Allocation Process
Cost allocation is the process of identifying, aggregating, and distributing indirect costs to specific products, work orders, or cost centers.
Overview
Not all costs can be directly traced to a product. Overhead expenses — such as factory utilities, equipment depreciation, and supervisory salaries — must be allocated using a fair and consistent method.
Step-by-Step Allocation Process
Step 1: Define Cost Centers
Set up cost centers that represent departments or functions in your facility (e.g., Machining, Assembly, Quality Control).
Step 2: Collect Indirect Costs
During the period, indirect costs are posted to the appropriate cost centers:
- Utilities bills → Machining cost center
- Maintenance labor → Assembly cost center
Step 3: Choose an Allocation Base
Select the driver that best reflects how each cost center consumes resources:
| Cost Center | Suggested Allocation Base |
|---|---|
| Machining | Machine hours |
| Assembly | Direct labor hours |
| Packaging | Units produced |
| Quality Control | Number of inspections |
Step 4: Calculate Allocation Rate
Allocation Rate = Total Overhead Cost / Total Allocation Base
Step 5: Apply Costs to Work Orders
Multiply the allocation rate by the actual base consumed by each work order:
Allocated Cost = Allocation Rate × Actual Base Consumed
Step 6: Review and Adjust
At period end, compare applied overhead to actual overhead. Any difference is recorded as an over- or under-absorption adjustment.
Allocation Methods
- Fixed Rate — A pre-determined rate applied uniformly throughout the period
- Actual Rate — Calculated at period end based on real costs incurred
- Activity-Based Costing (ABC) — Allocates costs based on specific activities that drive costs