In this article we will discuss about the treatment of special items of overheads.

1. Interest on Capital:

Different people have different of opinion on the question as to whether interest on capital should be included in cost or not. This so because, whether a concern pays interest on capital or not, depends upon its method of capitalisation. This means a company raising finance by equity capital only has not to pay interest whereas a company raising finance partly through debenture has to pay interest.

If interest actually paid is included in cost, companies not paying any interest will have lower cost and companies paying interest will show higher cost of production. This makes difficult the comparison of cost in different companies. Therefore, for the sake of uniformity, either interest paid should be included from cost, or alternatively, interest on the total capital employed (both equity and debenture capital) should be included in cost so that costs become comparable.

The following arguments are put forward for the inclusion of interest in cost accounts:


Arguments for Inclusion:

(i) Just as wages are the remuneration paid to labour factor, interest is the remuneration paid on capital, rent is the reward for land. As wages form part of production cost, interest must also form part of production cost.

(ii) As interest paid on borrowed capital is included in cost accounts, under the same principle, the notional interest on capital should also be included in cost accounts.

(iii) Cost comparison and profit evaluation is possible when interest is included in cost accounts.


(iv) The inclusion of interest in cost accounts also facilitates make or buy decision and to own or hire a machine.

(v) It enables in determining the cost of holding the inventory.

(vi) If interest is not included in cost of production, the cost of goods sold is understated and profit is overstated.

(vii) It is necessary to include interest if comparisons are to be made between different processes and operations.


(viii) Where management has to decide about the replacement of manual labour by machines, a true comparison of the costs of these two methods cannot be made unless interest on the cost of machine is taken into consideration.

(ix) Where articles of different values are produced and capital invested in each varies considerably, the inclusion of interest is of special importance.

Arguments against Inclusion:

The following arguments are usually advanced against including interest in cost of production:


(i) The remuneration payable on capital is profit as such interest should not be included in cost accounts.

(ii) Actual interest paid can be included in cost accounts but not the notional interest.

(iii) Interest is a matter of pure finance and hence it should be taken into costing Profit and Loss Account but not to Cost of Production Account.

(iv) Interest need not be included in determining the comparative cost of installation of a new asset as it is governed by depreciation, repairs and maintenance cost, etc.


(v) It involves additional clerical work and creates unnecessary complications in cost accounts.

(vi) It is quite difficult to determine the exact amount of capital upon which interest should be calculated. This is because working capital in the form of stock, debtors, cash, etc., changes every year now and then.

(vii) It is also difficult to determine a fair rate of interest as market rate of interest vary considerably.

(viii) Inclusion of interest inflates the value of Work-in-Progress and finished stock which implies an inflation of income to that extent.


(ix) Managerial decisions and comparisons involving interest can be best made on separate statements without introducing interest in cost accounts. Inclusion of interest in cost accounts creates unnecessary complications.


The arguments in favour of inclusion of interest in cost are mostly theoretical and they are out weighted by the arguments against inclusion of interest, which are based largely on expediency and practical difficulties.

Accordingly, interest is rarely taken into account in cost records, though it is sometimes proper to have regard to it in special reports like the following:


(i) Statements comparing the relative merits of various means of raising capital.

(ii) Statements comparing the cost of making or buying from, outside.

(iii) Cost estimates especially in those cases where a job takes a long period to complete and involves large sums.

(iv) Statements comparing the profitability between alternative projects like production by machinery or by hand labour.

2. Cash Discount:

Cash discount is purely a financial item and hence it is excluded from cost accounts. In fact as a general rule all financial items are excluded from the costs.

3. Carriage Inward:

This is directly concerned with the purchase of materials and is generally included in the cost of materials purchased, thereby treating it as a direct cost. Alternatively, it may be treated as an item of factory overhead.

4. Packing Expenses:


This expense may be divided into three categories:

(a) Packing which is necessary for handling of the product e.g., medicines, oil, other liquid products, must be packed to make them saleable. Such primary packing expenses are treated as direct material cost.

