Cost allocation is assignment of indirect costs to a cost object (a job or task) without arbitrary apportionment. Costs can be allocated where the amount to be assigned can be determined accurately. Generally cost allocation is fundamentally a problem of linking some cost or groups of costs with (2) one or more cost objectives, such as products, departments, and divisions. Ideally, costs should be assigned to the cost objective that caused it. In short, cost allocation tries to identify some function representing causation.
Linking costs with cost objectives is accomplished by selecting cost drivers. When used for allocating costs, a cost driver is often called a cost-allocation base. Major costs, such as newsprint for a newspaper and direct professional labour for a law firm, may each be allocated to departments, jobs, and projects on an item-by-item basis, using obvious cost drivers such as tonnes of newsprint consumed or direct-labour-hours used. Other costs, taken one at a time, are not important enough to justify being allocated individually. These costs are pooled and then allocated together. A cost pool is a group of individual costs that is allocated to cost objectives using a single cost driver. For example, building rent, utilities cost, and janitorial services may be in the same cost pool because all are allocated on the basis of square metres of space occupied. Or a university could pool all the operating costs of its registrar’s office and allocate them to its colleges on the basis of the number of students in each faculty. In summary, all costs in a given cost pool should be caused by the same factor. That factor is the cost driver.
Many different terms are used by companies to describe cost allocation in practice. You may encounter terms such as allocate, attribute, reallocate, trace, assign, distribute, redistribute, load, burden, apportion, and reapportion, which can be used interchangeably to describe the...