Overhead costs definition
/What are Overhead Costs?
Overhead costs are any expenditures not directly associated with the creation of a product or service. They must be incurred in order to stay in business, irrespective of the sales level of the organization. Overhead costs are any operational expenses stated in a company’s income statement that are not directly associated with the cost of goods or services. Thus, the cost of the manufacturing supervisor, materials handling staff, and facility rent are all classified as overhead costs, while the costs of direct materials are not overhead costs.
Examples of Overhead Costs
The exact types of overhead costs incurred will vary by business. For example, the overhead costs incurred by a casino will vary dramatically from those incurred by a manufacturer of sports equipment. Common examples of overhead costs found in many businesses are as follows:
Administrative compensation
Bank fees
Insurance expense
Manufacturing supplies
Office supplies
Rent expense
Supervisor compensation
Utilities expense
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How to Manage Overhead Costs
It is essential for management to monitor overhead costs at all times, since they can bleed off profits. There tends to be a lower level of oversight for overhead costs, so they can linger within a business, even when they are no longer needed. For example, a business might have rented too much office space, and should sub-lease it whenever the activity level of the business declines. Or, a firm invests in an expensive copier machine, despite experiencing relatively low photocopying volumes. A quarterly review of overhead costs is recommended, to ensure that these costs do not get out of hand.
Types of Overhead Costs
There are three types of overhead costs, which are fixed, variable, and semi-variable, as noted next:
Fixed overhead costs. Many overhead costs are fixed in nature, which means that they do not change with the volume level. For example, the salary of the production manager will not change even when there are significant changes in the number of units produced.
Variable overhead costs. Some overhead costs will change with unit volume, such as manufacturing supplies and the cost of electricity for a production facility; these costs cannot be tied to specific units produced, but still vary with volume levels.
Semi-variable overhead costs. It is possible for overhead costs to arise even in the absence of unit volume, but to increase further when unit volumes increase; these are called semi-variable overhead costs.