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Cost Accounting · Overheads

Overheads: Meaning, Classification and Codification

Updated 10 October 2026 · Fact-checked

Overheads are all indirect costs: indirect material, indirect labour and indirect expenses that cannot be traced to a single cost unit. You classify them by function, behaviour, element and controllability, then give each a code. To answer a question, read the nature of each item and place it under the correct head.

Understand Overheads: Meaning, Classification and Codification

Overheads are the total of indirect material, indirect labour and indirect expenses. You cannot easily trace them to one product, job or cost unit. Factory rent, supervisor salary, power for the whole plant and the advertising bill are typical examples. Overheads are also called on-cost or burden.

The reason to classify is control and costing. Overheads are a pool of mixed items. If you do not sort them, you cannot assign them to products fairly and you cannot hold anyone responsible for them. Each classification answers a different question.

There are four classifications to know:

  • By function: where in the business was the cost incurred? Factory (manufacturing), administration, selling and distribution. Some books add research and development as a further group.
  • By behaviour: how does the cost react to a change in activity? Fixed, variable or semi-variable.
  • By element: what is the nature of the cost? Indirect materials, indirect labour, indirect expenses.
  • By controllability: can a manager influence the cost? Controllable or uncontrollable.

Fixed overheads stay the same in total within a relevant range of activity, but per unit they fall as output rises. Variable overheads change in total roughly in proportion to activity, but stay constant per unit. Semi-variable (semi-fixed) overheads have a fixed part and a variable part, such as a telephone bill with fixed rental plus call charges.

Codification gives each cost item a code made of letters, numbers or both. A code saves writing, avoids errors, speeds up posting and helps in computer processing. A good code is brief, unique, flexible enough to add new items, and easy to remember. Codes are often built with a block of digits, where the first digit shows the type of cost or the department and later digits show the detail.

Key rules to remember

Overheads
Overheads = Indirect material + Indirect labour + Indirect expenses
Total of all costs that are not direct. Prime cost excludes them.
Semi-variable cost split (high-low)
Variable cost per unit = (Cost at high activity − Cost at low activity) ÷ (High activity − Low activity)
Then fixed cost = Total cost at either level − (Variable cost per unit × Activity at that level).
Fixed cost per unit
Fixed cost per unit = Total fixed cost ÷ Units of activity
Falls as activity rises, within the relevant range.
Variable cost behaviour
Total variable overhead = Variable overhead per unit × Units of activity
Per unit it stays constant.

How to solve Overheads: Meaning, Classification and Codification questions

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

  1. 1Read each item and decide first whether it is indirect. If it is direct, it is not an overhead.
  2. 2Identify the department or function where it arises: factory, administration, selling or distribution.
  3. 3Ask how it reacts to output: does it stay constant, move in proportion, or have both parts? Label it fixed, variable or semi-variable.
  4. 4Label its element: indirect material, indirect labour or indirect expense.
  5. 5Decide controllability by asking whether the manager of that department can change the amount in the period.
  6. 6If the cost is semi-variable and you are given two activity levels, use the high-low method to separate fixed and variable parts.
  7. 7For codification, build the code from a clear structure: first the cost type or department, then the detail, and keep each code unique.
  8. 8Present the answer as a small list or table-style layout with one line per item and a short reason.

Quickest way: Three-question sort

When to use it: Use this for MCQs and short classification questions where time is tight.

  1. Ask: can it be traced to one unit? If yes, it is direct, so not an overhead.
  2. Ask: where does it arise? That gives the function.
  3. Ask: if output doubles, what happens to the total? Same means fixed, doubles means variable, partly rises means semi-variable.
  4. For controllability, ask who decides the amount. If it is above the manager's level, it is uncontrollable for that manager.

Common mistakes in Overheads: Meaning, Classification and Codification

  • Treating every overhead as fixed because it is indirect.

    Students mix up indirect with fixed. These are different classifications.

    Fix: Classify direct versus indirect first, then behaviour separately. Indirect lubricants, for example, are variable.

  • Saying fixed cost per unit is constant.

    The word fixed makes students apply it to the per-unit figure.

    Fix: Remember that total fixed cost is constant and per-unit fixed cost falls as activity rises.

  • Classifying a cost by controllability in general instead of for a given manager.

    Controllability depends on the level of authority, and students ignore this.

