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The Comprehensive Guide to Cost Allocation in Accounting

Accounting is a fascinating field, and cost allocation is one of the most important concepts in accounting. Whether you’re an accounting student or an accountant just starting out, it’s important to understand how to allocate costs.

In this comprehensive guide, we’ll cover everything from what it means to its pros and cons. 

How Can Costs Be Allocated Among Departments or Product Lines When There Is No Clear Source?

Allocation is distributing costs among different departments or product lines in an organization. Trying to accurately estimate the cost of producing a good or rendering a service is a common challenge for many businesses.

This is especially true when there is no apparent source of the costs, as it requires the use of various techniques and methods to distribute the expenses fairly and reasonably.

What Is the Concept of Allocation?

Allocation (also known as “cost allocation”) is a process used to distribute the costs of a shared resource or expense among different departments, product lines, or activities within an organization.

This process is necessary to accurately determine the cost of producing a product, providing a service, or running a business. Allocation allows firms to identify the expenses incurred by each department or product line and helps make informed decisions about allocating resources.

The allocation concept has existed for centuries and is a fundamental part of modern accounting and financial management. The cost allocation process involves assigning costs to specific departments or product lines based on objective criteria, such as resource use or the benefit received from the expense.

The objective criteria used in the allocation process may vary depending on the type of business, but the goal is always to distribute the costs fairly and reasonably.

One of the main challenges of allocation is that many expenses cannot be traced directly to a specific department or product line. For example, the cost of electricity used to run a manufacturing plant cannot be directly traced to one particular product line.

In such cases, the cost of electricity must be allocated to different departments or product lines based on objective criteria, such as the number of hours each department uses the electricity or the production output of each product line.

There are different methods of allocation, each with its strengths and weaknesses. Some of the most common ways include direct allocation, step-down allocation, sequential allocation, and activity-based allocation. Each mode uses a different approach to allocating costs, but the goal is always to ensure that the costs are distributed fairly and reasonably.

What Doesn’t the Term Allocation Mean?

The term allocation” is commonly used in various contexts, such as finance, economics, project management, and resource management. However, it’s essential to understand that allocation ” doesn’t mean “equal distribution” or “uniform distribution” of resources.

Allocation refers to assigning a portion of resources, such as time, money, or labor, to specific tasks or activities. The goal of allocation is to optimize the use of resources to achieve the desired outcomes.

One of the most common misunderstandings about allocation is that it means dividing resources equally among tasks or activities. However, this is only sometimes the case. Resources are often not distributed evenly because different tasks or activities have different requirements and priorities.

For example, in project management, some jobs may require more time, money, or labor than others. In such cases, the project manager must allocate more resources to these critical tasks to ensure the project’s success.

Another misunderstanding about allocation is that it means distributing resources inflexibly and rigidly. Allocation is a flexible process that can be adjusted based on priorities or changes in resource availability. For example, in a business setting, the budget allocation may change based on market conditions or changes in customer demand. In these situations, the business must be able to reallocate its resources to respond to these changes.

The allocation also doesn’t mean that the resources are assigned once and never adjusted. Allocation is an ongoing process requiring constant monitoring and adjustments to ensure that resources are used optimally.

For example, in finance, the allocation of investments must be reviewed regularly to ensure that the portfolio is aligned with the investor’s goals and objectives.

Another misconception about allocation is that it only applies to tangible resources, such as money or equipment. However, allocation also applies to intangible resources like time and labor. These intangible resources are often more critical and limited than tangible ones. For example, allocating time is crucial in project management to ensure that projects are completed on time and within budget.

As you can see, allocation is a complex and flexible process that requires careful consideration of multiple factors, such as resource availability, priorities, and goals. It’s essential to understand that allocation doesn’t mean equal distribution or limited distribution of resources.

Instead, it’s a dynamic process that requires ongoing monitoring and adjustments to ensure the optimal use of resources. By avoiding common misconceptions about allocation, individuals and organizations can more effectively allocate their resources and achieve their desired outcomes.

Where the Term Allocation Originated From?

The word “allocation” comes from the Latin word “allocare.” The word allocation ” refers to setting aside or assigning a particular portion, amount, or portion of something for a specific purpose or recipient.

The allocation comes from the Latin prefix ad- (meaning “to”) and the noun loci (meaning “place”). The combination of these two words implies the idea of assigning a place, or portion of something, for a specific purpose.

In finance and economics, “allocation” refers to distributing resources, such as money, to different projects or initiatives based on their perceived importance and likelihood of success.

The allocation concept is ancient and can be traced back to the earliest civilizations, where resources were allocated based on the community’s needs. In early societies, central planning or direct control by the ruling class were common methods of allocation.

However, with the advent of market-based economies, the allocation has become more decentralized and is now primarily done through the market mechanism of supply and demand.

In modern economies, allocation is crucial in ensuring that resources are used efficiently and effectively. For example, in capital allocation, investors allocate their funds to different projects and businesses based on the perceived potential return on investment. This helps direct investment toward the most promising and profitable opportunities, thereby increasing the economy’s overall efficiency.

Similarly, prices play a crucial role in allocating goods and services in directing resources to where they are most needed. In a market economy, the interaction of supply and demand determines prices. When demand for a particular good or service is high, the price will increase, directing more resources toward its production. On the other hand, when demand is low, the price will decrease, reducing the allocation of resources to its production.

Government policies and regulations can also have an impact on allocation in addition to the market mechanism. For example, the government may allocate resources to specific sectors through funding or subsidies, such as education or healthcare.

Similarly, government regulations and taxes can also impact the allocation of resources by affecting the incentives for businesses and individuals to allocate their resources in a particular way.

How Allocation Relates to Accounting?

In accounting, allocation determines the cost of producing a product or providing a service. This information is then used to create accurate financial statements and make informed decisions about allocating resources in the future.

For example, a company may allocate resources to a new product line based on the expected revenue it will generate or distribute costs to specific departments based on their usage of resources.

The allocation also plays a crucial role in cost accounting . Cost accounting involves analyzing the cost of production, including direct and indirect costs, and using this information to make decisions about pricing and resource allocation.

By accurately allocating costs, a company can determine the actual cost of production and make informed decisions about pricing , production volume, and resource allocation.

In addition, allocation is used to allocate the costs of long-term assets, such as property, plant, and equipment. This is done through the process of depreciation, which is a systematic allocation of the cost of an asset over its useful life. Depreciation is used to determine the value of an investment for financial reporting purposes and the amount of tax that a company must pay.

Finally, allocation is also used in the budgeting process. In budgeting, an organization allocates resources to various departments and activities based on their priorities and goals. By accurately allocating resources, a company can ensure that it has enough resources to meet its goals and objectives while staying within its budget.

3 Examples of Allocation Being Used in Accounting Practice

Example #1 of allocation being used in accounting practice.

Allocating the Cost of Goods Sold In accounting, “cost of goods sold” (COGS) refers to the direct costs associated with producing a product or providing a service. These costs include the raw materials, labor, and overhead expenses incurred to produce the goods. COGS is crucial in determining a company’s gross profit because it represents the cost of producing and selling a product.

One example of allocation in accounting practice is when a company allocates the cost of goods sold to each product. This is done to understand the cost of producing each product and identify the most profitable products. 

The allocation process involves dividing the total COGS by the number of units sold to arrive at an average cost per unit. This average cost per unit is then applied to each unit of product sold to determine the COGS for that specific product.

This allocation process is vital because it allows the company to accurately determine the cost of producing each product. This information is then used to make informed business decisions such as pricing strategies, production decisions, and cost control measures. 

For example, suppose a company realizes that the cost of producing one product is much higher than the cost of producing another. In that case, it may choose to discontinue the higher-cost product or find ways to reduce the cost of production.

Example #2 of Allocation Being Used in Accounting Practice

One example of allocation in accounting practice is allocating indirect costs to different departments or products within a company. Indirect costs, such as rent, utilities, and office supplies, cannot be directly traced to a specific product or department. These costs must be allocated among different departments or products to calculate the cost of each accurately.

For example, consider a manufacturing company with three departments: production, research and development, and administration. The company has a total indirect cost of $100,000 for the year, which includes rent, utilities, and office supplies.

The company might determine the proportion of space each department uses to allocate these costs. If production uses 40% of the total space, R&D uses 30%, and administration uses 30%, the company would allocate 40% of the indirect costs to production, 30% to R&D, and 30% to administration.

Next, the company might allocate indirect costs based on the number of employees in each department. If production has 20 employees, R&D has 15, and administration has 10, the company would allocate indirect costs based on the ratio of employees in each department.

In this example, production would receive 40% of the indirect costs, R&D would receive 30%, and administration would receive 30%.

Finally, the company might allocate indirect costs based on the number of products produced in each department. If production produces 1000 products, R&D produces 500, and administration produces none, the company would allocate indirect costs based on the ratio of products produced in each department.

In this example, production would receive 67% of the indirect costs, R&D would receive 25%, and administration would receive 8%.

Example #3 of Allocation Being Used in Accounting Practice

Suppose a manufacturing company produces two products: Product A and Product B. To determine the cost of each product, the company must allocate the factory overhead costs, including utilities, rent, maintenance, and supplies, among other expenses. The overhead costs must be assigned to each product based on the proportion of total machine hours used to produce each product.

For example, if the company uses 60% of the total machine hours to produce Product A and 40% to produce Product B, then 60% of the factory overhead costs would be allocated to Product A and 40% to Product B. The company would then use the allocated overhead costs and the direct costs of material and labor to calculate the total cost of each product.

The allocation of overhead costs to each product is critical for the company to accurately determine the cost of goods sold and price its products competitively. The company can use an allocation method to ensure a fair and accurate picture of the costs of producing each product.

How to Do Cost Allocation in Simple Steps?

Cost allocation can be complex, but it doesn’t have to be. Here are five simple steps for cost allocation:

Step 1: Identify the Costs That Need to Be Allocated

The first step in cost allocation is identifying the costs that need to be allocated. This includes both direct and indirect costs. Direct costs can be easily traced to specific products or services, while indirect costs, such as rent and utilities, cannot.

Step 2: Choose the Appropriate Method of Cost Allocation

Once you have identified the costs that need to be allocated, the next step is to choose the appropriate cost allocation method. The most common methods include direct cost allocation, step-down allocation, sequential allocation, and activity-based costing. The method chosen will depend on the nature of the costs and the objectives of the cost allocation process.

Step 3: Determine the Allocation Base

The allocation base is the basis on which the costs will be allocated. This can be the number of units produced, the number of employees, or any other relevant factor that can be used to determine the cost of goods or services.

