Cost pertaining to a cost centre or cost unit may be divided into two portions direct and indirect. The indirect portion of the total cost constitutes the overhead cost which is the aggregate of indirect material cost, indirect wages and indirect expenses.
CIMA defines indirect cost as “expenditure on labour, materials or service which cannot be conveniently indirect with a specific saleable cost per unit.”
Indirect costs are those cost which is incurred for the beefier of a number of cost centres or costs unit. Indirect cost, therefore, cannot be conveniently identified with a particular cost centre or cost unit but it can be apportioned to or absorbed by cost centres or cost units. Broadly speaking, any expenditure over and above prime cost is known as overhead.
In general terms, overhead comprise all expenditure incurred for or in connection with the general organisation of the whole or part of the undertaking i.e. the cost of operating supplies and services used by the undertaking including the maintenance of capital assets. The terms burden’ ‘supplementary cost’ ‘on cost’ indirect expenses are used interchangeably for overhead.
Types of Overheads
Overheads can be classified into three parts:
a. Production Overhead: It refers to the indirect expenses incurred at the site of production or factory. For example oil and grease for machinery.
b. Administration Overhead: It refers to the office expenses like salaries, rent of the office and any other expenses pertaining to the office and administration. Salary of the factory manager will not be put in this category.
c. Selling and Distribution Overhead: There are some expenses that are necessary to incur in order to make sales and deliver the products to the buyer. For example packaging cost, transportation cost, so on and so forth. In the nutshell, it refers to the advertising and distribution cost etc.