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Cost and Management Accounting · Overheads - Absorption Costing Method

Meaning and Classification of Overheads for CA Intermediate

Updated 4 October 2026 · Fact-checked

Overheads are all indirect costs: indirect materials, indirect employee costs and indirect expenses that cannot be traced to a single cost unit. You classify them by function (factory, administration, selling, distribution), by behaviour (fixed, variable, semi-variable) and by controllability (controllable, uncontrollable). Always pick one basis and state it.

Understand Meaning and Classification of Overheads

A cost is direct if you can trace it to a cost unit in an economically feasible way. Otherwise it is indirect. The total of indirect materials, indirect employee cost and indirect expenses is called overheads.

The word to remember is *traceability*. Wood in a table is direct. Glue, factory rent and the supervisor's salary are indirect, because you cannot cheaply say how much belongs to each table. The same item can be direct in one case and indirect in another. A designer's fee for one customer order is direct to that job. A designer's salary shared by many jobs is indirect.

Overheads are classified in several ways because each way serves a different purpose. By function shows where the cost arises: manufacturing, administration, selling or distribution, and sometimes research and development. This helps in building the cost sheet and in valuing stock.

By behaviour shows how cost reacts when activity changes. Fixed overheads stay the same in total within the relevant range and the normal period, such as factory rent. Variable overheads change in total roughly in proportion to activity, such as power for machines or consumable stores. Semi-variable overheads have a fixed part and a variable part, such as a telephone bill with a rental plus call charges. Per-unit behaviour is the opposite: fixed cost per unit falls as output rises, and variable cost per unit stays constant.

By controllability separates costs that a manager can influence in the short run (controllable) from those the manager cannot (uncontrollable). This depends on the level of management. Factory rent is uncontrollable for a shop-floor supervisor but may be controllable by top management. Other bases you may meet are normal and abnormal, and product and period costs.

Key rules to remember

Overheads
Overheads = Indirect materials + Indirect employee cost + Indirect expenses
Total of all indirect costs. Direct costs are excluded.
Prime cost and overheads
Total cost = Prime cost + Overheads
Prime cost = direct materials + direct employee cost + direct expenses.
Semi-variable cost
Total cost = Fixed part + (Variable rate × Activity)
Use this to split a semi-variable cost into its two parts.
High-low split of variable rate
Variable rate per unit = (Cost at high activity − Cost at low activity) ÷ (High activity − Low activity)
Fixed part = Total cost at either level − (Variable rate × activity at that level).
Fixed overhead per unit
Fixed overhead per unit = Total fixed overhead ÷ Units produced
Falls as output rises. Variable overhead per unit stays constant.
Classification by function
Factory (production) | Administration | Selling | Distribution
Research and development and similar heads may be shown separately where relevant.

How to solve Meaning and Classification of Overheads questions

Use this method for any question that asks you to classify, identify or split overheads.

  1. 1Read the question and note the basis asked for: function, behaviour, controllability or direct/indirect.
  2. 2Take each item and ask first: can it be traced to a cost unit economically? If yes, it is direct and is not an overhead.
  3. 3For overhead items, assign the class under the asked basis. For function, ask where the cost is incurred. For behaviour, ask what happens to the total when output changes.
  4. 4For semi-variable items, split them into fixed and variable parts using the data given, with the high-low method if two activity levels are provided.
  5. 5Tabulate your answer with the item, the class and a one-line reason.
  6. 6Add totals for each class if the question asks for them, and check that the classes add back to the overall total.
  7. 7If the question asks for a discussion, give a definition, the classes, and one example for each.

Quickest way: Two-question test for each item

When to use it: Use this for MCQs and for the classification table in written answers when time is short.

  1. Ask 1: can I trace it to one unit or job? If yes, it is direct. Stop.
  2. Ask 2: where is it incurred? Factory means production overhead. Office means administration. Marketing means selling. Delivery of finished goods means distribution.
  3. For behaviour, imagine output doubling: total unchanged means fixed, total doubles means variable, part rises means semi-variable.
  4. In MCQs, eliminate options that call a per-unit fixed cost 'constant' or that put selling and distribution costs into factory overhead.
  5. In written answers, write a table with three columns (item, class, reason). A reason earns the step marks even if the class is debatable.

Common mistakes in Meaning and Classification of Overheads

  • Treating small items such as nails or thread as direct materials because they are physically part of the product.

    Students focus on physical presence rather than traceability.