(b) Fancy packing meant to attract customers, e.g., colourful attractive wrappers of cosmetics is a form of advertisement and should be treated as selling overhead.

(c) Packing that facilitate transportation and handling of products to customers place, e.g., T.V. sets or refrigerators, should be treated as distribution overhead.

5. Advertisement:

Advertisement cost incurred for promoting sales is a selling overhead. When advertisement is for individual products it should be allocated to products concerned. On the other hand, when a common advertisement is for more than one product or when it is of general nature which is meant to promote the sales of all the products of the company, the cost should be apportioned on the basis of sales value of products or any other suitable basis.

Sometimes heavy advertisement expenditure is incurred in the initial years on introducing a product line, the benefit of which is derived over a number of future years. Such costs should be deferred over two or three future years during which benefit is likely to be derived. In case advertisement is of permanent nature, such costs should be capitalised and its depreciation charged to selling overhead.

Certain advertisement do not form part of the sales promotion programme, e.g., advertisement for staff recruitment, inviting tenders, notice of legal proceedings, etc. These are not selling overheads and thus should be charged to the department concerned.

6. Royalties and Patent Fees:

Royalties may be payable for making use of a patent process or product in the course of manufacture, or the right to sell the financial product. Royalty payable for making use of a patent process in manufacture should be treated as direct expenses and included in Prime Cost. Royalties payable on the basis of sales should be regarded as selling overhead.

7. Drawing and Design Office Costs:

If drawings or designs are prepared for specific jobs, these costs may be treated as direct expenses. But, if drawings are to be enclosed with sales tenders, it may be treated as selling overheads. Where drawing and designing office if used as service department, its costs should be apportioned to production departments on the basis of technical estimates of services rendered or on any other suitable basis, like number of drawings made, man hours worked, etc.

8. Depreciation:

Depreciation is the decrease in the value of all fixed assets due to use and/or lapse of time. All fixed assets except land lose their value with their use and passage of time. The several factors that contribute in varying degrees to this decline in utility are wear and tear, lapse of time, obsolescence, etc. Accordingly, the cost of such assets is allocated to the periods, in which services are received from the assets, by a process called depreciation.

In cost accounts, depreciation is charged to the cost accounts on the following grounds:

(i) Depreciation represents a charge for usage of the capital resources.

(ii) The amount invested in the asset has to be recovered from the costs over a number of years equivalent to the life of the assets.

9. Rent or a Charge in Lieu of Rent:

When rent is paid, this is obviously a cost to be taken into account as production, administration or selling and distribution overhead, depending upon the use to which the building is put to. In many cases, however, the premises are owned by the business and no rent is payable. In such cases, a charge in lieu of rent should be made in cost accounts so that the true cost may be ascertained.

The annual value of premises, as assessed for rating purposes, is normally a satisfactory amount to charge in lieu of rent. If premises are owned by some concerns and rented by others in the same industry, the costs will vary if no rent for owned premises is charged in the cost accounts.

10. Directors Fees and Salaries:

Usually, this is considered as a part of administration overhead. Where separate directors are appointed for different functions like production, sales, etc. such costs should be allocated to the respective functional overheads. When there are no separate directors for different functions, directors remuneration may be apportioned to production, administration, and selling and distribution on the basis of time devoted by the directors.

11. Expenses on Removal and Re-Creation of Machinery:

Sometimes, a machinery is shifted to a new site due to factors like change in the method of production, an addition or alternation in the factory building, change in the flow of production, etc. All costs incurred on dismantle the existing installation and its recreation is treated as production overhead as it does not add to the value of the asset.

When the amount of such costs is large, it may be treated as deferred revenue expenditure and spread over a period of time, say 3 to five years. If removal is due to faulty planning or some other abnormal factor, it is charged to costing profit and loss account. When a new machinery is installed, the entire cost of installation is capitalised along with the cost of machinery.

