I manage several different subsidiaries that share resources-What is the best way to do cost allocation

This can be a fairly complicated process, but my first question would be why do you allocate costs? Is it for performance management purposes, transfer pricing purposes or something else?

The next question which you describe briefly is to identify the different "resource pull drivers". This could be revenue, costs, FTEs etc. As we are allocating for transfer pricing purposes we have split our overhead into shareholder cost, asset owner cost and asset operator cost. When we redefined our allocation matrix a few years ago we interviewed each of the departments to learn what they spent their time on and which resource allocation driver they should be allocated by. We then allocated into each of these groups based on the interviews and from there on we allocated asset owner cost and asset operator cost to our subsidiaries using the resource pull drivers. Since our operating managers are not measured on a result below overhead costs they did not take part in this study.

Obviously it is a different discussion if the various subs are measured on a result below overhead. Then you would probably want to consider both sides to ensure that the subs do not lose motivation from the use of an allocation key they do not understand.

No matter what purposes you are doing this for though I would recommend keeping it as simple as possible.

It is for performance management and cost allocation. We trade a labor pool between entities and share in resources, insurance, marketing and the like. My issue is one division does not want to support the labor uses of the other so by direct costing the labor I was trying to keep the labor costs pure and then allocate the other costs based on percent or total revenue. What other options do I have to looks at. I thank you for your help.

Now of course I do not know all the details, but I can only assume that this specific entity has a valid claim when they do not want the labor costs.

Even if that is the case it does not affect the way that you should allocate your costs. If you have 5 entities with 10 revenue each and one should not have allocated labor cost then for the labor cost you just allocate based on the remaining 40 in total revenue.

I understand it can be cumbersome to allocate when not every entity is included in the allocation. However I suggest you have a discussion with each of the departments that you allocate costs for and understand what is the most reasonable allocation key to use. For marketing revenue would probably be most obvious whereas for finance costs could be an alternative depending on which side is most transaction heavy (revenue or cost). For a department like HR total FTE in the entities would probably be a good allocation key. When this investigation is completed your basis for allocating cost is more solid. Then you would also want to test with each department which entities they carry out services for and if it is not directly then discuss which entities are indirectly benefited.

As I said in my first post you should keep it as simple as possible wherefore I do not think that applying direct costing on labor only is a viable long-term solution as it carries a significant transaction cost.

Instead of basing the allocation on revenue, you could allocate based on % of costs to the total. In this way, each labor pool would have some control over the allocation if they were to be more efficient than their peers. Also, they wouldn't be penalized for having strong revenues.

We allocate our corporate expenses as a percentage to our stores. We use a few metrics to determine what percentage should be allocated based on how much of the resources would be used to assist those stores. It has worked well for us.

There is no "right" way per se, there is the right way for you. Several of the other people have given you some ideas.

The only wrong way would be allocating more than 100% and not correcting that error by year end close.

Although it will take some extra effort to get the data, the best way to allocate cost is through the use or need of the resource/cost.

Example, you can't just allocate HR cost based on percentage if say a department is on a hiring spree and took HR's time to service the particular department. NOT all costs can be allocated this way but I generally agree with Wayne that what is important is what works for you. Even management time can't be allocated based on percentage. What if the President took extra effort and time to focus on a particular department?

A continuing review of cost allocation should also be a policy and more importantly, it will NOT be a "standard" and may change from time to time.

"Fair" allocation is too subjective and as I have said in another thread, "Someone's fair is another's unfair".

Allocation of total indirect cost is a standard requirement in my industry in order to be awarded Govt contracts and there are some very standard practices followed to ensure indirect costs are allocated on logical causal/beneficial basis to all contracts.

This starts with clearly segregating direct vs, indirect costs, where direct costs are defined as those which are clearly incurred for one and only one final cost objective such as a single customer contract which must be tracked by project to accumulate these direct cost. Once all direct costs are properly charged, what remains are the indirect costs to be allocated and they must be accumulated in indirect cost pools.

The three most common indirect cost pools are Fringe, Overhead and G&A pools. Fringe pool includes the statutory cost of employer-paid payroll taxes (FICA, FUTA and SUI) and workers compensation insurance, plus health and life insurances and any employer contributions to retirement plans as well as paid leave (PTO/holiday). These costs are logically allocated as a % of total labor costs, to direct and indirect.

Overhead cost includes the cost of management and support of the direct contract work such as their labor, allocated fringe, and cost of their facilities such as office rent, utilities, phone/internet service, maintenance and repairs and office supplies. These costs are logically allocated as a percentage of direct labor by contract use so that each contract is allocated a proportionate share of the total costs incurred.

G&A costs are considered company-wide meaning the benefit the whole company and are also called "residual costs", meaning they cannot be allocated on a more precise base like those above. These costs include the labor and allocated fringe and facilities costs of the CEO, CFO, Accounting, HR, Bus Dev & Contract Mgmt. G&A costs are allocated as a % of total non-G&A costs such as the direct costs plus their share of Fringe and OH, so they are spread like peanut butter onto all.

"I am looking for accuracy and the ability to just charge out overhead that is not a direct cost to the sub."
Wayne Spivak has pretty much summed it up. Allocation of any cost that's prorated, distributed by some allocation(s) by other than the originator, is simply a do-it-done. Much of the time, little regard is given to accountability and who's responsible for what - just do it.
You can spend hours crunching numbers, period and year end adjustments while doing this detail work, but in the final analysis, it's a tradeoff between scale of economy and how much is it worth at the end of the day.
Unfortunately, accountability is never really understood or agreed upon by all parties and therefore it's usually the finance executives that get the short end of things and the blame for any and all confusion(s).
Best of all worlds - agree upon a method that works to save time and expenses crunching numbers. Realize the purpose of being in business is business to make money.