    Fix: Write whose control you mean. Factory rent is uncontrollable for a factory manager but may be controllable by top management.

  • Putting selling and distribution costs into factory overheads.

    Both are indirect costs, so students lump them together.

    Fix: Use the functional split. Factory overheads go into factory cost, administration and selling costs are added later in the cost sheet.

  • Splitting a semi-variable cost using wrong activity levels in the high-low method.

    Students pick the highest and lowest cost instead of the highest and lowest activity.

    Fix: Choose the points by activity level, then take the cost belonging to those points.

  • Writing vague, non-unique codes in codification answers.

    Students describe codes loosely without a structure.

    Fix: Show a clear structure, such as a digit for department and digits for cost type, and state that every item gets one unique code.

Worked examples

Example 1

Classify each item by function, behaviour and element: (a) depreciation of factory machinery, (b) salary of the sales manager, (c) cost of cotton waste used for cleaning machines, (d) wages of the factory storekeeper.

Show the solution
  1. (a) Depreciation of factory machinery arises in production, so function is factory. It is a fixed amount each year under the straight-line method, so behaviour is fixed. It is an indirect expense.
  2. (b) The sales manager's salary arises in the selling function. It is a fixed amount per month, so it is fixed. It is a payment to an employee but not a cost of making a unit, so it is indirect labour.
  3. (c) Cotton waste for cleaning is used in the factory, so function is factory. It rises with machine use, so it is variable. It is indirect material.
  4. (d) The storekeeper's wages arise in the factory. They do not change with small changes in output, so they are fixed. The element is indirect labour.

Answer: (a) Factory, fixed, indirect expense. (b) Selling, fixed, indirect labour. (c) Factory, variable, indirect material. (d) Factory, fixed, indirect labour.

Example 2

A factory's power cost is semi-variable. It was ₹52,000 at 8,000 machine hours and ₹64,000 at 12,000 machine hours. Find the fixed and variable parts and estimate the power cost at 10,000 machine hours.

Show the solution
  1. Change in cost = ₹64,000 − ₹52,000 = ₹12,000.
  2. Change in activity = 12,000 − 8,000 = 4,000 hours.
  3. Variable cost per hour = ₹12,000 ÷ 4,000 = ₹3.
  4. Variable cost at 8,000 hours = 8,000 × ₹3 = ₹24,000.
  5. Fixed cost = ₹52,000 − ₹24,000 = ₹28,000.
  6. Check at 12,000 hours: 12,000 × ₹3 = ₹36,000, plus ₹28,000 = ₹64,000. This matches.
  7. Cost at 10,000 hours = ₹28,000 + (10,000 × ₹3) = ₹28,000 + ₹30,000 = ₹58,000.

Answer: Variable cost is ₹3 per machine hour and fixed cost is ₹28,000. Estimated power cost at 10,000 hours is ₹58,000.

Exam tips

  • MCQs often give an item and ask for its correct classification. Decide direct or indirect first, then behaviour.
  • In written answers, use a short list with the item, the head and a one-line reason. Reasons earn the marks.
  • Practise the high-low split. Always verify your fixed cost by checking both activity levels.
  • For codification, give the purpose, the features of a good code and a short illustration. Do not write only the definition.
  • Keep the controllability point tied to a named manager or level, since the answer depends on it.

Practice questions from Overheads

Overheads: Meaning, Classification and Codification in other exams

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

Overheads: Meaning, Classification and Codification: frequently asked questions

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

Fixed overheads stay the same in total when activity changes within the relevant range. Variable overheads change in total in proportion to activity. Semi-variable overheads have both a fixed part and a variable part, such as a telephone bill with rental and call charges.

How are overheads classified in cost accounting?

The common bases are function (factory, administration, selling and distribution), behaviour (fixed, variable, semi-variable), element (indirect material, labour, expenses) and controllability (controllable, uncontrollable). Each basis serves a different purpose, such as costing or control.

What is codification of overheads?

Codification means giving each cost item or account a unique code of letters, numbers or both. It reduces errors, saves time in recording and supports computer processing. A good code is brief, unique, flexible and easy to remember.

Are all indirect costs overheads?

Yes, overheads are the total of indirect material, indirect labour and indirect expenses. Direct costs are traced to a cost unit and form part of prime cost instead.