Cost Allocation
The process of assigning indirect costs to specific cost objects like departments, products, or services based on identified allocation bases.
Cost Allocation
The process of assigning indirect costs to cost objects such as departments, products, services, or customers, using allocation bases that reasonably reflect resource consumption.
For instance, a manufacturing company might allocate factory utility costs of $100,000 to various production departments based on square footage, allocate maintenance department costs to production departments based on machine hours, and then allocate all production department costs to products based on direct labor hours.
Cost allocation helps determine full product costs for pricing decisions and inventory valuation, evaluate department and product line profitability, and support cost control efforts. While necessary for many purposes, allocated costs should be interpreted cautiously, as different allocation methods can significantly impact reported profitability of cost objects.