Cost Pool Definition
A Cost Pool is a kind of cost strategy to identify the cost incurred by the business entity’s individual departments or service sectors. It helps determine the total expenses incurred in manufacturing goods and in allocating the same to the different departments or service sectors based on some reasonable identifier known as a cost driver.
Cost Pool can also be used in activity-based costingActivity-based CostingActivity based costing (also known as ABC costing) refers to the allocation of cost (charges and expenses) to different heads or activities or divisions according to their actual use or on account of some basis for allocation i.e. (cost driver rate which is calculated by total cost divided by total no. of activities) to arrive at a profit. to estimate the cost incurred in performing certain tasks in a business. Doing so assists in the allocation of the expenses to the various departments accurately according to the cost driversCost DriversA cost driver is a unit that derives the expenses and sets a basis on which a particular cost is to be allocated between the different departments and on the basis of that driver’s activity completed in that particular period the cost is allocated. These are the structural determinants of the activities on which cost is being incurred and determine the behavior of the costs on an activity.. Cost drivers are the allocation criterion used to allocate the costs between different departments and sectors, such as the number of units produced, the number of electricity units consumed, the number of labor hours consumed, etc.
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How to Create Cost Pools?
To create a cost pool for the costing strategy, first, the businesses need to identify the amount of overheadOverheadOverhead cost are those cost that is not related directly on the production activity and are therefore considered as indirect costs that have to be paid even if there is no production. Examples include rent payable, utilities payable, insurance payable, salaries payable to office staff, office supplies, etc. incurred during a specific time. The business’s next step is to identify the activities related to the amount of overhead that has been incurred and then group these activities into the pool. It will help them in ascertaining how the business spent the money. The business management will then be able to identify it and learn how to measure those cost pools.
Example of Cost Pool
Mynx is a manufacturing plant that has several departments producing different products. For example, one of the above departments produces sunglasses and applies activity-based costing to allocate overheads. The sunglasses department comprises three main pools, namely designing, molding, and assembly. The total amount of overheads incurred by the departments is $50,000.
By the application of cost pool analysis, the cost manager identifies the following cost drivers:
- Number of hours of maintenance
- Machine hours
- Labour hours
- Number of units produced
- Factory square foot area utilized.
The cost manager can analyze these three different pools based on the cost drivers, and the total cost of $50,000 can be divided between the three pools.
Hence, this method of assigning costs is more precise and reliable than estimating expenses or splitting the total cost equally. Moreover, some cost drivers like machine hours do not apply to all pools.
Uses of Cost Pool
- Used by the manufacturing sector as it helps them allocate costs according to the requirement in manufacturing products and services.
- It helps in allocating costs at a highly-refined level.
- It is used to know how the money was spent and helps make an accurate estimate of how much it will cost to create and sell a product.
- Calculating Overhead Rates: Enables a business to determine each department’s overhead costs, which help in ascertaining the overhead rate of every product manufactured.
- Efficient Use of Wealth: With the help of a cost pool, the best way of allocating wealth can be known, which maximizes maximizing the wealthMaximizing The WealthWealth maximization means the maximization of the shareholder’s wealth as a result of an increase in share price thereby increasing the market capitalization of the company. The share price increase is a direct function of how competitive the company is, its positioning, growth strategy, and how it generates profits. of a business.
- Budgetary Control: It is also useful to properly estimate the budget for the business to manufacture a product in a specific time.
- Excludes Some Manufacturing Cost: While using this method, some manufacturing costs get excluded from the product costsProduct CostsProduct cost refers to all those costs which are incurred by the company in order to create the product of the company or deliver the services to the customers and the same is shown in the financial statement of the company for the period in which they become the part of the cost of the goods that are sold by the company., such as the cost to heat the factory may not be included in the cost pool.
- Time Consuming Method: It is more time-consuming than the ordinary methods as the data collection and identifying the cost drivers takes much time.