Page 75 - DMGT202_COST_AND_MANAGEMENT_ACCOUNTING

Cost and Management Accounting Manpreet Kaur, Lovely Professional University

Notes Unit 5: Overheads

CONTENTS

Objectives
Introduction
5.1 Classification of Overheads

5.2 Absorption of Overheads

5.3 Under and Over Absorption of Overheads
5.3.1 Under Absorption of Overheads
5.3.2 Over Absorption of Overhead
5.4 Summary

5.5 Keywords
5.6 Review Questions
5.7 Further Readings

Objectives

After studying this unit, you will be able to:

Make classification of overheads
Describe the absorption of overheads
Illustrate under and over absorption of overheads
Introduction

Overhead has been defined by the Institute of Cost and Work Accountants, London as “the

aggregate of indirect material cost, indirect wages and indirect expenses”. By indirect, it means
one “which cannot be allocated, but which can be apportioned to or absorbed by cost centre or
cost unit”. Overheads are those indirect costs which cannot be directly related to any product, job
or process, because they cannot be directly attached to production activities. A major part of the
total cost is overheads. The total cost is divided into: Prime Cost, Factory Cost and Administrative
Cost. Overhead comprises of indirect material, indirect labour and indirect expenses.
Blocker has defi ned the overhead costs as “Operating of a business enterprise which cannot be
traced directly to a particular unit of output”. Overheads are the indirect costs which cannot be
directly allocated to any particular job and production activity or process as they are not capable
of being specifi cally identified to any particular activity.

5.1 Classification of Overheads

The method to be adopted for classification of overhead depends upon the type and size of the
business, nature of product or service rendered and policy of the management. Overhead costs may

be classified according to: (1) Functions, (2) Elements, and (3) Behaviour-wise classifi cation.

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