Administrative Expenses

Administrative expenses are overhead costs incurred to support a company’s overall operations but are not directly tied to producing a specific product or delivering a specific service. They enable the business to function and are typically reported below cost of goods sold (COGS) on the income statement.

Key takeaways

• Administrative expenses support the organization as a whole rather than individual production or sales activities.
• They can be fixed (incurred regardless of activity level) or semi-variable (part fixed, part variable).
• Companies often target administrative expenses first when cutting budgets because they don’t directly affect production.
• Reasonable, ordinary, and necessary administrative expenses are generally tax-deductible in the year incurred.

Common examples

Administrative expenses often include:
* Executive and senior management salaries and benefits
Accounting, legal, and consulting fees
Information technology and clerical staff wages
Office rent or building leases, utilities, insurance, and subscriptions
Office supplies and general administrative depreciation (classification depends on the asset)

Note: Research and development (R&D) costs are not typically classified as administrative expenses.

Fixed vs. semi-variable expenses

• Fixed administrative expenses: costs that exist regardless of production or sales volume (e.g., base salaries, lease payments).
• Semi-variable expenses: contain a fixed base portion plus a variable component that changes with usage (e.g., utilities with a base charge plus usage fees, commissions with a minimum retainer).

Allocation of administrative costs

Companies may allocate administrative expenses to departments or business units using bases such as:
* Percentage of revenue or expenses
Square footage occupied
Headcount or direct usage metrics

Allocation helps managers evaluate unit profitability and guide expansion or reduction decisions.

Allocation example (electric bill)

If a company’s monthly electric bill is $4,000 and total occupied space is 5,000 sq ft:
* Production (2,000 sq ft): (2,000 / 5,000) × $4,000 = $1,600
Manufacturing (1,500 sq ft): (1,500 / 5,000) × $4,000 = $1,200
Accounting (750 sq ft): (750 / 5,000) × $4,000 = $600
* Sales (750 sq ft): (750 / 5,000) × $4,000 = $600

Relationship to gross margin

Gross margin = Net sales − Cost of goods sold (COGS). Administrative expenses are deducted after gross margin when calculating operating income, so they do not affect gross margin but do affect operating profitability.

Depreciation

Depreciation records the gradual loss of value of assets over time. Depending on the asset’s use, depreciation may be classified as cost of goods sold, selling expense, or general/administrative expense.

Management use and measurement

Managers monitor administrative expenses to maintain efficient operations and leverage. A common metric is the sales-to-administrative expense ratio, which indicates how much sales revenue is required to cover administrative costs.

Bottom line

Administrative expenses are necessary overhead that keep a business running but do not directly produce goods or services. They can be adjusted when cost reductions are needed and are often tax-deductible if they meet standard business expense criteria. Proper classification and allocation help businesses evaluate unit performance and control overall operating costs.