Overhead
Definition:
Overhead is a type of indirect cost that is not directly related to the production or sale of a product, but is necessary for the company’s operations. These costs include items such as rent, depreciation, interest expense, and depreciation.
Examples of Overhead Costs:
- Rent
- Depreciation
- Interest expense
- Utilities
- Insurance
- Depreciation of equipment
- Employee salaries for administrative staff
Types of Overhead Costs:
- Fixed overhead: Costs that remain relatively constant regardless of the volume of production or sales, such as rent, depreciation, and interest expense.
- Variable overhead: Costs that fluctuate based on the volume of production or sales, such as utilities, raw materials, and employee salaries.
- Mixed overhead: Costs that are a combination of fixed and variable overhead, such as depreciation of equipment and salaries of administrative staff.
Treatment of Overhead Costs:
Overhead costs are typically accounted for separately from direct costs and are used to calculate the company’s overhead rate. The overhead rate is then used to allocate overhead costs to specific products or services.
Impact of Overhead Costs:
Overhead costs can have a significant impact on a company’s profitability. High overhead costs can reduce the company’s ability to compete effectively in the market. Conversely, low overhead costs can improve the company’s profitability.
Examples:
- A company with high overhead costs may have difficulty competing with companies that have lower overhead costs.
- A company that reduces its overhead costs can increase its profitability.
Conclusion:
Overhead costs are an important part of a company’s accounting system. By understanding the different types of overhead costs and how they are treated, companies can better manage their finances and make informed decisions about their operations.
