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Costs are a significant part of the operations of companies and businesses. Usually, these costs help generate revenues which help in making profits. Companies analyze and classify these costs to understand them better and report them accordingly. In this regard, the concept of cost pools is highly crucial. Before discussing this concept, it is critical to define what a cost driver is.
What is a Cost Driver?
A cost driver refers to the source of costs. It defines why a company incurs a particular cost. In other words, it shows what causes different types of costs and how they impact the total costs incurred by a company. Understanding cost drivers is crucial in helping companies understand how their costs work. Once they analyze those sources, companies work toward controlling those costs.
A cost driver can be a unit that shows how expenses occur. It also defines the base for which companies can measure a particular cost. Similarly, a cost driver is crucial in building cost pools which can further help in cost allocation. Cost drivers help companies determine the activities that contribute to specific costs. It is critical when studying the behaviour of costs within activity costing.
What is a Cost Pool?
A cost pool is a collection of various cost accounts accumulated based on similar cost drivers. It includes all expenses incurred within a specific area, department, or project. Usually, companies also divide their costs into cost pools based on whether they are direct or indirect. Cost pools allow companies to determine the costs for a specific product or project.
A cost pool is a part of the cost strategy used to analyze costs. Once companies accumulate those costs into cost pools, they can allocate them to specific products or areas. Cost pools are a crucial part of activity-based costing techniques. With cost pools, companies can estimate and allocate their costs more accurately.
How do Cost Pools work?
Cost pools relate to a company’s cost strategy. Based on that strategy, it can calculate how much overheads they have incurred during a specific time. Usually, this is the first step in creating various cost pools. Once companies calculate the amounts, they must determine which activities contribute to the overheads, also known as cost drivers. This step is crucial in dividing costs into cost pools.
Based on the cost drivers, companies can group various costs. The grouping together of these costs occurs in cost pools. Once companies calculate these amounts, they can identify and analyze those pools for different purposes. The cost pools for companies will differ based on their activities and strategies. However, these pools are essentially the same everywhere.
A company, Green Co., manufactures cameras and phones. The company pools its costs into these two categories. Furthermore, Green Co. also includes other cost pools for each product. For each of these pools, the company identifies the following cost drivers:
- Labour hours
- Machine hours
- Number of units produced
Based on these drivers, Green Co. divides its costs into these cost pools.
Identifying and analyzing costs are crucial in helping companies understand their options. Usually, companies establish cost drivers, which allow them to determine the source of these costs. Based on these drivers, companies can accumulate the costs into cost pools. This process helps companies to allocate various costs to products, departments, or projects.
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