Administrative OverheadExplained & Defined

Written By:
Lisa Borga

What is Administrative Overhead?

Administrative overhead, often referred to as general and administrative overhead, includes all costs of a company that are not directly tied to the production or development of its goods or services.

These are, instead, the many indirect expenses a business may face in the support, planning, and administration of its business.

This includes most overhead costs outside of those attributed to manufacturing overhead.

Some common examples of administrative overhead include utilities, administrative salaries, and legal expenses.

Understanding Administrative Overhead

For most companies, administrative overhead is primarily associated with office expenses.

This is because overhead that is directly related to production activities will instead be attributed to manufacturing overhead.

Administrative expenses are those incurred in managing business operations, establishing policies, and performing support activities.

Example of Administrative Overhead

As an example of administrative overhead, let’s consider the expenses incurred by Company X, which manufactures TVs.

The expenses they incurred in 20XX include:

In this example, the direct materials and wages for factory staff would be considered operational expenses.

However, all of the remaining expenses would be attributed to administrative overhead, including wages for sales staff and salaries for administrative staff.

This means that the company incurred a total of $445,000 in administrative overhead.

What Expenses Are Included in Administrative Overhead?

Administrative overhead includes all of the expenses related to operating a business that cannot be tied to the company’s production of its goods or services.

Administrative overhead still is necessary for the operation of a business, however, and includes a wide variety of expenses.

Though the particular expenses may vary depending upon the business, some extremely common examples include the wages for office, administrative, and sales staff as well as any commissions, legal and audit fees, office leases, utilities and telephone expenses, insurance premiums, office supplies, administrative and sales travel costs, and bank fees.

Keeping Administrative Overhead Under Control

For most businesses, administrative expenses account for a significant part of their overall spending.

Due to this, controlling these costs is important, and because the administrative overhead is not directly tied to a revenue-generating unit, they tend to increase and decrease as revenue increases and declines.

Regularly examining these expenses and determining which are necessary and which should be cut is vital to the success of any business.

Some cost control measures include:

• Create Effective Budgets: Just like for production costs controlling administrative overhead expenses begins with creating separate budgets for the allocation of funds. This allows limits to be set for individual categories of expenses and makes it far easier to determine where costs can be cut.
• Reduce Business Travel: Often, travel expenses are one of the easiest areas of administrative cost to trim. In many cases, video calls, telephone, and email can suffice in lieu of costly in-person visits. When travel is necessary, it is important to choose the least expensive travel option available. When regular travel is a necessity, companies should plan to use all possible travel benefits such as those offered by airlines for regular travel. These should be used, and optional costs should always be declined in order to control expenses.
• Avoid Unnecessary Celebrations: Traditionally, many business meetings may be celebrated with costly visits to restaurants involving both travel and dining expenses. These should be avoided in favor of virtual meetings, which can avoid most administrative overhead expenses. This also extends to avoiding unnecessary office celebrations, which can add to high costs.
• Track Staff Expenses: It is crucial to keep track of staff expenses and ensure that any cash accounts provided to staff for regular expenses are not misused. This includes any credit lines or gas cards that may be provided for travel expenses.
• Reduce Office Expenses: Office supplies, including endless stacks of paperwork, have traditionally been ubiquitous in administrative offices. However, with the advent of modern computerized accounting and office management systems, much of this paperwork and its associated office supplies can be eliminated, potentially saving a considerable sum along with it.
• Outsource Some Functions: For many companies, the expense of maintaining many specialized functions can drive up administrative overhead costs for little return. It is possible to outsource these functions to outside providers and save a significant sum.

Importance of Distinguishing Fixed and Variable Expenses

When analyzing a company’s administrative overhead costs, it is important to distinguish between its fixed costs and its variable costs that can change with time.

Fixed costs might include expenses such as mortgages, fixed salaries, and insurance.

These must be paid regardless of the level of production and may be unavoidable, with few if any ways to reduce them.

Then there are variable costs that can change with time which could include costs related to sales, the number of administrative or sales workers, or certain capital expenses.

It is important to understand both of these expenses because they reflect the administrative overhead which are within a company’s ability to control.

Accounting for Administrative Overhead Expenses

Finding total administrative overhead for a company simply requires adding up all expenses that are not directly related to the production of a company’s product.

However, the way in which these expenses are then apportioned may vary.

The simplest way to account for administrative overhead is to simply add up all of the costs not linked to production and record them as an administrative overhead expense on the income statement.

In some cases, management may choose to distribute these costs between the two main activities which a business performs, producing a good or service and selling it.

In others, all administrative overhead costs may be apportioned to the cost of production.

Key Takeaways

Administrative overhead includes all of the expenses unrelated to the production of a company’s product.

This includes many expenses, including those related to general administration, sales, engineering, accounting, marketing, and many more.

These are not related to the central production of a company’s product, but they are critical to the continued operation of a business.