Classification of Overheads

Because overhead is such a large and varied group of costs, it is classified in several different ways, each useful for a different purpose — controlling costs, fixing prices, or preparing cost sheets. A single item of overhead can appear under more than one classification at the same time (factory rent, for example, is a production overhead by function and a fixed overhead by behaviour).

1. Classification by function (the most important). This groups overhead by the part of the business where it arises:

• Factory (works / production / manufacturing) overhead — indirect costs of the factory: factory rent, power, depreciation of plant, works manager's salary, factory lighting, indirect material and indirect wages of the works.
• Office and administration overhead — indirect costs of running the general office: office rent, salaries of office staff, printing and stationery, audit fees, postage.
• Selling and distribution overhead — indirect costs of securing orders and delivering goods: advertising, salesmen's salaries and commission, carriage outward, warehouse rent, depreciation of delivery vans.

2. Classification by behaviour (variability). This groups overhead by how it responds to a change in the volume of output:

• Fixed overhead — remains the same in total whatever the level of output, within a range: factory rent, insurance, managerial salaries. Fixed cost per unit falls as output rises.
• Variable overhead — changes in total in direct proportion to output: power for machines, indirect material, consumable stores. Variable cost per unit stays roughly constant.
• Semi-variable (semi-fixed) overhead — has both a fixed and a variable part: a telephone bill (fixed rental + variable call charges), repairs and maintenance, supervision.

3. Classification by element. This follows the three elements already met — indirect material, indirect labour and indirect expenses.

4. Classification by normality. This groups overhead by whether it was expected:

• Normal overhead — the overhead normally expected at a given level of output; treated as part of the cost of production.
• Abnormal overhead — overhead not normally expected (cost of an idle plant during a strike, loss from a fire); charged to the Costing Profit and Loss Account, not to the product.

The table below summarises the four bases of classification.