Overhead Finance Dictionary: Key Terms Explained

Understanding overhead costs is crucial for effective financial management. This dictionary clarifies common terms related to overhead finance, helping you analyze and control these expenses. Activity-Based Costing (ABC): A costing method that assigns overhead costs to specific activities, then allocates those costs to products or services based on their consumption of those activities. ABC provides a more accurate picture of true product costs than traditional methods. Allocation Base: A measure used to distribute overhead costs to cost objects (e.g., products, departments). Common allocation bases include direct labor hours, machine hours, or square footage. Choosing the right allocation base is vital for accurate cost assignment. Applied Overhead: The amount of overhead costs assigned to products or services based on a predetermined overhead rate. It represents the estimated overhead costs incurred during production. Cost Driver: A factor that directly influences the cost of an activity. Identifying cost drivers helps manage and control overhead costs more effectively. For example, the number of engineering change orders could be a cost driver for engineering overhead. Cost Object: Anything for which a cost is being determined. This can be a product, service, department, project, or any other entity for which a business wants to track costs. Departmental Overhead Rate: An overhead rate calculated for each department within an organization. This rate is then used to allocate overhead costs only related to that department. It improves accuracy compared to a plant-wide rate if departments have significantly different cost structures. Fixed Overhead: Overhead costs that remain relatively constant regardless of changes in production volume. Examples include rent, property taxes, and insurance. Indirect Costs: Costs that are not directly traceable to a specific product or service. These are also referred to as overhead costs. Examples include factory utilities, depreciation on equipment, and supervisory salaries. Manufacturing Overhead: All indirect costs associated with the production of goods. This includes indirect materials, indirect labor, factory rent, and factory utilities. Non-Manufacturing Overhead: Overhead costs that are not directly related to the production of goods. This includes selling, general, and administrative expenses. Over-Applied Overhead: Occurs when the applied overhead is greater than the actual overhead incurred. This means more overhead was assigned to products than was actually spent. Overhead: The ongoing administrative and operational expenses of a business that cannot be directly attributed to a specific product or service. Understanding and managing overhead is essential for profitability. Overhead Allocation: The process of assigning overhead costs to various cost objects. Accurate overhead allocation is crucial for determining the true cost of products or services. Overhead Rate: A predetermined rate used to allocate overhead costs to products or services. The rate is typically calculated by dividing estimated overhead costs by an allocation base. Plant-Wide Overhead Rate: A single overhead rate used to allocate all overhead costs across an entire factory or plant. This is a simpler approach than departmental rates but can be less accurate if departments have different overhead structures. Predetermined Overhead Rate: An overhead rate calculated at the beginning of an accounting period. It is used to apply overhead costs to products or services throughout the period. The formula is typically estimated overhead costs divided by estimated allocation base. Under-Applied Overhead: Occurs when the applied overhead is less than the actual overhead incurred. This means not enough overhead was assigned to products to cover the actual expenses. Variable Overhead: Overhead costs that fluctuate in direct proportion to changes in production volume. Examples include indirect materials and utilities that vary with production. By understanding these terms, you can better analyze, control, and ultimately reduce overhead costs, improving your organization’s financial performance.

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