What Are Administrative Expenses and What Are Some Examples?

What Are Administrative Expenses?

Administrative expenses are expenses incurred by an organization 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 rather than to individual departments or business units.

Understanding Administrative Expenses

Administrative expenses may include the salaries of senior management and the costs associated with general services or supplies, such as legal, accounting, clerical work, and information technology. These costs generally aren't directly related to the production of goods or services and are usually excluded from gross margins.

Companies incur administrative expenses to perform basic operations such as administering payroll or healthcare benefits. They incur them to increase oversight and efficiency and/or to comply with laws and regulations. Administrative expenses appear below cost of goods sold (COGS) on the income statement and they may be shown as an aggregate with other expenses such as general or selling expenses.

Some administrative expenses are fixed in nature because they're incurred as part of the foundation of business operations. They would exist regardless of the level of production or sales that occur. Other administrative expenses are semi-variable. A business will always use some minimum level of electricity to keep the lights on. It can take measures to reduce its electric bill beyond that point.

A business can eliminate administrative expenses without a direct impact on the product it sells or produces so these costs are typically first in line for budget cuts. Management is strongly motivated to maintain low administrative expenses relative to other costs because this allows a business to use leverage more effectively. The sales-to-administrative expense ratio helps companies measure how much sales revenue is being portioned to cover administrative costs.

Companies can deduct administrative expenses that are reasonable, ordinary, and necessary for business operations on their tax returns. These expenses must be incurred during the usual course of business and deducted in the year they're incurred.

Other Types of Administrative Expenses

Wages and benefits to certain employees such as accounting and IT staff are considered to be administrative expenses. All executive compensation and benefits are considered to be administrative expenses. Building leases, insurance, subscriptions, utilities, and office supplies may be classified as general expenses or administrative expenses.

Depreciation expenses may be classified as general, administrative, or selling (marketing) expenses depending on the asset being depreciated. Organizations may choose to include consulting and legal fees as administrative expenses as well but research and development (R&D) costs aren't considered to be administrative expenses.

Example of Administrative Expenses

XYZ Company might allocate the cost according to the square footage each department occupies if it spends $4,000 monthly on electricity and records this as an administrative expense. 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

The Bottom Line

Administrative expenses are those that are incurred to allow a business to function. They don’t directly pay for the production of goods or services. They effectively allow a business to function so they’re unavoidable. They’re flexible, however, and can be tweaked when budget cuts are necessary. They’re also tax deductible in some cases.