What Do Administrative Costs Entail?

An organization’s administrative expenses are any costs not directly related to one of its major operations, such as manufacturing, production, or sales. Unlike specific departments or business units, the corporation is responsible for these overhead costs.

Recognizing Administrative Costs

Salaries for senior management and prices for general services or supplies, such as legal, accounting, secretarial labor, and information technology, are examples of administrative expenses. These expenses are typically not included in gross margin calculations because they are not directly tied to creating a company’s products or services.

Administrative costs are incurred by businesses to carry out fundamental tasks (such as managing payroll or healthcare benefits), improve oversight and productivity, and adhere to legal requirements. Administrative costs are listed on the income statement underneath the cost of goods sold (COGS) and may be combined with other general or selling costs.

Some administrative costs are recurring since they are necessary to run a firm. Regardless of the production or sales volume, these costs would still be necessary. Other administrative costs are somewhat unpredictable. For instance, a business will constantly need a certain minimum amount of electricity to keep the lights on. After that, it can take action to lower its electric bill.

Administrative costs are often the first to be eliminated from a budget because doing so does not directly affect the goods a company sells or produces. Management is highly incentivized to keep administrative costs low compared to other expenditures since doing so enables a company to use leverage more successfully. Businesses can determine how much of their sales money will pay their administration costs by using the sales-to-administrative expenditure ratio.

Administrative costs that are reasonable, customary, and essential for conducting business can be written off by businesses on their tax returns. These costs must be incurred normally during business and written off in the year of expense.

Additional Administrative Costs

Administrative costs include salaries and benefits for some employees, including those in accounting and information technology. Administrative costs include all executive salaries and benefits. Building leases, insurance, membership fees, utilities, and office supplies may all be considered administrative or general expenses.

Depending on the depreciating asset, depreciation costs can be categorized as a general, administrative, or selling (marketing) expense. Legal and consultancy expenses may sometimes be categorized as administrative costs by organizations. However, charges associated with research and development (R&D) are not regarded as administrative costs.

A corporation may distribute administrative expenses to each department according to a percentage of revenue, expenses, square footage, or other factors to obtain a complete picture of the expenses related to operating specific business units. Internally, this enables management to decide whether to increase or decrease specific business divisions.

An illustration of administrative costs

For instance, if XYZ Company reports $4,000 in monthly electricity costs as an administrative expense, it may divide the cost based on how much space each department uses. Assume:

The production facility has a square footage of 2,000.
The production facility measures 1,500 square feet.
The accounting department has 750 square feet.
Seven hundred fifty square feet make up the sales office.

The business has 5,000 square feet of space. These options for allocating the electric bill are:

Production: $1,600 or $4,000 multiplied by (2,000/5,000).
Production cost: $1,200 or (1,500/5,000) x $4,000
$600 or (750 / 5,000) times $4,000 in accounting
$600 in sales or (750 / 5,000) x $4,000

Conclusion

• Costs incurred to support a business’s operations but unrelated to creating a particular good or service are referred to as administrative costs.
• As a necessary component of operations, administrative costs will always be borne to some extent.
• Administrative expenses are frequently among the first recognized budget cuts because they have no direct impact on a company’s core business operations.
• Management may divide administrative costs among its business units based on a percentage of sales, expenses, or other metrics.