The Farce of Allocation

If you have a company with multiple product lines or divisions then you may have encountered the age-old difficulty involved in allocation of overhead. This is an area that often creates heated debate.

An Example

Imagine a company with two clear product lines, A and B. In this same company there are administrative roles that are handled by the corporate office, which has no direct connection to either product line but exist to serve both. Here are some ways that the corporate expenses may be allocated:

SALES – The corporate expenses may be allocated based on the sales of each product line. So, if Product Line A has 70% of the sales then it gets 70% of the corporate expenses.

SQUARE FOOTAGE – If Product Line A uses 40% of the square footage of facilities, then it gets 40% of the corporate expenses.

NUMBER OF EMPLOYEES – If Product Line A has 80 employees and Product Line B has 20 employees then Product Line A get 80% of the corporate expenses

There are numerous other ways and I have seen a number of them. But what is the problem with each of these?

Reality

Do any of the above methods of allocation truly reflect reality? Just because a product line or division has the most sales, should they necessarily get more expenses allocated to them? Perhaps they require very little resources of the corporate office to attain their level of sales.

At first glance square footage may seem like a logical way for allocation of expenses. But, does this consider how efficiently they utilize the space and how much they depend on the support of the corporate office. A division or product line may use very little space and yet lean heavily on the corporate office relative to other divisions or product lines. Again, that does not seem fair.

Again, number of employees may seem like a rational method of allocating expenses, but look a little close. Like with square footage, a division with a lot of employees may require only minimal support from a corporate office.

Just a Suggestion

I think there is something to be said for identifying those support expenses that can clearly be associated with a particular division or product line and allocating those where appropriate. With expenses that are general in nature where no clear method of allocation is identifiable, I think you might as well just allocate these any way you choose. However, when it comes to evaluating the performance of the division or product line, perhaps these should not be part of the equation.

Is the allocation of expense an area of dispute in your company? Do you have a way to identify those expenses with a clear connection to a particular operation and those which are so general that allocation is essentially meaningless?

If you want to know more, contact AimCFO – Contact

As always, your comments are welcomed.

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