Cost pool - What is a cost pool?
A cost pool is used in certain costing strategies to determine how much individual departments or services cost the company within a specific period of time.
Want to know more about cost pools and how they work in a costing strategy? Check out our article on activity-based costing.
Cost pools are the amount of money spent on an ‘activity’, for instance, customer service or manufacturing. Cost pools are used in activity-based costing to accurately determine where the money is spent rather than splitting the overhead costs equally over all departments.
Why are cost pools used?
Cost pools are mainly used in the manufacturing sector as it is easier to allocate costs to certain products and services.
Compared to standard costing methods, such as the cost of goods sold, using a cost pool method allows you to allocate costs at a highly-refined level to see where exactly your money is being spent, and further identify how much is spent to create and sell each product.
Using these methods will help you clearly understand how much is being spent on each activity. You can then make changes accordingly.
For instance, instead of allocating costs based only on machine hours, the use of cost pools would allow you to allocate costs based on machine hours, labour, customer service, inspections, and order processing.
How to create cost pools
To create cost pools for your costing strategy, you will first need to find out how much overhead the business had during the time frame you are measuring.
Then, you will identify the activities that were associated with the amount of overhead, and group them into cost pools. These cost pools will identify how the money was spent. You will identify the cost pools (activities) and how you will measure them.
For instance, one cost pool could be order processing which is measured by the number of orders during the time period. Another could be manufacturing which is measured by the number of units produced.
Cost pools in activity-based costing
Cost pools are used in the activity based costing method to allocate costs.
Once you have determined your cost pools and how they are measured, you allocate the overhead to the cost pools. You do this by interviewing employees about how much time is spent on each activity and estimate the amount of overhead that cost pool used.
Once you allocate the amount of overhead used for each cost pool, you can calculate the ‘activity rate’, which is calculated by dividing the cost associated with the cost pool by the measurement.
For instance, if you allocated £10,000 to the manufacturing cost pool, and 5,000 units were produced in that period, the activity rate would be:
£10,000 ÷ 5,000 = £2 per unit
Finally, once you have the activity rate of each cost pool, you can calculate how much is spent on each product you sell. For instance, if it costs £2 per unit to manufacture a certain product if you sold 8,000 units in the time period, you spent £16,000 on that product.