Cost Allocation & Apportionment: Methods, Bases & Real-World Applications

Core Concepts

1. Definitions: Allocation vs. Apportionment

graph LR
    A["Indirect Costs"] --> B["Allocation"]
    A --> C["Apportionment"]
    B --> D["Arbitrary Basis\n(e.g., 50:50 split)"]
    C --> E["Logical Basis\n(e.g., floor area, machine hours)"]

• Allocation: Splitting costs subjectively (e.g., 60% to Product A, 40% to Product B) when no direct link exists.
• Apportionment: Distributing costs objectively using a cause-and-effect relationship (e.g., electricity bills by machine hours).
• Key Difference:

  Allocation	Apportionment
  No direct link to cost driver	Direct link to cost driver
  Example: Rent split 50:50	Example: Water bill by liters used

2. Why It Matters: The "Nepali Daraz" Example

Daraz’s Kathmandu fulfillment center where indirect costs (rent, salaries) must be split between thousands of orders. (Image: Romlogistics, CC BY-SA 3.0, via Wikimedia Commons)

Scenario: Daraz Nepal operates from a single warehouse in Kathmandu. Monthly costs:

• Rent: Rs. 500,000
• Salaries (warehouse staff): Rs. 300,000
• Electricity: Rs. 100,000

Problem: How to assign these costs to Product A (Electronics) and Product B (Groceries)?

• Allocation: Split rent 60:40 (arbitrary).
• Apportionment: Use floor space occupied (Electronics: 600 sq.m; Groceries: 400 sq.m).

Calculation:

Rent Allocation:
- Electronics: (600/1000) × 500,000 = Rs. 300,000
- Groceries: (400/1000) × 500,000 = Rs. 200,000

Why This Matters:

• Daraz uses apportionment to price products accurately (e.g., electronics may have higher "hidden" costs due to space).
• Exam Tip: Always ask "Is there a logical basis?" before choosing allocation/apportionment.

3. Step-by-Step: Allocating Costs to Departments

Step 1: Identify Indirect Costs

Example: A Kathmandu-based textile factory (e.g., Siddhartha Group) has:

• Factory Overhead: Rs. 2,000,000
  • Rent: Rs. 500,000
  • Depreciation: Rs. 300,000
  • Supervisor Salaries: Rs. 1,200,000
• Departments:
  1. Cutting (5 machines, 2 supervisors)
  2. Sewing (10 machines, 3 supervisors)
  3. Finishing (3 machines, 1 supervisor)

Step 2: Choose Allocation Bases

Step 3: Calculate Allocation Rates

1. Rent:

   • Total floor area: 500 sq.m (Cutting: 100; Sewing: 300; Finishing: 100).
   • Rate = Rs. 500,000 / 500 = Rs. 1,000/sq.m.
   • Cutting: 100 × 1,000 = Rs. 100,000.

2. Depreciation:

   • Total machine hours: 20,000 (Cutting: 5,000; Sewing: 12,000; Finishing: 3,000).
   • Rate = Rs. 300,000 / 20,000 = Rs. 15/hour.
   • Cutting: 5,000 × 15 = Rs. 75,000.

3. Supervisor Salaries:

   • Total salaries: Rs. 1,200,000.
   • Rate = Rs. 1,200,000 / 6 = Rs. 200,000/supervisor.
   • Cutting: 2 × 200,000 = Rs. 400,000.

Step 4: Prepare Allocation Table

Verification: Totals match the original Rs. 2,000,000.

4. Real-World Applications

Example 1: NTC’s Cost Apportionment

NTC’s transmission towers share costs between voice, internet, and TV services. (Image: wfmillar, CC BY-SA 2.0, via Wikimedia Commons)

Scenario: NTC allocates maintenance costs (Rs. 50,000,000) to:

• Voice Calls: 60% usage
• Internet: 30% usage
• TV Services: 10% usage

Calculation:

Voice: 60% × 50,000,000 = Rs. 30,000,000
Internet: 30% × 50,000,000 = Rs. 15,000,000
TV: 10% × 50,000,000 = Rs. 5,000,000

Why? Ensures fair pricing for each service.

