It’s important to set up a general framework before developing diversity strategies and specific plans for different situations.
The way indirect factors are allocated in a company should be practical and purposeful. If you accurately account for the direct costs of a specific product or service in the accounting system, you can figure out the real cost of running the business.
On the other hand, overhead costs are extra expenses not directly linked to making or providing specific goods or services. These include organizational and production management expenses, which need to be carefully distributed based on chosen methods.
Legislative Definition of Overhead
The idea of “overhead costs” isn’t specifically defined in the rules for accounting. This term is more about management accounting than regular accounting. It’s related to estimating the costs of building, renovation, and maintenance of construction facilities, as well as work to maintain cultural heritage sites. It’s not officially approved by law but comes from cost management practices.
What Is Included in The Overhead?
Each organization independently determines which expenses cannot be directly attributed to the cost of production but are incurred during the production of goods or services.
Typically, overhead costs include salaries for administrative, managerial, and general production personnel, insurance premiums for the Pension Fund, depreciation of fixed assets not directly used in production, maintenance and repair costs for such assets, and rent for non-production facilities like offices or general production premises.
Overhead Allocation
As mentioned earlier, overhead costs cannot be directly assigned to a specific product, project, or service. Therefore, they need to be allocated to the cost of goods sold each month (or at the end of another designated period) using a reasonable allocation method laid out in the accounting policy.
So, you can allocate overhead costs to the cost price in proportion to the:
- Salary of production personnel.
- Actual cost of raw materials and materials used in production.
- Standard cost of products (works, services).
- Proceeds from selling a specific type of product (work, service).
- Sales volume (in quantitative terms), etc.
It’s imperative to figure out how to distribute costs and tie them to the main factor in making products or providing services. For example, if the most considerable cost of doing work is paying employees, then it makes sense to factor in overhead costs based on their salaries.
If each product brings in different profits and sales depending on the type of product, it might be better to allocate overhead costs based on the revenue from each product. This way, you get a more accurate idea of how much profit each product is making.
It’s easy to work out how much you make from direct costs, but then you need to figure out the overall efficiency of the whole operation. This leads to the question of how to divide up overhead costs properly. There might not be one right answer to this, but there are methods for doing it. It’s essential to understand why you’re doing it before you start.
Each management report should help make decisions. These steps will make the company more efficient and improve its financial position. If dividing up the costs makes decision-making more manageable and helps the company save money without causing any problems, then it definitely makes sense.
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