Step 4: Allocate the Costs

Once you have determined the allocation base, the next step is to allocate the costs. This can be done by dividing the total cost by the number of units, employees, or another relevant factor and multiplying this by the number of units, employees, or another relevant factor for each product, service, or department.

Step 5: Review and Adjust the Cost Allocation

Once the costs have been allocated, the final step is to review and adjust the cost allocation as necessary. This may involve reallocating costs based on new information or changes in the business.

Which Industries Can Cost Allocation Be Applied?

With the proper guidance, cost allocation can be applied to almost any industry. It’s all about the data you have and how you use it.

Let’s take a look at some of the industries that could benefit from cost allocation:

The healthcare industry is one of the most expensive in the world. It is also one of the most heavily regulated. These factors make cost allocation a necessity for many healthcare providers.

Healthcare organizations have many different costs, but the most significant sources are labor and supplies. Labor costs can be very high in this industry because it requires highly skilled people to perform various tasks, including surgery, patient care, and patient education. Supplies like bandages and IV bags are also expensive because they have to be sterile and meet regulatory requirements.

A hospital’s supply department has much control over its budget, but it also has little control over what happens in other departments, such as surgery or patient care. This makes it difficult to allocate costs accurately when they don’t know how much they will spend on supplies or how many patients they’ll see each year.

Cost allocation helps solve these problems by allowing managers to see which departments are consuming the most resources. They can adjust accordingly without guessing what’s happening behind closed doors (or behind locked doors).

Manufacturing

The manufacturing industry is one of the most common places where cost allocation can be applied. In this industry, it is crucial to know how much it costs to make each product and how much it costs to produce goods (including materials and labor) for sale.

With this information, manufacturers can determine how much they need to charge for their products to cover all of their expenses, including overhead costs like rent or electricity bills.

Cost allocation can also help manufacturers determine which products are more profitable than others so that they can focus on those areas instead of wasting time and money on less popular lines of goods. For example, suppose a company produces clothing and electronics but finds its clothing line more popular among consumers than its electronics line.

In that case, it may want to stop producing electronics altogether because there would need to be more demand for these products for them to make any money off of them.

This is an industry that benefits from cost allocation. Energy companies have long been able to allocate costs to different projects and branches, but they often face challenges when assigning overhead expenses. That’s because overhead costs are shared among the company’s functions, making them difficult to track.

Cost allocation software can help energy companies assign overhead expenses in a way that makes sense for each project or branch. The software also allows them to better understand where their money is going and gives them more flexibility in budgeting and forecasting future expenses.

Retailers are a great example of an industry that can benefit from cost allocation.

Retailers are often sold on the idea of one-stop shopping: you go to a store and buy everything you need, from clothing to food to furniture. But in reality, there are many different types of retailers, such as grocery stores, department stores, clothing stores, etc. And each has its own distinct set of costs for running that type of business. So how do these retailers know how much each product line contributes to their overall profits? They use cost allocation.

Cost allocation is a technique for allocating overhead costs across product lines based on their relative importance to the company’s overall performance. This way, retailers can determine which products contribute most (or least) to their bottom line and make decisions accordingly.

Information Technology

Information technology (IT) is one of the most significant cost allocation areas. IT costs are often divided into two categories: direct costs and indirect costs. The former refers to those costs that can be directly attributed to a particular project or product, while the latter refers to those costs that cannot be directly attributed.

Cost allocation in IT has many benefits. It helps managers determine how much it costs to develop a new product or service and where inefficiencies lie in their IT departments.

It also allows them to understand better how much revenue they’re generating from each product or service line, which will help them make better decisions about future investments in the company’s infrastructure.

Construction

This is one of the most apparent industries to apply cost allocation. Construction projects are often massive and complex, with many different stakeholders involved in the planning, execution, and completion of a project. It’s common for construction projects to have hundreds or thousands of contracts with hundreds or thousands of different suppliers.

Cost allocation helps ensure that those involved in the project are paid what they’re owed without overpaying anyone else who participated. It’s also used to ensure that a company only spends a little money on a project by ensuring that every expense is only charged once.

Transportation

This is the industry that can benefit the most from cost allocation.

Transportation has many parts that must work in unison to transport goods or passengers. It can be difficult to determine which part of a vehicle’s operation should be allocated to specific parts, and it usually requires a lot of math.

Cost allocation can make it easier for companies in this industry to understand which parts are costing them more than they expected so that they can make changes accordingly.

Food and Beverage

Food and beverage companies can benefit significantly from cost allocation. These companies are typically comprised of many different departments that must be managed to ensure the entire business runs smoothly. Each department has specific costs that it incurs, so allocating those costs among all of the departments will help you understand where your money is going and how it can be used most effectively.

Cost allocation is also helpful when dealing with food or beverage products because it allows you to track the costs associated with each product line and make sure you profit on every product line. This way, you know what kinds of products are selling well, which ones aren’t selling as well, and how much money each product line has made for your company.

Real Estate

This is one of the most common industries to use cost allocation methods. Real estate developers often create multiple project phases, which must be accounted for separately. The costs of these phases are usually allocated to determine how much profit (or loss) will be made in each phase.

This lets developers decide which phases should be completed first and what incentives may be offered to convince buyers to purchase units from those phases.

Utilities are another excellent example of an industry where cost allocation can be used.

They must deal with various costs, including purchasing raw materials, paying for labor, and buying equipment. The type of utility and the sector it operates in determine the cost of each of these. For example, a water utility may have very high costs for purchasing raw materials but low costs for labor and employee benefits because they only need a few employees or benefit packages.

Cost allocation can help utilities determine how much money they should spend on each part of their business so that they’re not overspending on one part while underinvesting in another.

Pros of Cost Allocation

Cost allocation is a common business practice. Companies use it to help determine the profitability of individual products, services, and departments within a company. Here are the pros of cost allocation:

Improved Decision Making

Cost allocation helps businesses make informed decisions by accurately determining the cost of goods or services. Companies can make informed decisions on pricing, production, and marketing strategies with a better understanding of the costs associated with producing a product or offering a service.

Better Resource Allocation

Cost allocation helps businesses to determine the costs associated with different departments, products, or services. This information can then be used to allocate resources more efficiently and allocate more resources to more profitable areas.

Increased Profitability

By allocating costs accurately, businesses can identify less profitable areas and make changes to improve profitability. This could involve reducing costs, improving efficiency, or adjusting pricing.

Better Budget Planning

Cost allocation helps businesses to create more accurate budgets. Companies can plan their budgets more effectively as they understand the costs associated with each product, service, or department.

Improved Internal Control

Cost allocation helps businesses to maintain better internal control over their operations. By allocating costs accurately, companies can track expenses and identify improvement areas. This helps to prevent fraud and embezzlement and increases accountability within the company.

Better Understanding of Overhead Costs

Overhead costs can be challenging to understand and allocate accurately. Cost allocation helps businesses to understand these costs better and allocate them to the proper departments or products. This allows companies to make informed decisions on pricing and production.

Improved Cost Reporting

Cost allocation helps businesses to produce more accurate cost reports. This allows companies to make informed pricing, production, and marketing strategies decisions. Cost reports are also essential for tax purposes and to meet regulatory requirements.

Better Negotiations

Cost allocation helps businesses to understand their costs better, which can be used in negotiations with suppliers and customers. Companies can better understand costs and negotiate better prices, terms, and conditions with suppliers and customers. This helps businesses to maintain better relationships and increase profitability.

Cons of Cost Allocation

Cost allocation can be an excellent tool for helping you understand where your money is going and how to save it, but this method has some drawbacks.

Time-Consuming Process

Cost allocation can be time-consuming and requires significant effort from various departments within the company. This can divert resources from other important tasks and may slow down other processes.

Increased Complexity

Cost allocation can be complex, especially for large organizations with multiple departments and products. This complexity can result in errors and misunderstandings, negatively impacting the accuracy of cost reports and other important financial information.

Implementing a cost allocation system can be expensive and require a significant investment in technology, software, and training. This cost can be a barrier for smaller organizations or those with limited resources.

Unreliable Data

Cost allocation is only as accurate as the data used in the process. Poor quality data, errors in data entry, and outdated data can all result in inaccurate cost reports and inefficient resource allocation.

Resistance to Change

Some employees may resist implementing a cost allocation system, especially if they feel the process may negatively impact their department or lead to job loss.

Limited Flexibility

Cost allocation systems are often rigid and lack the flexibility to adapt to changes in business conditions. This can result in inefficiencies and limit the ability of the company to respond to new opportunities or challenges.

Potential for Misallocation

If not implemented correctly, cost allocation can misallocate costs, negatively impacting decision-making and profitability.

Dependence on Cost Allocation

Overreliance on cost allocation can lead to a lack of creativity and initiative within departments. Employees may become too focused on cost allocation and need to be more focused on driving innovation and growth for the company. This can limit the ability of the company to adapt to changing market conditions.

Frequently Asked Questions- Cost Allocation in Accounting

What are the main objectives of cost allocation.

The main objectives of cost allocation are to accurately determine the cost of goods or services, improve resource allocation, increase profitability, create more accurate budgets, improve internal control, and provide better cost reporting.

What Is Direct Cost Allocation?

Direct cost allocation refers to assigning costs directly to specific products or services. This method is used when the costs can be easily traced to specific business areas.

What Is Step-Down Allocation?

Step-down allocation refers to allocating costs from one department to another department or product. This method is used when costs cannot be directly traced to specific products or services.

What Is Sequential Allocation?

Sequential allocation refers to allocating costs based on the sequence in which they are incurred. This method is used when costs cannot be directly traced to specific products or services.

What Is Activity-Based Costing?

Activity-based costing refers to allocating costs based on the activities involved in producing a product or offering a service. This method is used when multiple activities are involved in creating a product or service.

Why Is Cost Allocation Important for Businesses?

Cost allocation is essential for businesses as it helps them understand the costs associated with each business area and make informed pricing, production, and resource allocation decisions. This leads to improved profitability and better resource allocation.

How Does Cost Allocation Impact Resource Allocation?

Cost allocation helps companies determine the costs associated with each department, product, or service, which are used to allocate resources more efficiently. By allocating resources based on accurate cost

How Does Cost Allocation Impact Pricing Decisions?

Cost allocation helps companies understand the costs associated with each product or service used to make informed pricing decisions. By accurately determining the cost of goods or services, companies can ensure that their pricing is based on a solid understanding of the costs involved.

The Comprehensive Guide to Cost Allocation in Accounting – Conclusion

Allocation of costs is a critical component of any business. By allocating costs, you can ensure that your company makes the best use of its resources and operates efficiently.

