OVERHEAD CHARGES. Overhead charges, or on-costs, are an important factor in cost accounts. Prime cost represents outlays directly incurred for a particular purpose, and thus capa ble of being charged directly thereto. In addition, there are a number of indirect expenses which can only be dealt with by spreading them as equitably as may be over the total output.
Generally speaking, Overhead charges consist of such items as rent, rates, taxes, salaries, depreciation, interest, discounts, bad debts, etc., from which may be deducted corresponding credits. But in order to arrive at costs that are comparable with those of similar undertakings, various adjustments become necessary. Thus, where business premises are owned, the rental value should be in cluded, although not actually expended. When time is of im portance, interest on outlays should be included, even although no interest may actually have been paid away. Per contra, interest on borrowed monies (including debentures) is not properly a factor in costs at all; and interest received on investments, although un doubtedly a profit, does not tend to reduce operative costs and should therefore be excluded. Many authorities also consider that bad debts have nothing to do with the costs. Depreciation of equipment is generally a very important factor but the modern tendency is to charge a machine rate of so much per hour as part of the direct costs, such rate being designed to cover depreciation. repairs and interest on capital; when this is done, no charge in respect of depreciation falls to be included as Overhead.
Formerly, it was thought to be sufficiently accurate to add a given percentage to prime cost as a loading to cover Overhead. It is now recognized that no satisfactory results can be achieved in this way. A uniform percentage of loading for Overhead would re sult in the aggregate amount actually charged against output vary ing directly with the prime cost, and thus the amount so charged would almost certainly be appreciably more or appreciably less than the true figure, according to whether the output was above or below the average. Further, such a system of allocation assumes
that the fair loading for Overhead varies directly with the prime cost, whereas the employment of expensive materials does not nec essarily increase the Overhead burden, and in many cases econo mies in labour costs can only be achieved by increasing the Over head burden, e.g., when machine work is substituted for hand work. Most production is complex, and consists of a series of suc cessive processes or operations, each involving its own Overhead charges. The modern practice is accordingly in the direction of analysing Overhead into departments, and distributing the burden of the departmental Overhead over the output of the department, usually pro rata according to the time occupied. In this way some approach to substantial accuracy may be reached, but no cut and dried formula will meet all cases.
Sometimes costs are appreciably increased by "spoils"—the curtailment of saleable output as a result of defective materials, machinery, workmanship or supervision. The only satisfactory way to deal with losses arising from spoils is to charge them as part of the Overhead burden of the department causing the spoil. If and when this is done the loss is thrown upon the right shoul ders, and the effect commonly is to reduce very materially the loss arising from spoils by compelling managers to enquire more care fully into causes and possible remedies. (L. R. D.)