    Fix: Use the economic traceability test. Small items such as nails or thread are indirect even though they are in the product.

  • Saying fixed overhead per unit is fixed.

    The word fixed is applied to both total and per-unit cost.

    Fix: Fixed means fixed in total within the relevant range. Per unit it falls as output rises. Variable is constant per unit.

  • Putting selling and distribution overheads into factory overheads.

    Students see them as just indirect costs and skip the functional split.

    Fix: Keep four functional groups. Factory overheads enter product cost, while administration, selling and distribution are shown separately in the cost sheet.

  • Classifying a semi-variable cost wholly as fixed or wholly as variable.

    It is quicker to give one label.

    Fix: Split it into a fixed element and a variable element using the data. Use the high-low method when two activity levels are given.

  • Saying controllability is a property of the cost itself.

    Students memorise examples like rent is uncontrollable.

    Fix: Controllability depends on the manager and the time period. Name the level of management when you answer.

Worked examples

Example 1

Classify the following items as direct cost or overhead, and state the functional class of each overhead: (a) wood used in making furniture; (b) factory supervisor's salary; (c) salary of the sales manager; (d) depreciation of delivery vans; (e) office rent.

Show the solution
  1. (a) Wood can be traced to each piece of furniture, so it is direct material, not an overhead.
  2. (b) The supervisor works for the whole factory and cannot be traced to one unit. This is an indirect employee cost and a factory overhead.
  3. (c) The sales manager's salary is an indirect employee cost incurred in marketing. It is a selling overhead.
  4. (d) Delivery vans move finished goods to customers. Depreciation is an indirect expense and a distribution overhead.
  5. (e) Office rent is an indirect expense incurred for general management. It is an administration overhead.

Answer: (a) Direct material. (b) Factory overhead. (c) Selling overhead. (d) Distribution overhead. (e) Administration overhead.

Example 2

A factory's maintenance cost is semi-variable. It was ₹46,000 when machine hours were 4,000 and ₹58,000 when machine hours were 6,000. Split the cost into fixed and variable parts and estimate the cost at 5,000 machine hours.

Show the solution
  1. Variable rate per hour = (₹58,000 − ₹46,000) ÷ (6,000 − 4,000) = ₹12,000 ÷ 2,000 = ₹6.
  2. Variable cost at 4,000 hours = 4,000 × ₹6 = ₹24,000.
  3. Fixed part = ₹46,000 − ₹24,000 = ₹22,000.
  4. Check at 6,000 hours: 6,000 × ₹6 = ₹36,000, and ₹36,000 + ₹22,000 = ₹58,000. This matches the given figure.
  5. Estimated cost at 5,000 hours = ₹22,000 + (5,000 × ₹6) = ₹22,000 + ₹30,000 = ₹52,000.

Answer: Variable rate ₹6 per machine hour, fixed part ₹22,000, and the estimated cost at 5,000 machine hours is ₹52,000.

Exam tips

  • Expect MCQs asking you to pick the correct classification of an item, or how a cost behaves per unit. Learn the per-unit behaviour of fixed and variable costs cold.
  • In written answers always give a one-line reason for each classification. It protects marks when the examiner's class differs.
  • If a question gives two activity levels for a semi-variable cost, use the high-low method and show the check step.
  • Name the basis of classification before listing classes. Keep function, behaviour and controllability separate and do not mix them in one list.
  • Write a short definition of overheads first in theory questions, then the classes with one example each.

Practice questions from Overheads - Absorption Costing Method

Meaning and Classification of Overheads in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Meaning and Classification of Overheads: frequently asked questions

What are overheads in cost accounting?

Overheads are the indirect costs of running the business: indirect materials, indirect employee cost and indirect expenses. You cannot trace them to a single cost unit in an economical way. They are collected, distributed and then absorbed into cost units.

What is the difference between fixed, variable and semi-variable overheads?

Fixed overheads stay the same in total when output changes within the relevant range. Variable overheads change in total roughly in proportion to output. Semi-variable overheads have both a fixed part and a variable part, so the total rises but not in proportion.

How are overheads classified by function?

By function they are grouped as factory or production, administration, selling and distribution overheads. Research and development may be shown separately. Factory overheads form part of product cost, and the rest are shown separately in the cost sheet.

Is the same cost sometimes direct and sometimes indirect?

Yes. It depends on traceability. A cost that can be traced to a specific job or unit is direct. The same type of cost shared across many jobs is indirect and becomes an overhead.