It is common practice to classify and separately collect the production, administrative, selling and distribution costs. The administrative overheads are related to office expenses. The selling and distribution expenses are related to marketing. All these expenses combined together give us the total selling cost. While accounting the production overheads and valuing the closing stock, no administrative, selling or distribution expenses are taken into account. They are separately accounted for and are shown separately in the cost sheet.
Administrative Overheads – Definition
Administrative overheads refer to the indirect expenditures incurred in connection with (i). formulating policy, (ii) directing the organization, (iii) controlling the operation of the enterprise, and (iv) other allied matters pertaining to administration, but not related to research and development expenses directly.
It is concerned with the expenditure of general nature and does not relate to any particular function like production, sales or distribution. administrative overheads are usually constant. They are not affected by any change in the volume of production, etc.
Administrative Overheads – Examples
Some of the office and administrative expenses ( overheads) are listed below:
1. Indirect Materials
(a). Printing and Stationery used in the office.
(b). Cost of dusters, brushes etc. for cleaning.
2. Indirect Labour
(a). Salaries and allowances or fees of director, managers, managerial staff, accounts staff, secretary and the staff and all those who are connected with the office.
(b). Salaries and allowances of Public Relation Officer and his staff.
(c).Salaries and allowances of a legal adviser, his staff and other allied expenses.
(d). Other statutory expenses, e.g. fees to auditors, salary and allowances to internal auditors etc.
3. Indirect expenses
(a). Office Rent, Rates and Taxes.
(b). Office Insurance, heating, cleaning, etc.
(c). Depreciation of office buildings, equipments etc.
(d). Repairs and maintenance of office building, etc.
(e). Legal Charges.
(f). bank Charges.
(g). Trade Subscription.
(h). Other Expenses related to office operation.
From the above, it is clear that, as the Institute of Cost and Management Accountants, England has defined, Administrative Overheads as “the cost of formulating the policy, directing the organization and controlling the operations of an undertaking, which is not related directly to research, development, production, distribution or selling activity or function.”
Apportionment of Administrative Overheads
There are three methods of apportioning administrative overheads:
- Apportionment to manufacturing and selling divisions.
- Transfer to Costing Profit and Loss Account.
- Addition as a separate item of cost.
Apportionment to manufacturing and selling divisions
Here the principle followed is that administrative overheads are also incurred for manufacturing and also for selling divisions. A part of administrative expenses, therefore, must be charged to the manufacturing division and another part to selling division. In this way, administrative overheads are absorbed in both manufacturing and selling and distribution overheads.
However, the problem here is that no suitable basis can easily be found out for the apportionment of 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.
Transfer to Costing Profit and Loss Account
Here 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 Costing Profit and Loss account by transferring the same. One argument in support of this principle is that there cannot be any equitable base to charge office and administrative overheads to other functions of the products, therefore, it shall be a wise step to transfer it to Costing Profit and Loss account.
But non-inclusion under costs the cost of the product etc. Moreover, manufacturing and selling divisions cannot effectively function without the help of administrative function. They should, therefore, be charged to these two divisions.
Addition as a separate item of cost
According to this method, the office and administrative overheads are added separately to the cost of the job, process, product, etc. according to some suitable basis selected for the purpose. The basis may either be sales value, sales quantity, manufacturing cost or manufactured unit. The rate for absorption is computed with the help of the following formula:
Rate of absorption of overhead = (Administrative overhead x 100) / Sales Quantity (if this is the base)
Say, if administrative overhead has been calculated as $5,000 and total volume of sales during the corresponding period is 50,000; the rate will be as:
= 5000 x 100 / 50,000 = 10%
The administrative overheads can be controlled effectively either by suitably classifying them and analyzing them properly; or by comparing the current overheads with those of past overheads and draw conclusions. Thereafter adopt certain controlling as well as corrective measures. The technique of budgetary control can also be used for the purpose. Similarly, setting of standards may also help in controlling the administrative overheads effectively.