Reviewed by Sep 30, 2020| Updated on
Overhead refers to a business expense which remains fixed in nature. Overheads do not increase or decrease with an increase or decrease in the production or manufacturing of goods or provision of services.
It is important to determine the overhead costs while drawing up the budget of an organisation. Inclusion of overhead helps determine the actual cost of production of the products.
The expenses incurred on overheads are ongoing in nature but do not include the costs directly associated with the production of a product. Some times, the overhead costs may be variable or fixed or semi-variable in nature.
Overheads are essential to keep the factory place, maintain the security of the premises, salaries for the administrative staff and other administration expenses.
Overhead costs are reported separately in costing statements to do a costing analysis. Costing statements help understand the contribution of various costs to the production cost of a product.
While arriving at the profit or loss of an organisation, overhead costs are included in the general or specific expense heads, such as building rent, insurance expense on the building, machinery, staff, etc.
The quantum of overhead expenses affects the profits of a business. The income or profits are determined after reducing the fixed and variable costs of a business.
The organisation’s turnover, also known as topline, should be reduced by production, administrative and marketing overheads and other variable costs such as selling and distribution costs, to arrive at the profit or loss.
An organisation may allocate overheads to different products or different departments based on the consumption or use by each department. The ratio may be in a number of production hours or the number of units.
Certain overheads may be semi-variable which consist of a base cost and incremental costs for incremental usage. Semi-variable overheads are also allocated based on consumption or use.
In a general sense, overheads are the management and administrative expenses incurred such as the human resources department for hiring and managing labour policies, building security and housekeeping, facility maintenance, rent, among others.
In marketing and distribution, overheads may include fixed costs of advertisements in print and electronic media, deposits for the display of products at retail outlets and so on. Overhead costs need to be identified and allocated to arrive at the profit or loss of the business.