Administrative ExpensesDefined along with Examples
What are Administrative Expenses?
Administrative expenses are costs that are necessary for running a business but are not directly related to production or any specific department.
Instead, these expenses are part of maintaining the company’s daily business.
Administrative Expenses Explained
Administrative expenses consist of a variety of expenses, such as the costs that are associated with supplies or general services.
These could be for information technology services, legal services, clerical work, or accounting services.
Generally, these costs are not directly related to producing the business’s services or goods and are typically not included in gross margins.
Companies need to incur administrative expenses as a result of running their business on a day-to-day basis.
These expenses cover normal business operations, including complying with regulations or laws or paying the salaries and benefits of administrative workers.
When companies prepare their income statement, administrative expenses will be placed below the company’s cost of goods sold.
They are sometimes combined with expenses such as selling expenses or general expenses.
Administrative expenses can be fixed expenses that are a result of the business’s main operations.
These types of expenses will occur no matter how much production occurs or what the level of sales is.
However, there are also administrative expenses that are semi-variable.
This could be an expense such as natural gas used for heat and hot water.
The business will use at least some natural gas for hot water, such as hot water for washing hands.
However, the business can work to control this cost.
Since administrative costs are not incurred as part of the production process, businesses often work to reduce these costs.
Most companies try to keep their administrative costs lower than other costs.
One way businesses help measure these expenses is by using the sales-to-administrative expense ratio.
This can help businesses to see how much of their sales revenue is being used to pay administrative expenses.
Businesses are allowed to deduct a reasonable amount of administrative expenses that are necessary for their business operations from their taxes.
Although, these expenses must be a normal part of operating their business and are required to be deducted in the same year in which they were incurred.
Kinds of Administrative Expenses
There are many different expenses included in administrative expenses.
The benefits and wages provided to some employees are treated as administrative expenses.
Additionally, benefits and compensation for executives are classified as administrative expenses.
Other items such as insurance, office supplies, subscriptions, building leases, and utilities could also be treated as administrative expenses or sometimes general expenses.
In some cases, depreciation expenses are considered to be administrative expenses.
This really depends on the asset the company is depreciating.
Depreciation expenses might also be classified as selling expenses or general expenses.
Some companies will also choose to classify legal or consulting fees as administrative expenses.
In contrast, research and development costs are not included in administrative expenses.
In order to look at the costs of running different departments, some companies allocate administrative expenses to their various departments.
These companies allocate these expenses in different ways, such as on the basis of square footage, percentage of revenue, expenses, or other criteria.
Administrative Expenses Example
As an example, Company X uses $6,000 a month in electricity and accounts for this as an administrative expense.
They could choose to allocate the cost of the electricity based on the square footage of their different departments. Suppose:
The company has a 3,000 square foot production facility.
The factory has 1,000 square feet.
The business offices are 1,000 square feet.
The sales offices are 1,000 square feet.
If the company chooses to allocate the cost of electricity based on square footage, it would be allocated as shown below.
Production facility: $3,000 = (3,000/6,000) x $6,000
Factory: $1,000 = (1,000/6,000) x $6,000
Business offices: $1,000 = (1,000/6,000) x $6,000
Sales offices: $1,000 = (1,000/6,000) x $6,000
Key Takeaways
- Administrative expenses are not a direct cost of production for a business’s goods or services. Instead, they are costs that are necessary for running the business that are not directly related to production.
- All businesses have some administrative expenses as a part of normal business operations.
- Administrative expenses are a frequent target of budget cuts since they have no direct impact on the primary business function of the company.
- Management sometimes chooses to allocate administrative expenses to the company’s various departments based on square footage, expenses, percentage of revenue, or other forms of measurement.