The ability to allocate costs allows you to make strategic decisions about your business’s operations and management and take appropriate actions regarding financial reporting.

The Comprehensive Guide to Cost Allocation in Accounting – Recommended Reading

Corporate Accountant: What Are the Responsibilities, Duties, & Salary of a Corporate Accountant?

How Can Business Intelligence Help with Budget Planning (in 2023)

Standard Costing- Common Problems (And How to Solve Them)

 Updated: 5/19/2023

Meet The Author

Danica De Vera

Danica De Vera

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What Is Cost Allocation?

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Table of Contents

For your business to make money, you must charge prices that not only cover your expenses, but also provide a profit. Cost allocation is the process of identifying and assigning costs to the cost objects in your business, such as products, a project, or even an entire department or individual company branch.

While a detailed cost allocation report may not be vital for extremely small businesses, such as a teen’s lawn service, more complex businesses require the process of cost allocation to ensure profitability and productivity.

In short, if you can assign a cost to any part of your business, it’s considered a cost object.

What is cost allocation?

Cost allocation is the method business owners use to calculate profitability for the purpose of financial reporting . To ensure the business’s finances are on track, costs are separated, or allocated, into different categories based on the area of the business they impact.

For instance, cost allocation for a small clothing boutique would include the costs of materials, shipping and marketing. Calculating these costs consistently would help the store owner ensure that profits from sales are higher than the costs of owning and running the store. If not, the owner could easily pinpoint where to raise prices or cut expenses .

For a larger company, this process would be applied to each department or individual location. Many companies use cost allocation to determine which areas receive bonuses annually.

Regardless of your business size, you’ll want to review and choose the best accounting software to help this process run as smoothly as possible.

Types of costs

In the boutique example above, the process of cost allocation is pretty simple. For larger businesses, however, many more costs are involved. These costs break down into seven categories.

  • Direct costs: These expenses are directly related to a product or service. In your business’s financial statements, these costs can be linked to items sold. For a small clothing store, this might include the cost of inventory.
  • Direct labor: This cost category includes expenses directly related to the employee production of items or services your business sells. Direct labor costs include payroll for employees involved in making the items your business sells.
  • Direct materials: As the name suggests, this category includes costs related to the resources used to manufacture a finished product. Direct materials include fabric to make clothing, or the glass used in building tables.
  • Indirect costs: These expenses are not directly related to a product or service, but necessary to create the product or service. Indirect costs include payroll for those who work in operations. It also lists costs for materials you use in such small quantities that their costs are easy to overlook.
  • Manufacturing overhead: This category includes warehouse costs, and any other expenses directly related to manufacturing the products sold. Manufacturing overhead costs include payroll for warehouse managers, as well as warehouse expenses such as rent and utilities.
  • Overhead costs: These include expenses that support the company as a whole but are not directly related to production. Some examples of overhead costs are marketing, operations and utilities for a storefront.
  • Product costs: Also called “manufacturing costs” or “total costs,” this category includes expenses for making or acquiring the product you sell. All manufacturing overhead costs are also listed in this category.

Example of cost allocation

To better explain the process of cost allocation and why it’s necessary for businesses, let’s look at an example.

Dave owns a business that manufactures eyeglasses. In January, Dave’s overhead costs totaled $5,000. In the same month, he produced 3,000 eyeglasses with $2 in direct labor per product. Direct materials for each pair of eyeglasses totaled $5.

Here’s what cost allocation would look like for Dave:

Overhead: $5,000 ÷ $3,000 = $1.66 per pair

Direct costs:

  • Direct materials: $5 per pair
  • Direct labor: $2 per pair
  • Overhead: $1.66 per pair
  • Total cost: $8.66 per pair

As you can see, without cost allocation, Dave would not have made a profit from his sales. Larger companies would apply this same process to each department and product to ensure sufficient sales goals. [Read related article: How to Set Achievable Business Goals ]

How to allocate costs

Cost objects vary by business type. The cost allocation process, however, consists of the same steps regardless of what your company produces.

1. Identify cost objects.

To begin allocating costs, you’ll need to list the cost objects of your business. Remember that anything within your business that generates an expense is a cost object. Review each product line, project and department to ensure you’ve gathered all cost objects.

2. Create a cost pool.

Next, gather a detailed list of all business costs. It’s a good idea to categorize the costs based on the reason for each amount. Categories should cover utilities, insurance , square footage and any other expenses your business incurs.

3. Allocate costs.

Now that you’ve listed cost objects and created a cost pool, you’re ready to allocate costs. As demonstrated in the example above, add up the costs of each cost object. At a glance, your report should justify all expenses related to your business. If costs don’t add up correctly, use the list to determine where you can make adjustments to get back on track.

What is cost allocation used for?

Cost allocation is used for many reasons, both externally and internally. Reports created by this process are great resources for making business decisions , monitoring productivity and justifying expenses.

External reports are usually calculated based on generally accepted accounting principles (GAAP) . Under GAAP, expenses can only be reported in financial statements during the time period the associated revenue is earned. For this reason, overhead costs are divided and allocated to individual inventory items. When the inventory is sold, the overhead is expensed as a portion of the cost of goods sold (COGS) .

Internal financial data, on the other hand, is usually reported using activity-based costing (ABC). This method assigns all products to the overhead expenses they caused. This process may not include all overhead costs related to operations and manufacturing.

Cost allocation reports show which cost objects incur the most expenses for your business and which products or departments are most profitable. These findings can be a great resource to pair with employee monitoring software when evaluating productivity. If you determine that a cost object is not as profitable as it should be, you should do further evaluations on productivity. If another cost object is found to exceed expectations, you can use the report to find staff members who deserve recognition for their contributions to the company.

Recognition is one of the best ways to keep employees motivated .

What is a cost driver?

A cost driver is a variable that can change the costs related to a business activity. The number of invoices issued, the number of employee hours worked, and the total of purchase orders are all examples of cost drivers in cost accounting .

While cost objects are related to the specific process or product incurring the costs, a cost driver sheds light on the reason for the incurred cost amounts. These items can take different forms – including fixed costs, such as the initial fees during the startup phase . Cost drivers give a bird’s-eye view of the entire company and how each department operates.

It’s common for only one cost driver to be used with very small businesses , since they are focused on using minimal reporting to estimate overhead costs.

Benefits of cost allocation

  • It simplifies decision-making. Cost allocation gives you a detailed overview of how your business expenses are used. From this perspective, you can determine which products and services are profitable, and which departments are most productive.
  • It assists in staff evaluation. You can also use cost allocation to assess the performance of different departments. If a department is not profitable, the staff productivity may need improvement. Cost allocation can also be an indicator of departments that exceed expectations and deserve recognition. Awards and recognition are a great way to motivate staff and, in turn, increase productivity. [Read related article: Best Business Productivity Apps ]

Even if you operate a very small business, it’s a great idea to learn the process of cost allocation, especially if you anticipate expansion in the future. Since the method can be complex, it’s ideal to use accounting software as an aid. Whether you choose to start allocating costs on your own with software or hire a professional accountant , it’s a process no business owner can afford to overlook.

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Allocated Costs: Explained

What is it, how to calculate it, formula, why it's important.

Related terms

Hey, fellow business enthusiasts! Today, I am going to spill the beans on one of the most confusing topics in the business world - allocated costs! Yes, I know, the phrase alone can send shivers down your spine, but trust me, by the end of this article, you'll be eager to allocate your costs like a pro!

First of all, let's define allocated costs. Simply put, they are indirect costs that are assigned or allocated to a particular product or service. These costs cannot be traced directly to the product or service but are incurred in the process of producing it.

Allocated costs are important because they help businesses determine the true cost of producing a product or service. By accurately allocating costs, businesses can make better decisions on pricing, resource allocation, and even strategic planning.

Types of Allocated Costs

There are several types of allocated costs, but I'll focus on the most common ones:

Overhead Costs

Overhead costs are indirect costs that are not easily quantifiable. Examples of overhead costs include rent, utilities, insurance, and depreciation of equipment. These costs are difficult to allocate because they are shared among different products or services.

A common method of allocating overhead costs is by using a predetermined overhead rate. This rate is calculated by dividing the total overhead costs by the total amount of direct labor or machine hours used in production. The predetermined overhead rate is then applied to each product or service based on the number of labor or machine hours used in producing it.

Selling and Administrative Costs

Selling and administrative costs are indirect costs that are not related to the production process. Examples include salaries of sales and administrative staff, marketing expenses, and office supplies.

Allocating selling and administrative costs to products or services can be done by several methods, such as allocating them based on sales revenue, number of employees working on the product/service, or even the square footage used by the product/service.

The Benefits of Accurately Allocating Costs

Accurately allocating costs has several benefits for businesses:

Accurate Pricing

By allocating costs accurately, businesses can determine the true cost of producing a product or service. This information can be used to set prices that are competitive and profitable.

Better Resource Allocation

Allocating costs can help businesses determine which products or services are more profitable and should receive more resources. It can also help businesses identify areas where costs can be reduced.

Improved Strategic Planning

Allocating costs can help businesses make better decisions when planning for the future. By knowing the true cost of producing a product or service, businesses can make informed decisions on expansion, diversification, or even discontinuation of a product or service.

Allocated costs may seem confusing, but they are an essential part of determining the true cost of producing a product or service. By accurately allocating costs, businesses can make better decisions on pricing, resource allocation, and strategic planning. So, don't be afraid to allocate your costs like a pro!

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Allocations

Definition:.

Allocations divide costs between different departments or activities within a company. For instance, overhead costs such as the rent and utilities are often allocated to the company’s operating units. Determining accruals and allocations nearly always entails making assumptions and estimates.

Let’s use the rent and utilities as an example. If you take the amount of rent and utilities for a month, you could allocate that based on the square footage of each operating unit, or you could allocate it based on the number of employees in each operating unit.  There are many ways to allocate costs, pick a method that makes the most sense for your company that you can defend.

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Accountants use accruals and allocations to try to create an accurate picture of the business for the month. After all, it doesn’t help anybody if the financial reports don’t tell us how much it cost us to produce the products and services we sold last month. That is what the controller’s staff is trying so hard to do, and that is one reason why it takes as long as it does to close the books.

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What are Allocated Expenses?

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  • What Is Included in Figuring Out the Predetermined Overhead Rate for Manufacturing?
  • What Qualifies as General & Administrative Expenses in Sales?

