Overhead refers to the total cost of indirect materials, indirect labour and indirect expenses. Indirect costs are those which cannot be identified with the production of some specific goods or services. These costs are incurred for the organization as a whole.
Overhead allocation occurs when an overhead can be identified as belonging to a specific cost centre and is charged to that centre. Therefore there is no need for apportionment of such overheads.
Overhead apportionment occurs when overheads cannot be identified as belonging to a specific cost centre and are therefore shared out on an equitable basis. Overheads though not directly related to the items being manufactured, should finally form part of the total cost of the products being manufactured. If an organization has two or more departments each carrying out a separate activity, then the overheads of the organization should be divided among these departments equitably. The process of sharing the overhead costs between products or departments or divisions in an organization is referred to as appointment of overheads. The initial distribution of overheads that is done to all departments, whether production or service departments, is called primary distribution of overheads. Bases of overhead appointment This refers to the logic for sharing a common overhead cost between various departments or products within the organization. The most common bases of overhead apportionment include:
- Base: Overhead to which the base may apply
- Floor area: Rent, rates, heat and lighting costs, depreciation of buildings, maintenance of building, insurance of buildings etc.
- Book value of assets: Maintenance and repairs of plant and machinery, insurance of plant and machinery etc.
- Number of employees: Expenses of personnel canteens, welfare expenses, safety expenses, supervision expenses etc.
- Weight of material: Material handling expenses, packaging expenses.
- Sales value: Advertisement costs, selling and distribution costs etc
- Technical estimates: Power consumption, water usage etc.
- Direct wages: Staff training expenses, provident fund contributions etc.