What is Administrative Overhead?

Administrative Overhead

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Administrative Overhead

Administrative overhead refers to the indirect expenses incurred in running and managing a business that are not directly tied to the production of goods or services. These expenses are necessary to maintain the company’s operations, but they do not contribute to the actual production process. Administrative overhead is a subset of the company’s total overhead costs, which also includes manufacturing and selling overheads.

Examples of administrative overhead include:

  • Salaries and wages for administrative staff: Compensation for employees such as office managers, human resources personnel, and accountants who handle day-to-day operations and management tasks.
  • Rent and utilities for office space: Expenses related to maintaining office facilities, including rent, electricity, water, and internet services.
  • Office supplies and equipment: The cost of purchasing and maintaining items such as computers, printers, paper, and pens necessary for administrative tasks.
  • insurance: Premiums for liability insurance, property insurance, and other types of insurance that protect the company from potential risks and liabilities.
  • Legal and professional fees: Expenses related to hiring attorneys, consultants, or other professionals to provide advice and services to the company.
  • Depreciation of office furniture and equipment: The loss of value over time for assets used in the company’s administrative functions.

Administrative overhead expenses are typically reported on a company’s income statement as a separate line item under operating expenses. Companies aim to control and minimize administrative overhead costs to improve overall profitability and efficiency.

Example of an Administrative Overhead

Let’s consider a hypothetical example of a small software development company to illustrate administrative overhead costs.

In this scenario, the company has the following administrative overhead expenses:

  1. Salaries and wages for administrative staff:
    • Office manager: $45,000 per year
    • Human resources specialist: $40,000 per year
    • Accountant: $50,000 per year
  2. Rent and utilities for office space:
    • Monthly rent: $3,000
    • Monthly utilities (electricity, water, internet): $500
  3. Office supplies and equipment:
    • Annual office supplies cost: $2,000
    • Annual equipment maintenance and replacement: $4,000
  4. Insurance:
  5. Legal and professional fees:
    • Annual fees for legal advice and consultation: $5,000
  6. Depreciation of office furniture and equipment:

To calculate the total annual administrative overhead cost, we can add up all these expenses:

  • Salaries and wages: $135,000
  • Rent and utilities: ($3,000 + $500) * 12 = $42,000
  • Office supplies and equipment: $2,000 + $4,000 = $6,000
  • Insurance: $6,000 + $3,000 = $9,000
  • Legal and professional fees: $5,000
  • Depreciation: $3,000

Total administrative overhead = $135,000 + $42,000 + $6,000 + $9,000 + $5,000 + $3,000 = $200,000

In this example, the software development company has an annual administrative overhead cost of $200,000. This amount would be reported on the company’s income statement under operating expenses, separate from other overhead costs such as manufacturing and selling expenses.

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