Other Expenses and Depreciation: Capturing Non-Labour Overheads

Learning objectives

By the end of this chapter you should be able to:

• Classify non-labour overheads by function, behaviour, and traceability for reporting and internal analysis.
• Distinguish between capital and revenue expenditure and record each appropriately.
• Calculate depreciation using common methods and explain how it affects cost and profit.
• Prepare accrual and prepayment adjustments so expenses are reported in the correct period.
• Apply a practical, repeatable approach to capturing overheads that supports costing, control, and reliable financial statements.

Overview & key concepts

Non-labour overheads include costs such as rent, utilities, insurance, maintenance, marketing, and depreciation. These costs are often high in value, recur regularly, and are shared across functions—so errors in classification or cut-off can quickly distort reported profit, inventory values, and management information.

This chapter takes an integrated approach:

• Financial reporting focus: correct period recognition (accruals and prepayments), correct asset recognition (capital vs revenue), and appropriate depreciation.
• Costing focus: correct functional classification (production vs non-production) and sensible allocation/apportionment for product costing and control.

Keep both perspectives in mind: a cost can be correctly recorded in total, yet still be misanalysed if it is placed in the wrong function or cost centre.

The three essentials are:

1. Where the cost belongs(production vs administration vs selling/distribution).
2. When the cost belongs(accruals and prepayments for correct period reporting).
3. How long the benefit lasts(recognise as a non-current asset where appropriate, then depreciate/amortise over time).

Overhead and its classification

What “overhead” means in practice

Overheads support operations but cannot be economically traced to a single unit of output. They still need to be captured and analysed, but their accounting treatment depends on function and the costing approach being used.

Classification by function (where the cost sits)

• Production overheads: incurred to manufacture goods (factory rent, production utilities, maintenance of production equipment, depreciation of production machinery).
  • In a manufacturing setting, production overheads are part of the cost of conversion and may be included ininventoryuntil the related goods are sold.
• Administration overheads: support the business overall (head office rent, finance and HR costs, general legal and professional fees).
• Selling & distribution overheads: costs of promoting and delivering products (marketing, sales staff costs, distribution-related costs).

Absorption costing vs marginal costing (critical boundary)

Under absorption costing, both variable and fixed production overheads are treated as part of product cost. Fixed production overheads are absorbed using a rate based on normal capacity, which means under-/over-absorption can arise when actual activity differs from normal capacity.
Under marginal costing (for internal decision-making), fixed production overheads are treated as period costs and are not carried in inventory. Variable production overheads follow production activity, but fixed production overheads are charged in full against the period’s profit.

Classification by behaviour (how costs respond to activity)

Behaviour labels are mainly for planning and decision-making:

• Fixed: total cost is stable within a relevant range (e.g. annual rent).
• Variable: total cost changes with activity (e.g. power linked to machine usage).
• Mixed/semi-variable: contains fixed and variable elements (e.g. utilities with a standing charge plus usage).

Classification by traceability (direct vs indirect)

Direct/indirect depends on the chosen cost object (unit, batch, product line, department).

• Direct: can be traced to a cost object economically (e.g. a dedicated component used only for one product line).
• Indirect: supports multiple cost objects (e.g. factory security).

Cost centres, allocation and apportionment

Cost centres

A cost centre is a part of the organisation used to collect costs for control and analysis (for example, Production, Administration, Sales; or separate production departments).

Allocation vs apportionment

• Allocation: charging the whole cost to one cost centre because it relates entirely to that area (e.g. marketing costs to Sales).
• Apportionment: splitting a shared cost across cost centres using a reasonable driver.

Typical drivers (choose what best reflects usage):

• Rent and rates → floor area occupied
• Utilities → metered usage; if not available, machine hours or floor area as a proxy
• Welfare/canteen → headcount
• Maintenance → machine hours or number/value of machines

Consistency matters, but the driver should still be reviewed if operations change.

Accruals and prepayments

Period reporting requires expenses to be recognised in the period they relate to, regardless of when cash is paid.

Accruals (expense incurred, not yet paid)

• Recognise the expense now.
• Recognise a liability for the unpaid amount.

Journal logic (quick rule):
Expense is missing → Dr expense, Cr accrual (liability).

Typical effect on the accounting equation:

• Expenses increase → profit decreases → equity decreases.
• Liabilities increase.

Prepayments (paid in advance, benefit not yet used)

• Recognise an asset for the unused portion.
• Recognise expense only for the portion consumed in the period.

