Allocation rate is the standard amount of overhead applied to a unit of production or other measure of activity. This is done when shifting costs to a cost object, which may be required under one of the accounting frameworks to ensure that a full cost is applied to inventory. An allocation rate can also be used as part of an internal accounting effort, to ensure that overhead costs are applied throughout a business.
As an example of an overhead rate, a business has a factory overhead cost pool of $100,000, and routinely produces 20,000 widgets per month. In this case, the allocation rate is $5 per widget, which is calculated as follows:
$100,000 Cost pool / 20,000 Units of production = $5 Allocation rate
As another example, a parent company allocates its corporate overhead to its subsidiaries based on their revenues. Total corporate overhead is $1 million, and the sum total of all revenue generated by all subsidiaries is $100 million. Given these activity levels, the allocation rate should be $.01 million per million of revenue. Thus, if a subsidiary generates $20 million of revenue, the allocation rate mandates that $200,000 be applied to that subsidiary.