What Are Administrative Expenses?
Administrative expenses are the expenses an organization incurs not directly tied to a specific function such as manufacturing, production, or sales. These expenses are related to the organization as a whole as opposed to an individual department or business unit. Salaries of senior executives and costs associated with general services such as accounting and information technology (IT) are examples of administrative expenses. They tend to be unrelated to gross margins.
- Administrative expenses are costs incurred by a business that are not directly related to a specific business function.
- Some level of administrative expenses will always be incurred as a necessary part of operations.
- Administrative expenses are often the first identified during budget cuts because they do not have a direct impact on a company's main business function.
- Management may allocate administrative expenses out to business units or departments based on a percentage of revenue, expense, or other measures.
Understanding Administrative Expenses
On the income statement, administrative expenses are listed below cost of goods sold and may be shown as an aggregate with other expenses such as general or selling expenses. Administrative expenses are necessary for the basic operation of an entity. These expenses are vital to a company’s success as they are incurred to increase efficiency or comply with laws and regulations.
A portion of administrative expenses are typically 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, some minimum level of electricity will always be used by a business just to keep the lights on and necessary machines running. Beyond that point, measures can be taken to reduce electricity costs.
Because administrative expenses may be eliminated without direct impact on the product being sold or produced, they are typically the first expenses identified for budget cuts. There is strong motivation from management to maintain low administrative expenses relative to other expenses as an organization may utilize leverage more effectively with lower administrative costs. An entity may utilize the sales-to-administrative ratio to gauge the portion of sales revenue attributable to covering administrative costs.
Administrative expenses that are reasonable, ordinary, and necessary for business operations may be deducted on a company’s corporate income tax return. These expenses must be deducted in the year they were incurred, and they must have been used during the usual course of business.
Examples of Administrative Expenses
Wages and benefits to certain employees, such as the accounting and IT departments, are considered administrative expenses. All executive compensation and benefits are considered an administrative expense, as well. Building rent, insurance, subscriptions, utilities, and office supplies may be classified as either a general expense or an administrative expense.
Depending on the asset being depreciated, depreciation expense may be classified as a general, administrative, or selling expense. Organizations may choose to include consulting fees and legal fees as an administrative expense as well. Research and development costs are not considered administrative expenses.
To view the full costs associated with running certain business units, a company may allocate its administrative expenses out to each business unit based on a percentage of revenue, expense, square footage, or other measure. Internally to the company, this allows management to make decisions about expanding or reducing individual business units.
For example, if the total electricity bill at XYZ Company is $4,000 per month, and the business records the electricity bill under administrative expense, it can allocate out the electricity costs to individual departments based on square footage. Assume the production facility is 2,000 sq ft, manufacturing is 1,500 sq ft, accounting is 500 sq ft, and sales is 500 sq ft. The total square footage is 4,500, so the electric bill could be allocated out to each department as follows: production $1,777.78 (2,000 / 4,500 * $4,000), manufacturing $1,333.33 (1,500 / 4,500 * $4,000), and accounting and sales both receive $444.44 (500 / 4,500 * $4,000).