Allocation is indirect cost assignment. It is more subjective and more flexible than tracing. You can use allocation even when you do not have a direct allocation of cost to an activity or when you cannot obtain one cost effectively.

For example, you can assign a cost to the activity, Taking Inventory, based on the amount of hours employees spend on that activity and how much they are paid for that time.

With allocation, you collect costs into cost centers (most often organizational units). You then use cost drivers to pull cost from that cost center (in the form of estimated amounts or percentages) and assign them to the activities needing the services and/or resources of that cost center. The following table explains:

Drivers are often themselves activities (such as “setup” or “rework.”) However, they are usually too detailed to be an interesting part of the activity model. If you have built the activity model to the most detailed level, you can simply give drivers placeholder names. Drivers contain information about the cost to be pulled from the cost center, the cost center to pull from, and whether this cost is pulled at each occurrence of the activity or only once during a defined set of occurrences. Driver detail is determined via interviews and/or observation.

You collect this information into the Cost Driver Definition. Drivers are assembled into “cost pools,” which are little more than a list of the drivers for an activity. The following table shows the benefits and drawbacks of the allocation method.