How to Allocate Tricky Corporate Costs in Cost Accounting
When conducting cost accounting, each division should probably bear some of the cost of the company’s corporate headquarters. Why? Because without the work done by the divisions, there wouldn’t be a need for the corporate headquarters at all. However, corporate (head-office) costs can be hard to allocate to divisions. You need to develop a formula you can justify. Here are some typical corporate costs that are allocated:
Interest expense on company loans
Salary, benefits, and other costs for human resources, accounting, and legal staff
Salary, benefits, and other costs for administrative staff
Head-office building costs: utilities, insurance, and maintenance
Keep in mind that each division has its own set of costs, too — both direct and indirect. Each one, presumably, makes a product and has direct costs. And each division has indirect costs of its own. Each one has production managers, whose salaries and benefits are allocated as indirect costs to products. Those costs are all separate from the corporate costs.
Your decision about allocation boils down to three choices:
Allocate the entire corporate cost to the divisions.
Don’t allocate any corporate cost to the divisions; use the corporate cost only to evaluate company-wide financial results.
Allocate some of the corporate costs based on a method that justifies a partial allocation.
Say you determine that the head office exists entirely to support the divisions. To fully price each division’s product, each division should receive a corporate cost allocation. You capture all of the costs to make your product (in this case, refrigerators).
The second choice is to not allocate any corporate costs. It argues that because the divisions have no control over the spending at corporate headquarters, they shouldn’t get an allocation. Now, that doesn’t mean that the costs disappear, of course, but this choice will make the division managers happy!
Here’s how your financials would look if you decide not to allocate any costs to the divisions.
|Less corporate costs||$5,000,000|
|Equals company-wide profit||$12,000,000|
Corporate costs are sometimes called common costs. Because these are costs that the firm as a whole incurs, you may not be able to readily assign them to a specific division, department, product, or unit. So you show the common costs at the bottom of your income statement. That way, readers of the profit and loss statement (P&L) can see that those corporate costs aren’t directly related to either the residential or the commercial division.
The final option is to allocate some of the costs. Essentially, any corporate cost you can justify allocating gets allocated. You justify the allocation by finding a cause and effect. Any cost you can’t justify allocating to the divisions remains an unassigned corporate cost. These unassigned costs are shown at the bottom of the income statement, similar to the costs in the table.
You can also consider allocating costs if the division has some control over those costs. For example, insurance costs for all company buildings are paid through the head office. However, say each division works with the insurance company. The division determines the amount of insurance coverage and policy details. Because the division has some decision-making ability, it’s reasonable to allocate those costs to the divisions.