Short definition: Cost allocation is the process of assigning indirect costs to various cost objects, such as departments, products, or projects.
Explanation: It involves distributing common costs that cannot be directly traced to a specific cost object in a fair and systematic manner. Cost allocation helps businesses understand the true cost of their products or services, make informed pricing decisions, and evaluate the profitability of different segments.
Example: A manufacturing company might allocate the cost of rent for its factory space to different product lines based on the square footage they occupy.
Additional information (optional): Cost allocation is an essential part of management accounting and can be done using various methods, such as direct labor hours, machine hours, or activity-based costing (ABC). The choice of method depends on the nature of the costs and the desired level of accuracy.