Cost allocation assigns a specific cost to a project. An example of a cost that needs allocation would be an electric bill for several different projects. A cost object is a task or a job. An example cost object would be manufacturing widgets. There are numerous ways to determine the allocation; however, it is important to not just arbitrarily assign costs. Since there are numerous ways to allocate costs, it is important a company chooses an appropriate base. The base can range from direct labor hours to units produced.
Calculate the total amount of the costs needing assignment. For example, a company wants to allocate electricity costs for producing two products. Electricity costs are $50,000 for the year.
Determine the base to use and the percentages to allocate based on the base. For example, the company wants to use direct labor hours as its base. For Product A, the company needs 1,400 direct labor hours. For Product B, the company needs 1,600 direct labor hours. Therefore, 1,400 direct labor hours divided by 3,000 direct labor hours equals an allocation base of about 46 percent for Product A. Then 1,600 direct labor hours divided by 3,000 direct labor hours equals an allocation base of about 54 percent for Product B.
Multiply the total cost by the allocation base. In our example, for Product A, $50,000 times 46 percent equals $23,000. For Product B, $50,000 times 54 percent equals $27,000.