Define Overheads. What are the various methods of classifying overheads. Discuss functional classification.

Overheads:

Overheads refer to the indirect costs of production that cannot be directly attributed to a specific product, service, or department. These costs are incurred in the day-to-day operations of a business and are necessary for the production process but are not directly involved in the production of goods or services.

1. Methods of Classifying Overheads:

1.1 Nature of Expenses:

• This method classifies overheads based on their nature, such as rent, utilities, salaries, depreciation, etc. It helps in understanding the types of expenses incurred by the organization.

1.2 Function:

• Overheads can be classified based on the functions or activities they support, such as production overheads, administration overheads, selling and distribution overheads, etc. This classification helps in identifying the areas of the business where costs are incurred.

1.3 Behavior:

• Overheads can be classified based on their behavior in relation to changes in the level of activity. This includes fixed overheads, which remain constant regardless of the level of activity, and variable overheads, which vary with the level of activity.

1.4 Controllability:

• Overheads can be classified based on their controllability by management. This includes controllable overheads, which can be influenced or controlled by management, and uncontrollable overheads, which cannot be easily controlled.

1.5 Time:

• Overheads can be classified based on the time period for which they are incurred, such as short-term overheads, which are incurred for a specific period, and long-term overheads, which are incurred over a longer period.

2. Functional Classification of Overheads:

2.1 Production Overheads:

• Production overheads are costs incurred in the manufacturing process that cannot be directly attributed to a specific product. This includes costs such as factory rent, utilities, depreciation of machinery, and indirect labor.

2.2 Administration Overheads:

• Administration overheads are costs incurred in the general administration of the business. This includes costs such as salaries of administrative staff, office rent, office supplies, and other administrative expenses.

2.3 Selling and Distribution Overheads:

• Selling and distribution overheads are costs incurred in selling and distributing products to customers. This includes costs such as sales commissions, advertising, transportation, and warehousing.

2.4 Research and Development (R&D) Overheads:

• R&D overheads are costs incurred in the development of new products or processes. This includes costs such as salaries of R&D staff, materials used in research, and other expenses related to R&D activities.

2.5 Financial Overheads:

• Financial overheads are costs related to the financial management of the business. This includes costs such as interest on loans, bank charges, and other financial expenses.

3. Advantages of Functional Classification:

3.1 Cost Control:

• Functional classification helps in identifying the areas of the business where costs are incurred, allowing management to focus on controlling these costs.

3.2 Performance Evaluation:

• Functional classification helps in evaluating the performance of different functions or departments within the organization. This can help in identifying areas of improvement and making informed decisions.

3.3 Cost Allocation:

• Functional classification helps in allocating overhead costs to the appropriate cost centers or departments based on the functions they support. This ensures that costs are allocated accurately and fairly.

3.4 Decision Making:

• Functional classification provides management with the information needed to make informed decisions regarding cost reduction, pricing, product mix, and resource allocation.

Conclusion:

• Functional classification of overheads is an important tool for cost accounting that helps in identifying, classifying, and allocating overhead costs to different functions or departments within an organization. By understanding the nature and classification of overheads, management can make informed decisions to improve cost control, performance evaluation, and overall efficiency.