How To Accounts: Overheads in Profit & Loss (P/L/( Income Statement)

 How To Accounts: Overheads in Profit & Loss (P/L/( Income Statement)

In this article on “how to accounts”, today, we are going to discuss all about the overheads in P/L (accounting basics). There are plenty of expenses that the company is prone to, in the process of Revenue Generation, These expenses other than the direct labor cost and direct material cost can be aggregated as referred as overhead expenses.

Variable overhead are the overhead which varies accordingly with the production level, like it goes along in proportion with the actual level of the activity for which the overhead actually relates i.e. higher the production/ Sales of good,  higher the variable overhead.

Again, both direct and indirect overheads need to get segregated. Direct variable costs are the cost that are specifically assigned to the product costing directly and is to be included in the calculation of COGS like direct labor and direct material. The overheads which can directly be assigned to the production process can be termed as direct overheads and which doesn’t constitutes in production process by any means then those overheads are indirect overheads.

Suppose, if Company A produces 4,000 units of products for which they require $100,000 of raw material and it the units of products to be increased like say, 5,000 units then the raw material has to be increased which increases the amount say, $125,000. This is a perfect example of direct variable cost as it increases/decreases with the activity level. Again let’s Say, if it is a retails distribution channel which usually delivers 1 quantity of product at a time and the distribution of the products varies with the level of sales made i.e. pertaining to the same example as above if the 4,000 units of products takes $2,000, it is obviously clear, that to deliver 5,000 units the cost will rise to 2500 which is not specifically a production related expenses so it is termed as Indirect Variable Expenses.

Fixed Overhead refers to the overhead that is fixed despite the level of production like the machinery expenses. There are other sub-terms like step-fixed means the fixed amount can also change upon reach of the particular production unit. Suppose, at 4,000 unit level production, the Fixed overhead is $50,000 and the amount is fixed despite of the level of production of units it has up to 4,000 but when it goes beyond 4000 unit the fixed amount gets rise to $100,000 up to 8000 unit so, the production cost can be higher if it finishes up producing the 4100 unit and the same production cost per unit fall if it goes to the optimal extreme level of the far end like 4,000 unites and 10,000 units. R & Maintenance of the Production Plant, Rent on Factory Premise can be referred as an example of the fixed and step fixed nature of overhead. And it is almost crystal clear that the fixed and step fixed nature of overhead needs to get optimized in order to manage the cost per unit of the product.

Semi-variable overhead is a mixture of both the fixed and variable component in it like, the minimum threshold is always fixed despite the level of production and it then varies according to the level of production. For example, bonus or commission designed for the level of sales like, a company can pay minimum $100 fixed amount as a commission for 1,000 units of sales. Then again, if the level crosses 2,000 units then the minimum fixed amount increases to $250. Thus the actual payout varies with the level of sales made. This sort of expenses can be seen elsewhere in various other departments but the nature is similar. Again, this can be associated with indirect activities as it particularly doesn’t relate to the production of the unit.

Ok this is it for now, in terms of the overheads in P/L (accounting basics) on “how to accounts”.

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