Journal logic (quick rule):
Expense is too high → Dr prepayment (asset), Cr expense.

Typical effect on the accounting equation:

• Asset increases (prepayment) and expense decreases (profit increases relative to the unadjusted figure).
• When the benefit is used later, the prepayment reduces and expense increases.

Capital and revenue expenditure

The decision rule

Ask: Does this spending create (or enhance) a resource that will be used over more than one accounting period?

• Capital expenditure: spending that results in anon-current assetor improves an existing non-current asset (e.g. purchasing machinery; upgrading to increase capacity or extend useful life). The cost iscapitalised(recognised as an asset) and charged to profit over time through depreciation or amortisation.
• Revenue expenditure: spending that supports current operations (e.g. routine repairs, short-term licences, regular maintenance). It is charged to profit in the period it relates to (subject to accruals/prepayments).

Common judgement points

• Repairs vs improvements: repairs restore the existing condition; improvements enhance capacity, efficiency, or useful life.
• One-year software licence: usually an operating cost, with a prepayment at the reporting date if part is unused.
• Legal and professional fees: often operating costs unless directly attributable to acquiring or bringing a specific asset into the condition needed for use.

Depreciation

Depreciation is the accounting charge for using up a long-term asset over time. Instead of expensing the full purchase price immediately, the asset is recognised on the statement of financial position and a regular charge is recorded that reflects how the asset’s economic usefulness is being consumed.

In practice, depreciation:

• reduces profit for the period (it is an expense), and
• reduces the asset’s carrying amount via accumulated depreciation (or directly against the asset).

Depreciation affects reported profit, but it is not a cash payment—cash typically left the business when the asset was acquired.

When depreciation starts

Depreciation begins when the asset is available for use (i.e. in the location and condition necessary for it to operate as intended), not simply when the invoice is paid.

The “amount to depreciate” (practical view)

Think of the depreciable amount as the part of the asset’s cost you expect to “use up”. It is the purchase price (plus costs needed to get it ready for use), minus what you reasonably expect to recover on disposal at the end of its life (the residual value).

Common methods

• Straight-line: equal charge each year.
• Reducing balance: higher charge early, lower later.
• Units of output: based on usage (hours run, units produced).

Review of estimates

Useful life, residual value, and depreciation method should be reviewed regularly (typically at least annually) and updated if expectations change.

Core theory and frameworks

A practical framework for capturing non-labour overheads

Use the following workflow to reduce misstatements and improve costing information:

1. Identify the cost: what is it and what triggered it (invoice, meter reading, contract)?
2. Classify by function: production / administration / selling & distribution.
3. Assess capital vs revenue: does it create or enhance a non-current asset, or is it an operating cost?
4. Apply cut-off: accrue if incurred but unpaid; prepay if paid but not yet used.
5. Assign to cost centres: allocate where possible; apportion shared costs using a defensible driver.
6. Report appropriately:
   • production overheads may be included in inventory and then cost of sales under absorption costing,
   • non-production overheads are period expenses.

Worked example

Narrative scenario

ABC Ltd is a manufacturing business with three cost centres: Production, Administration, and Sales. Its reporting year ends on 31 December.

During the year, ABC Ltd recorded the following non-labour overhead transactions:

1. On1 January, the company paid£120,000rent covering the period1 January to 31 Decemberfor combined factory and office premises.
2. Electricity costs for the year totalled£24,000. At 31 December,£6,000was unpaid.
3. A new machine was purchased for£50,000on1 January. It is expected to have aresidual value of £5,000and auseful life of 10 years.
4. Insurance of£12,000was paid for the policy period1 April to 31 March.
5. Maintenance costs of£8,000were incurred and paid during the year.
6. Office supplies costing£3,000were purchased and paid. At year-end, supplies of£500remained unused.
7. Marketing costs of£15,000were incurred and paid during the year.
8. A software licence fee of£5,000was paid on1 July, covering12 monthsfrom that date.
9. Legal fees of£10,000relating to a new commercial contract were incurred and paid during the year.
10. Staff training costs of£2,000were paid. At year-end,£500relates to a course scheduled for next year.

Required

1. Calculate the annual depreciation charge for the new machine using the straight-line method.
2. Prepare the year-end accrual and prepayment adjustments for rent, electricity, insurance, office supplies, and software.
3. Determine the total non-labour overhead expense to be recognised in profit or loss for the year (after adjustments).
4. Identify capital expenditure items and explain their treatment.
5. Explain the impact of these transactions on the financial statements.

