What does allocation mean?

In accounting,

An allocation is the process of

• Assigning or
• Distributing expenses
• That cannot be directly traced to a specific department or cost center.

Such expenses, often called indirect costs or overhead, cannot be directly attributed to a single department or cost center.

However, they support essential business operations.

Allocation Concept Simplified

Consider a scenario where a company incurs security costs to protect its assets. Since there is no direct method to assign these expenses to cost centers, management creates an allocation policy. The company assigns security costs to each cost center based on the area occupied by its assets, ensuring a rational and consistent allocation.

Consider another example

Electronic manufacturing companies separate operations into functions to gauge performance. For example, Laptops, Smartphones, and Printers are three functions.

The business operates with manpower hired by the HR department.

Each HR employee assists in hiring the best talent for all the functions.

It isn’t practical to assign one manager, one assistant manager, and one associate to each function. By serving multiple functions, recruitment teams are used efficiently.

A manager might work in one or more of these three departments each day, or not at all. Tracking costs for each recruitment job is nearly impossible.

Instead, why not allocate HR costs based on the number of recruitments completed in each function this year?

This approach provides a clear allocation method.

How does a business monitor Overhead Allocations?

Businesses set checkpoints by top management to identify any anomalies, such as

• Actuals vs. Budgets,
• Prior Periods compared with Current Period, and
• A review of the allocation percentage.

Summary

Allocations transfer common expenses to all cost centers in a GL Account and ensure equal cost distribution across them.