Overhead
Indirect costs of running a business that cannot be traced to a specific product, such as rent, utilities, and administrative salaries.
What is Overhead?
Overhead refers to the ongoing indirect costs required to operate a business that cannot be attributed to any specific product, service, or project. Manufacturing overhead includes factory rent, equipment maintenance, utilities, and quality control — costs that support production but are not direct materials or direct labor. Operating overhead (also called SG&A) includes selling expenses, general expenses, and administrative salaries. Overhead is allocated to products or services using a predetermined overhead rate based on a cost driver such as direct labor hours or machine hours. Accurate overhead allocation is essential for correct product costing, pricing decisions, and profitability analysis.
Example
An electronics manufacturer incurs $2 million per month in manufacturing overhead: $800,000 in factory rent, $600,000 in equipment depreciation, $400,000 in utilities, and $200,000 in quality control salaries. The factory runs 100,000 direct labor hours per month, resulting in an overhead rate of $20 per direct labor hour. A product requiring 2 direct labor hours is assigned $40 of overhead cost, which is added to direct materials and direct labor to calculate total product cost and set a profitable selling price.