Question

How do companies decide what allocation bases to use to allocate indirect costs to departments?

Answer 1

When items of cost cannot directly charge to or accurately identifiable with any departments, they are prorated or distributed amongst the departments on some predetermined basis. This method is known as cost apportionment. Thus we see that items of indirect costs residual to the process of cost allocation are covered by cost apportionment. The predetermination of suitable basis of apportionment is very important and usually following principles are adopted - (i) Service or use (ii) Survey method (iii) Ability to bear. The basis ultimately adopted should ensure an equitable share of common expenses for the departments and the basis once adopted should be reviewed at periodic intervals to improve upon the accuracy of apportionment