To stay profitable, a company has to determine the total expense of providing its products or services. Often, companies break these costs down on a department-by-department basis, by company program or by product, to assess what individual departments and programs cost to run and what certain products cost to make. An accurate accounting must take all expenses into consideration. Direct costs -- the ones that are obviously related to a certain product or department -- are easy to allocate. But the shared or indirect ones, such as the costs of a company cafeteria, office supplies and human resources, are less straightforward. These indirect, shared expenses can be allocated in several ways.

Number of Staff

Shared, indirect costs often are divided between company departments based on the number of employees in each department. For example, the cost of a company cafeteria could be allocated to departments in proportion to the number of employees in each department, because they all may be assumed to use it, suggests the Principles of Accounting website. The overall cost of office supplies could be allocated to departments based on the number of employees in each one.

Square Footage

Expenses often are allocated on the basis of square footage in each department. For example, janitorial services might be allocated among office departments or divisions on a square-footage basis. Expenses such as rent and utilities in a manufacturing plant or office could be allocated based on how much space is used in each department, according to the Jo Landers Business Services website.

Labor Hours

The cost of a particular product, service or company program can be allocated based on the number of labor hours used to produce it. The cost of a certain model of car, for example, could be allocated based in part on the labor hours used to produce it. The cost of a program could be allocated among departments based on the number of labor hours each department puts into its implementation.

Expenses can be allocated in many ways, but some general principles should be applied to the method used, according to the Charity Tax Tools website. There should be as clear a relationship as possible between the cost of the item or service and the basis of allocation. The method of allocation should be applied consistently to similar items and programs, and it should remain consistent over time. Expenses should be allocated among departments in proportion to their involvement with the expense -- not equally if two departments were not equally involved, the site advises.

  • Principles of Accounting:Concepts In Allocating Service Department Costs

Mary Strain's first byline appeared in "Scholastic Scope Magazine" in 1978. She has written continually since then and has been a professional editor since 1994. Her work has appeared in "Seventeen Magazine," "The War Cry," "Young Salvationist," "Fireside Companion," "Leaders for Today" and "Creation Illustrated." She earned her Bachelor of Arts in English from Oglethorpe University in Atlanta.

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  • 1 Objectives of Cost Allocation
  • 2 Sequential Method in Accounting
  • 3 Chargeback Methods
  • 4 The Advantages of the Direct Method of Cost Allocation

AcqNotes

The Defense Acquisition Encyclopedia

Financial Management

An Allocated Cost is a type of expense that is clearly associated with and so can be readily assigned to a certain business process, project or department. Allocated cost types might include fabrication costs, sales costs, project management costs, and associated fixed costs. Another example, a company might allocate or assign the cost of an expensive computer system to the three main areas of the company that uses the system. A company with only one electric meter might allocate the electricity bill to several departments in the company.

Regulation: Federal Acquisition Regulation (FAR) Clause (FAR 31.201)

Allocated Cost is the cost that is allocable to a government contract if it: [1]

  • is incurred specifically for the contract;
  • benefits both the contract and other work, and can be distributed to them in reasonable proportion to the benefits received; or
  • is necessary to the overall operation of the business, although a direct relationship to any particular cost objective cannot be shown.

Allocated Cost Determination

In government contracting, a cost is determined allowable only when the cost complies with all of the following requirements: [1]

  • Reasonableness
  • Allocability
  • Standards promulgated by the CAS Board, if applicable, otherwise, generally accepted accounting principles and practices appropriate to the circumstances
  • Terms of the contract
  • Any limitations set forth in this subpart

AcqLinks and References:

  • [1] Website: FAR 31.201 Contracts with Commercial Organizations

Updated: 7/20/2021

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define allocated expenses

Reporting and Operations

Expenses are allocated to show the total cost of activities, services, and projects.  It is very important for the board and management to know the total costs of activities, services, and projects so both can see how the nonprofit’s resources are used.

Expenses that benefit an activity, service, or project should be charged to the activity, service, or project according to the relative benefit received by the activity, service, or project.

  • Salaries are allocated through using timesheets to record the actual effort (typically the number of hours) for each employee per activity, service, or project.
  • Timesheets should be reviewed and signed by both the employee and their supervisor.  This dual review helps ensure the accuracy of the timesheet
  • Fringe benefits expenses for each staff typically are allocated based on salary allocations.
  • Expenses for facilities are typically allocated based upon the staffing effort for each activity, service, or project.  Two frequently used measures of staffing effort are full time equivalents and salaries.
  • General and administrative expenses should be shared by all activities, services, or projects.  Again staffing effort could be used as the allocation basis.  Total costs for each activity, service, or project could also be used.

The basis used for allocation of expenses also needs to be consistent.  If the allocation basis is frequently changed:

  • Management of the financial results of the activities, services, and projects becomes more difficult since the resources available for the activities, services, or projects may change because the allocated expenses change.
  • Budgeting for individual activities, services, or projects and the nonprofit as a whole is more difficult since each new activity, service, or project could have a different allocation basis.
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True Program Costs: Program Budget and Allocation Template and Resource

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This guide and accompanying spreadsheet template break down the process of understanding true program costs, either through budgeting or financial reports, into several stages.

While the long-term goal for nonprofits is not to return profits to shareholders, we all know that nonprofits are business entities that need to maintain financial health and stability in order to achieve their mission. Understanding the true, full cost of delivering various programs and services in the community is a critical piece of the management puzzle.

Why Does This Matter?

Equipped with accurate information about the cost of each program area, nonprofit leaders are better able to plan and manage budgets and make the case for support and for contract terms that cover the full cost of services. One of the most valuable results of understanding the true cost of programs is the ability to make wise choices about how to support mission critical work. For most nonprofits, some programs may be financially self-sustaining or even generate a surplus. Other activities may require periodic or ongoing subsidy from fundraising or other program areas. Deciding whether and how to support these services is a central strategic decision for nonprofits. Knowing the real costs of each program allows us to make informed decisions and choices that will lead to mission and financial success.

Propel Nonprofits Program Budget and Allocation Template and Resource

Propel Nonprofits developed this guide and spreadsheet template to help nonprofits implement program-based budgeting and financial reporting. This resource is an overview of the concepts and management decisions needed to calculate the true costs of activities for a nonprofit and also a how-to guide for the accompanying spreadsheet template. You can find a glossary of terms in our resource library and below, a list of articles and resources for more in-depth discussion or technical guidance on this topic. The accompanying spreadsheet template may be used for a one-time analysis project or to implement ongoing program-based budgeting and financial management practices. While a calculation can be completed for a single program or activity, we highly recommend that these concepts and practices be used throughout a nonprofit. Program-based financial information will be most useful for planning, management, and communications if it is comprehensive, accurate, and used consistently.

Getting Started

Before diving into the numbers and spreadsheets, it’s important to begin with a discussion about why the organization is undertaking this process, any specific goals you have, how the financial information will be used, and who will be involved in developing and using the information. If the organization has never allocated costs or overhead before, spend some time discussing the concepts and practices described in this guide. Having a shared understanding and buy-in from senior leaders, financial staff, and program managers is critical to both creating the budget and to using the information for planning and strategic decisions.

Gather the Data

Developing accurate program budgets and allocation formulas requires a number of data sources. Assemble as much as you can in advance, though it’s likely that more questions will come up once the process is underway. Some of the information will be specific to your organization, but as a first step you’ll need: a list of income and expense categories, detailed budgets, a list of staff, their compensation, and records or estimates of their activities, and information about major expense items, such as facility and program expenses.

Overview of the Process

  • Define your programs
  • Establish format and structure for accounting
  • Identify direct and indirect costs
  • Select allocation approach and methods
  • Allocate staff salaries, benefits, and taxes
  • Assign direct expenses
  • Allocate direct costs by an appropriate method
  • Identify program specific and general income categories
  • Allocate indirect (administrative) costs
  • Allocate fundraising costs
  • Bring it all together for review

1. Define your programs.

The process begins with the decision of which activities at your organization comprise a program for the purpose of budgets and financial reports. Often, the definition of programs is evident in how your organization delivers services and functions internally. You may already have clearly defined programs, departments, or projects. Some nonprofits identify every activity or grant as a separate program while others combine many activities under the umbrella term. For budgeting and allocations we suggest that you separate your activities into distinct programs that will provide meaningful insight into the financial model. At the same time, avoid making it overly detailed or complicated. As an example, an afterschool program may operate in two locations or be funded by three grants. If the program operates with similar goals, measures, costs, and staff, we’d suggest that these be grouped as a single program.

2. Establish format and structure for accounting

Calculating and analyzing the true cost of programs and activities can be completed as a one-time project or implemented as an ongoing management practice, as we recommend. If that is the goal, it’s worthwhile to make sure that the program and cost definitions match the setup of your accounting system. Any accounting software can be used to maintain program-based financials, but they each have their own structure and terminology. One benefit of structuring accounting this way is that you can control your chart of accounts – the list of income and expense categories. Nonprofits that create new line items in their accounting system every time they start a new program or get a new grant will find that they can simplify their accounting by using program “cost centers.” Whichever system you use, make use of “cost centers” for the programs you defined and for management & general (administration) and for fundraising. These two cost centers are important components of understanding true costs and are created in parallel with the programs. By organizing your budget and allocations this way, you’re also setting up the accounting system to track and report the three functional expense categories required on audits and the IRS Form 990.

3. Identify direct and indirect costs

The terms direct and indirect costs are used with widely varying definitions in the accounting world. For our purposes, we define indirect costs as those expenses that support the overall management of the organization – often called administrative costs or management and general costs. Indirect expenses include the costs of accounting, board meetings, general liability insurance, and other costs associated with running the organization as a whole. This distinction has been problematic for many nonprofits because of the simplistic idea that common costs such as rent, utilities, and technology are all indirect costs, or overhead. The accurate definition for direct costs is those costs that are required to carry out a program or function. Direct costs may be devoted to one program but more often are shared by more than one program. Rent, for example, is a direct cost for all programs that make use of the facility to plan, manage, and deliver the program services based on how much of the space they use. The portion of rent that is for space used for general administration is categorized as indirect. Fundraising may also have direct costs or receive an allocated portion of a direct cost, as will be explained later. Sometimes direct costs will be allocated to all program areas and cost centers, including fundraising and administration. We will discuss the allocation of both direct and indirect costs later in the process. This step asks you to take a fresh look at the list of expenses and identify all of the direct and indirect costs.

