Administrative overheads are the cost of formulating the policy, directing the organization and controlling the operation of undertaking. They cannot be directly located with the production of goods. The examples of such expenses are salaries of office staff, legal charges, audit fees, depreciation of office machines and building, office rent, stationary, postage, typing charges etc. Administrative overheads are collected and classified in the same manner as production overheads. They are usually apportioned to various administrative departments which act as cost centers like general office; accounts department, personal department, law department etc.
As administrative overheads are incurred for the benefits of the production and sales, they should be apportioned between these departments on some equitable basis. But, generally it is advocated that administration is also a separate function like production and sales and, therefore, the administrative overheads should be taken as an independent item of cost and added to the cost of a job or a product.
There are various methods of absorption of administration overheads. These are:
- Production unit method (absorption rate worked out per unit of output).
- As a percentage of conservation cost.
- As a percentage of sales.
- As a percentage of work cost.
Of these, the most commonly used method is the percentage of work cost. Under this method the absorption rate is worked out as follows:
Total Administration Overheads / Total Works Cost X 100.
For example. if the work cost is Rs. 10,000 and the total administration overheads are Rs. 2000, the absorption rate will be 20% (2000 / 10,000 X 100) of work cost. Now, if the work cost of a particular product is Rs. 600, the administration cost to be added to its cost will be Rs. 120 (20% of Rs. 600). Administration overheads are fixed in nature. Control on them can be exercised through budgets, standard costing and by comparison with part performance.