Overhead
Overhead refers to the ongoing business expenses not directly attributed to creating a product or service. It is important for budgeting purposes but also for determining how much a company must charge for its products or services to make a profit. In short, overhead is any expense incurred to support the business while not being directly related to a specific product or service.
Definition: Indirect costs refer to ongoing operating expenses that are not directly related to the creation of a product or the provision of a service. These costs are crucial for budgeting and help determine how much a company must charge for its products or services to be profitable. In simple terms, indirect costs are any expenses incurred to support the business but are not directly tied to a specific product or service.
Origin: The concept of indirect costs originated during the Industrial Revolution when businesses began mass production, making resource management and allocation more complex. As companies grew, managers realized the need for a method to allocate expenses that could not be directly attributed to a specific product or service.
Categories and Characteristics: Indirect costs can be divided into fixed indirect costs and variable indirect costs. Fixed indirect costs are those that do not change with the level of production, such as rent, salaries of administrative staff, and insurance. Variable indirect costs, on the other hand, change with the level of production, such as electricity, water, and office supplies. Fixed indirect costs are characterized by their relative stability in the short term, while variable indirect costs fluctuate with business activity.
Specific Cases: 1. A manufacturing company pays monthly rent for its factory and salaries for its administrative staff. These costs need to be paid regardless of the number of products produced, thus they are fixed indirect costs. 2. A software company pays monthly electricity bills and office supplies costs, which vary with the number of employees and working hours, thus they are variable indirect costs.
Common Questions: 1. How are indirect costs allocated to product costs? Typically, allocation rates or bases are used to distribute indirect costs proportionally to various products or services. 2. Why are indirect costs important for budgeting? Because they constitute a portion of the total costs of a company, accurately estimating and controlling indirect costs helps improve the company's profitability.
