Overhead Cost
What Are Overhead Costs
Overhead costs are the ongoing expenses associated with running a business that cannot be directly linked to producing a specific product or service. These costs are essential for the day-to-day operations of a company but do not directly generate revenue. Examples include rent, utilities, administrative salaries, and office supplies. Overhead cost is critical for keeping the business functional and supporting all activities, whether the company is manufacturing products, providing services, or performing other business operations.
Types of Overhead Costs
The overhead costs can be categorized into three main types: fixed, variable, and semi-variable overhead costs.
- Fixed Overhead Costs
These are expenses that remain constant regardless of the level of production or sales, such as rent, salaries of permanent staff, and insurance.
- Variable Overhead Costs
These costs fluctuate with the level of business activity, such as utility bills, office supplies, and shipping costs.
- Semi-Variable Overhead Costs
These expenses have both fixed and variable components, like a base salary plus commission or a fixed monthly phone bill with additional charges for extra usage.
How to Calculate Overhead Costs
Divide the total overhead costs by the chosen allocation basis to determine the overhead rate. The formula is:
Overhead Rate=Total Overhead Costs/Allocation Basis.
To calculate overhead costs, first, list all the expenses that fall into the overhead category, including fixed, variable, and semi-variable costs. Summing these expenses gets the total overhead cost. Then, dividing the total overhead cost by the total direct costs (such as direct labor and materials) or by a relevant activity base (like machine hours or labor hours) determines the overhead rate. This rate helps allocate overhead costs to specific products or services, providing a clearer picture of total production costs.
