Methods of Cost Allocation – What are the different methods to allocate cost?

Methods of Cost Allocation

Although there is no judicial precedent available to determine what would be the best method of apportionment of common or indirect expense but the method of allocation should be considered wisely considering the nature/work undertaken by the enterprise.

Following cost allocation methods have been developed over the period of time[1], namely:

1. Turnover Basis
2. Head Count Basis
3. Space Basis
4. Plant Capacity utilization
5. Any other reasonable basis

Turnover Basis: Under this method the common cost of the entity is apportioned on the basis of turnover. Wherein the total turnover of the various related entities is combined and the cost is allocated on a proportionate basis. Even Kerala High Court in CIT v. Parry Agro Industries Ltd. (2002) 177 CTR (Ker) 257 held that the indirect cost attributable to the export of trading goods has to be worked out in a proportionate manner, i.e. in the ration of the export turnover in respect of the trading goods to the total turnover.

Head Count Basis: Under this method the common cost of the entity is apportioned on the basis of the number of employees collectively working in the all the organizations. Even Delhi High Court in the case of CIT v. Ehpt India P. Ltd. ITA 1172/2008 & ITA 1194/2008 held that no prescribed method to allocation cost and contrary to Ld. AO’s . The High Court held that method adopted by assessee (Head Count) was right and the same can’t be set aside to apply turnover method.

Space Basis: Under this method the common cost of the entity is apportioned on the basis of total space/total seats/total area etc. Even ITAT Delhi, In DCIT, Circle-18(1) and Ors. v. Xansa India Ltd. and Ors. MANU/ID/0082/2016 held that –

“When the expenses are related to the number of employees it is located on the basis of headcount and in other cases such as space cost it is located on the basis of seats.”

“In view of the above facts and circumstances, we do not see any infirmity in the revised working of allocation of direct cost of business support services as well as allocation of indirect business support cost based on headcount and space cost on the basis of number of desk.”

Plant Capacity Utilization Basis: Under this method the common cost of the entity is apportioned on the basis of quantum at which the Plant Capacity is utilized. The proportion of the all the plant is taken collectively to determine the ratio for allocating cost.

[1] An article on ISD and Cross Charge Mechanism under GST Regime by White Paper, RSM.