# What Is a Cost Allocation Base? Example, Calculate, Overview

A Cost Allocation Base (CAB) is a financial tool that allows users to allocate their budget to different costs across a portfolio, such as a product line or a new market. The resulting report gives users a view of the cost of each product and a breakdown of the cost structure.

## What Is a Cost Allocation Base?

A cost allocation basis is an approach used to determine the most appropriate method for assigning or allocating costs to certain cost items. A project, a department, or even a function inside a department might be a cost object.

In accordance with generally accepted accounting rules, it is feasible to develop a cost allocation base that takes into account the number of cost objects involved and the manner in which specific types of expenses are to be allocated among those objects.

As with the process of cost allocation, the objective is not necessarily to assign particular quantities of costs, but rather to determine where certain cost kinds might be allocated most effectively.

## How to Calculate Cost Allocation Base?

### Step 1: Determine the total reach of the support department.

Say, for a large outsourcing company, the primary support team will consist of the IT Team, which offers technical assistance for all employees. Consider that the organization need help for 10,000 computers and 5,000 laptops.

Multiple departments utilize PCs and laptops, but only one support staff is responsible for their maintenance. The support team has access to 10,000 computers and 5,000 laptops in total.

### Step 2: Find the Allocation Base.

The support crew is responsible for assisting 10,000 desktop computers and 5,000 laptops. As a result, 15,000 will be regarded as the complete reach of the support team, and hence as the allocation base.

The base for any support-related overhead expenses that must be added to a particular project is \$15,000.

### Step 3: Allocating Overhead to the individual project.

When a corporation analyzes the cost of a specific project, say project A, support overhead is included as part of the project’s overall overhead. If the project utilizes one thousand computers and the entire cost of keeping the support crew is \$500,000, then the cost per PC is \$1,000. Then the assistance expenses allocated to project A will be

Support Overhead Allocated to Project A = Total Cost of Support Team * (Number of Desktops Used by Project A / Total Computers Supported by Support Team)

• Support Overhead allotted to Project A equals \$500,000 * (1/10,000) = \$33,333.

Consequently, when computing the cost of project A, the cost of assistance should be \$33,333.

## Example of Cost Allocation Base

The company XYZ owns its own building. There are ten active projects in this building. The corporation is attempting to determine the pantry and administrative support costs for project A.

The pantry supplies all ten projects at an annual cost of \$500,000 for pantry service. Additionally, all projects share the support service. The administrative support service is shared by all projects and costs \$20,000 total.

Solution:

The Allocation Base for the Pantry and Administrative Support will be \$500,000 and \$20,000, respectively, when the corporation attempts to determine the overhead costs for project A.

The Overhead Cost of Pantry for Project A = Total Cost of Pantry / Number of Projects

• The overhead cost of the pantry for project A = \$500,000 / 10 = \$50,000
• So for one project, the overhead cost will be \$50,000

Similarly,

The Overhead Cost of Administrative Support for Project A = Total Cost of Administrative Support / Number of Projects

• Administrative Support for Project A= \$20,000 / 10 = \$2,000

Total Overhead Cost of Project A = Overhead Cost of Pantry for Project A + Overhead Cost of Administrative Support for Project A

• Total Overhead cost of Project A = \$50,000 + \$2,000
• Total Overhead cost of Project A = \$52,000

Therefore, the total cost of overhead for project A is determined using the Allocation Base of Pantry and Administrative Support.

## Allocation Bases for Factory Overhead

The plant operates on a combination of labor and machinery. The allocation foundation for machines and manpower will therefore be machine hours and labor hours.

Consider a machine with a cost of \$100,000 and a lifespan of 500 hours. Therefore, when calculating the overhead cost of making the final product, the base cost of the machine will be 500 hours, and the cost per hour will be \$100,000 / 500 = \$200.

If a finished product requires 10 hours of machine use, the overhead machine cost for that product will be equal to the number of hours used multiplied by the cost per hour.

Goodwill Cost of Overhead Machine = 10 200 = \$2,000

Similarly, the total labor cost can be utilized as the allocation base for labor overhead associated with the production of a single well. It assists businesses in determining a product’s selling price, as the cost of production is determined using this factor.

Similarly, the total labor cost can be utilized as the Allocation base for Labor overhead associated with the production of a single well. It aids businesses in establishing a selling price for the product, as the cost of production is determined using this factor.

