Definition:
Allocations divide costs between different departments or activities within a company. For instance, overhead costs such as the rent and utilities are often allocated to the company’s operating units. Determining accruals and allocations nearly always entails making assumptions and estimates.
Example:
Let’s use the rent and utilities as an example. If you take the amount of rent and utilities for a month, you could allocate that based on the square footage of each operating unit, or you could allocate it based on the number of employees in each operating unit. There are many ways to allocate costs, pick a method that makes the most sense for your company that you can defend.
Book Excerpt:
(Excerpts from Financial Intelligence, Chapter 2 – Spotting Assumptions, Estimates, and Biases)
Accountants use accruals and allocations to try to create an accurate picture of the business for the month. After all, it doesn’t help anybody if the financial reports don’t tell us how much it cost us to produce the products and services we sold last month. That is what the controller’s staff is trying so hard to do, and that is one reason why it takes as long as it does to close the books.