4. Select allocation approach and methods

Once you’ve defined which expense items are direct program costs that are shared by more than one program, you also need to decide how to allocate the cost appropriately. The best allocation methods are reasonable and justifiable while also being simple enough to calculate and maintain over time. An example would be the cost of office supplies that are used by all of our programs and by fundraising and administration. Rather than counting every pen we look for a reasonable basis on which to share the expense proportionally. For our office supplies example, we’ll allocate the expense based on the number of staff members who work in each program, calculated based on FTE. This is a practical method for expenses that “follow the people.” The most common allocation methods are: FTE or staff time, square footage, number of clients, “units” of services, and percentage of total direct costs. Other methods may also be appropriate and useful if there is a reasonable connection between the method and the actual use of the resources or expense. The basis of the calculation is sometimes called a “cost driver.” In order to keep the allocation system manageable we recommend that you create and maintain just a few allocation choices. The chart on the next page can help you select allocation methods.

5. Allocate staff salaries, benefits, and taxes

Given the significance of personnel expenses to our finances, allocating these costs is essential to understanding true costs. How does each member of the staff spend their time? Job title doesn’t necessarily provide the answer. If the Program Director spends 50% of his or her time managing Program A, 30% supervising the managers of Program B, and 20% acting as the organization’s HR director, then 80% of the cost of salary and related benefits will be allocated between the programs and 20% will be included in administrative, or indirect costs. Many Executive Directors spend a substantial amount of time working directly in programs. Ideally, salary allocations will be based on regular, reliable tracking of time. The data is already available for nonprofits that track time for grants and contracts. If that has not been your practice we urge you to gather some accurate information by completing a timekeeping report or adding time reporting to payroll or database records. We know from experience that allocating time based on general estimates or gut feeling is often inaccurate. The goal of program-based budgets and allocations is to gain a solid understanding of the true costs, and staff cost is too important to leave to guesswork.

6. Assign direct expenses

When an expense is clearly and exclusively incurred for a specific program area or cost center, we simply assign the expense to that program area or cost center. Examples might include materials purchased specifically for a tutoring program or the cost of an evaluation consultant to document the results of a preschool program. Administration and fundraising may have direct expenses assigned to them as well. The cost of an annual audit would be assigned to administration. The cost of return envelopes to be included in a fundraising mailing would be assigned directly to fundraising.

7. Allocate direct costs by an appropriate method

In this step you apply the allocation methods described above to the various direct costs that are shared between programs, which may include administration and fundraising cost centers. For the earlier office supply example, you would add up how many FTEs work in each program area and calculate a formula as a percent of the total number of staff. These calculations may be automated through the accounting system or completed manually. The formulas should be revisited if there are major changes in the way expenses are used, such as staff reassignments or growth of a program. For many organizations the formulas don’t change more than annually. At this point you will have a subtotal of the direct costs of each program, administration, and fundraising. The process doesn’t end there, though.

8. Identify program specific and general income categories

This process is most valuable when a nonprofit can understand both the full cost of delivering programs and the amount and type of income that relates to those programs. Leaders can use this information to analyze the financial model of programs individually and as part of the whole. In this step you will identify which income items are connected to specific program areas and what income can be directed at the organization’s discretion. Examples of income that is assigned directly to a program include contract or fee income for a preschool program or a grant that is received for a tutoring program. For this step we recommend that contributed income that is unrestricted or general operating support be assigned to the fundraising category for the analysis. The final analysis will clearly show what program areas require these sources of support and enable leaders to make the all-important decision about how to best attract and direct flexible funds.

9. Allocate indirect (administrative) costs

The cost of administration, categorized as indirect costs, adds value to every program at a nonprofit. Programs are more effective, better managed, and more responsive to the community when an organization has good accounting and technology, high quality leadership, planning, and governance. In order to have a true picture of what our programs really cost, we must allocate these indirect or administrative costs as well. If we ignore this step, we will be underrepresenting the expense involved in supporting each program area. As explained above, indirect expenses are generally all of our administrative expenses – those expenses that support the overall management of the organization. Some expenses are assigned to the indirect category specifically, such as the audit. Others are allocated to the indirect category, such as a portion of rent and telephone. For this reason we wait until after all the direct allocations are completed before we turn to allocating the indirect costs. The two most common methods for allocating indirect costs to programs are percentage of total direct costs and percentage of FTE.

10. Allocate fundraising costs

Similarly, the cost of fundraising is valuable to programs and the final step is to allocate fundraising expenses to each. The most common basis for allocating fundraising costs is based on percentage of total support received by each program. This method matches the percentage of fundraising expense charged to a program to the percentage of contributed income that program receives. We leave this step until last because some funders, including many government funders, will not allow fundraising expenses to be charged to their grants or contracts. Regardless of whether a funder will pay for fundraising expense, it remains part of the total cost of running each program and we need this information to be truly informed. The same is true for allocating administrative/indirect costs.

11. Bring it all together for review

After completing the full program-based budget or financial analysis it’s worthwhile to take a fresh look for both accuracy and a gut check. Do the formulas, amounts, and financial results match what you expected, or do they surprise you? If there are surprises, first review the data to verify the calculations and choices about allocations and definitions. Sometimes, though, the surprise comes from seeing the true and full costs for the first time. The benefit is that you now have better information for discussions about priorities and how resources are used. With this information your organization is better equipped to review costs, prices, and contract terms; communicate gaps and fundraising priorities; and discuss which programs require financial support and how that relates to accomplishing your mission goals.

Allocation Methods

define allocated expenses

Additional Resources and Links

This overview and guide to using the Program Budget and Allocation Template is not intended to be a definitive or comprehensive document for such a complex financial management practice. We hope that you will be able to use this resource to understand the concepts and steps and to implement this valuable process at your nonprofit.

From Propel Nonprofits:

  • Overhead Cost Definitions
  • 10 Step Budgeting Checklist
  • Transforming Nonprofit Business Models

From other sources:

  • Real Talk About Real Costs video , Forefront
  • Costs are Cool: The Strategic Value of Economic Clarity , The Bridgespan Group
  • Nonprofit Cost Analysis: Introduction , The Bridgespan Group
  • Book: The Sustainability Mindset by Jeanne Bell and Steve Zimmerman

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About Propel Nonprofits

Propel Nonprofits strengthens the community by investing capital and expertise in nonprofits. The organization works with nonprofits in all fields of service by offering loans, training, and financial management advice and resources to help organizations address unexpected events, finance new opportunities, and realize strategic goals. Propel Nonprofits is also a leader in the nonprofit sector, with research and reports on issues and topics that impact that sustainability and effectiveness of nonprofit organizations.

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Allocated Loss Adjustment Expenses (ALAE) Definition, Examples

Julia Kagan is a financial/consumer journalist and former senior editor, personal finance, of Investopedia.

define allocated expenses

What Are Allocated Loss Adjustment Expenses (ALAE)?

Allocated loss adjustment expenses (ALAE) are costs attributed to the processing of a specific insurance claim. ALAE is part of an insurer’s expense reserves. It is one of the largest expenses  for which an insurer has to set aside funds, along with contingent commissions .

Key Takeaways

  • Allocated loss adjustment expenses (ALAE) are expenses attributed to a specific insurance claim.
  • ALAE, along with unallocated loss adjustment expenses (ULAE), represent an insurer's estimate of the money it will pay out in claims and expenses.
  • Expenses associated with ULAE are more general and may include overhead, investigations, and salaries.
  • Small, straightforward claims are the easiest for an insurance company to settle and often require less ALAE when compared to claims that may take years to settle.

Understanding Allocated Loss Adjustment Expenses (ALAE)

Allocated loss adjustment expenses, along with unallocated loss adjustment expenses (ULAE), represent an insurer's estimate of the money it will pay out in claims and expenses. Insurers set aside reserves for these expenses to ensure claims aren't made fraudulently and to process legitimate claims quickly.

ALAEs link directly to the processing of a specific claim. These costs may include payments to third parties for activities like investigating claims, acting as loss adjusters, or as legal counsel for the insurer. Expenses associated with ULAE are more general and may include overhead, investigations, and salaries.

Life insurance companies that use in-house employees for field adjustments would report that expense as an unallocated loss adjustment expense.

Special Considerations

Some commercial liability policies contain endorsements, which require the policyholder to reimburse its insurance company for loss adjustment expenses (ALAE or ULAE). Adjusting a loss is "the process of ascertaining the value of a loss or negotiating a settlement."

Therefore, loss adjustment expenses are most often those costs incurred by an insurance company in defending or settling a liability claim brought against its policyholder. These expenses can include fees charged by attorneys, investigators, experts, arbitrators , mediators, and other fees or expenses incidental to adjusting a claim.

It is important to carefully read the endorsement language, which may say that a loss adjustment expense is not intended to include the policyholder’s attorney fees and costs if an insurer denies coverage and a policyholder successfully sues the insurer. In this situation, where the insurance company has done no actual “adjusting” of the claim, it should not be entitled to apply its deductible to the expenses incurred by the policyholder in defending the claim abandoned by the insurance company.

ALAE vs. Unallocated Loss Adjustment Expenses (ULAE)

Insurers have gradually shifted from categorizing expenses as ULAE to categorizing them as ALAE. This is primarily because insurers are more sophisticated in how they treat claims and have more tools at their disposal to manage the costs associated with claims.

Small, straightforward claims are the easiest for an insurance company to settle and often require less ALAE when compared to claims that may take years to settle. Claims that could result in substantial losses are the most likely to receive extra scrutiny by insurers and may involve in-depth investigations, settlement offers, and litigation. With greater scrutiny comes greater cost.

Analysts can tell how accurate an insurance company has been at estimating its reserves by examining its loss reserve development. Loss reserve development involves an insurer adjusting estimates to its loss and loss adjustment expense reserves over a period of time.

What are the Differences Between ALAE and ULAE?

Allocated loss adjustment expenses (ALAE) are costs attributed to the processing of a specific insurance claim. ALAE is part of an insurer’s expense reserves. Expenses associated with unallocated loss adjustment are more general and may include overhead, investigations, and salaries.

What Should Policyholders Know About "Endorsements"?

Endorsements require the policyholder to reimburse the insurance company for loss adjustment expenses. Read the endorsement language, which may say that a loss adjustment expense is not intended to include the policyholder’s attorney fees and costs if an insurer denies coverage and a policyholder successfully sues the insurer. 

Washington State Legislature. " WAC 284-24D-020: Definitions ."

Bruening Insurance Agency. " Common General Liability Insurance Endorsements, And Why You Need Them ."

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Allocated Loss Adjustment Expenses (ALAE): Definition & Calculator

Allocated loss adjustment expenses (ALAEs) are loss adjustment expenses that are assignable or allocable to specific claims.

Allocated Loss Adjustment Expenses (ALAE) Explained

An example of allocated loss adjustment expenses (alae).

