Allocation
In accounting, allocation refers to the process of distributing and assigning costs, revenues, or resources among different accounts, departments, or projects. Allocation is used to spread expenses or income across various periods, activities, or cost centers, ensuring that each segment bears its fair share of the costs or benefits.
The purpose of allocation is to provide an accurate representation of the financial performance of a company’s various divisions, departments, or projects. It helps management make informed decisions about resource allocation and budgeting, as well as to evaluate the efficiency and profitability of different operations within the company.
For example, a company may allocate its overhead costs, such as rent, utilities, and administrative salaries, among its different departments based on their proportional use of resources or other relevant factors, such as the department’s revenue generation or headcount.
Example of an Allocation
Here’s an example of allocation in accounting:
Suppose a company operates three departments: Production, Marketing, and Sales. The company’s total overhead costs for the month are $30,000, which includes rent, utilities, and administrative salaries. To allocate these overhead costs fairly among the three departments, the company decides to use the headcount as the allocation basis.
The headcounts for the departments are as follows:
- Production: 50 employees
- Marketing: 30 employees
- Sales: 20 employees
Total employees: 100
Now, to allocate the overhead costs, the company calculates the allocation rate per employee:
$30,000 (total overhead costs) / 100 (total employees) = $300 per employee
Next, the company multiplies the allocation rate by the headcount in each department to determine the allocated overhead cost:
- Production: 50 employees x $300 per employee = $15,000
- Marketing: 30 employees x $300 per employee = $9,000
- Sales: 20 employees x $300 per employee = $6,000
The allocated overhead costs for each department now accurately reflect their proportional use of resources based on the headcount. This allocation helps the company to have a clearer understanding of the costs associated with each department and aids in better decision-making regarding budgeting and resource management.
