What Are Administrative Expenses?
Administrative expenses are expenses an organization incurs that are not directly tied to a specific core function such as manufacturing, production, or sales. These overhead expenses are related to the organization as a whole, as opposed to individual departments or business units.
- Administrative expenses are costs incurred to support the functioning of a business, but which are not directly related to the production of a specific product or service.
- Some level of administrative expenses will always be incurred as a necessary part of operations.
- Administrative expenses are often among the first identified for budget cuts, because they do not directly impact a company's main business functions.
- Management may allocate administrative expenses to its business units based on a percentage of revenue, expenses, or other measures.
Understanding Administrative Expenses
Administrative expenses may include salaries of senior management and the costs associated with general services or supplies; for example, legal, accounting, clerical work, and information technology. These costs tend not to be directly related to the production of goods or services of a business and are usually excluded from gross margins.
Companies incur administrative expenses in order to perform basic operations (e.g., administer payroll or healthcare benefits), increase oversight and efficiency, and/or comply with laws and regulations. On the income statement, administrative expenses appear below cost of goods sold (COGS) and may be shown as an aggregate with other expenses such as general or selling expenses.
Some administrative expenses are fixed in nature, as they are incurred as part of the foundation of business operations. These expenses would exist regardless of the level of production or sales that occur. Other administrative expenses are semi-variable. For example, a business will always use some minimum level of electricity to keep the lights on. Beyond that point, it can take measures to reduce its electric bill.
Because a business can eliminate administrative expenses without a direct impact on the product it sells or produces, these costs are typically first in line for budget cuts. Management is strongly motivated to maintain low administrative expenses relative to other costs, as this allows a business to utilize leverage more effectively. The sales-to-administrative expense ratio helps companies to measure how much sales revenue is being portioned to covering administrative costs.
Companies can deduct from their tax returns administrative expenses that are reasonable, ordinary, and necessary for business operations. These expenses must be incurred during the usual course of business and deducted in the year they are incurred.
Other Types of Administrative Expenses
Wages and benefits to certain employees, such as accounting and IT staff, are considered administrative expenses. All executive compensation and benefits are considered an administrative expense. Building leases, insurance, subscriptions, utilities, and office supplies may be classified as a general expense or administrative expense.
Depending on the asset being depreciated, depreciation expenses may be classified as a general, administrative, or selling (marketing) expense. Organizations may choose to include consulting and legal fees as an administrative expense as well. However, research and development (R&D) costs are not considered administrative expenses.
To get the full picture of the costs associated with running certain business units, a company may allocate out administrative expenses to each of its departments based on a percentage of revenue, expenses, square footage, or other measures. Internally, this allows management to make decisions about expanding or reducing individual business units.
Example of Administrative Expenses
For example, if XYZ Company spends $4,000 monthly on electricity and records this as an administrative expense, it might allocate the cost according to the square footage each individual department occupies. Assume:
- The production facility is 2,000 square feet
- The manufacturing facility is 1,500 square feet
- The accounting office is 750 square feet
- The sales office is 750 square feet
The company occupies 5,000 square feet. The electric bill could be allocated as follows:
- Production: $1,600 or (2,000 / 5,000) x $4,000
- Manufacturing: $1,200 or (1,500 / 5,000) x $4,000
- Accounting: $600 or (750 / 5,000) x $4,000
- Sales: $600 or (750 / 5,000) x $4,000