Internal cost allocation explained simply – methods, examples and benefits

What is internal cost allocation? 

In short: internal cost allocation (innerbetriebliche Leistungsverrechnung, ILV) makes sure that the different departments of a company are charged fairly when they support each other. Whether it is IT support, cleaning or internal training - all of it causes costs that have to be booked somewhere. To stop that ending in chaos, there are various calculation methods.

‍

Which methods are there? 

Depending on how precise and how involved you want it to be, there are various ways of carrying out internal cost allocation: 

The direct allocation method (Anbauverfahren) - simple, but imprecise

The direct allocation method is the simplest form of internal cost allocation. Here internal services are only charged in one direction, with no charging back. That means no mutual dependencies between departments are taken into account. 

Example: In a commercial cleaning business, the building maintenance department is given the job of cleaning office buildings. This department only charges the cleaning work to administration, but the fact that cleaning also uses the technical maintenance area, for the upkeep of heating systems for instance, is not taken into account. In other words, the maintenance department gets nothing charged back for the support it receives from cleaning. The distribution of costs is therefore not entirely accurate. 

‍

The step-down method (Stufenleiterverfahren) - one step more accurate 

With the step-down method, departments are charged one after another. Services that one department provides to several others are included in the calculation. However, later departments cannot charge services back to earlier ones. 

Example: Imagine the scheduling department in a trades business working together with the procurement department. Scheduling orders material for job sites on a regular basis, and procurement delivers it to the job site. The scheduling department is charged for ordering the material, and the procurement services then feed into the calculation. However: if procurement comes back to scheduling and stock has to be ordered, for example, that service is not captured. 

‍

The iterative method - more precision 

The iterative method goes one step further: here mutual charging between departments is taken into account by repeating the process over several rounds until a stable distribution of costs is reached. 

Example: A mid-sized trades business manages several job sites and needs material regularly. The job site department orders the material from materials management, and the warehouse department helps redistribute the material between the job sites. In the iterative method, it is now calculated step by step how much each department (e.g. materials management and the warehouse) actually took on from the other. This process repeats until the distribution of costs between the departments produces a fair and stable result. 

‍

The simultaneous equation method (Gleichungsverfahren) - as accurate as it gets, but complex 

The simultaneous equation method is the most precise but also the most complicated method. Here systems of mathematical equations are used to charge all internal services at the same time. 

Example: In a facility management company several departments work together: the technical department maintains the heating systems, the accounting department has to clean regularly, and administration has more work because of the documentation of maintenance and repairs. The simultaneous equation method uses complex mathematical models to calculate how much each department contributes to the services of the others. This takes into account, for example, how much each department assigns to its services and how often cleaning is supported by the technical department during a repair to the heating system, and the other way round. In the end each department receives its precisely calculated share of the costs.

‍

Methods of internal cost allocation - advantages and disadvantages 

How does time tracking help with internal cost allocation? 

Internal cost allocation is a complex subject in which what matters is recording the right numbers and sharing services out fairly between departments. But how can this system be made genuinely precise and efficient, without constant errors or delays? 

The problem for many companies: without exact and continuous time tracking it is barely possible to guarantee correct cost allocation. In large businesses in particular, or companies with many different departments supporting each other, confusion sets in quickly. Who worked exactly how many hours? Who provided which internal services? And - most importantly - how are those services shared out between the different departments in the end? 

Sources of error in manual recording: 

In many companies time tracking is still done manually or through outdated systems. That often leads to errors: an employee forgets to record their working hours correctly, or enters them late. These inaccuracies feed straight through to internal cost allocation. Because how are you supposed to charge a service fairly if the time a department spent on it was not recorded correctly? 

Complexity from multiple departments 

The more departments are involved in a project or a service, the more complicated cost allocation becomes. With methods such as the iterative or the simultaneous equation method in particular, where mutual services have to be captured and taken into account precisely, manual processes quickly reach their limits. The same sources of error appear here too: estimates, imprecise records and forgotten services.

Precise cost allocation stands or falls on one question: who did what, when, and for whom? Without complete time tracking, many services stay in the dark – especially when they are documented manually or with gaps.

The answer: digital time tracking via app 

With clockin it works like this:

The technical department starts work in the app, picks the relevant project or internal service – for instance “heating maintenance, administration” – and clockin automatically documents who worked on what and for how long.

No recalculating, no chasing people – the service is recorded and ready to be charged.

clockin's project time tracking is the key here:

clockin shows you not only when work was done, but what it was for – and who for.

That is the basis for any fair cost allocation between departments.

Here is how it works:

• Every step of the work can be recorded separately with the clockin app, whether it is maintaining the heating system or providing materials on the job site. You can see straight away how many hours were spent for which department. 
• By categorising into subprojects, individual activities can also be assigned to customer projects. That makes for smooth internal cost allocation and for correct invoices to the customer as well. 
• clockin lets you assign the recorded hours precisely to the respective projects and departments. Even complex cost allocations (as in the iterative or simultaneous equation method) can be carried out easily, because all the relevant data is already there. The project team does not have to wrestle with the question of how many hours were “estimated” for a project – everything is recorded cleanly and traceably.
• No manual effort, no late entries. All hours are recorded in real time, which minimises sources of error and simplifies accounting. With project time tracking in particular, where every hour is booked to a specific project or job, clockin helps you keep the overview and make sure no hour goes missing.
• With clockin, every department has access to its recorded hours and their distribution across projects at any time. That builds trust and makes for a fair distribution of costs. With internal cost allocation between departments too (e.g. procurement for a job site or technical maintenance work), the recorded hours can be carried into the charging simply and transparently. There is no uncertainty left about how much a department actually spent on a project or for another department.

Why clockin helps with cost allocation in particular: 

Bringing clockin into your business makes internal cost allocation not only faster and more efficient, but considerably more accurate. Thanks to the detailed recording of working hours, and project time tracking in particular, you can make sure that each department only pays for what it actually received. Exactly how much time each department invested in each project is documented, and that forms the basis for fair cost allocation. All without additional sources of error or laborious recalculation. That saves you not only time but also the costs that inaccurate charging would create. 

Recording project hours precisely also makes the link to internal accounting processes more transparent and the charging of the work provided more realistic. clockin gives you complete, digital recording of all working hours, which then feeds straight into cost allocation – project by project, without you having to enter or estimate a single hour by hand.

‍

‍