What are administrative expenses?
Administrative expenses are costs a company incurs to run the business as a whole rather than to make or sell a particular product. These are overhead items that support general operations — for example, executive pay, accounting, human resources, office rent, utilities, insurance, and some IT and legal fees. Because they do not form part of cost of goods sold (COGS), they are recorded below COGS on the income statement and reduce operating profit after gross margin.
Key definitions
– Administrative expense: An overhead cost incurred to support company-wide functions (not directly traceable to producing or selling a specific product).
– Overhead: Broad term for ongoing business expenses not directly tied to production, including administrative, selling, and facilities costs.
– Fixed expense: A cost that does not change with short-term changes in production or sales (e.g., office rent).
– Semi-variable expense (also called mixed cost): A cost with a fixed base plus a variable portion that rises with activity (e.g., utility bills with a service charge plus usage).
– Gross margin: Net sales minus cost of goods sold (COGS). It measures what the business earns from sales before deducting administrative and selling expenses.
– Depreciation: The systematic allocation of an asset’s cost over its useful life; depreciation expense may be classified as administrative, selling, or COGS depending on how the asset is used.
Why administrative expenses matter
– Profitability: Lower administrative expenses (relative to sales) generally improve operating margins and free up cash for investment.
– Cost control: Administrative items are often the first place managers look when cutting expenses because reducing them usually doesn’t directly affect production.
– Compliance and tax: Reasonable, ordinary, and necessary administrative expenses are generally deductible for tax purposes in the year incurred (subject to tax rules).
Common examples
– Salaries and benefits for corporate staff (executives, HR, accounting, IT)
– Office rent and utilities
– Insurance, subscriptions, and office supplies
– Professional fees (legal, audit, consulting)
– Depreciation on non-production assets
Classification and allocation
Companies often present administrative expenses either as a separate line or bundled with selling/general expenses (SG&A). When a firm wants to assign overhead to business units, typical allocation bases include:
– Percentage of revenue
– Share of total expenses
– Square footage occupied
– Headcount or machine-hours
Checklist: How to review administrative expenses
1. Identify and list all items currently classified as administrative.
2. For each item, ask: Is this required for the business to operate? (necessary, ordinary)
3. Decide whether the cost is fixed, variable, or semi-variable.
4. If allocating to departments, choose a fair base (revenue, sq ft, headcount) and document the method.
5. Benchmark administrative expenses as a ratio to sales or to total operating expenses.
6. Check tax-deductibility rules and retain supporting documentation (invoices, contracts).
7. Review contracts and subscriptions for cancellation or renegotiation opportunities.
8. Track changes over time to spot trends or anomalies.
Worked numeric examples
A. Allocation of an administrative utility bill by square footage
– Scenario: Company pays $4,000 per month for electricity and occupies 5,000 square feet.
– Allocation rule: split the bill in proportion to the sq ft each department uses.
– If Department A uses 2,000 sq ft, Department B uses 1,500 sq ft, Department C uses 1,500 sq ft:
– Department A share = (2,000 / 5,000) × $4,000 = 0.4 × $4,000 = $1,600
– Department B share = (1,500 / 5,000) × $4,000 = 0.3 × $4,000 = $1,200
– Department C share = same as B = $1,200
B. Gross margin and impact of administrative expenses
– Scenario: Net sales = $100,000; COGS = $60,000; administrative expenses = $10,000.
– Gross margin = Net sales − COGS = $100,000 − $60,000 = $40,000.
– Operating profit before other items = Gross margin − Administrative expenses = $40,000 − $10,000 = $30,000.
– Interpretation: Administrative spending consumed 25% of the gross margin ($10,000 / $40,000).
Practical manager’s tips
– Track administrative expense ratios (e.g., admin expense / sales) monthly to detect drift.
– Separate one-time administrative items (reorg costs, legal settlements) from recurring items to avoid misleading trend analysis.
– When cutting costs, prioritize those with minimal operational impact and consider long-term consequences (e.g., cutting compliance or critical IT support can create greater costs later).
Tax and accounting notes
– For tax purposes in the U.S., many administrative costs are deductible if they meet the IRS tests of ordinary, necessary, and reasonable; consult IRS guidance and a tax professional.
– Depreciation classification depends on the asset’s use: depreciation on a corporate office may be administrative; on factory machinery it would be COGS.
Sources for further reading
– Investopedia — Administrative Expenses: https://www.investopedia.com/terms/a/administrative-expenses.asp
– Internal Revenue Service — Publication 535, Business Expenses: https://www.irs.gov/publications/p535
– Corporate Finance Institute — Overhead (definition and examples): https://corporatefinanceinstitute.com/resources/knowledge/accounting/overhead/
– AccountingTools — What is Depreciation?: https://www.accountingtools.com/articles/what-is-depreciation.html
Educational disclaimer
This explainer is for educational purposes only. It is not individualized tax or investment advice. For decisions that affect your taxes or company financial reporting, consult a qualified accountant or tax professional.