What is the best way to allocate expenses in a decentralized organization?

In my experience, it is important to start with the cost centre structure so you can conveniently establish all the decentralized cost cebtre for cost allocation. Here the accounting set up becomes key at this stage.

An easy way to distribute corporate overhead expenses is the use of a corporate allocation. To do this, set up a corporate division where expenses that impact all other departments are tracked. These expenses should be for property and casualty insurance, office leases, accounting, etc. Each month allocate your corporate division expenses to zero them out and proportionately expense to the other revenue generating divisions.

That's a valid approach! Identifying the cost driver and using an actual method of allocation can provide more accurate results in certain cases. While the direct allocation method may be easier, it may not always capture the true cost drivers and could lead to misallocation of costs. By following an actual method of allocation based on cost drivers, you can ensure that costs are allocated more accurately and reflect the underlying factors that drive those costs.

Direct allocation will succeed if the seperate units are registered as seperate legal entity and a seperate contract between the legal entity and the overhead expense supplier is held. It's also easier for the corporate entity to recharge with a mark up all unit related costs. ( adds in complexity in consolidation to erase intercompany profits)

Lay a foundation by identifying relevant Profit Center and Cost Center structures. Anticipate, plan, agree methodology upfront, remove discretion, automate execution and follow through with a review mechanism.

My preferred method is to identify the drivers of overheads and this is what ABC (activity based costing) does. Undertake a quasi ABC exercise when preparing budgets. At budget time enter into a “12 month contract “ with each division for their share of fixed costs using budget $$$ and this is what gets charged each month. If Actual expenses vary significantly from budget then perhaps consider a variation and/ or do a year end variation a little like a commercial lease. Alternatively determine % share in budget process considering various drivers of costs and keep % for the 12 months and vary only for significant changes.

This is my most preferable method of allocating costs in a decentralized organisation.ABC provides a more accurate reflection of costs by tracing expenses directly to the activities that drive them. It eliminates arbitrary and inaccurate allocation methods, providing a more precise understanding of costs incurred by different activities or products. ABC enables better decision-making by revealing the true cost drivers within the organization. This allows for more informed choices when it comes to pricing, product mix, process improvements, and resource allocation.

A “one size fits all” solution is not always the correct approach with the dynamics in organisations , and so a hybrid method for allocating expenses in a decentralised organisation is often the way to go. Some expenses will be direct, some step approach, and some definitely activity based. The increased availability of data ( in today’s life) and sophisticated allocation tools makes it possible to ensure the most appropriate approach is followed.

Agreed Willem. With the evolution of data and integrated Performance Management applications your Allocations framework no longer needs to be driven by a single approach or forced into shape by limitations of software One size fits all is definitely not the way to go. An organisation wide allocations framework and posting hub should incorporate all methodologies required that best suit each area of the business. Also consider your ultimate objective. Is it Regulatory reporting/Ledger posting purposes or required for Management reporting/analytics/forecasting? These two routes would also determine how your allocations are built with slight variances between the two, however both approaches should still be accommodated in single framework

In practical application, organizations often discover that a blend of expense allocation methods proves most effective. For instance, one might opt for direct allocation when dealing with readily identifiable expenses, while embracing activity-based allocation for costs associated with specific operational activities. The paramount principle is to maintain flexibility and adaptability in the approach to expense allocation, remaining responsive to shifts in the organization's requisites and circumstances. This adaptability encompasses considerations of purpose and scope, data quality and availability, unit complexity and diversity, interdepartmental interplay, the influence on behavioral dynamics, resource implications and …

In most cases, the organization will be forced to use a hybrid cost allocation method. Using direct allocation together with some other method. My colleagues and I had experience in developing a system for allocating costs between two types of services that were provided simultaneously within the same technological process, but in addition to common ones had different direct costs. As a result, we came to a hybrid of direct distribution and distribution proportional to the volume of services provided. This problem was solved for the purposes of pricing and management accounting; for accounting purposes, such distribution was not required.

In most cases, the organization will be forced to use a hybrid cost allocation method. Using direct allocation together with some other method. My colleagues and I had experience in developing a system for allocating costs between two types of services that were provided simultaneously within the same technological process, but in addition to common ones had different direct costs. As a result, we came to a hybrid of direct distribution and distribution proportional to the volume of services provided. This problem was solved for the purposes of pricing and management accounting; for accounting purposes, such distribution was not required.

Allocating costs in a decentralized organization can be made easy by employing functional areas, which is the approach used in my current workplace. A range of functional areas such as Sales, Finance, Operations, Marketing, Technical, Customer Service, Engineering, and more are used to allocate all costs related to each area. With this approach, tracking costs becomes an effortless task, and it also enhances efficiency, yields savings, and enables better budgeting.