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Cost Pool: A One Stop Shop to All Questions

What is Cost Pool?

A cost pool is pooling or clubbing together of expenses from various service lines basis certain cost drivers. These pools are further allocated to products or services depending upon the underlying usage of the relevant cost drivers.

The guiding principle behind the cost pool is to attribute indirect costs to certain cost drivers. This, in turn, helps allocate all overhead costs to the final product or service using a segregation mechanism.

The jargon may sound intimidating. However, ABC costing is the crispest and accurate method for cost allocation. Consider the below over-simplified example to explain the concept for further clarity.

Consider a business manufacturing two products- Tables & Chairs

There are broadly three types of expenses incurred:

Amount in $ Cost Driver
Power & Fuel 1500 Kilo Watts Consumed
Labor 600 No of Hours
Rent 600 Area Occupied
Total 2700

These costs are then clubbed to form a cost pool of the final product. The cost pool is determined basis cost drivers. Cost drivers are nothing but units of activity. These units have a direct impact on the cost under question. For example, labor cost is directly affected by the labor hours worked (unit of activity).

These costs will be absorbed into final cost of production depending upon the volume of cost drivers utilized respectively.

Cost Pool

Advantages of Using Cost Pool

Single Overhead Recovery Rate

Every cost pool enlists the overhead amount to be absorbed basis the level of activity. Also, it is a level above the traditional costing system where overheads are absorbed at an overall factory level. A pool enables viewing the overhead rate for every department and service line individually. This, in turn, enables computation of the overhead rate for every product manufactured. Thus, a cost pool makes possible to view overhead recovery rates from multiple angles of the department as well as production.

Identifying Profit Centers 

Cost pool enables a view of overhead absorption at the department as well as the product level. It, therefore, becomes a matter of simple comparison against corresponding revenue to ascertain the extent of profitability generated by every individual product manufactured. Since a cost pool causes the overheads to be dissected to the hair, it provides the most accurate picture of product profitability.

Cost Efficiency & Budgetary Control

 The management can have a view of the expenditure incurred at every cut. A department that may seem to be working efficiently may be weighing heaviest as a cost component in the final product. Alternatively, a product being produced at the budgeted costs may still have scope for cost reduction owing to departmental inefficiencies waiting to be smoothed out.

Pricing Decisions

Having a pre-determined cost pool and computed recovery rates at hand enables management to maintain flexibility when it comes to pricing decisions. A breakup of the overall cost of production to the T makes known to the management exactly how much room it has, to maneuver when it comes to setting prices. Having such a detailed cost breakup makes businesses more confident in responding to market forces and tackling competition.  

Establishes Cause & Effect Relationship 

As discussed, a cost pool is an accumulation of all departmental and indirect costs as going into the making of the final product. This one on one mapping of the intermediary to the finished stage of production draws a clear thread as to what goes into the manufacture of the output. This information is useful in determining the service lines on which the output is most heavily dependent on and vice versa. It also brings out the extent of consumption thus drawing the attention of management to most emergent areas when required.1

Cost Pool Explained with Illustration

Consider a plant manufacturing 3 products- X, Y & Z.
Given, total overhead costs for the period amount to $750,000 and total machine run time is 2500 hours divided equally among all three products.
On analysis, the overheads could be broken down as below mentioned:

Costs relating to set-ups 40%
Costs relating to materials handling 10%
Costs relating to machinery 30%
Costs relating to inspection 20%
Total production overhead 100%

Activities for the Period:

Number of Set-Ups No of Material Movement No of Inspections
Product X 75 12 150
Product Y 115 21 180
Product Z 480 87 670
670 120 1000

Now, to allocate all costs to a product a pool, the cost driver rates must be computed. The working is as below:

Set Up Cost Machine Cost Material Handling Cost Inspection Expense Total
40% 30% 20% 10% 100%
Overhead Allocated ($) 300,000 225,000                                    150,000                         75,000        750,000
Cost Driver Number of Set Ups Machine Hours No of Material Movements Count of Inspections
Rate per Driver  447.76 90 1250 75
(300,00/670) (225,00/2500) (150,000/120) (75,000/1000)

Therefore, the computed cost pool for each product is as follows:

Product X Total Cost Pool (Activity X Rate per Driver)
Set Up Cost.                33,582 (75 X 447.76)
Machine Cost.                75,000 (833 X 90)
Material Handling Cost.                15,000 (12 X 1250)
Inspection Expense.                11,250 (150 X 75)
Total Cost Pool              134,832
Similarly, for Y & Z
Y Z
Set Up Cost                51,405               214,925
Machine Cost                75,000                 75,000
Material Handling Cost                26,250               108,750
Inspection Expense                13,500                 50,250
Total Cost Pool              166,155               448,925

 

1.
Activity Cost Pool. aziroff.com. [Source]
Last updated on : May 22nd, 2020
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