Solution

1) Depreciation (straight-line)

Assuming the machine was available for use from 1 January, a full year’s depreciation is charged.

• Cost: £50,000
• Residual value: £5,000
• Useful life: 10 years

Depreciable amount = £50,000 − £5,000 = £45,000
Annual depreciation = £45,000 / 10 = £4,500

Journal (period end):

• Dr Depreciation expense £4,500
• Cr Accumulated depreciation £4,500

Classification note: Because the machine is used in production, this depreciation would normally be included within production overhead and absorbed into inventory/cost of sales under absorption costing (rather than always appearing as a stand-alone operating expense line).

2) Accrual and prepayment adjustments

(a) Rent

Rent paid 1 January covers the full reporting year (1 Jan–31 Dec). No accrual or prepayment at 31 December.

Expense recognised in the year: £120,000

Examiner note (costing/classification): Although cut-off is correct, rent for combined factory and office premises should usually be apportioned between Production and Administration (commonly by floor area). The production element feeds product costs under absorption costing; the administration element remains a period cost.

(b) Electricity (accrual)

Total electricity expense for the year is £24,000, with £6,000 unpaid at year-end.
(Assuming the £6,000 unpaid amount has not already been recorded in payables.)

Year-end journal:

• Dr Electricity expense £6,000
• Cr Accrued expenses (liability) £6,000

Expense recognised in the year: £24,000
Liability at year-end: £6,000

(c) Insurance (prepayment)

Policy runs 1 April to 31 March. At 31 December, 9 months have been used (Apr–Dec).

Monthly cost = £12,000 / 12 = £1,000
Expense for the year = 9 × £1,000 = £9,000
Prepayment at year-end (Jan–Mar next year) = 3 × £1,000 = £3,000

Year-end journal:

• Dr Prepaid insurance (asset) £3,000
• Cr Insurance expense £3,000

(d) Office supplies (unused portion treated as asset)

Supplies purchased: £3,000
Unused at year-end: £500
Supplies consumed (expense) = £3,000 − £500 = £2,500
Asset at year-end: £500

Year-end journal:

• Dr Supplies on hand (asset) £500
• Cr Supplies expense £500

(e) Software licence (prepayment)

Licence paid 1 July covers 12 months to 30 June next year.

Used in the year: 1 July–31 December = 6 months
Monthly cost = £5,000 / 12 = £416.67
Expense for the year = 6 × £416.67 = £2,500
Prepayment at year-end (Jan–Jun next year) = £2,500

Year-end journal:

• Dr Prepaid software licence (asset) £2,500
• Cr Software expense £2,500

3) Total non-labour overhead expense for the year (after adjustments)

Staff training note: £2,000 paid, with £500 relating to next year → expense this year £1,500 and a prepayment (asset) £500.

4) Capital expenditure and treatment

Machine purchase (£50,000) is capital expenditure because it provides benefits over multiple periods.

Initial recognition (on purchase):

• Dr Non-current asset (machine) £50,000
• Cr Cash / Payables £50,000

Subsequent treatment:

• Depreciate over useful life:£4,500 per year(assuming available for use from 1 January).
• Review useful life, residual value, and method regularly and adjust prospectively if expectations change.

Other items are operating costs, although several create current assets at year-end (prepayments and supplies on hand).

5) Impact on the financial statements

Statement of profit or loss

• Expenses recognised for the year reduce profit by£197,000.
• Depreciation of £4,500 reduces profit even though it is not a cash outflow in the period.

Manufacturing presentation note: Where depreciation relates to production equipment, it is typically included within production overhead. Under absorption costing, part of that overhead may be included in inventory at the reporting date (if goods remain unsold), with the remainder included in cost of sales for goods sold.

Statement of financial position (year-end balances created by the adjustments)

• Non-current assets: machine at cost £50,000 less accumulated depreciation £4,500 → carrying amount£45,500.
• Current assets:
  • Prepaid insurance:£3,000
  • Prepaid software licence:£2,500
  • Supplies on hand:£500
  • Prepaid training:£500
• Current liabilities:
  • Accrued electricity:£6,000

Accounting equation (high-level movement)

• The machine increases assets; depreciation reduces equity (via lower profit) and reduces the asset’s carrying amount through accumulated depreciation.
• Accrued electricity increases liabilities and reduces equity (via the expense).
• Prepayments and supplies on hand increase current assets and prevent overstating expenses in the current period.

