Definition
Indirect Overhead is a type of indirect cost that cannot be directly traced to the production of specific goods or services. Instead, these costs are incurred to ensure the overall operation of the business. Examples include rent, utilities, and managerial salaries that are essential for keeping a manufacturing plant operational but do not directly contribute to the production of a saleable item.
Examples
- Rent on a Manufacturing Plant: The cost incurred for leasing the manufacturing plant is an indirect overhead, as it supports the production environment.
- Utility Expenses: Expenses related to electricity, water, and heating in the production facility are categorized as indirect overhead since they support the overall manufacturing process.
- Depreciation: The depreciation of machinery and equipment in a manufacturing facility is considered an indirect overhead expense.
- Managerial Salaries: Salaries for non-production staff, such as administrative and managerial personnel, are classified as indirect overhead.
Frequently Asked Questions
What distinguishes indirect overhead from other indirect costs?
Indirect overhead is specifically related to general business expenses necessary for operation but not directly tied to any specific product or service. In contrast, other indirect costs, such as indirect materials or indirect labor, may still be associated with the production process, albeit not directly.
Can indirect overhead be applied to services?
Yes, indirect overhead can apply to service-based businesses as well. For example, rent, utilities, and administrative salaries in a consulting firm or healthcare facility are considered indirect overhead.
Are marketing expenses considered indirect overhead?
No, marketing expenses are generally categorized separately from overhead costs, although they are indeed indirect costs. They are not classified as overhead because they do not support the day-to-day operational capacity but aim to promote sales and company growth.
How is indirect overhead allocated in accounting?
Indirect overhead is typically allocated using various cost drivers or allocation bases such as labor hours, machine hours, or square footage, depending on the most appropriate measure for distributing these expenses across different departments or products.
Why is it important to correctly identify and allocate indirect overhead?
Proper identification and allocation of indirect overhead are crucial for accurate product costing, budgeting, and financial reporting. This ensures that each product in a multi-line facility or each service in a service-based business is accurately reflected in its true cost, aiding in more precise pricing and financial decision-making.
Related Terms
- Overhead Costs: All ongoing business expenses not related directly to creating a product or service. Overhead costs include both indirect overhead and other indirect costs.
- Indirect Costs: Costs that cannot be directly attributed to the production of a specific product or service, including indirect overhead, indirect materials, and indirect labor.
- Direct Costs: Costs that can be directly attributed to the production of specific goods or services, such as raw materials and direct labor.
- Variable Overhead: Overhead costs that vary with production output, such as utility costs based on machine usage.
- Fixed Overhead: Overhead costs that remain constant regardless of production output, such as rent or salaried personnel.
Online References
Suggested Books for Further Study
- “Managerial Accounting” by Ray H. Garrison, Eric W. Noreen, and Peter C. Brewer
- “Cost Accounting: A Managerial Emphasis” by Charles T. Horngren, Srikant M. Datar, and Madhav V. Rajan
- “Principles of Cost Accounting” by Edward J. Vanderbeck and Maria R. Mitchell
Fundamentals of Indirect Overhead: Cost Accounting Basics Quiz
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