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Process of Classification of Overheads | Basis of Overhead Classification

Process of Classification of Overheads
Process of Classification of Overheads

Classification of Overheads

The process of classification of overheads involves:

(a) The determination of the classes or groups in which the costs are sub-divided.

(b) The actual process of classification of the various items of expenses into one or another of the groups.

The number of overheads are too much and it is difficult to determine how much amount has been spent on particular item in the period.

Overheads are classified into a number of specified heads so that items of expenses of a similar nature may be grouped together under one head.

The process of classification of overheads endure depends upon die type and size of a business and the nature of the product or service rendered:

Also Read- What is Overheads | Bases For Allocation of Expenses to Departments

Generally overheads are classified on the following basis:

1. Nature or Element-wise Classification.

2. Function-wise Classification.

3. Normality-wise Classification.

4. Control-wise Classification

5. Variability or Behavior-wise Classification.

(1) Nature or Element-wise Classification 

Based on its elements, overhead is classified in the following

(i) Indirect Materials.

(ii) Indirect Labour.

(iii) Indirect Expenses.

Also Read- Meaning of Collection Allocation | Apportionment of Overhead Expenses

(2) Function-wise Classification

Overheads can be divided into the following categories on functional basis:

(i) Factory Overheads

(ii) Office and Administration Overheads

(iii) Selling Overheads

(vi) Distribution Overheads

(3) Normality-wise Classification

Based on its normality, overhead is classified in the following two categories:

(i) Normal overheads

It is the overhead at a given level of output in the condition at which that level of output is normally achieved. These overheads are included in the production cost of commodities.

(ii) Abnormal overhead

It refers to those overheads which are expected to be incurred in attaining given output For example, cost of abnormal idle time, fire, theft, breakdown of machine, strike or lock out, etc. Such costs are charged to costing profit & loss account, not included in cost.

Also Read- What is Primary Distribution of Overheads | Definition

(4) Control-wise Classification

It can be divided into two parts-

(i) Controllable overheads: If refers to those overheads which can be controlled by management action at the point of their incurrence. The variable costs fall under this category.

For example, cost of materials may be controlled by purchasing in economic lots, seasonal purchasing, etc.

(ii) Uncontrollable overheads: It refers to those overhead which cannot be controlled by management at the point of their incurrence. The fixed costs ate fall under this category because they are not influenced by managerial action.

(5) Variability or Behavior-wise Classification

Based on the variability patterns overheads can be classified into the following categories

(i) Fixed overheads

It refers to those expenses which remain fixed in total amount with increase or decrease in volume of output for a particular period of time, e.g., rent of building, salary of manager, insurance of assets, etc.

Also Read- What is Re-Apportionment of Service Departments Overheads | Basis of Re-Apportionment

Fixed overhead costs remain the same from one period to another except when they are deliberately changed, e.g., increments granted to staff. The incidence of fixed overhead on unit cost decreases as production increases and vice-versa.

In a hypothetical organization no expenditure remains unchanged for all time. Therefore, it is true to state that “fixed overhead is fixed within specified limit relating to time and activity.”

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