What is Administrative Overhead?

Explanation

Administrative overheads are mostly related to the office expenses of the business. These expenses are not the manufacturing overheads as they are not directly related to producing goods & services. The administrative expensesAdministrative ExpensesAdministrative expenses are indirect costs incurred by a business that are not directly related to the manufacturing, production, or sale of goods or services provided, but are necessary for the smooth functioning of business operations, such as information technology, finance & accounts.read more are the expenses for conducting the business’s operationsOperations Of The BusinessBusiness operations refer to all those activities that the employees undertake within an organizational setup daily to produce goods and services for accomplishing the company’s goals like profit generation.read more, formulation of policies, and other expenses not related to the production and research & development of the business.

You are free to use this image on you website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Administrative Overhead (wallstreetmojo.com)

Example

Let’s take the example of a company named Clothes incorporation which deals with clothes manufacturing. The expenses incurred by the company during the financial year 2019-20 are as follows:

Solution:

Calculation of Administrative Overheads:

The direct material purchased and the salary paid to the factory staff are directly linked to the production, which is not included in the administrative cost as they are production overhead. Moreover, the sales & marketing costs are part of the selling & distribution costDistribution CostDistribution cost is the total of all expenses incurred by the producer to make possible the delivery of the product from its location to the location of the end customer.read more, and research & development expenses are part of the research & development cost, so they are also not included. Therefore, the total administrative overhead is $870,000.

What Does Administrative Overhead Include?

The administrative overhead includes all the expenses that are not linked to the specific business function. The administrative expenses include wages & salaries to the office staff, audit and legal expenses, consultancy fees, rent, insurance premiums paid, utility expensesUtility ExpensesUtilities Expenses are the prices incurred by a Company for the usage of utilities like sewage, electricity, waste disposal, water, broadband, heating, & telephone. These are included as operating expenses in the Company’s income sheet. read more, rates & taxes, subscriptions, transport and conveyance charges, bank charges, repairs & maintenance expenses, printing & stationery expenses, etc. These expenses are necessary for conducting the operations of the business.

Measures to Control Administrative Overhead

The various measures to control are as follows:

Accounting Treatment

The following methods can account for the administrative costs of the company:

  • The first method is booking the cost as an expense in the company’s income statement by assuming that all the expenses are not directly linked to the production, manufacturing & selling of goods & services.The second method of the accounting treatment is based on the assumption that the business has two main activities, i.e., production activity and selling & distribution activity. So by following this assumption, the administrative overhead is apportioned between these two main activities.Now in this third method of accounting for administrative overhead, this expense is separately included in the work cost to measure the cost of production because an owner thinks that the administrative costs are as important as the production and selling & distribution costs.

Limitations

  • The administrative overhead includes the cost of administration, like staff salary, rent, etc. These costs are fixed costsFixed CostsFixed Cost refers to the cost or expense that is not affected by any decrease or increase in the number of units produced or sold over a short-term horizon. It is the type of cost which is not dependent on the business activity.read more that must be paid whether there is profit in the business. For example, if the business is shut down for the month due to unavoidable circumstances, then the factory’s rent is also to be paid.Also, these administrative costs being fixed in nature have the limited ability to get reduced. Companies that have centralized management generally have high administrative overheads.

Conclusion

Administrative overheads are not directly linked to the production and selling of goods & services. These overheads areIndirect expenses are the general costs incurred for running business operations and management in any enterprise. In simple terms, when you want to buy grocery from a supermarket, the transportation cost to get you to the supermarket and back is the indirect expenses.read more indirect expensesIndirect ExpensesIndirect expenses are the general costs incurred for running business operations and management in any enterprise. In simple terms, when you want to buy grocery from a supermarket, the transportation cost to get you to the supermarket and back is the indirect expenses.read more such as rent, insurance, salary paid to office staff, printing & stationery expenses, consultancy & legal charges, audit fees, etc. These are incidental to the main business activity and are also important to conducting the company’s affairs.

This has been a guide to what is administrative overhead. Here we discuss examples, accounting treatment, measures to control, and what it includes. You may learn more about financing from the following articles –

  • Applied OverheadSG&A ExpensesFactory CostAbsorbed OverheadManufacturing Overhead