Basis of Allocation of Common Expenditure among Various Departments

In departmental accounting, common expenses are costs that benefit more than one department and cannot be directly attributed to a specific department. These expenses must be allocated fairly among all relevant departments to ensure an accurate reflection of each department’s financial performance. The allocation should be done using a rational and systematic method, so that each department’s financial results are meaningful and equitable.

1. Floor Area Basis (Space/Occupancy)

The floor area method is commonly used to allocate expenses like rent, utilities, and maintenance costs, which are directly tied to the physical space used by each department. The allocation is based on the proportion of floor space occupied by each department relative to the total floor area of the organization.

• Formula:

Allocated Expense for Department = (Floor Area of Department / Total Floor Area) × Total Common Expense

• Example:

If Department A occupies 2000 sq. ft., and the total area of the office is 10,000 sq. ft., the expense allocated to Department A will be 20% of the total common expense.

2. Sales Basis

The sales basis is used for allocating expenses related to selling and distribution activities, such as advertising, commission, or delivery costs. Expenses are distributed among the departments based on the proportion of each department’s sales to the total sales of the business.

• Formula:

Allocated Expense for Department = (Sales of Department / Total Sales) × Total Common Expense

• Example:

If Department B generates $50,000 in sales and the total sales across all departments are $250,000, Department B will be allocated 20% of the total common expenses.

3. Direct Labor Hours Basis

This method is suitable for allocating costs related to labor, such as wages for shared staff, supervisors, or support personnel who serve multiple departments. Expenses are allocated based on the proportion of direct labor hours worked by each department.

• Formula:

Allocated Expense for Department = (Labor Hours for Department / Total Labor Hours) × Total Common Expense

• Example:

If Department C uses 400 direct labor hours out of a total of 2000 hours worked, it will receive 20% of the labor-related expenses.

4. Machine Hours or Production Units Basis

When expenses relate to machinery maintenance, depreciation, or raw materials, the allocation is often done based on the machine hours used by each department or the number of production units manufactured. This method is especially applicable in manufacturing or production-based organizations.

• Formula:

Allocated Expense for Department = (Machine Hours or Production Units for Department / Total Machine Hours or Total Production Units) × Total Common Expense

• Example:

If Department D used 500 machine hours out of a total of 2500 machine hours, it will be allocated 20% of the total machine-related expenses.

5. Time Spent Basis

The time spent basis is typically used for allocating expenses related to administrative support or managerial salaries when multiple departments benefit from shared services. The allocation is done based on the amount of time spent by a shared employee or resource on each department.

• Formula:

Allocated Expense for Department = (Time Spent on Department / Total Time Spent)×Total Common Expense

• Example:

If a shared supervisor spends 10 hours on Department E out of a total of 50 hours worked across all departments, Department E will be allocated 20% of the supervisor’s salary as a common expense.

6. Revenue Basis

This allocation method is based on the revenue generated by each department. It’s particularly useful when there is no significant difference in the space occupied, labor hours, or other measurable metrics across departments. Expenses are allocated in proportion to the revenue each department generates.

• Formula:

Allocated Expense for Department = (Revenue of Department / Total Revenue) × Total Common Expense

• Example:

If Department F generates $75,000 in revenue out of $500,000 total revenue, it will be allocated 15% of the common expenses.

7. Headcount Basis

The headcount basis is used when the expenses relate to human resources, such as shared employee benefits, insurance premiums, or payroll administration. It allocates costs based on the number of employees in each department.

• Formula:

Allocated Expense for Department =  (Number of Employees in Department / Total Number of Employees) × Total Common Expense

• Example:

If Department G has 10 employees and the total number of employees across all departments is 100, it will be allocated 10% of the total employee-related expenses.

8. Combination of Methods

In many cases, a combination of the above methods is used to allocate common expenses, particularly if the expense benefits several factors in varying degrees. For example, rent may be allocated based on floor space, while selling expenses may be allocated based on sales.