8.3 Overhead costs: production and non-production

Production overhead costs are costs involved in the manufacturing of goods, such as manufacturing overhead. Non-production costs are costs incurred that are not part of manufacturing, for example, selling and administrative expenses. Overhead costs are indirect costs.

Examples of production overhead costs include supervisors’ salaries and factory rent. In addition to materials and labour costs, a wide range of other overhead costs needs to be recorded and collected so that an appropriate estimate of cost can be made. Many of these overhead costs will be periodic expenditure on items with which you will be familiar, including:

• rent and business rates (either related to production or non-production)
• insurance (either related to production or non-production)
• administration expenses (likely to be non-production)
• motor and travelling expenses (likely to be non-production).

Non-production overheads are usually grouped into three classifications, as demonstrated in Interactive Figure 2.

Classification in this way is known as classification by function. This provides a clear understanding of the different types of expenses incurred and helps businesses to make informed decisions regarding their cost structure. Costs that cannot be fully classified into these groups may be classified as general overheads or may receive their own separate name, such as research and development costs.

These expenses are recorded in the accounting system and allocated or apportioned to the appropriate departments, and analysed to aid decision making. In addition to these costs, which are paid in the normal course of trading, there are other costs, notably depreciation, which do not necessarily involve a cash outlay during the period under review. Depreciation (which is, of course, an operating cost) will have to be calculated using a suitable method.