Since indirect costs such as phone bills for the entire company cannot be solely allocated to one department, coming up with estimations of usage for each department is the moist suitable method of cost allocation. In this example, you would review phone records for each department. Calculate the percentage of the total phone bill each department incurs and use the percentages as a basis for cost allocation.
Categorize the cost into either fixed or overhead costs. This helps you narrow down the departments to which indirect costs should be allocated. Fixed costs such as wages fall on the management or financial department. Office supplies costs fall on every department in the organization depending on the departmental usage of supplies.
Each program in an organization has direct costs allocated to it in the organizations budget. Indirect or shared costs are also accounted for and should therefore be distributed evenly among each program or function. Calculate the indirect cost rate using the direct costs as a base. . Say you have project X allocated a direct cost of $2,000 and project Y allocated a direct cost of $8,000. These projects have a shared cost of $5,000 bringing the total budget to $15,000 with the total direct cost being $10,000. Divide the total indirect cost, $5,000, by the total direct cost, $10,000, to get the percentage of indirect cost each project is accountable for, in this case 50 percent. Project X therefore is allocated $1,000 of the indirect cost, $2,000*50 percent, thus catering for a fifth of the indirect cost while Project Y caters for the remainder four-fifths.
This method of indirect cost allocation is similar to that of cost estimations. This method is, however, time consuming and therefore discouraged. In this method, you are required to keep records of each activity categorized as incurring indirect cost. Later review these records to come up with the appropriate amount of indirect costs to be allocated each activity or department.