Overhead is the term used when referring to indirect costs. Overhead costs are therefore costs incurred by a company which cannot be directly allocated to a specific cost unit; i.e. there is an element of sharing involved. If a company wishes to find the cost, of a cost centre or cost unit, the overhead incurred must be apportioned using some fair base. For example, electricity costs which are incurred lighting and heating a building would be shared out or apportioned using floor space.

A Cost Centre is a location, person or item of equipment for which costs may be ascertained, related to cost units and used for control purposes. Typical examples could include a slicing machine or the canning department or a solicitor.

A cost unit is a quantitative unit of product or service in relation to which costs are ascertained. Typical examples could be a loaf of bread, a litre of paint, or a meal served.

B) Why and how overhead cost is apportioned

One reason why overhead may need to be apportioned is because management need to be aware of the level of expenditure on overheads. If left uncontrolled, the amount spent can increase year on year, eroding significant proportions of gross profit and reducing competitiveness. Therefore it is important to know both the overhead expenditure per cost centre or department and the overhead costs per unit. Analysing overhead costs per cost centre or department helps in the overall control of overhead within an organisation.

The process by which overheads are divided between several cost centres in a 'fair' proportion is referred to as cost apportionment.  Each overhead type is examined and a suitable base for sharing out the cost is established.  For example, the best way of sharing out property rental cost can be justified as ‘floor space’ or square metres occupied, because each cost centre occupies floor space within the property.  Cost is apportioned by dividing the total overhead cost of rent by the total floor space and multiplying by the space used by the cost centre.