Financial Terms
overhead costs

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Definition of overhead costs

Overhead Costs Image 1

overhead costs

overhead generally refers to indirect, in contrast to direct,
costs. Indirect means that a cost cannot be matched or coupled in any
obvious or objective manner with particular products, specific revenue
sources, or a particular organizational unit. Manufacturing overhead
costs are the indirect costs in making products, which are in addition to
the direct costs of raw materials and labor. Manufacturing overhead
costs include both variable costs (electricity, gas, water, etc.), which vary
with total production output, and fixed costs, which do not vary with
increases or decreases in actual production output.

Related Terms:

Cost of goods sold

The charge to expense of the direct materials, direct labor, and
allocated overhead costs associated with products sold during a defined accounting

Expense ratio

The percentage of the assets that were spent to run a mutual fund (as of the last annual
statement). This includes expenses such as management and advisory fees, overhead costs and 12b-1
(distribution and advertising ) fees. The expense ratio does not include brokerage costs for trading the
portfolio, although these are reported as a percentage of assets to the SEC by the funds in a Statement of
Additional Information (SAI). the SAI is available to shareholders on request. Neither the expense ratio or the
SAI includes the transaction costs of spreads, normally incurred in unlisted securities and foreign stocks.
These two costs can add significantly to the reported expenses of a fund. The expense ratio is often termed an
Operating Expense Ratio (OER).

fixed expenses (costs)

Expenses or costs that remain the same in amount,
or fixed, over the short run and do not vary with changes in sales volume
or sales revenue or other measures of business activity. Over the
longer run, however, these costs increase or decrease as the business
grows or declines. Fixed operating costs provide capacity to carry on
operations and make sales. Fixed manufacturing overhead costs provide
production capacity. Fixed expenses are a key pivot point for the analysis
of profit behavior, especially for determining the breakeven point and for
analyzing strategies to improve profit performance.

Fixed overhead

That portion of total overhead costs which remains constant in size
irrespective of changes in activity within a certain range.


The allocation of either under- or over-allocated overhead costs among the
work-in-process, finished goods, and cost of goods sold accounts at the end of an
accounting period.

Agency costs

The incremental costs of having an agent make decisions for a principal.

applied overhead

the amount of overhead that has been assigned to Work in Process Inventory as a result of productive activity; credits for this amount are to an overhead account

Overhead Costs Image 2

Avoidable costs

costs that are identifiable with and able to be influenced by decisions made at the business
unit (e.g. division) level.

capitalization of costs

When a cost is recorded originally as an increase
to an asset account, it is said to be capitalized. This means that the outlay
is treated as a capital expenditure, which becomes part of the total
cost basis of the asset. The alternative is to record the cost as an expense
immediately in the period the cost is incurred. Capitalized costs refer
mainly to costs that are recorded in the long-term operating assets of a
business, such as buildings, machines, equipment, tools, and so on.

Carring costs

costs that increase with increases in the level of investment in current assets.

carrying costs

costs of maintaining current assets, including opportunity cost of capital.

Costs Capitalized in Stealth

A particularly egregious form of aggressive cost capitalization
where inappropriately capitalized costs are hidden within other unrelated account balances.

costs of financial distress

costs arising from bankruptcy or distorted business decisions before bankruptcy.

Direct costs

costs that are readily traceable to particular products or services.

Execution costs

The difference between the execution price of a security and the price that would have
existed in the absence of a trade, which can be further divided into market impact costs and market timing

Factory overhead

All the costs incurred during the manufacturing process, minus the
costs of direct labor and materials.

Financial distress costs

Legal and administrative costs of liquidation or reorganization. Also includes
implied costs associated with impaired ability to do business (indirect costs).

Fixed costs

costs that do not change with increases or decreases in the volume of goods or services
produced, within the relevant range.

fixed costs

costs that do not depend on the level of output.

fixed overhead spending variance

the difference between the total actual fixed overhead and budgeted fixed overhead;
it is computed as part of the four-variance overhead analysis

fixed overhead volume variance

see volume variance

Friction costs

costs, both implied and direct, associated with a transaction. Such costs include time, effort,
money, and associated tax effects of gathering information and making a transaction.

Funding Costs

The price of obtaining capital, either borrowed or equity, with intent to carry on business operations.

Incremental costs and benefits

costs and benefits that would occur if a particular course of action were
taken compared to those that would occur if that course of action were not taken.

Indirect costs

costs that are necessary to produce a product/service but are not readily traceable to particular products or services – see overhead.

Information costs

Transaction costs that include the assessment of the investment merits of a financial asset.
Related: search costs.

Market impact costs

Also called price impact costs, the result of a bid/ask spread and a dealer's price concession.

Market timing costs

costs that arise from price movement of the stock during the time of the transaction
which is attributed to other activity in the stock.

Menu Costs

The costs to firms of changing their prices.

Non-production overhead

A general term referring to period costs, such as selling, administration and financial expenses.

