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  Classification of Overheads

Introduction to Classification of Overheads

Overheads may be categorized as per to their nature, variability, function and a number of other characteristics. The classification can be shortened as follows:

According to nature

(i) Indirect Material.

(ii) Indirect Labour.

(iii) Indirect Expenses.

According to normality

(i) Normal overheads.

(ii) Abnormal overheads.

Normal overheads consider to such overheads that are supposed to be incurred in attaining a specified output. These overheads are not avoidable. So they are involved in production costs.

Abnormal overheads consider to those overheads costs that are not supposed to be incurred in attaining a specified output example cost of abnormal idle time. Such types of costs are charged to costing profit and loss account.

According to controllability

(i) Controllable overheads.

(ii) Uncontrollable overheads.

Controllable overheads are those that can be controlled through executive action at the point of their incurrence. Overheads that are not so controllable are known as uncontrollable. For instance, cost of power employed in a specific department can be controlled through the departmental manager, although the share of general lighting costs in the factory to be borne through his department cannot be controlled through him. The for merits, so controllable item of overheads when the later is an uncontrollable item so far like the departmental manager is concerned.

According to variability

Fixed overheads: These costs are not influenced in monetary terms during a specific period via a change in output. But this will be right only when the change in production is not considerable. If the change in output is considerable these will also raise and will stay constant after such type of increase till a specific level of activity is attained. The instances of such types of costs are - rent and rates; plant and fittings, insurance of buildings, salaries etc.

Variable overheads:

 These costs change in similar ratio where the output changes. The instances of such types of costs are power, selling commission etc.

Semi-variable overheads:

 These costs are partially fixed and partially variable. They do not alter in the same ratio in which the output changes. The instances of such types of costs are depreciation, cost of maintenance and repairs etc. In case the factory output is doubled, the depreciation would not generally be doubled, it might increase with 50% only like the amount of depreciation depends upon

(i) efflux of time and

(ii) Wear and tear. That part of depreciation that is because passage of time is fixed, when that part which is because wear and tear is variable, and so that depreciation is a semi-variable expense.

The difference among fixed and variable overheads is beneficial from the following angles

1. Difference among fixed and variable overheads is to be preserved for estimation of costs at dissimilar levels of activity. So, it helps in preparation of the flexible budgets.

2. If costs are to be controlled, it must be known which costs and through whom they can be controlled. Fixed overheads are policy costs' and are mainly not controllable. If any control is to be exercised, it can be completed only through the top management. Variable overheads can, though, be controlled at lower levels.

3. Some significant management decisions cannot be accurately taken unless a distinction is made among fixed and variable overheads. For an instance, decisions considering fixation of price throughout depression or for export or discontinuance of the slightest profitable product etc need consideration of fixed and variable overheads alone.

4. The methods profit volume relationship and break-even analysis principally need separation of fixed and variable overheads.

According to function

(i) Factory overheads.

(ii) Administration overheads.

(iii) Selling and distribution overheads.

It is to be noticed that it is similar overhead although we classify it in dissimilar ways to suit our own purpose. For instance, rent of the factory is an item of Factory Overhead. It might also be categorized like Fixed Overhead while the methods of marginal costing are employed. Likewise, when classifying overheads as per to their nature it will be put as an item of indirect expense.

The functional division of overhead is the predictable technique of classifying overheads in order to determine the cost of each main function with the final objective of controlling costs and submission of income statements.

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