In cost accounting, the stand-alone cost allocation method collects information from the users of a common cost. You assess how much of the total common cost is used by each entity and then you make the cost allocation based on how much each party uses. This is relatively simple.
Assume you have a clothing company with two divisions — the department store division and the small shops division. You sell clothing to stores in both markets. The two divisions use the shipping department to get products to customers. Whenever possible, the divisions work together to put goods on the same truck for shipment. The cost for shipping is based on the weight of the product in the truck.
The department store was quoted $300 to ship 200 pounds of goods from St. Louis, Missouri, to Chicago, Illinois, in two days. The small shops division has a quote of $190 to ship 100 pounds of goods from St. Louis to Milwaukee, Wisconsin, in two days. The two destination cities are relatively close to each other. You can easily calculate the cost allocation. But wait! There’s more!
The divisions combined their orders and asked for a quote from the shipping department. The combined quote was $420 to ship all 300 pounds to the two cities. (What the Dickens? This is a tale of two cities. That’s a savings of $70 — $490 versus $420). Consider how the stand-alone method would allocate the $420 common cost.
This method says to allocate the common cost on the same percentage basis as the costs that would have been paid by each entity alone. For example, the percentage allocation for the department store division would be 61.2 percent ($300 ÷ ($300 ÷ $190)). The small shops division gets an allocation of 38.8 percent (($190) ÷ ($300 ÷ $190)).
| Division | Percent Allocation | Common Cost | Cost Allocated |
|---|---|---|---|
| Department store | 61.2 | $420 | $257.04 |
| Small shops | 38.8 | $420 | $162.96 |
| Total Allocated | $420.00 |
Multiply the common cost ($420) by the allocation percentages, giving you the amount to be allocated to each division.
Pretty simple. Costs are shared proportionally based on use in terms of dollars. Anyway, your division managers will probably judge the allocation process to be fair.