What is a Cost Pool?

A cost pool is a grouping of individual costs, typically by department or service center. Cost allocations are then made from the cost pool to cost objects. Examples of cost objects are products, product lines, departments, and sales regions. For example, the cost of the maintenance department is accumulated in a cost pool and then allocated to those departments using its services.

How Are Cost Pools Used?

Cost pools are commonly used for the allocation of factory overhead to units of production, as required by several accounting frameworks. They are also used in activity-based costing to allocate costs to activities. A business that wants to allocate costs at a highly-refined level may choose to do so using a number of cost pools. The outcome of a detailed cost allocation from one or more cost pools will be a better understanding of where overhead costs are used within a business. This information can be used to decide where to reduce overhead costs, whether to adjust product prices, and where profits are really being generated within a business.

Cost Pool Best Practices

There are several best practices associated with the use of cost pools, which are as follows:

Reduce cost pools. It can be expensive to account for a large number of cost pools, so consider the incremental benefit of adding more cost pools. In many cases, it is more cost-effective to reduce the number of cost pools to a level that still generates actionable information.
Strip out direct costs. Some direct costs may be inadvertently added to a cost pool. This is usually done in error, or because a transaction was mistakenly recorded within an overhead cost account. A periodic audit can identify these costs, so that you can charge them directly to a cost object, rather than indirectly through a cost pool.

Example of a Cost Pool

A business incurs six types of overhead costs within its production operations, which are transferred into a cost pool. The total cost stored in the cost pool at the end of November is $30,000. It has been determined that the most accurate allocation of these costs is by machine hours used within the product facility for the month of November. These machines were operated for a total of 3,000 hours during November, so the allocation from the cost pool is $10 per hour of machine time. Therefore, this charge is applied to every product processed by the machines, based on the time spent at the machines.