Common pitfalls and misunderstandings

• Blurring absorption and marginal costing: under absorption costing, production overheads can be included in inventory; under marginal costing, fixed production overheads are period costs.
• Ignoring normal capacity for fixed production overhead absorption: this is a common cause of under-/over-absorption.
• Missing cut-off adjustments: failing to accrue unpaid costs or defer prepaid amounts misstates both profit and net assets.
• Treating cash paid as the expense: payment timing does not determine the expense for the period.
• Depreciating from the wrong date: depreciation starts when the asset is available for use, not when paid for.
• Ignoring residual value: depreciation should be based on the depreciable amount.
• Incorrect time apportionment: insurance and licences often span reporting dates; count months carefully.
• Capitalising routine maintenance: routine servicing is usually an expense; only enhancements are capitalised.
• Forgetting that unused consumables are assets: supplies on hand should not remain in expense at year-end.
• Weak apportionment logic: shared overhead drivers must be reasonable and applied consistently, then reviewed when operations change.

Summary

Non-labour overheads must be captured accurately to avoid distorted profit, inventory values, and performance measures. High-quality treatment requires:

• Correctfunctional classification(production vs non-production),
• Correctperiod cut-offusing accruals and prepayments,
• Correctcapitalisation decisionsfor non-current assets, and
• Appropriatedepreciation, starting when assets are available for use and reviewed regularly.

A disciplined workflow—identify, classify, assess capital vs revenue, apply cut-off, and assign to cost centres—supports both reliable reporting and effective internal control.

FAQ

What is the difference between capital and revenue expenditure?

Capital expenditure results in a non-current asset or improves an existing one, providing benefits over more than one period. It is capitalised and then charged to profit over time through depreciation or amortisation. Revenue expenditure supports current operations and is charged to profit in the period it relates to (after accrual/prepayment adjustments where needed).

How do accruals and prepayments change the financial statements?

Accruals recognise expenses that relate to the period even if unpaid, increasing liabilities and reducing profit. Prepayments recognise that part of a payment relates to future periods, increasing assets and reducing the current period expense (thereby increasing profit relative to the unadjusted figure).

Why is depreciation important?

Depreciation reflects the consumption of a non-current asset’s economic usefulness over time. It ensures profit includes a fair charge for using long-term assets and prevents the statement of financial position from carrying assets at amounts that ignore usage and wear.

Which depreciation method should be used?

Choose a method that reflects how the asset’s benefits are consumed. Straight-line suits stable usage, reducing balance suits higher early consumption, and units of output suits assets where usage can be measured reliably.

How do you choose an apportionment basis for overheads?

Select a driver that best reflects what causes the cost (floor area, machine hours, headcount, metered usage). The basis should be reasonable, consistently applied, and updated when operational realities change.

What happens if overheads are misclassified?

Misclassification can misstate profit and net assets. Treating capital expenditure as an expense understates assets and profit; treating a current expense as an asset overstates profit and assets. Misclassifying production overheads can also distort inventory and cost of sales.

Glossary

Overhead
A cost that supports activities but cannot be economically traced to a single unit of output.

Production overhead
Indirect costs incurred to manufacture goods (for example, factory rent, production utilities, depreciation of production machinery).

Non-production overhead
Indirect costs not directly linked to manufacturing, such as administration and selling/distribution costs.

Cost centre
A part of the organisation used to collect costs for control and analysis.

Allocation
Charging an entire cost to one cost centre because it relates wholly to that centre.

Apportionment
Splitting a shared cost across cost centres using a reasonable driver.

Accrual
A year-end adjustment recognising an expense that relates to the period but remains unpaid, creating a liability.

Prepayment
A year-end adjustment recognising that part of a payment relates to a future period, creating an asset until consumed.

Capital expenditure
Spending that results in a non-current asset or enhances an existing non-current asset, recognised as an asset and charged to profit over time.

Revenue expenditure
Spending that supports current operations, charged to profit in the period it relates to (after cut-off adjustments).

Depreciation
The periodic expense reflecting the consumption of a non-current asset’s economic usefulness over its useful life.

Residual value
The amount expected to be recovered on disposal of an asset at the end of its useful life (after considering disposal proceeds and costs where relevant).