Allocation of Indirect Expenses

Allocation of Indirect Expenses refers to the process of distributing costs that cannot be directly attributed to a specific department or product across multiple departments or products. These indirect expenses, such as utilities, rent, and administrative salaries, support the overall operations but are not tied to any single revenue-generating activity.

The allocation process involves selecting a basis or criteria for distribution:

• Percentage of Total Revenue: Allocating based on the proportion of each department’s revenue.
• Floor Space: Distributing costs based on the area each department occupies.
• Number of Employees: Allocating based on the number of staff in each department.

Accurate allocation ensures that all departments or products bear a fair share of the indirect costs, leading to more precise cost and profitability analysis. It aids in budgeting, performance evaluation, and financial reporting by providing a clearer picture of each department’s true cost structure.

Journal entries of Allocation of Indirect Expenses:

Assume we are allocating utilities and rent expenses to Department A and Department B based on a specific criterion.

Example Scenario:

• Utilities Expense: ₹10,000 (Allocated 60% to Department A and 40% to Department B)
• Rent Expense: ₹15,000 (Allocated 50% to Department A and 50% to Department B)

Journal Entries

Explanation:

1. Allocation of Utilities Expense:

   • Utilities Expense is initially recorded in the expense account.
   • A portion of the utilities expense is then allocated to Department A (₹6,000) and Department B (₹4,000), reflecting their respective shares of the total utility cost.

2. Allocation of Rent Expense:

   • Rent Expense is initially recorded in the expense account.
   • The rent expense is allocated equally to both departments, with each department bearing ₹7,500 of the total rent cost.