Opportunity costs

The difference in the performance of an actual investment and a desired investment
adjusted for fixed costs and execution costs. The performance differential is a consequence of not being able
to implement all desired trades. Most valuable alternative that is given up.

overapplied overhead

a credit balance in the overhead account
at the end of a period; when the applied overhead
amount is greater than the actual overhead that was incurred


Any cost other than a direct cost – may refer to an indirect production cost and/or to a non-production expense.


any factory or production cost that is indirect to
the product or service; it does not include direct material
or direct labor; any production cost that cannot be directly
traced to the product

Overhead allocation

The process of spreading production overhead equitably over the volume of production of goods or services.

overhead application rate

see predetermined overhead rate

overhead efficiency variance

the difference between total budgeted overhead at actual hours and total budgeted
overhead at standard hours allowed for the production
achieved; it is computed as part of a three-variance analysis;
it is the same as variable overhead efficiency variance

Overhead rate

The rate (often expressed per hour) applied to the time taken to produce a product/service, used to allocate production overheads to particular products/services based on the time taken. May be calculated on a business-wide or cost centre basis.

overhead spending variance

the difference between total actual overhead and total budgeted overhead at actual
hours; it is computed as part of three-variance analysis; it
is equal to the sum of the variable and fixed overhead
spending variances

Period costs

The costs that relate to a period of time.

Policy Acquisition Costs

costs incurred by insurance companies in signing new policies, including expenditures on commissions and other selling expenses, promotion expenses, premium
taxes, and certain underwriting expenses. Refer also to customer, member, or subscriber
acquisition costs.

Political Costs

The costs of additional regulation, including higher taxes, borne by large and
high-profile firms.

predetermined overhead rate

an estimated constant charge per unit of activity used to assign overhead cost to production or services of the period; it is calculated by dividing total budgeted annual overhead at a selected level of volume or activity by that selected measure of volume or activity; it is also the standard overhead application rate

Preopening Costs

A form of start-up cost incurred in preparing for the opening of a new store or facility.

Price impact costs

Related: market impact costs

Production overhead

A general term referring to indirect costs.

Round-trip transactions costs

costs of completing a transaction, including commissions, market impact
costs, and taxes.

Search costs

costs associated with locating a counterparty to a trade, including explicit costs (such as
advertising) and implicit costs (such as the value of time). Related:information costs.

Semi-fixed costs

costs that are constant within a defined level of activity but that can increase or decrease when
activity reaches upper and lower levels.

Semi-variable costs

costs that have both fixed and variable components.

shortage costs

costs incurred from shortages in current assets.

Standard costs

A budget cost for materials and labour used for decision-making, usually expressed as a per unit cost that is applied to standard quantities from a bill of materials and to standard times from a

standard overhead application rate

a predetermined overhead rate used in a standard cost system; it can be a separate variable or fixed rate or a combined overhead rate

Start-up Costs

costs related to such onetime activities as opening a new facility, introducing
a new product or service, commencing activities in a new territory, pursuing a new class of customer,
or initiating a new process in an existing or new facility.

Sunk costs

costs that have been incurred and cannot be reversed.

Sunk costs

costs that have been incurred in the past.

sunk costs

costs that have been incurred and cannot be recovered.

total overhead variance

the difference between total actual overhead and total applied overhead; it is the amount of underapplied or overapplied overhead

Trading costs

costs of buying and selling marketable securities and borrowing. Trading costs include
commissions, slippage, and the bid/ask spread. See: transaction costs.

Transactions costs

The time, effort, and money necessary, including such things as commission fees and the
cost of physically moving the asset from seller to buyer. Related: Round-trip transaction costs, Information
costs, search costs.

Undepreciated Capital Costs

The tax definition of the value of an asset that is eligible for tax deprecation.

underapplied overhead

a debit balance in the overhead account at the end of a period; when the applied overhead amount is less than the actual overhead that was incurred

variable costs

costs that change as the level of output changes.

variable overhead efficiency variance

the difference between budgeted variable overhead based on actual input activity and variable overhead applied to production

variable overhead spending variance

the difference between total actual variable overhead and the budgeted amount of variable overhead based on actual input activity

absorption costing

a cost accumulation and reporting
method that treats the costs of all manufacturing components
(direct material, direct labor, variable overhead, and
fixed overhead) as inventoriable or product costs; it is the
traditional approach to product costing; it must be used for
external financial statements and tax returns

conversion cost

Refers to the sum of manufacturing direct labor and overhead
costs of products. The cost of raw materials used to make products
is not included in this concept. Generally speaking, this is a rough measure
of the value added by the manufacturing process.

Cost of goods sold

The accumulated total of all costs used to create a product or service,
which is then sold. These costs fall into the general sub-categories of direct
labor, materials, and overhead.

Indirect cost

A cost that is not directly associated with a single activity or event. Such
costs are frequently clumped into an overhead pool and allocated to various activities,
based on an allocation method that has a perceived or actual linkage between
the indirect cost and the activity.

joint cost

the total of all costs (direct material, direct labor,
and overhead) incurred in a joint process up to the splitoff point

normal cost system

a valuation method that uses actual
costs of direct material and direct labor in conjunction with
a predetermined overhead rate or rates in determining the
cost of Work in Process Inventory

product cost

This is a key factor in the profit model of a business. Product
cost is the same as purchase cost for a retailer or wholesaler (distributor).
A manufacturer has to accumulate three different types of production
costs to determine product cost: direct materials, direct labor, and
manufacturing overhead. The cost of products (goods) sold is deducted
from sales revenue to determine gross margin (also called gross profit),
which is the first profit line reported in an external income statement
and in an internal profit report to managers.

Product cost

The total of all costs assigned to a product, typically including direct
labor, materials (with normal spoilage included), and overhead.

standard cost system

a valuation method that uses predetermined
norms for direct material, direct labor, and overhead
to assign costs to the various inventory accounts and
Cost of Goods Sold

variable costing

a cost accumulation and reporting method
that includes only variable production costs (direct material,
direct labor, and variable overhead) as inventoriable
or product costs; it treats fixed overhead as a period cost;
is not acceptable for external reporting and tax returns







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