Based on their classification, costs are of two types:
- Direct costs
- Indirect costs
While direct costs are the costs that are directly attributable to the manufacturing and include costs like direct material and direct labor, the indirect costs are those costs that are not directly attributable to any activity and usually include manufacturing overhead. These costs are the supportive costs incurred in the manufacturing of the product. Therefore, these costs become a part of the product and allocated to the product in a number of ways. Once these costs are allocated, the price of the product is set so that all the costs incurred in manufacturing process are accounted accordingly. This helps in better understanding of the individual profitability of the product.
Manufacturing overheads includes the electricity bills attributable to the product during the factory hours, or the depreciation charged to the asset during its use. It can also include the costs of factory supplies or personnel (other than labor). These costs pile up to make manufacturing overheads.
Types of overheads
Manufacturing overheads are of two further types:
· Variable overheads
· Fixed overheads
Variable overheads are the costs that are constant when calculated per unit but become variable when totaled to the volume of the output. All costs like repairs and maintenance, indirect labor, etc., are variable overhead costs.
The overheads costs that are constant when totaled but variable in nature when calculated per unit are known as fixed overheads. Fixed costs tend to decrease per unit with the increase in the production output. This category includes costs like rent, depreciation and salary of the managers, etc.
Non-manufacturing overheadsAs the name suggests, non-manufacturing overheads are the costs that are not incurred in the manufacturing process of the product hence these costs are not attributable to this process. These costs are the expenses occurred in the other apart from the manufacturing are usually classified under the head of Selling, Admin and General Expenses. The interest expense also falls in the same category and since these are non-manufacturing overheads, they are simply reported under the expenses while preparing the income statement of the company.