Glossary
Cost allocation
Assigning shared or indirect costs, such as overhead, to the departments, products, or customers that use them.
Cost allocation spreads costs that are not directly tied to a single department, product, or customer, things like facilities, shared IT infrastructure, or a central support team, across the parts of the business that benefit from them. It requires choosing an allocation basis or driver, such as headcount, square footage, revenue share, or usage volume, and applying it consistently so each cost center carries a fair share of the shared cost.
This differs from direct costs, which need no allocation because they can already be traced to a specific unit, matching the variable costs subtracted in a contribution margin calculation. Allocated costs, by contrast, always involve a judgment call about the fairest basis to use, and different allocation bases can produce materially different reported profitability for the same underlying business. Allocation choices are typically finalized during financial close and revisited whenever zero-based budgeting challenges legacy assumptions about shared costs.
Cost allocation matters because it determines whether a product line, region, or customer segment looks profitable or unprofitable once shared costs are factored in, which directly affects pricing, investment, and cost-benefit analysis decisions. A common pitfall is using an allocation basis that no longer reflects actual usage, for example allocating shared IT costs by headcount long after usage patterns diverged from headcount across teams, which systematically over- or under-charges some units.
Last reviewed September 22, 2026