What is Overhead : Overheads comprise of indirect materials, indirect employee costs and indirect expenses which are not directly identifiable or allocable to a cost object in an economically feasible way. Overheads are the joint cost or common expenses incurred for a number of departments and cost centers or cost units.

Allocation of overhead : There are certain items of overheads that can be directly identified with a particular department or other departments or cost centre. The process of charging such items of overhead to a particular department or cost centre is known as allocation of overhead. Allocation of overhead can be made only when the amount of overhead incurred by a particular department or cost centre is known. Therefore, allocation of overheads means charging all the amount of cost to a particular department or cost centre. For example repairs and maintenance for a machine should be charged or allocated to that department where the machine is installed.

Apportionment of Overhead : Allocation of overheads is assigning a whole item of cost directly to a cost centre. An item of expense which can be directly related to a cost centre is to be allocated to the cost centre. For example, depreciation of a particular machine should be allocated to a particular cost centre if the machine is directly attached to the cost centre. There are certain overheads, which are common to a number of departments or cost centres. They cannot be directly identified or allocated to a particular department or cost centre. The distribution of such overhead to several departments or cost centers proportionately on some equitable basis is known as apportionment of overheads. For example, salary paid to the general manager should be distributed to the production, administration and selling departments as the general manager looks after all the departments. Some other common expenses are electricity, rent, lighting, etc.

Absorption of Overhead

The process of the overhead of a cost center or department to different cost units or product is called absorption of overhead. In other words, it is the process of sharing of overheads by all products or jobs of the department. A basis for absorption of overhead for each department is found out so that each job or product gets due share of overhead for each department when it passes through that department.