When it comes to insurance claims, the headline figures only tell part of the story. Delve a little deeper, and you'll come across Allocated Loss Adjustment Expenses (ALAE) . These are the direct costs that an insurance company incurs while investigating and settling an insurance claim.

Why does ALAE matter? For insurers, understanding ALAE is crucial for accurate pricing and risk assessment. For policyholders, it impacts the premiums you'll pay and provides a window into the efficiency and fairness of an insurance company's claims process.

Accurate ALAE calculations are essential for both parties, as they can affect the insurer's profitability and the customer's satisfaction.

In an industry where margins and customer experience are everything, ALAE serves as a critical metric . A high ALAE might indicate inefficient claims processing, while a low ALAE could suggest a streamlined operation but may also raise questions about the thoroughness of claim investigations.

💡 Key Insights

  • For insurers, a well-managed ALAE can indicate operational efficiency and risk management prowess.
  • For policyholders, a reasonable ALAE level suggests you're not overpaying for administrative inefficiencies.

Suppose an individual files an auto insurance claim after an accident. The insurer might spend money on appraisals, legal fees, and investigators to assess the validity of the claim.

If these costs total $2,000, that sum is considered the ALAE for that specific claim.

Allocated Loss Adjustment Expenses (ALAE) Calculator

Does a high alae always mean inefficiency.

Not necessarily. A high ALAE might reflect a complex case requiring thorough investigation, but consistently high ALAE levels could indicate operational inefficiency.

How does ALAE affect insurance premiums?

Insurers factor in ALAE when calculating premiums. High ALAE could lead to higher premiums to maintain profitability.

Can ALAE impact the speed of claims processing?

Yes, higher expenses might prolong claim investigations, delaying settlements.

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Defining and Allocating Costs

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Cost allocations move costs and revenues between cost types, cost centers, and cost objects. You can define as many allocations as you need. Each allocation consists of:

  • An allocation source.
  • One or more allocation targets.

The allocation source establishes which costs must be allocated, and the allocation targets determine where the costs must be allocated. For example, an allocation source can be the costs for the Electricity and Heating cost type. You allocate all electricity and heating costs to three cost centers: Workshop, Production, and Sales. These cost centers are your allocation targets.

For each allocation source, you define an allocation level, a validity period, and a variant as grouping identifier. You can use a batch job to set filters to select allocation definitions and then run cost allocations automatically.

For each allocation target, you define an allocation base. The allocation base can be either static or dynamic.

  • Static allocation bases are based on a definite value, such as square footage or an established allocation ratio, such as 5:2:4.
  • Dynamic allocation bases depend on changeable values, such as the number of employees in a cost center or sales revenue of a cost object throughout a certain time period.

The following table describes a sequence of tasks, with links to the topics that describe them.

Setting Up Allocation Source and Targets

Each allocation consists of an allocation source and one or more allocation targets. The allocation source defines which costs will be allocated. The allocation targets determine where the costs will be allocated.

To set up cost allocations

Lightbulb that opens the Tell Me feature.

  • On the Cost Allocation page, choose the Edit action.
  • Enter an ID for the allocation source in the ID field.
  • Define a level as a number between 1 and 99 in the Level field. The allocation posting will follow the order of the levels.
  • Enter a cost type to define which cost types will be allocated in the Cost Type Range field. If all costs for a cost type are allocated, no range is defined.
  • Enter a cost center together with costs to be allocated in the Cost Center Code field.
  • Enter a cost object together with costs to be allocated in the Cost Object Code field. Most often, this field stays empty, because cost objects are rarely allocated to other cost objects.
  • Enter a cost type in the Credit to Cost Type field. The costs that are allocated will be credited to the source cost type. The credit posting will be posted to the cost type given here.
  • On the Lines FastTab, define the allocation targets. On the first line, enter a cost type in the Target Cost Type field. It defines which cost type the allocation is debited to.
  • On the first line, enter the first allocation target in the Target Cost Center field or Target Cost Object the field. These two fields define which cost center or cost object the allocation is debited to. You can only fill in one of these fields, but not both.
  • Repeat the same steps on the second line to set up additional allocation targets.
  • After you have set up the allocation target and sources, choose the Calculate Allocation Key action to calculate the total share values.

Select the Blocked check box to deactivate the allocation setup.

Setting Filters for Dynamic Allocation Bases

The dynamic allocation method is based on changeable values. For example, the number of employees in a cost center or the items sold of a cost object in a specific time period. There are nine pre-defined allocation bases and twelve dynamic date ranges. You set different filters based on the allocation base.

Setting Filters

The following table shows which filters are possible for different allocation bases and which values are valid in the No. Filter and Group Filter fields. Select F1 in the Date Filter Code field to read detailed descriptions.

Scenario 1: Defining Static Allocations Based on Allocation Ratio

Static allocation method is based on a definite value, such as square meters used, or an established allocation ratio such as 5:2:4.

This topic describes how to define three new allocation target cost objects for the allocation source PROD cost center using the established allocation ratio 5:2:4. The three target cost objects are ACCESSO, PAINT, and FITTINGS.

The example uses the demo data in the Business Central.

To define the allocation source PROD cost center on the General FastTab

  • On the Cost Allocation page, choose the New action.
  • In the ID field, select Enter or enter an ID.
  • In the Level field, enter 1 .
  • In the Valid From and Valid To fields, enter appropriate dates.
  • In the Cost Center Code field, enter PROD .
  • In the Credit to Cost Type field, enter the cost type 9903 .

To define the allocation target cost objects on the Lines FastTab

  • On the first line, in the Target Cost Type field, enter 9903 .
  • On the first line, in the Target Cost Object field, select ACCESSO .
  • On the first line, in the Allocation Target Type field, select All Costs to define how all accrued costs are allocated.
  • On the first line, in the Base field, select Static to use the static allocation method.
  • On the first line, in the Share field, enter the allocation ratio 5 .
  • On the second line, in the Target Cost Type field, enter 9903 .
  • On the second line, in the Target Cost Object field, select PAINT .
  • On the second line, in the Allocation Target Type field, select All Costs to define how all accrued costs are allocated.
  • On the second line, in the Base field, select Static to use the static allocation method.
  • On the second line, in the Share field, enter the allocation ratio 2 .
  • On the third line, in the Target Cost Type field, enter 9903 .
  • On the third line, in the Target Cost Object field, select FITTINGS .
  • On the third line, in the Allocation Target Type field, select All Costs to define how all accrued costs are allocated.
  • On the third line, in the Base field, select Static to use the static allocation method.
  • On the third line, in the Share field, enter the allocation ratio 4 .

Business Central automatically calculates the Percent field using a percentage rate that is dependent on all three allocation ratios that are entered in the Share field for all three lines.

Scenario 2: Defining Dynamic Allocations Based on Items Sold

This topic shows an example of how to define allocations by using the dynamic allocation method. In the example, you change the dynamic allocation of the costs for the SALES cost center to support the new cost object IT EQUIPMENT. IT EQUIPMENT packages have item numbers in the range from 8904-W to 8924-W. You use the previous year’s sales figures to calculate the share. The allocation is posted to the helping cost type 9903.

To define dynamic allocations based on items sold in the previous year

  • In the Cost Center Code field, enter SALES .
  • In the Target Cost Type field, enter the cost type 9903 .
  • In the Target Cost Object field, choose New to create a new cost object IT EQUIPMENT and fill in fields as necessary. Select IT EQUIPMENT . Leave the Target Cost Center field blank.
  • In the Allocation Target Type field, select All Costs to define how all accumulated costs are allocated.
  • In the Base field, select the allocation base Items Sold (Amount) .
  • In the No. Filter field, enter 8904-W..8924-W .
  • In the Date Filter Code field, enter Last Year .
  • Choose the Calculate Allocation Key action to calculate the share.

Business Central uses the previous years’ sales figures to calculate a share of 1596.50 LCY with 100 percent for the IT EQUIPMENT packages. This means that all of the items sold last year will be allocated to the cost object IT EQUIPMENT.

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Home > Finance > Allocated Loss Adjustment Expenses (ALAE) Definition, Examples

Allocated Loss Adjustment Expenses (ALAE) Definition, Examples

Allocated Loss Adjustment Expenses (ALAE) Definition, Examples

Modified: October 10, 2023

Discover the definition and examples of Allocated Loss Adjustment Expenses (ALAE) in the finance industry. Gain a better understanding of this crucial term.

  • Definition starting with A

(Many of the links in this article redirect to a specific reviewed product. Your purchase of these products through affiliate links helps to generate commission for LiveWell, at no extra cost. Learn more )

Understanding Allocated Loss Adjustment Expenses (ALAE)

When it comes to the world of finance, there are numerous terms and concepts that may seem overwhelming at first. One such concept is Allocated Loss Adjustment Expenses, or ALAE for short. In this article, we will break down the definition of ALAE, provide examples, and explore how it impacts financial decision-making.

Key Takeaways:

  • Allocated Loss Adjustment Expenses (ALAE) are the costs associated with investigating, processing, and settling insurance claims.
  • ALAE includes expenses such as legal fees, expert fees, and administrative costs.

So, what exactly are Allocated Loss Adjustment Expenses? In the insurance industry, ALAE refers to the costs incurred by an insurance company when processing and settling claims. These expenses are separate from the actual claim payments made to policyholders and are an important consideration for insurers when analyzing their financial performance. ALAE covers a wide range of costs, including legal fees, expert fees, administrative expenses, and other costs associated with investigating and resolving claims.

Let’s take a closer look at some examples of ALAE to better understand its impact:

Example 1: Legal Fees

When a claim is disputed or requires legal action, the insurance company may need to hire external legal counsel to represent its interests. These legal fees fall under ALAE and can vary depending on the complexity and duration of the legal process. From hiring attorneys to paying for court fees, ALAE covers all the legal expenses incurred during the claim resolution.

Example 2: Expert Fees

In some cases, insurance companies may need to seek the help of outside experts to investigate the circumstances of a claim. These experts could include accident reconstruction specialists, medical professionals, or engineers who provide valuable insights for claim settlement. The fees associated with hiring these experts are considered part of ALAE and are crucial in properly evaluating and processing the claim.

ALAE is an essential factor in the financial analysis of insurance companies. By tracking and monitoring these expenses, insurers can gain insights into their claims management practices, identify cost-saving opportunities, and make informed decisions to improve their overall financial performance.

The Importance of ALAE in Financial Decision-Making

Allocated Loss Adjustment Expenses play a vital role in determining the profitability and efficiency of insurance companies. Here are two key takeaways to remember:

  • Effective management of ALAE can lead to cost savings and improved financial performance for insurance companies.
  • Proper analysis and control of ALAE can help insurers make informed decisions and optimize their claims management processes.

