What Are Administrative Expenses?

What Are Administrative Expenses?

Let me explain administrative expenses directly to you: these are the costs your organization incurs that aren't directly linked to core functions like manufacturing, production, or sales. Think of them as overhead that supports the entire organization, not just specific departments or units.

Key Takeaways on Administrative Expenses

You need to know that administrative expenses support your business's functioning without relating directly to producing a specific product or service. Some level of these expenses is always necessary for operations. They're often the first to face budget cuts because they don't directly affect main business functions. Management might allocate them to business units based on percentages of revenue, expenses, or other measures.

Understanding Administrative Expenses

Administrative expenses can include salaries for senior management and costs for general services like legal, accounting, clerical work, and IT. These aren't directly tied to producing goods or services, so they're usually left out of gross margin calculations.

Your company incurs these to handle basic operations, such as payroll or healthcare benefits, to boost oversight and efficiency, or to meet legal requirements. On the income statement, they appear below cost of goods sold and might be grouped with general or selling expenses.

Some are fixed, existing as the foundation of operations regardless of production or sales levels. Others are semi-variable; for instance, you'll always use some electricity to keep lights on, but you can cut back beyond that minimum.

You can often eliminate these without directly affecting your products, making them prime for budget cuts. Management aims to keep them low relative to other costs to leverage resources better. The sales-to-administrative expense ratio shows how much sales revenue covers these costs.

On tax returns, you can deduct reasonable, ordinary, and necessary administrative expenses incurred in the usual course of business, taken in the year they occur.

Other Types of Administrative Expenses

Wages and benefits for employees like accounting and IT staff count as administrative expenses. All executive compensation falls here too. Building leases, insurance, subscriptions, utilities, and office supplies might be classified as general or administrative.

Depreciation can be administrative, general, or selling depending on the asset. You might include consulting and legal fees here, but research and development costs don't count as administrative.

Remember, a company can allocate these expenses to departments based on revenue percentages, expenses, square footage, or other metrics, helping management decide on expanding or reducing units.

Example of Administrative Expenses

Take XYZ Company as an example: if it spends $4,000 monthly on electricity recorded as an administrative expense, it might allocate based on square footage each department occupies.

Assume the production facility is 2,000 square feet, manufacturing is 1,500, accounting office is 750, and sales office is 750, totaling 5,000 square feet. The allocation would be: production gets $1,600 (2,000/5,000 x $4,000), manufacturing $1,200 (1,500/5,000 x $4,000), accounting $600 (750/5,000 x $4,000), and sales $600 (750/5,000 x $4,000).

What Is Gross Margin?

Gross margin is your company's net sales minus cost of goods sold—it's what you earn from sales before subtracting administrative expenses.

What Are Some Semi-Variable Administrative Expenses?

Semi-variable ones include salaries, audit and legal fees, vehicle use, commissions, and utilities with a base charge plus usage fees.

What Is Depreciation in Accounting?

Depreciation tracks an asset's gradual value loss over time as it becomes less usable and efficient, recorded as an expense over the period you expect revenue from it.

The Bottom Line

Administrative expenses keep your business running but don't directly fund production of goods or services. They're unavoidable for functionality, yet flexible for tweaks during budget cuts and sometimes tax-deductible.