Allocation is the assignment of a cost, an item of income, or a share of anything divisible to a cost object, a period, an entity, a jurisdiction or an owner on a stated basis. In cost accounting it is used where the amount cannot be traced to one cost object, or where a rule declines to trace it even though tracing would be possible. In tax the governing rule fixes the shares instead, and it may divide the item among several recipients or assign the whole of it to one. A cost object is whatever is being costed: a job, a product, a department, a contract or a client.
The basis carries the weight, because it is what fixes each share. The federal contract cost principles state that test directly: a cost is allocable if it is assignable or chargeable to one or more cost objectives on the basis of relative benefits received or other equitable relationship (48 CFR 31.201-4). Whether a given cost can be traced at all is the direct versus indirect question, and it is worked through in overhead.
Where a US Firm Meets the Word
Each of the four is a separate rule with its own basis, and the sense is fixed by the rule being applied rather than by the word itself.
Cost Accounting
A pool of indirect cost is spread over cost objects through an allocation base, the measure of activity each object consumed, and a rate built on that base. Choosing the base, setting the rate, and disposing of whatever the rate over-applied or under-applied is the subject of costing overheads.
Partnership Tax
An item of income, gain, loss, deduction or credit is assigned among the partners, and the partnership agreement is what sets each partner’s distributive share, meaning that partner’s share of the item, subject to a statutory test that can displace it (26 U.S. Code section 704). That test sits in equity ownership.
State Income Tax
Here allocation is the counterpart of apportionment rather than a loose synonym for it. Non-apportionable income is assigned whole to one state instead of being spread, while apportionable income is divided among the states by formula, and the split is set out in apportionment.
Purchase Price Allocation
One price paid for a business is spread across classes of assets, under what the statute calls the special allocation rules for certain asset acquisitions (26 U.S. Code section 1060). What the class order then does to each party’s tax result belongs to what a buyer of an accounting practice is actually pricing.
What Allocation Is Confused With
Direct tracing charges a cost to the one object that caused it, so there is no basis and no share to fix. In cost accounting allocation begins where tracing stops, or where a rule declines to trace something that could have been traced.
Common Questions
Say a firm rents one floor and wants each department to carry its part of the rent. The rent arrives as one amount for the whole floor and no part of it is traced to a single department, so the firm picks floor area as the basis.
Office rent for the year $60,000
Tax department floor area 3,000 sq ft
Audit department floor area 2,000 sq ft
Total floor area 5,000 sq ft
Tax department 60,000 x 3,000 / 5,000 = $36,000
Audit department 60,000 x 2,000 / 5,000 = $24,000The rent itself did not change. The basis decided the two shares, and headcount or billable hours would have produced different ones from the same amount.
To hand out shares of one amount by a rule that fixes each share. In accounting that rule is the allocation base, and naming the base is most of the work.
Accountably places trained offshore accountants and tax preparers inside US CPA and EA firms, and a trial task lets a firm’s own reviewer grade a real block of its own state allocation and apportionment workpapers before any client file depends on it.
