Overhead Costs in Cost Management

Overhead costs are indirect costs that can’t be traced back to a specific product as well as ongoing administrative expenses that do not generate revenues. These costs do not involve direct labor, direct materials, or direct expenses.

Definition of Overhead Costs

Overhead includes activities that are not directly related to the products or services that the firm offers, but they support the firm’s profit-making activities. For example, paying the rent is not a profit-making activity, but it allows the firm to maintain a building and manufacture its products.

Therefore, the overhead is an important part of business operations, regardless of whether the firm generates a high volume of business or not. Overhead costs can include both fixed and variable costs such as rent, research & development, advertising, office supplies, taxes, interest, depreciation, insurance, and others. It can include pretty much anything that doesn’t go directly into production.

There are essentially 2 types of business overheads: Administrative overheads and Manufacturing overheads.

Overhead Costs

1. Administrative Overhead Costs

Administrative overheads include items such as utilities, strategic planning, and various supporting functions. These costs are treated as overheads due to the fact that they aren’t directly related to any particular function of the organization nor does it directly result in generating any profits. Instead, these costs simply take on the role of supporting all of the business’ other functions.

Examples

  • Employee salaries
  • Office equipment and supplies
  • External legal and audit fees
  • Company cars

2. Manufacturing Overhead Costs

Manufacturing overheads are all costs endured by a business that is within the physical platform in which the product or service is created. Difference between manufacturing overheads and administrative overheads is that manufacturing overheads are categorized within a factory or office in which the sale takes place. Whilst administrative overheads is typically categorized within some sort of back-office or supporting office. Although there are cases when the two physical buildings may overlap, it is the usage of the overheads that separates them.

Examples

  • Employee salaries
  • Depreciation of assets and equipment
  • Rent of factory building
  • Utilities for factory