12. Set-Up Costs:

When a specific job is completed, machines may require setting up with a different set of tools for taking up the next job. The cost of setting up time is, therefore, normally charged to that particular job for which preparation is being made.

But when setting up is frequent and cost abnormally high, the situation demands proper measurement and control of set-up costs. In such cases, it may be preferable to treat such cost as production overhead for booking against all jobs equitably.

13. Market Research Cost:

Market research includes study of tastes and habits of customers, future trend of demand, potential markets, competitive products, trading practices and channels of distribution. The expenditure on market research is in the nature of policy costs and depends upon the policy of management in this regard.

Many concerns do not spend any amount under this head while others spend heavy amount on this item. Market research cost is normally treated as selling, overhead.

14. Research and Development Costs:

Due to certain special features of research and development costs, different accounting treatments for such expenditure are required for different circumstances. Therefore, there is no general agreement regarding the treatment of such costs in cost accounts.

The following are the various methods of treating these costs in cost accounts:

(a) As Revenue Expenditure:

This method is usually used when such amount is not very heavy. In such a situation, research and development costs are treated as general overhead and apportioned and absorbed accordingly.

(b) As Deferred Revenue Expenditure:

When benefits of research and development are to be derived over a period of two or three years, it is usually treated as deferred revenue expenditure and recovered over a period of two or three years.

(c) Transfer to Costing Profit and Loss Account:

The research and development costs are written off to Profit and Loss Account of the period in which expenditure is incurred. This method is particularly suitable when research and development proves unsuccessful and does not produce any tangible results.

15. Fringe Benefits:

The benefits which are provided to the workers in addition to their wages, salaries and other allowances are known as fringe benefits. These can be monetary as well as non-monetary.

List of such benefits is given below:

(i) Dearness Allowance

(ii) Night shift Allowance

(iii) Sick leave pay

(iv) Annual Bonus

(v) Provident Fund

(vi) Employees state Insurance

(vii) Gratuity, Pension

(viii) Holiday pay

(ix) Maternity leave pay, etc.

Fringe Benefits (Group) Nonmonetary:

(i) Free housing

(ii) Medical care

(iii) Educational facilities

(iv) Subsidised conveyance

(v) Subsidised canteen facilities, etc.

These costs should be charged to the unit of production on appropriate basis. Another way is to treat all these expenses as overheads and allocate them.

As regards expenditure on non-monetary benefits, it should be aggregated and allocated or apportioned over departments on the basis of quantum of benefits received.

16. Bonus Payable to Employees:

Under the payment of Bonus Act 1965, it is obligatory to pay a minimum bonus of 8 1/3% to employees irrespective of Profit or Loss in the organisation. Such a minimum amount of bonus may be either treated as an overhead or alternatively bonus payable to direct workers may be included in their wages and their wages rate is inflated to cover the amount of bonus. Any bonus paid over and above the minimum amount of bonus should be treated as an Appropriation of Profit and thus transferred to costing Profit and Loss Account of the period.

Some cost accountant prefers to treat the entire amount of bonus as overhead and apportion it to various departments on the basis of wages bill of each department.

17. Bad Debts:

According to some accountants bad debts are financial losses and thus excluded from cost accounts. If, however, bad debts are included in cost, it should be treated as selling overhead and may be apportioned to various products on the basis of the credit sales of products. Abnormal amounts of bad debts, which are of exceptional nature, should be included in cost accounts.

18. After Sales Service:

Some engineering companies offer free after sales service during specified guarantee period. This cost is also a part of the selling overhead. This includes free repairs and sometimes free replacement of parts and components. In addition to cost of materials, salaries, wages and travelling expenses of service staff are also included in this cost. Each such case is analysed and investigated and expenditure on after sales service is treated accordingly.

For example – while servicing cost is treated as selling overhead; free replacement of any defective component part may be charged to production department. However, cost of major repairs and replacement of exceptional nature should be either treated as a deferred charge or written off to the costing Profit and Loss Account.