Administrative cost

Administrative cost refers to expenses incurred by an organization to support its general operations rather than direct production activities. These costs encompass salaries of non-production personnel, office rent, utilities, insurance premiums, and professional fees. The Institute of Cost and Management Accountants (ICMA) defines administrative overheads as "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."^[1]

Historical development

Administrative costs were not separately tracked in early business accounting. The scientific management movement changed this approach fundamentally. Frederick Winslow Taylor, working at Midvale Steel Company during the 1880s, developed systematic methods for analyzing workplace efficiency.^[2] His 1911 publication The Principles of Scientific Management laid groundwork for modern cost accounting practices.

Seymour Melman documented the transformation of administrative expenses in American industry. His 1951 study published in Oxford Economic Papers tracked administrative overhead growth from 1899 to 1947. Manufacturing firms saw these costs rise significantly during this period. By the mid-twentieth century, separating administrative from production expenses became standard accounting practice.

Classification and types

Administrative costs fall into several distinct categories based on their nature and function within the organization.

Personnel-related expenses

Wages paid to office staff constitute the largest portion of administrative overhead. Human resources departments, legal counsel, executive management, and accounting personnel generate ongoing salary obligations. Benefits packages add substantial costs beyond base compensation.

Facility costs

Office space rental or mortgage payments represent fixed administrative expenses. Utility bills for electricity, heating, water, and telecommunications services accumulate monthly. Building maintenance and cleaning services also fall under this category.

Professional services

External audit fees, legal consultations, and management consulting engagements create periodic expense obligations. Insurance premiums for liability coverage and professional indemnity require annual outlays.

Office operations

Supplies, equipment depreciation, software licensing, and postal services generate recurring costs. These smaller items aggregate into significant annual expenditures when combined across departments.

Calculation methods

The administrative cost rate measures overhead as a percentage of total revenue. Organizations calculate this by dividing administrative expenses by gross revenue and multiplying by 100. A company with $50,000 in administrative costs and $500,000 in revenue has a 10% administrative cost rate.^[3]

Benchmarking against industry standards helps evaluate administrative efficiency. Service industries typically carry higher administrative cost ratios than manufacturing firms. Professional service companies may spend 20-30% of revenue on administration. Manufacturing operations often target ratios below 10%.

Treatment in financial reporting

Administrative costs are classified as period costs in accounting. They must be recognized in the period incurred rather than capitalized into inventory values. This treatment differs from manufacturing overhead, which can be allocated to product costs.

Financial statements present administrative expenses on the income statement below cost of goods sold. Combined with selling expenses, they form the Selling, General, and Administrative (SG&A) line item. Analysts scrutinize this figure when evaluating operational efficiency.

Control strategies

Organizations employ various approaches to manage administrative costs effectively.

Process automation

Software systems reduce manual processing requirements. Enterprise resource planning implementations consolidate administrative functions. Document management systems decrease paper-handling costs.

Shared services

Centralizing functions like payroll, accounts payable, and human resources across business units generates economies of scale. Large corporations often establish shared service centers in lower-cost locations.

Outsourcing

Contracting specialized functions to external providers can reduce fixed overhead. Common outsourced activities include payroll processing, information technology support, and facilities management.

Advantages of tracking administrative costs

• Enables accurate product and service pricing decisions
• Supports identification of cost reduction opportunities
• Facilitates comparison with industry benchmarks
• Provides data for budgeting and planning processes
• Helps evaluate management efficiency over time

Limitations and challenges

• Allocation methods can be arbitrary when shared resources serve multiple functions
• Cost cutting may harm long-term organizational capability
• Benchmarking proves difficult when companies classify expenses differently
• Some administrative activities provide intangible strategic value difficult to quantify

Infobox5 — recommended articles

Cost Management Efficiency Planning Organization Production Quality management

References

• Cooper, R. (2000). Cost Management: Frederick Taylor to the Present. Journal of Cost Management, 14(1).
• Institute of Cost and Management Accountants. Terminology of Management and Financial Accountancy. ICMA Publications.
• Melman, S. (1951). The Rise of Administrative Overhead in the Manufacturing Industries of the United States 1899-1947. Oxford Economic Papers, 3(1), 62-112.
• Taylor, F.W. (1911). The Principles of Scientific Management. Harper & Brothers.

Footnotes

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1. Institute of Cost and Management Accountants definition
2. Taylor's work at Midvale Steel began in 1878 and continued through the 1890s
3. Standard formula: (Administrative Costs / Total Revenue) × 100