GlossaryKind of term: Cost and economicsOverhead
What is overhead?
Overhead is cost you cannot assign directly to a single order, such as the office, sales, quality and the building.
Its counterpart is direct cost, which you can assign to a cost object such as an order or a part: the material, the subcontracted finishing, the hours booked to the order. Overhead runs for the business as a whole: office and administration, sales, quality and the inspection room, IT, insurance, management and the building. Manufacturing engineering is often a borderline case: programming time for one order can be booked directly, the rest of the department cannot. Cost accountants also call it indirect cost.
What does overhead depend on?
Overhead reaches the cost through an allocation key. With a percentage mark-up you add it to direct cost, or in a refined version to part of it, such as labour or material. With cost centres you first spread it over departments and machines and absorb it into the hourly rates. Activity-based costing allocates it by activity, such as quoting or purchasing. Every key shifts cost between orders: a mark-up on direct cost puts a lot of overhead on material-heavy work, absorption through the hourly rate on machine-heavy work.
How does overhead work in practice?
Combining methods is fine as long as each cost item appears once. Production overhead in the hourly rate and selling and administrative overhead as a mark-up on cost is a common split. Put an overhead mark-up on a rate that already holds all overhead and you count it twice, and the price comes out higher than the cost justifies. Record which item sits where, so that someone else can still trace the price.
What is overhead often confused with?
Overhead is not the same as fixed cost: direct or indirect is about assignment to an order, fixed or variable about behaviour as output rises or falls. Time-based depreciation of a machine is fixed and belongs directly to that machine as a cost centre, but reaches the order only through the hourly rate. Nor is overhead margin: margin comes on top of cost.
Frequently asked questions
Should overhead go on as a mark-up or in the hourly rate?
Either, or a combination. Through the rate, machine-heavy work carries more; a mark-up on direct cost also loads overhead onto material and subcontract work. Make sure each item counts once.
Is overhead part of the machine hour rate?
That is your choice. Part of production overhead, such as the shop building and shop-floor supervision, can sit in the rate, with sales and administration in a separate mark-up. Record the choice once and keep to it.