Example 2: Khalti’s Transaction Fees

Scenario: Khalti’s server costs (Rs. 20,000,000) are split between:

• Retailers: 70% of transactions
• Service Providers (e.g., Ncell): 20%
• Government Payments: 10%

Calculation:

Retailers: 70% × 20,000,000 = Rs. 14,000,000
Service Providers: 20% × 20,000,000 = Rs. 4,000,000
Government: 10% × 20,000,000 = Rs. 2,000,000

Impact: Retailers pay slightly higher fees to cover their share of infrastructure costs.

5. Common Allocation Bases

6. Worked Example: NEPSE’s Cost Allocation

Scenario: NEPSE (Nepal Stock Exchange) allocates IT infrastructure costs (Rs. 10,000,000) to:

1. Trading Platform (uses 60% of servers)
2. Clearing House (uses 30% of servers)
3. Customer Support (uses 10% of servers)

Step 1: Identify the base → Server Usage (%). Step 2: Allocate:

Trading Platform: 60% × 10,000,000 = Rs. 6,000,000
Clearing House: 30% × 10,000,000 = Rs. 3,000,000
Customer Support: 10% × 10,000,000 = Rs. 1,000,000

Exam Tip: Always justify your base (e.g., "Server usage is directly linked to IT costs").

7. Common Mistakes to Avoid

1. Ignoring the Cause-and-Effect Principle:

   • ❌ Allocating rent by number of employees (wrong).
   • ✅ Allocating rent by floor area (correct).

2. Using the Wrong Base:

   • ❌ Allocating supervisor salaries by machine hours.
   • ✅ Allocating by number of supervisors.

3. Forgetting to Verify Totals:

   • Always check: Sum of allocated costs = Original total cost.

8. Exam Tip: How to Score Full Marks

Step-by-Step Answer Structure

1. Define the terms (allocation vs. apportionment).
2. Identify the cost to be allocated.
3. Choose the base and justify it.
4. Calculate the allocation rate.
5. Prepare a table with clear headings (Department/Product vs. Cost Type).
6. Verify totals.
7. Interpret the results (e.g., "This shows Product A bears higher costs due to...").

Sample Exam Question

Question: A company has two departments, A and B, with the following data:

• Rent: Rs. 240,000 (A occupies 60% space, B occupies 40%).
• Depreciation: Rs. 180,000 (A uses 4 machines, B uses 6 machines). Allocate the costs.

Answer:

1. Rent Allocation:

   • Base: Floor Area (%).
   • Rate: Rs. 240,000 / 100% = Rs. 2,400/sq.m.
   • A: 60% × 240,000 = Rs. 144,000
   • B: 40% × 240,000 = Rs. 96,000

2. Depreciation Allocation:

   • Base: Number of Machines.
   • Rate: Rs. 180,000 / 10 machines = Rs. 18,000/machine.
   • A: 4 × 18,000 = Rs. 72,000
   • B: 6 × 18,000 = Rs. 108,000

3. Table:

   Department	Rent	Depreciation	Total Allocated
   A	144,000	72,000	216,000

| B | 96,000 | 108,000 | 204,000 | | Total | 240,000 | 180,000 | 420,000 |

Marking Scheme

9. Quick Revision Table

10. Practice Questions

1. Ncell’s Cost Allocation: Ncell allocates network maintenance costs (Rs. 80,000,000) based on:

   • Voice: 50% usage
   • Data: 30% usage
   • SMS: 20% usage Allocate the costs.

2. Pathao’s Driver Costs: Pathao has two driver categories:

   • Premium Drivers: 30% of fleet, handle 70% of rides.
   • Standard Drivers: 70% of fleet, handle 30% of rides. Allocate insurance costs (Rs. 5,000,000) using:
   • Option 1: Number of drivers (allocation).
   • Option 2: Number of rides (apportionment). Compare both methods.

Final Note: Master this unit by practicing with real-world examples (Nepali businesses like NTC, Daraz, or banks). Always justify your allocation base in exams!