Multi Pool, Multi Cost Object Allocation: Direct, Simple Allocation

Most large organizations have multiple pools of cost to allocate to multiple cost objects. There are three methods of allocation to consider: direct simple, step down, and reciprocal. We will cover direct, simple here and post separate blogs for step down and reciprocal.

All use the basic methodology discussed in other blogs. This means than a driver or basis of distribution is used to distribute the cost pool to cost objects using a rate or proportion method.

The illustration depicts the allocation paths if four overhead cost pools are distributed to seven cost objects. The cost pools could be overhead functions like facilities, personnel, accounting, and senior management. The cost objects could be products or business elements supported by the overhead functions. Each pool allocates to seven cost objects so there are twenty eight paths for allocated cost.

A direct, simple allocation methodology starts with determination of a logical basis of distribution for each support function’s cost pool. Let’s consider the facilities overhead and suppose it costs 1000. We would then chose the basis of allocation and let’s pick square feet occupied.

Next we would determine the amount of square footage in each cost object. Let’s say they were 10, 20, 30, 40, 50, 60, and 70 square feet square feet for a total of 280. The resulting allocation below shows proportions and the resulting distribution of cost.

But What About the Square Footage in Other Overhead Functions?

Note that simple, direct allocation has ignored square footage in other overhead functions. This is in spite of the fact that the personnel, accounting, and senior management functions all occupy space. That space costs money to heat, cool, clean, rent etc. Shouldn’t the cost of facilities be allocated to these other overhead functions?

Even the facilities department occupies space. This brings up another interesting question. Should facilities cost be allocated to facilities itself?

We will define two other allocation methods that address alternatives that allocate some or all overhead to other overhead functions in separate blogs for step down allocation and reciprocal allocation. These alternatives can be considered when designing the managerial costing system.

However, all three alternatives must eventually move all cost from cost pools to cost objects. Allocation of overhead to other overhead doesn’t change the fact that 1000 will be allocated to the cost objects at the end of the day.

Any cost that facilities allocates to personnel, accounting, senior management and even itself must eventually be passed to the cost objects. In my experience the difference is typically small and the affordability goal often results in direct, simple being the method of choice. Furthermore, the more complex allocation methods are often more difficult for manager/users to understand: reducing their credibility.