ACCOUNTING FOR OVERHEADS

Accounting for Overheads

Accounting for Overheads

Introduction

In Cost and Management Accounting the collection and analysis of overheads, their distribution and allotment to different cost centers and absorption to units manufactured or services plays a vital role in deciding the cost and finding measures to control the costs. A proper system of better allocation of overheads can just make sure greater accurateness in determination of cost of services or products.

Overheads can be classified on account of functions to which the overheads are associated with:

- Production overheads

- Distribution overheads

- Selling overheads

- Administrative overheads

Overheads can also be categorized by their behavior such as variable overheads, semi-variable overheads and fixed overheads. Variable overheads can be referred to as expenses which vary in line with the change in volume of production. Such as, cost of utilities etc. Fixed overheads may be explained as expenses whose value remains unchanged when the production volume changes such as salaries, rent etc. Semi-variable overheads are those which are to a certain extent affected when the production volume changes. They are moreover divided into fixed and variable overheads. Any items of overheads arising out of abnormal situation in business activity should not be treated as overheads. They are charged to Costing Profit and Loss Account. Items not related to business activities such as donation, loss / profit on sale of assets etc are also not to be treated as overheads. Borrowing cost and other financial charges including foreign exchange fluctuations will not form the part of overheads. (Hall, 1999, 12-45)

Importance of Accounting for Overheads to Organizations

Every business concern has overheads. Overheads got this name to stand for assets that are essential for running the business, but don't directly add to the net profit. Such as, that building that managers work in is taken as overhead because managers need the building for running their business, but the building does not add directly to the bottom line. The buildings have the call center and house the staffs who bring in such consignments that do add to the bottom line directly.

A building is clearly overhead, but how to account for more slight things, such as when the staffs exercise their efforts on activities that don't add value. They might spend a large amount of time upon administration that might or might not actually be needed. This kind of issues sneak in to a company or business the as its size grows.

The overhead's issue is that they are inevitable to control. It is easy for a business concern to be involved too much in programs that do not add value, managers and assets that add nothing directly to the net income. Before the managers know it, their company is stuck with heavy expenses in their financial statements. (Geroski, 2005, 369-386)

Various approaches to Accounting for Overheads

Absorption Costing

The overheads are accounted for in the total number of units produced. Or we can say that, every single unit's cost of manufacturing includes the direct labor, the direct material and the overall overheads (both fixed ...