Overhead explained: this guide covers what it means, who it applies to, the step-by-step process, documents required, fees, due dates and penalties in India — so you can stay compliant with confidence and avoid costly mistakes.
Rent, power, supervision and depreciation are bills for the whole factory, yet a product passes through particular departments. Before an overhead can be charged to a product, it has to be pushed to the departments, and the costs of service departments such as stores and maintenance have to be pushed on again to the departments that use them. This guide is for owners and accountants who need a defensible way to do it.
Allocation charges a whole overhead to the one department that caused it. Apportionment splits a shared overhead between departments on a fair basis (area, power units, headcount, asset value). Re-apportionment then moves the service departments' totals to the production departments. Use the result to compute a department-wise absorption rate and to see which department really carries the factory's cost.
What the technique answers and the data you need
The question is "what does each production department cost to run, once the service departments have been paid for?" You need the list of overhead expenses for the period, a measure of how each department uses them (floor area, metered kilowatt hours, headcount, asset values, requisition counts, maintenance hours), and the department structure. The result feeds the overhead absorption rate and, through it, the price of each product. Owners who want a pricing model built on this logic can see a costing and pricing analysis.
The method
- Collect and classify overheads by nature (rent, power, depreciation, indirect wages, supervision).
- Allocate items that belong wholly to one department, such as the maintenance supervisor's wages to the maintenance department.
- Apportion shared items on a basis that reflects use. Rent goes on area; power on metered units; depreciation on asset value; supervision on headcount; stores cost on requisition counts; maintenance on hours.
- Summarise in a primary distribution table: one row per overhead, one column per department.
- Re-apportion the service departments' totals to the production departments (or to each other) using the bases in the table below.
| Re-apportionment method | How it treats services between service departments | Effort |
|---|---|---|
| Direct | Ignores them: service costs go only to production departments | Lowest |
| Step (sequential) | Starts with the service department that serves the most others and passes its cost forward, never back | Moderate |
| Reciprocal | Recognises two-way service by solving simultaneous equations (department cost = own cost + share of the other's cost) | Highest |
The bases are in words: share for a department = (department's units of the basis ÷ total units of the basis) × overhead.
Worked example: a unit with two production and two service departments
A factory has Machining (M) and Assembly (A) as production departments and Stores (S) and Maintenance (Mt) as service departments. All figures are for one month and assumed.
Primary distribution
| Overhead | Basis | M | A | S | Mt | Total |
|---|---|---|---|---|---|---|
| Rent 60,000 | Area 400, 300, 200, 100 sq ft | 24,000 | 18,000 | 12,000 | 6,000 | 60,000 |
| Power 40,000 | kWh 3,000, 1,000, 200, 800 (₹8 a unit) | 24,000 | 8,000 | 1,600 | 6,400 | 40,000 |
| Depreciation 30,000 | Asset value 60, 20, 10, 10 | 18,000 | 6,000 | 3,000 | 3,000 | 30,000 |
| Indirect wages 39,000 | Allocated | 12,000 | 10,000 | 8,000 | 9,000 | 39,000 |
| Supervision 20,000 | Headcount 5, 3, 1, 1 | 10,000 | 6,000 | 2,000 | 2,000 | 20,000 |
| Total | 88,000 | 48,000 | 26,600 | 26,400 | 189,000 |
Check the column totals: M = 24,000 + 24,000 + 18,000 + 12,000 + 10,000 = 88,000. A = 18,000 + 8,000 + 6,000 + 10,000 + 6,000 = 48,000. S = 12,000 + 1,600 + 3,000 + 8,000 + 2,000 = 26,600. Mt = 6,000 + 6,400 + 3,000 + 9,000 + 2,000 = 26,400. Together 88,000 + 48,000 + 26,600 + 26,400 = 189,000, which equals the sum of the overheads (60,000 + 40,000 + 30,000 + 39,000 + 20,000 = 189,000).
Service bases. Stores cost by material requisitions: M 120, A 60, Mt 20. Maintenance cost by maintenance hours: M 300, A 100 (Maintenance does not serve Stores).
Direct method (ignore Maintenance's use of Stores; split Stores 120 : 60, that is 2 : 1)
- Stores 26,600: M = 26,600 × 2/3 = 17,733; A = 26,600 × 1/3 = 8,867 (rounded to the nearest rupee; 17,733 + 8,867 = 26,600).
- Maintenance 26,400 on 300 : 100 (3 : 1): M = 19,800; A = 6,600.
- M = 88,000 + 17,733 + 19,800 = 125,533. A = 48,000 + 8,867 + 6,600 = 63,467. Total 189,000.
Step method (Stores first, because it serves three departments; its cost goes to M, A and Mt on 120 : 60 : 20, that is ₹133 a requisition)
- Stores 26,600 ÷ 200 requisitions = ₹133: M = 15,960; A = 7,980; Mt = 2,660.
- Maintenance now holds 26,400 + 2,660 = 29,060, split 3 : 1: M = 21,795; A = 7,265.
- M = 88,000 + 15,960 + 21,795 = 125,755. A = 48,000 + 7,980 + 7,265 = 63,245. Total 189,000.
| Production department | Direct method (₹) | Step method (₹) | Difference (₹) |
|---|---|---|---|
| Machining | 125,533 | 125,755 | 222 |
| Assembly | 63,467 | 63,245 | −222 |
| Total | 189,000 | 189,000 | 0 |
Reciprocal method in brief. If Maintenance also serviced Stores (say a share p of its hours) while Stores served Maintenance, write S = 26,600 + p × Mt and Mt = 26,400 + q × S, solve the pair, then distribute the solved totals. A spreadsheet handles this easily.
How to read the result
Both methods land within ₹222 of each other on a ₹189,000 pool. When services between the service departments are small, the direct method is adequate. When two service departments rely heavily on each other, use the step or reciprocal method. Either way, the real insight is that Machining carries about two-thirds of the factory's overhead, so its absorption rate, not the factory average, should set machine-heavy prices.
Common mistakes
- Apportioning on a convenient basis (equal shares) instead of a basis that follows use.
- Allocating a shared item to one department because it is "mostly theirs".
- Forgetting that the step method must not send cost back to a department already cleared.
- Re-apportioning service costs and then dividing by the wrong hours when computing the absorption rate.
- Not revisiting the bases when a department moves or adds machines.
Overheads are one family of cost; see cost classification for how they differ from direct costs, and the activity based costing guide for a finer way to trace them.
Need help with department-wise costing?
If your factory charges overheads at one blended rate, a department-wise study can show where the cost really sits and what each product should carry. Our team can help with a costing and pricing analysis that begins with the primary distribution above.
Key takeaways
- Allocate whole items; apportion shared items on a basis that follows use.
- A primary distribution table makes the work auditable.
- Re-apportion service departments by direct, step or reciprocal method, depending on how much they serve each other.
- The methods differ only slightly when inter-service use is small; the total never changes.
- The outcome feeds department-wise absorption rates.
Read next
- Overhead absorption rates and the machine hour rate
- Activity based costing: cost pools and cost drivers
- Cost classification for a small business
Disclaimer: The methods described are standard cost accounting and financial management techniques. The worked example uses an invented business and invented figures, including any tax, interest or exchange rate, which are assumptions for illustration and not current rates. Where the article refers to a legal requirement, the linked guide and the official text should be checked. This article is general information, not legal advice; check the official text before acting.