of Manufacturing Overheads:
Absorption refers to the process of including overhead costs into the cost of a product.
This is usually done by applying a predetermined overhead absorption rate to the
actual production volume. The absorption rate is calculated based on the estimated
overhead costs and the estimated activity level (e.g., machine hours or labor hours).
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Primary and Secondary Overheads
• These are directly related to the
manufacturing or production
process.
• Examples include the cost of factory
rent, utilities, depreciation of
machinery, and direct labor
supervision in the production area.
• These costs are considered primary
because they are directly tied to the
production of goods or services.
Primary Overhead Secondary Overhead
• Secondary distribution overhead, also
known as service department overhead,
these are indirect costs associated with the
overall management and administration of
the business.
• Examples include salaries of
administrative staff, office supplies, and
general administrative expenses.
• While not directly tied to the production
process, these costs are necessary for the
overall functioning of the business.
Absorption of Overheads
• Absorption of overheads refers to the process of allocating and
apportioning indirect costs or overhead costs to the products or
services produced by a business.
• Overheads are indirect costs that cannot be directly traced to a specific
product or service. Instead, they are incurred for the overall operation of
the business.

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Methods of Absorption of Overheads
1. Percentage of Direct Wages/Cost of Direct Labor:
In this method, overhead costs are absorbed based on the percentage of direct wages or
the cost of direct labor. The assumption is that the level of direct labor is directly
proportional to the incurrence of overhead costs.
2. Percentage of Prime Cost:
Prime cost includes direct materials, direct labor, and direct expenses. Overheads are
absorbed as a percentage of the total prime cost. This method is simple and easy to
apply.
3. Percentage of Works Cost:
In this method, overhead costs are absorbed as a percentage of the total cost of
production, including direct materials, direct labor, and factory expenses. This method
is useful in industries where the production process is continuous.
4. Machine Hour Rate:
Overheads are absorbed based on the number of machine hours utilized in the production
process. This method is suitable for industries where machinery usage is a significant factor in
determining overhead costs.
5. Labor Hour Rate:
Overheads are absorbed based on the number of direct labor hours worked. This method is
appropriate when labor is a major contributor to the incurrence of overhead costs.
6. Production Unit Method:
Overheads are absorbed based on the number of units produced. This method is also known as
the per-unit rate or production unit rate. It is straightforward and easy to understand.
7. Activity-Based Costing (ABC):
ABC is a more sophisticated method that allocates overhead costs based on the actual
activities that consume resources. It identifies cost drivers and allocates overhead costs to
products or services based on the consumption of these drivers.
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Basis of Apportionment
Machine Hour Rate (MHR)
• Machine Hour Rate (MHR) is a method used
by manufacturing companies to allocate or
spread the total cost of operating machines
or equipment over the number of machine
hours utilized in production.
• This rate is helpful in determining the cost of
manufacturing a product or providing a
service based on the machine usage.

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Machine Hour Rate Basis of Apportionment
Format of
Machine Hour
Rate

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PROBLEMS
A. Problems on Overheads
1. Primary Distribution
2. Secondary Distribution
B. Problems on Machine Hour Rate (MHR)
For Problems and Solutions
refer class notes and pdf notes