allocation base

Say five housemates share one electricity bill and want to split it fairly. They could divide it equally, or by the number of nights each slept there, or by who ran the air conditioner most. Whatever yardstick they pick to spread the shared cost becomes the basis for everyone's share. In cost accounting, that yardstick — the measure used to spread a pool of indirect cost across products or jobs — is called the allocation base.

An allocation base is the activity measure used to apply overhead to cost objects. Common bases are direct labor hours, direct labor cost, machine hours, or units produced; you compute a rate as overhead divided by total base, then charge each job the rate times the base it used. If overhead is 600,000 dollars and the base is 40,000 machine hours, the rate is 15 dollars per machine hour, and a job that ran 30 machine hours absorbs 450 dollars. The base should ideally be something that actually causes overhead to rise and fall — a true cost driver — so that jobs using more of the resource bear more of its cost.

Choosing the allocation base is one of the most consequential decisions in costing, because it silently decides which products look cheap and which look expensive. For decades, factories defaulted to direct labor hours, which worked when labor was the dominant cost. But as automation grew, labor shrank and overhead ballooned, so a labor-based rate began over-costing labor-heavy products and under-costing machine-heavy ones — distorting prices and decisions. This very weakness motivated activity-based costing, which uses many bases (one per activity) instead of a single plant-wide one. The honest point: a poorly chosen base doesn't just add a little noise; it can systematically reward the wrong products.