Insurance companies dedicate considerable resources to managing and controlling ALAE to ensure they operate efficiently. By effectively managing ALAE, insurers can mitigate potential losses, enhance their financial strength, and provide better value to their policyholders.

Now that you understand the definition of Allocated Loss Adjustment Expenses (ALAE) and how it impacts financial decision-making, you can navigate the world of insurance with greater confidence. Whether you are an insurance professional or simply interested in expanding your knowledge, having a grasp of ALAE will undoubtedly prove beneficial in understanding the complex dynamics of the insurance industry.

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Loss Adjustment Expense (LAE): Definition, How It Works, And Types

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FinOps X 19-22 June 2024

  • Capabilities

Framework / Domains / Understand Cloud Usage & Cost / Allocation

Define strategies to assign and share cloud costs using accounts, tags, labels, and other metadata, creating accountability among teams and projects within an organization.

Maintain an allocation strategy

  • Define organizational groupings to which we allocate all cloud costs in our business
  • Define specific terminology to describe all the allocation groupings

Maintain a tagging & hierarchy strategy

  • Define specific tags, labels, naming standards, grouping structures used to identify that a cost is in a particular grouping
  • Define how to identify subsets of cost that are shared

Maintain a shared cost strategy

  • Define the need to share any subsets of cost among allocation targets
  • Define mechanisms to share costs for each shared cost item

Validate allocation compliance

  • Create mechanisms to ensure adequate allocation of cost to our allocation groupings
  • Define and maintain an allocation taxonomy of categories for our cloud usage
  • Define and maintain a strategy to document apportionment of shared costs and impacts to allocation targets

The FinOps Principle , “Everyone takes ownership for their cloud usage,” is enabled by Allocation.

Allocation defines how cloud costs should be apportioned to those responsible for each component of that cost, whether directly or as a shared element. In the context of FinOps, this involves using account structures, tags, labels and derived metadata to identify categories to which we assign costs in a way that provides product managers, engineers, and other personas with a transparent and complete understanding of the cost of cloud resources for which they are responsible.

Allocation from aggregated usage datasets can be done by splitting costs manually or using a known list of owners of accounts, projects, subscriptions, resource groups or other logical groupings of cloud resources. Allocation granularity is enhanced using resource-level naming conventions and tags or labels applied within the cloud. Even more granular allocation, or allocation of shared cost elements can be accomplished using other sources such as the organization Configuration Management Database (CMDB), observability, or utilization data. The methods and intricacy of the allocation will generally increase as organizations demand more detailed Reporting & Analytics .

Allocation will require three primary strategies: Allocation Strategy, Tagging Strategy and Shared Cost Strategy. Each is described below.

  • The allocation strategy defining how costs should be mapped to the organization. The allocation strategy primarily involves understanding and defining how the organization wishes to look at cloud costs in order to do showback to various teams, chargeback to finance, or allocation to cost centers. See the Invoicing & Chargeback Capability for more information on the impact of Cost Allocation to Showback / Chargeback. There can be multiple layers of cost allocation and multiple ways to slice the cost and usage data. For example, finance may need to see costs divided by Cost Center or by type of spending (e.g. R&D, COGS), but engineering teams may need more granular breakdown by application, and operations teams may need to see all costs related to Production environments for all applications.
  • The tagging or metadata strategy defining how cloud usage and resources will be mapped to the defined parts of the organization. The tagging strategy primarily involves understanding what mix of cloud data will be required, how resources will be segregated into accounts, how accounts will be grouped, how naming standards will be used, how tags or labels will be applied, and how all of that information will be aggregated. Tagging strategies must take into account the challenges of tagging compliance and consistency, differences in how resources can be tagged in different environments, and the fact that some costs cannot be tagged in cloud environments. Tagging can be much more effective as well using automation, infrastructure as code, or using tools to manage tags after resources are launched.While the scope of the metadata strategy discussed here is confined to Cost Allocation, the metadata strategy may also encompass or be combined with the needs of other areas within an organization such as operations, automation, and security. The organization’s tagging strategy may be owned by a Cloud Center of Excellence (CCOE), Cloud Platform team, or DevOps team, requiring collaboration with those groups to contribute Cost Allocation requirements in the combined plan.
  • The shared cost strategy which defines how each set of shared resources will be allocated to budgets. Most organizations will also have shared costs to be allocated. Examples include support costs that benefit all users, centralized networking services, or shared environments (platforms, containers, etc.). While the ultimate goal of an organization may be full allocation of costs, the allocation and reporting of shared costs can be complex. Many early FinOps practices adopt an “informed ignore” approach where a business decision is explicitly made to centrally budget for shared cost items, rather than allocating from each cost center’s budget. Choose for each shared cost what kind of allocation policy generates the best value for the organization. Most organizations use a mix of strategies with some shared costs allocated to cost center budgets and others funded from central budgets. Allocation of shared costs can be performed in a variety of ways including fixed allocations, proportional or by using proxy metrics to determine a variable proportion.As an organization’s cloud use and FinOps practice matures, and particularly as automation is introduced or increased, it is likely that these strategies will change and mature as well. These changes will inform the Data Ingestion capability to obtain all the data and contextual information required. Multiple versions of these strategies could be in force at any given time. So 100% consistency in tagging, allocation, or shared cost allocation may be difficult to achieve. The goal should be to achieve the level of allocation that provides the organization with the level of information to make good decisions at its chosen level of maturity.
  • Maturity Assessment
  • Simple Allocation strategy where costs of accounts, projects or subscriptions are allocated to the business units, portfolios or cost centers using a list of accounts known to belong to specific cost centers or business units
  • resource naming standards
  • Account, Project, Subscription naming standards
  • Tagging strategy compliance is inconsistent
  • Monthly challenges identifying the owners of unknown, untagged, unidentified accounts
  • 50% of total cost of cloud can be allocated without adjustments or alterations to metadata
  • Tags or labels are used for some allocation, but cannot be used consistently, or not used for a majority of spend
  • Shared costs are not identified beyond common charges such as support, tax, etc.
  • Shared costs are allocated to central budgets or cloud platform teams directly and not charged back to cost centers or business units
  • Product owners and engineers primarily manage to direct costs only, resulting in reduction in accuracy of forecasting and budgets
  • Basic KPIs for Cost ALlocation are defined and manually created on an inconsistent cadence
  • Allocation tasks are primarily managed with cloud service provider systems and tooling
  • Well-documented Allocation strategy identifying multiple mechanisms for allocating cost has been implemented but may not be used consistently or universally
  • Infrequent investigation to identify unallocated, untagged, or unidentified cost elements
  • 75% of cloud cost can be allocated without adjustment, alteration or investigation
  • Cost allocation can be done to an application or service level
  • Tagging strategy for resources and hierarchy groupings is well-documented and followed
  • Tagging compliance is consistent in key areas or applications but not universal
  • Allocation mechanisms will typically include a combination of factors, such as accounts, projects or subscriptions which are identified by metadata or naming standard as belonging to specific cost centers, resources within shared cost pools which can be identified as belonging to a particular cost center, and some mechanisms for the distribution of shared costs
  • Legacy or less critical parts of the cloud infrastructure which are not consistently using the allocation standards still exist and require some manual or estimation effort
  • Shared cost strategy is well documented and understood for multiple elements of shared cost
  • Shared costs are split using an appropriate distribution model(s) (proportional, fixed, even-split) across the entirety of the organization
  • Use of a combination of Cloud Service Provider tools, third party, or custom tooling to manage allocation and sharing
  • Discounts are spread proportionally across all teams cloud spend
  • KPIs for cost allocation understood, but not automated
  • Shared platform owners are able to showback costs generated by internal customers
  • Product owners and engineers are aware of their portion of shared platform/service costs and include these costs when forecasting and budgeting
  • Shared cost process documented to enable and manage expectations of “fair share” onboarding of new cost centers/business units
  • Cloud costs are allocated at any level of granularity required by the organization
  • Direct allocation or consistent mechanisms for distributing shared cost items, and strategies for metadata, hierarchy and naming standards are being used consistently and effectively universally
  • 80-100% of FinOps managed costs are allocated without adjustment, alteration, or investigation
  • Automation allows for multiple sources of data to be used to allocate shared costs at the level they can be where important to the organization (e.g. using metering tools to capture usage and augment billing data to attribute shared costs with greater accuracy)
  • There are few scenarios where all cost is not allocated at the most granular level or is unidentified, requiring essentially no research or reporting generation time
  • Use of Cloud Service Provider tools, third party tools, custom tools integrated consistently
  • Employing automation in the provisioning of resources to create consistency of resource and account tagging and metadata
  • Using mechanisms to automatically correct for or augment cloud service provider tagging capabilities after receipt of billing data to achieve high allocation percentage compliance
  • KPIs well understood and automated.
  • Cost allocation is performed in near real time allowing for Product Owners and Engineers to better understand their monthly costs
  • Product owners and engineers are aware of their portion of shared platform/service costs and include all costs as part of their forecasting & budget planning
  • Shared platform/service owners are able to fully allocate and chargeback costs generated by internal customers
  • Shared platform/service owners are able to recover costs generated by internal customers and perform accurate forecasting/budget planning
  • Shared cost recovery reflects commercial discounts/commitment based discounts
  • Shared cost process automated to enable “fair share” onboarding of new cost centers/business units
  • Shared costs are distinguished from dedicated costs
  • Functional Activities

FinOps Practitioner

As someone in the FinOps team role, I will…

  • Develop naming standards for all required and optional layers of hierarchical groupings (Accounts, Projects, Folders, Subscriptions, Departments, Organizational Units, etc.)
  • Develop compliance standards for various groups
  • Coordinate with CCOE or Cloud Platform teams to coordinate Tagging Strategy and metadata needs with other operational or security requirements
  • Coordinate with owners of shared services to determine the appropriate level of shared cost management for each and document in Shared Cost Strategy
  • Coordinate with Leadership on appropriate level of granularity for Cost Allocation Strategy
  • Evaluate compliance with established allocation strategies

As someone in a Product role, I will…

  • Provide feedback on cost allocations made to products within my control

As someone in a Finance role, I will…

  • Determine the organizational and budgetary units to which costs will be allocated
  • Determine how to allocate percentages of any shared cost items

Engineering

As someone in an Engineering role, I will…

  • Determine how and when metadata will be applied to hierarchical groupings and resources
  • Enforce and automate metadata standards for cost allocation metadata
  • Identify and provide all metadata sources required for analysis and cost allocation
  • Comply with organizational allocation strategies where required, and provide feedback on issues or opportunities to improve

