Pro rata refers to a proportional allocation. In accounting, this means the allocation of revenues, expenses, assets, liabilities, or other items among participants, based on each participant’s proportional share of the whole. A participant may be an individual or an entity. The pro rata term can be applied to a number of scenarios. For example:
- Billing. A customer prepays for services not yet provided in the amount of $1,000, and then cancels service 10 days into the 30-day service period. The seller calculates the amount it has earned as 10 service days divided by the 30-day service period, or $300, and returns the remaining $700 to the customer. This is a pro rata distribution based on the passage of time.
- Business liquidation. A business is sold, and the proceeds are distributed to the common shareholders based on the number of shares held by each one. This is a pro rata distribution based on share holdings.
- Cost accounting. A company uses a standard costing system to account for its inventory, and has an unfavorable variance of $100,000 that it must allocate between the cost of goods sold and ending inventory. There is $200,000 of ending inventory, and there were $800,000 of cost of goods sold during the period. Accordingly, the company allocates $20,000 of the unfavorable variance to ending inventory (calculated as $200,000 ending inventory ÷ $1,000,000 allocation base, multiplied by the $100,000 variance) and $80,000 to the cost of goods sold (calculated as $800,000 cost of goods sold ÷ $1,000,000 allocation base, multiplied by the $100,000 variance). This is a pro rata distribution based on recorded cost.
- Expense allocation. A company incurred $1,200 of interest expense over an entire year, and wants to allocate it to individual months. One method of doing so is to evenly allocate it by month, so that each month is charged $100. This is a pro rata distribution based on the number of months.
- Partnership liability. Under a partnership agreement, each partner is liable to pay for any claims against the partnership, up to his or her partnership share. There is a legal settlement for $1,000,000. Partner Smith has a 20% interest in the partnership, and so is liable for $200,000 of the legal settlement. This is a pro rata payment based on ownership interest.