Allocation base definition
/What is an Allocation Base?
An allocation base is the basis upon which an entity allocates its overhead costs. An allocation base takes the form of a quantity, such as machine hours used, kilowatt hours consumed, or square footage occupied. Cost allocations are mostly used to assign overhead costs to produced inventory, as required by several accounting frameworks. This is done in a fair and systematic manner, which makes these allocations more predictable. The typical allocation process in a multi-department company is as follows:
Allocate service department costs to operating departments.
Assign operating department costs (including the allocations from service departments) to products and services.
The allocation base should be a cause, or driver, of the cost being allocated. A good indicator that an allocation base is appropriate is when changes in the allocation base roughly correspond to changes in the actual cost. Thus, if machine usage declines, so too should the actual cost incurred to operate the machine.
Managers should be aware of every allocation base being used, since it is the basis for overhead charges being assigned to their departments. They may alter the activities of their departments to reduce their use of each allocation base, thereby reducing the costs assigned to their departments.
Allocation Base Best Practices
Most organizations use a very small number of allocation bases to allocate overhead costs, though a detailed activity-based costing system may use quite a large number of them. The reason for using few allocation bases is that it can be expensive to collect allocation information. Consequently, consider using the following best practices:
Use existing data collection systems. Where possible, use allocation bases for which existing data collection systems are already in place. This minimizes any incremental increases in expenses incurred.
Run a cost-benefit analysis. If there is no clear benefit associated with using an additional allocation, then do not install it.
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Examples of Allocation Bases
Here are several examples of appropriate allocation bases:
Number of computers used. The computer services department allocates its costs based on the number of personal computers used by each operating department, or by the number of service calls to each operating department.
Number of machine hours used. The production department allocates its overhead based on the amount of time required to process each unit of production through its machines. This is a good choice for highly-automated production systems where the main cost is the equipment.
Square footage occupied. The janitorial department allocates its costs based on the square footage occupied by each operating department.
Number of employees on staff. The human resources department allocates its costs based on the number of employees working in each operating department.