As someone in a Leadership role, I will…

  • Review and approve cost allocations assigned to organizations within my control
  • Review and approve cost allocation strategies
  • Determine and provide feedback when cost allocation must become more granular or mature

Allied Personas

As someone in an Allied Persona role, I will…

  • Provide feedback to FinOps personas on appropriate level of granularity and compliance requirements for allocation related to areas within my control (e.g. IT Security, ITAM, Service Management, IT Financial Management, etc.)
  • Measures of Success & KPIs
  • The majority of cloud costs can be categorized and allocated directly to an organizational unit. According to the FinOps Community of Practitioners , comprehensive allocation translates to at least 80% of cloud spend is allocated for a FinOps practice operating at a Crawl maturity level; and 90% for a FinOps practice operating at a Run maturity level
  • Ability to surface the percentage of cost that cannot be categorized and allocated directly, and which must be investigated at a low level
  • Metadata compliance as a percent of spend (i.e. 80% of cost has appropriate allocation metadata, or is within a known hierarchical grouping)
  • Stakeholder notifications for missing allocation metadata when resources are deployed
  • See the KPI Library for a longer list of FinOps KPIs that could be used for Cost Allocation

Mapping Business Metadata

Objective: Achieve comprehensive cost allocation to organizational units

KPI: Percentage of cloud costs allocated directly to organizational units

Thresholds: – Crawl maturity level: 50% or higher – Run maturity level: 90% or higher

Uncategorized Cost Percentage

Objective: Minimize unallocated cloud costs

KPI: Percentage of cloud costs that cannot be categorized and allocated directly

Threshold: Maintain below a specified threshold, e.g., 10%

Metadata Compliance

Objective: Ensure accurate and complete metadata for cost allocation

KPI: Percentage of cloud costs with appropriate allocation metadata

Threshold: Maintain at least 80% compliance

Stakeholder Notifications

Objective: Proactively address missing allocation metadata

KPI: Number of stakeholder notifications for missing metadata

Threshold: Minimize notifications by ensuring comprehensive metadata compliance

Investigation Response Time

Objective: Efficiently investigate and resolve unallocated costs

KPI: Average time taken to investigate and resolve unallocated costs

Threshold: Set a target response time, e.g., within 48 hours

Cost Trend Variance

Objective: Monitor and control costs against forecasted trends

KPI: Percentage variance of actual costs from forecasted trends

Thresholds: Define acceptable variance levels based on financial goals

Continuous Improvement in Allocation Accuracy

Objective: Continuously enhance the accuracy of cost allocations

KPI: Quarterly improvement in the accuracy of cost allocations

Threshold: Achieve a set percentage improvement each quarter

Resource Deployment Compliance

Objective: Ensure all deployed resources have proper metadata

KPI: Percentage of resource deployments with missing allocation metadata

Threshold: Minimize missing metadata for resource deployments

Training and Awareness

Objective: Improve understanding and adherence to cost allocation practices

KPI: Percentage increase in awareness and adherence to cost allocation practices

  • Inputs & Outputs
  • Provide requirements to inform Data Ingestion activities as a feedback loop for improving Allocation strategy goals
  • Receive requirements from initiatives related to Reporting & Analytics activities to inform the requirements of Allocation mappings to achieve organizational reporting goals
  • Incorporate Cloud Adoption Frameworks / Architecture Frameworks from Cloud Service Providers
  • Consolidate existing tag/label standards and establish consistent naming conventions
  • Overlay the organizational business metadata for each element of allocation metadata. For example: constructs like Project Names, Application IDs, Cost Center IDs, …etc.
  • Establish reports that surface any spend that is not allocated by the established allocation metadata
  • Align roles for organizational P&L groupings to map cost ownership back to Invoicing & Chargeback activities
  • Leverage the capabilities of CI/CD, platform, cloud provider capabilities
  • Ensure allocation requirements align with Policy & Governance activities, including tag compliance, allocation compliance, governance mechanisms

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  1. What is Cost Allocation? Definition & Process

  2. 3 Ways to Allocate Common Costs (Stand-alone, Incremental, and Shapley Value methods)

  3. Elements of cost

  4. What is an Expense ?

  5. What is an Expense? (Financial Accounting)

  6. Accounting

COMMENTS

  1. Expense allocation definition

    An expense allocation occurs when indirect costs are assigned to cost objects. Expense allocations are required by several accounting frameworks in order to report the full cost of inventory in the financial statements. A cost object is anything for which a cost is compiled. Examples of cost objects are products, product lines, customers, sales ...

  2. What Is Cost Allocation? (Definition, Method and Examples)

    Cost allocation is the process of identifying, accumulating and assigning costs to specific cost objects. A cost object can be a specific product or product line, a particular service you offer, a production-related activity or a department or division in your company. To make a connection between a cost and its cost object, you can choose a ...

  3. What Is Cost Allocation? (+ Types of Costs & Examples)

    Cost allocation example 2. Carrie's manufacturing company manufactures backpacks. In July, Carrie produced 2,000 backpacks with direct material costs of $5.50 per backpack, and $ 2.25 direct ...

  4. Cost Allocation

    If costs are allocated to the wrong cost objects, the company may be assigning resources to cost objects that do not yield as much profits as expected. Types of Costs. There are several types of costs that an organization must define before allocating costs to their specific cost objects. These costs include: 1. Direct costs

  5. Allocated Costs: Understanding the Impact on Business Finance

    Allocated Costs Definition Allocated costs are the set expenses attributed to a particular department, product, or service within a company, as part of cost allocation process. It is a methodology used to distribute indirect costs amongst different operations or production units based on certain allocation base such as labor hours, machine ...

  6. The Comprehensive Guide to Cost Allocation in Accounting

    The allocation base is the basis on which the costs will be allocated. This can be the number of units produced, the number of employees, or any other relevant factor that can be used to determine the cost of goods or services. Step 4: Allocate the Costs. Once you have determined the allocation base, the next step is to allocate the costs.

  7. What Is Cost Allocation?

    Cost allocation is the method business owners use to calculate profitability for the purpose of financial reporting. To ensure the business's finances are on track, costs are separated, or ...

  8. Allocated Costs: Explained: What is it, how to calculate it, formula

    First of all, let's define allocated costs. Simply put, they are indirect costs that are assigned or allocated to a particular product or service. These costs cannot be traced directly to the product or service but are incurred in the process of producing it. Allocated costs are important because they help businesses determine the true cost of ...

  9. What is cost allocation?

    Definition of Cost Allocation. Cost allocation is the assigning of a cost to several cost objects such as products or departments. The cost allocation is needed because the cost is not directly traceable to a specific object. Since the cost is not directly traceable, the resulting allocation is somewhat arbitrary.

  10. Allocations in Financial Accounting

    Definition: Allocations divide costs between different departments or activities within a company. For instance, overhead costs such as the rent and utilities are often allocated to the company's operating units. Determining accruals and allocations nearly always entails making assumptions and estimates.

  11. What are Allocated Expenses?

    Expenses often are allocated on the basis of square footage in each department. For example, janitorial services might be allocated among office departments or divisions on a square-footage basis.

  12. Cost allocation

    Let us understand the concept of cost allocation plan with the help of a suitable example as given below. This process can be understood by way of the following example. A company produces two products, "A" and "B" on the premises of the same factory. Factory Rent = $1,00,000. Units Produced of "A" = 30,000.

  13. Operating Expense (OpEx) Definition and Examples

    Operating Expense: An operating expense is an expense a business incurs through its normal business operations. Often abbreviated as OPEX, operating expenses include rent, equipment, inventory ...

  14. Allocated Cost

    An Allocated Cost is a type of expense that is clearly associated with and so can be readily assigned to a certain business process, project or department. Allocated cost types might include fabrication costs, sales costs, project management costs, and associated fixed costs. Another example, a company might allocate or assign the cost of an ...

  15. Allocating Expenses

    Expenses are allocated to show the total cost of activities, services, and projects. It is very important for the board and management to know the total costs of activities, services, and projects so both can see how the nonprofit's resources are used. Expenses that benefit an activity, service, or project should be charged to the activity ...

  16. True Program Costs: Program Budget and Allocation Template and Resource

    Propel Nonprofits developed this guide and spreadsheet template to help nonprofits implement program-based budgeting and financial reporting. This resource is an overview of the concepts and management decisions needed to calculate the true costs of activities for a nonprofit and also a how-to guide for the accompanying spreadsheet template.

  17. Budget Allocation: A Step-by-Step Guide

    20% from existing revenue. 10% from expected growth from a new revenue stream. Assuming you can match your funding amounts with the expected costs, then you're good to move forward. If not, you may need to reassess your expenses to identify areas to cut back, or seek further funding. 3. Allocate Budget by Department.

  18. Allocated Loss Adjustment Expenses (ALAE) Definition, Examples

    Allocated loss adjustment expenses (ALAE) are attributed to the processing of a specific insurance claim. ALAE are part of an insurer's expense reserves. It is one of the largest expenses for ...

  19. Allocated Loss Adjustment Expenses (ALAE): Definition & Calculator

    An Example Of Allocated Loss Adjustment Expenses (ALAE) Suppose an individual files an auto insurance claim after an accident. The insurer might spend money on appraisals, legal fees, and investigators to assess the validity of the claim. If these costs total $2,000, that sum is considered the ALAE for that specific claim.

  20. Defining and Allocating Costs

    Enter a cost type to define which cost types will be allocated in the Cost Type Range field. If all costs for a cost type are allocated, no range is defined. Enter a cost center together with costs to be allocated in the Cost Center Code field. Enter a cost object together with costs to be allocated in the Cost Object Code field. Most often ...

  21. Allocated Loss Adjustment Expenses (ALAE) Definition, Examples

    In the insurance industry, ALAE refers to the costs incurred by an insurance company when processing and settling claims. These expenses are separate from the actual claim payments made to policyholders and are an important consideration for insurers when analyzing their financial performance. ALAE covers a wide range of costs, including legal ...

  22. Allocated Expenses Definition

    Define Allocated Expenses. means the aggregate of all costs allocated quarterly to NYGB by NYSERDA, generally based on the proportion which NYGB's direct salary costs bear to the total salary costs of all NYSERDA program staff, expressed in dollars. Allocated Expenses fall into the following categories:

  23. Capability: Allocation

    Define organizational groupings to which we allocate all cloud costs in our business; Define specific terminology to describe all the allocation groupings; Maintain a tagging & hierarchy strategy. Define specific tags, labels, naming standards, grouping structures used to identify that a cost is in a particular grouping