It is common practice to classify and separately collect production, administrative, selling, and distribution costs. Administrative overheads are related to office expenses. By contrast, selling and distribution expenses are related to marketing. All these expenses combined give the total selling cost. In accounting for the production overheads and valuing closing stock, no administrative, selling, or distribution expenses are considered. They are separately accounted for and are shown separately in the cost sheet. Administrative overheads are indirect expenditures incurred in connection with any of the following: Administrative overheads are concerned with expenditures of a general nature, which do not relate to any particular function (e.g., production, sales, or distribution). An important characteristic of administrative overheads is that they are usually constant. They are not affected by changes in the volume of production, sales, or other factors. Examples of office and administrative overheads are listed below: Having considered the above examples of administrative overheads, it is worthwhile to examine the definition from the Institute of Cost and Management Accountants (ICMA) in England. ICMA defines administrative overheads as: There are three methods used to apportion administrative overheads: Here, the principle followed is that administrative overheads are also incurred for the manufacturing and selling divisions. A portion of administrative expenses, therefore, must be charged to the manufacturing division and another part to the selling division. In this way, administrative overheads are absorbed in both manufacturing and selling and distribution overheads. However, the problem here is that it is not easy to find a suitable basis for apportioning this overhead between the two divisions. The nature, object, and function of administrative overheads will thus form the basis of apportionment. If depreciation of buildings is to be apportioned, then the space occupied or floor area of each division shall form the apportionment basis. In this case, the principle applied is that the administrative overheads have no direct relationship with the manufacturing or selling divisions. Hence, they should not be charged to these divisions. Instead, they should be shown in the costing profit and loss account by transferring the same. One argument in support of this principle is that there cannot be any equitable basis for charging office and administrative overheads to other functions of the products. Therefore, it is a wise step to transfer them to the costing profit and loss account. The manufacturing and selling divisions cannot function effectively without the help of the administrative function. Administrative overheads should, therefore, be charged to these two divisions. According to this method, office and administrative overheads are added separately to the cost of the job, process, or product according to some suitable basis selected for the purpose. The basis may be the sales value, sales quantity, manufacturing cost, or number of units to be manufactured. The rate of absorption is calculated using the formula below: Overhead absorption rate = (Administrative overhead x 100) / Sales quantity (if this is the base) If an administrative overhead has been calculated as $5,000 and the sales volume during the period is 50,000 units, the rate will be 5,000 x 100 / 50,000 = 10%. It is possible to control administrative overheads by classifying them and analyzing them properly, or by comparing the current overheads to those of past overheads and drawing sound conclusions. Afterward, control measures and corrective measures can be adopted, and budgetary control techniques can be used. Similarly, setting standards may help in controlling administrative overheads.Administrative Overheads: Definition
Administrative Overheads: Examples
1. Indirect Materials
2. Indirect Labor
3. Indirect Expenses
Explanation
Administrative overheads are the cost of formulating the policy, directing the organization, and controlling the operations of an undertaking, which are not related directly to research, development, production, distribution, or selling activities or functions.
Apportionment of Administrative Overheads
1. Apportionment to Manufacturing and Selling Divisions
2. Transfer to Costing Profit and Loss Account
3. Addition as a Separate Item of Cost
Example
Administrative Overheads FAQs
There are three types of administrative overhead: general control, administrative support service centers, Depreciation on office equipment and furniture
This will not have any effect on costing. In this case, only a portion of the net book value of office equipment and furniture is recorded as Depreciation charge for a given accounting period.
In this case, four types of administrative overhead may be absorbed: Depreciation on buildings, renovation expenses, rent paid for building used by the administration, cleaning expenses of administrative buildings
The basis usually used in allocating this overhead will be either the net book value or the floor space.
An example is the round-the-clock security services offered to each building by the administration.
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.
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