## How is Allocation Base Used in Setting Allocation Rates?

Consider a warehouse that is rented to manufacture automobiles. The warehouse produces one hundred vehicles every month. The monthly warehouse lease is \$10,000. Currently, the warehouse allocation base is \$10,000.

If 100 automobiles are manufactured in a month, each automobile will share an overhead rent cost of = Number of Automobiles / Monthly Rent.

• Car Will Share a Rent Overhead Cost = \$10,000 / 100 = \$100

The Allocation rate is thus \$100. Each vehicle costs \$100 in warehouse rent to complete.

## Advantages Of Cost Allocation Base

• It serves as the benchmark for allocating overhead costs to certain products or projects. Without determining the allocation base, assigning recurring overhead expenses would be challenging.
• With the use of this base, the decision on the cost of the created product or service can be easily estimated, hence aiding in the determination of the Selling price.

## Disadvantages Of Cost Allocation Base

• The product or service is irregularly employed by multiple departments, and there is no fixed cost for the services.
• Due to the fact that different services have distinct Allocation Bases, accounting for overhead expenses is difficult and time-consuming. It raises accounting costs by necessitating expensive software, storage, and auditing teams.

## Types of Costs

Before distributing expenses to their respective cost objects, an organization must establish a variety of cost kinds. These costs consist of:

### 1. Direct costs

Direct costs are costs that may be traced to a specific product or service and do not require allocation to the cost object.

Because the firm understands which expenses are allocated to the precise departments that make profits, as well as the costs associated with manufacturing particular goods and services.

For instance, the salaries paid to industrial workers assigned to a particular division are known and do not require redistribution.

### 2. Indirect costs

Indirect costs are expenses that are not directly associated with a function, product, or department. These expenses are necessary for the company’s operations and well-being. Examples of indirect costs include security expenditures and administrative costs, among others.

First, the expenses are recognized, then they are pooled, and then they are assigned to individual cost objects inside the business.

Indirect costs can be classified as either fixed or variable. Fixed costs are costs that are constant for a certain product or division. The compensation of a division-assigned project supervisor is an example of a fixed cost.

The other kind of indirect costs is variable costs, which fluctuate with output level. Indirect expenses rise or fall in proportion to the level of output.

Overhead costs are indirect expenses that are not included in production costs. They are not associated with the labor or material expenses incurred in the production of goods or services. They facilitate the production or sale of the goods or services.

Overhead expenses are charged to the expense account and must be paid continuously regardless of whether or not the business is selling products.

Examples of overhead expenditures include rent, utilities, insurance, mailing and printing, administrative and legal fees, and research and development expenses.

## Cost Allocation Mechanism

The following are the main steps involved when allocating costs to cost objects:

### 1. Identify cost objects

Identifying the cost items for which the organization must independently estimate the associated cost is the initial stage in cost allocation. It is crucial to identify distinct cost items since they serve as the business’s primary drivers, and decisions are made with them in mind.

The cost object may be a brand, a project, a product line, a division/department, or a business division. The company must also decide the cost allocation base, which is the basis on which costs are assigned to cost objects.

### 2. Accumulate costs into a cost pool

The following stage, after identifying the cost objects, is to gather the costs into a cost pool, pending allocation to the cost objects. When accumulating costs, you can group them into multiple categories based on the cost allocation base. Examples of cost pools include power consumption, water consumption, square footage, insurance, rent costs, gasoline consumption, and vehicle upkeep.

## What is a Cost Driver?

A cost driver is an element that influences the cost of an activity. The amount of machine-hours, direct labor hours, payments processed, purchase orders, and bills sent to clients are examples of cost drivers.

## Benefits of Cost Allocation

The following are some of the reasons why cost allocation is important to an organization:

### 1. Assists in the decision-making process

The allocation of costs aids in determining whether or not particular departments are lucrative. If the cost object is not profitable, the corporation can assess the performance of its employees to discover whether a loss in productivity is to blame.

### 2. Helps evaluate and motivate staff

The allocation of costs aids in determining whether or not particular departments are lucrative. If the cost object is not profitable, the corporation can assess the performance of its employees to discover whether a loss in productivity is to blame.

Conversely, if the organization recognizes and rewards a particular department for attaining the highest profitability in the company, the employees assigned to that department will be motivated to work hard and maintain their good performance.

## Conclusion

Allocation Base is the most significant method for allocating overhead expenses to various projects and products. Without this, it will be difficult to calculate the price of a service or product. This base should be calculated and used in accounting using the appropriate methods.

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