Q.Explain the classification of overheads on the basis of
Overhead is classified in several ways for different purposes; the two asked for here are the most important.
(a) Classification by function groups overhead by the part of the business in which it arises:
- Factory (works / production) overhead — indirect costs of the factory: factory rent, power, depreciation of plant, works manager's salary, factory lighting, indirect material and indirect factory wages.
- 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 getting and fulfilling orders: advertising, salesmen's salaries and commission, carriage outward, warehouse rent, depreciation of delivery vehicles.
This classification is used to build up the cost sheet in stages — prime cost, then works (factory) cost, then cost of production, then cost of sales.
(b) Classification by behaviour (variability) groups overhead by how it responds to a change in the volume of output:
- Fixed overhead — remains the same in total whatever the output, within a range: factory rent, insurance, managerial salaries. Its cost per unit falls as output rises.
- Variable overhead — changes in total in direct proportion to output: power for machines, indirect material, consumable stores. Its 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, and supervision.
This classification is essential for cost control, marginal costing and break-even analysis, because it separates the costs that change with activity from those that do not.
By function, overhead is classified into factory (works) overhead, office & administration overhead and selling & distribution overhead. By behaviour or variability, it is classified into fixed overhead (constant in total), variable overhead (varying in direct proportion to output) and semi-variable overhead (partly fixed and partly variable).
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