Selling and Distribution Overheads: Definition
According to the terminology adopted by the Institute of Cost and Management Accountants in England, selling overheads refer to “the cost incurred in promoting sales and retaining customers.“
Additionally, distribution overheads are “the cost of the process which begins with making the packed product available for despatch and ends with making the reconditioned returned empty packages available for re-use.“
Selling and Distribution Overheads: Explanation
Selling overheads are all the costs associated with creating or stimulating demand or of securing orders. Examples of such overheads are sales office expenses, advertisements, the sales manager’s salary, and travel expenses.
Distribution overheads are all the expenses incurred from the time the product is finished in the factory until it is delivered to end consumers. Examples include warehouse rent, warehouse utility bills, maintenance for delivery vans, carriage on sales, and packing charges.
For the purpose of distribution, selling and distribution overheads are taken together.
The classification, codification, and collection of selling and distribution overheads are done in a manner similar to the approach adopted for factory overheads.
In particular, they are classified according to their type, nature, or purpose, and separate cost account numbers are used for their codification.
List of Selling Overheads
The following is a list of selling overheads:
(1) Indirect Materials
- Cost of printing and stationery used in marketing
- Mailing cost of literature, catalogs, price lists, offer letters, etc.
(2) Indirect Labor
- Salaries, commissions, etc. of sales staff, including sales organizers, salesmen, etc.
- Salaries, commission, allowances, etc. of technical representatives, sales executives, etc.
(3) Indirect Expenses
- Advertising Expenses
- Bad debts
- Showroom rent
- Travel and entertainment expenses
- Expenses on branch establishment
- Expenses for sales office
- Fees for directors (e.g., sales director)
List of Distribution Overheads
The following are examples of expenses that can be classified as distribution overheads:
(1) Indirect Materials
- Cost of packing and packages
- Cost of oil, grease, spare parts, etc. used in maintaining delivery vans
(2) Indirect Labor
- Wages of packers
- Wages of van drivers
- Wages of despatch clerks
(3) Indirect Expenses
- Godown Expenses
- Rent, insurance, etc. of the godown
- Carriage outward
- Other transport charges
- Depreciation of delivery vans
- Running cost of delivery vans
From the above lists, it is clear that selling overheads are related to the promotion of sales, whereas distribution overheads start when the order is received to supply the materials and end when the goods are despatched to the customer.
Although these overheads are separately accounted for, it is advisable to include them in the overall cost structure of the product. They should also be shown and included in the total cost of sales.
Accounting Treatment of Selling and Distribution Overheads
Advertisement is a sales promotion expenditure. Hence, it is a selling overhead. When advertisement expenditure is incurred on an individual product, it should be allocated to the product concerned.
However, when common advertisement expenditure is incurred, the cost, therefore, needs apportionment on the basis of sales turnover. Heavy advertisement expenditures are spread over to different coming years.
In such cases, the cost should also be spread over.
The cost of advertisement of a permanent nature should generally be capitalized instead of included in the cost structure. However, advertisements for staff recruitment, inviting tenders, and legal public notices should be appropriated to concerned departments.
Goods sold usually contain a clause pertaining to after-sales services. Selling overheads include the cost of after-sales services. These are for the stipulated guarantee period. Therefore, such costs should be analyzed and then charged accordingly.
For example, if in after-sales service, a defective part is replaced, then the cost of the replaced part is charged to the production department.
Warehouse rent is apportioned to various products on the basis of floor area used, the number of packages warehoused, or any other basis depending upon technical estimates or other factors.
Royalty is payable for the right to manufacture a product or use a piece of land for mining or other purposes. It is a direct charge and should be charged, and it is included in prime cost. However, if royalties are based on units sold, the cost is treated as a selling overhead.
Insurance for transit risk is usually taken. If it is for a single product, then the whole amount is charged to the product insured.
If, however, it is for more than one product, it should be apportioned to all the products for which the insurance is taken, and it is usually apportioned on the basis of the sale value.
Remuneration of Salesmen
Remuneration of salesmen may either be treated as fixed cost or variable cost. This is because salaries are a fixed expense, whereas commissions are a variable expense.
Fixed expenses are apportioned to various products that the salesmen deal with, whereas the variable expenses are directly allocated to the products.
Bad debts are financial losses and, as such, they should be excluded from cost accounts. However, as another opinion, bad debts should be included in cost accounts. However, if such a policy decision is taken, bad debts should be included in selling overheads.
Market Research Cost
Market research cost is a selling overhead and should be treated as such. However, the management may decide to defer this cost and spread it over the period for which benefit of the research is likely to derive.
Absorption of Selling and Distribution Overheads
For the purpose of absorption, selling and distribution overheads may be divided into two parts:
- Category I: Expenses incurred on the sale of products only that are directly related to the items sold
- Category II: Expenses that are fixed over time, which do not depend on sales volume
Items belonging to Category I can be directly added to the cost of production so as to arrive at the cost of sales. But items under Category II may be charged to products using any of the following bases:
- Estimated rate per article
- Percentage on work cost
- Percentage on selling price
An overview of these bases is given in the rest of this article.
1. Estimated Rate per Article
Under this method, the total selling and distribution expenses (having already been calculated for a product) are divided by the estimated number of units of product to be sold. This yields the rate of selling expenses per unit.
The overhead rate, under this method, is computed using the following formula:
Overhead rate = Estimated selling and distribution expenses / Expected sales in units
2. Percentage of Work Cost
Under this method, the selling and distribution expenses are charged as a percentage of the work cost of articles sold. The overhead rate is calculated in advance based on the normal expenses and expected amount of work cost.
The overhead rate is calculated using this formula:
Overhead rate = (Selling and distribution expenses / Work cost) x 100
3. Percentage of Selling Price
In this method, the overhead rate is expressed as a percentage of selling price. It is calculated based on the normal level of such expenses and the normal sales volume of the past.
The following formula is used to calculate the overhead rate:
Overhead rate = (Selling and distribution expenses / Total sales) x 100
This method of absorption assumes that the selling price would be known and can be adopted successfully where the products are sold at standard prices.