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Sunday, 7 March 2010

Accounting Terms - Overheads

In accounting, overheads refer to indirect costs that are charged to production and other functions or departments. Indirect costs are those that are not fully attributable to a product, service or department. They apply to materials, wages/labour and expenses. As such, it follows that there are indirect materials, indirect wages and indirect expenses for different functions departments that relate to those categories.

== Production overhead ==

Production overheads are also known as factory overheads. These cover indirect costs that are incurred during the completion of a product or provision of a service. Factory overheads include materials that are too negligible in terms of charges or quantity for cost tracing. For example, if you are using 8 screws that cost 50 cents per screw, that amount might be immaterial in relation to other charges associated with the product manufactured.

The commissions or wages of non-productive workers are also part of production overhead. However, if a supervisor does not actually work on the product, he is productive if his salary/wages are directly traceable to a product, service or department. Indirect expenses are another dimension of production overheads. Examples of those include depreciation of equipment and plant maintenance.

== Administrative overhead ==

In producing a product, an entity will have expenses related to administrative personnel and processing costs-such as stationery. Salaries of office staff and insurance for the business premises are additional overheads that relate to administration.

== Distribution overhead ==

A product or service must reach clients and there are charges attached to packaging and delivering the goods. Distribution overheads deal with aspects of the completed product and do not include transport fees to other plants before the product is finished. Transport costs, containers or boxes for shipment, wages for drivers, warehousing and insurance for stock are some examples of distribution overheads.

== Selling overhead ==

Businesses need to advertise their product or service and maintain their clientele. Indirect costs incurred in doing this constitute selling overhead. Material costs for this function include flyers, brochures and website fees. Labour charges include salaries, commissions and wages for salesmen, clerks and customer service representatives. Expenses including advertising, market research and rent/insurance for showrooms.

Production overhead forms part of production costs. However, overheads in other areas constitute costs that are separate from production costs but included in the TC. The equation for total costs is as follows:

TC = Prime Cost + Production overhead + Other overheads

While overheads refer to indirect costs, prime cost refers to the total of direct material, wages and expenses.

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