Pool rate definition
/What is a Pool Rate?
A pool rate is the application rate used to assign the overhead costs in a cost pool to cost objects. It is calculated by dividing the aggregate cost total in a cost pool by the cost driver assigned to that pool. If you are storing overhead costs in a number of cost pools, then there will be a separate pool rate for each one.
Advantages of a Pool Rate
The primary advantages of using a pool rate are as follows:
Simplifies cost allocation. By consolidating similar overhead costs into a single pool, the pool rate reduces the complexity of allocating costs to products or services. This streamlines the accounting process.
Increases accuracy. Pool rates based on appropriate cost drivers (such as machine hours, labor hours, or units produced) improve the accuracy of overhead cost allocation, ensuring that cost objects absorb costs in proportion to their resource usage.
Facilitates better decision-making. With more accurate cost information, managers can make more informed pricing, budgeting, and production decisions. Understanding true product costs helps in setting competitive prices and identifying cost-saving opportunities.
Supports activity-based costing. Pool rates align well with the activity-based costing system, which uses multiple cost pools and drivers to allocate overhead more precisely. This approach reduces distortions in product costing compared to traditional single-rate methods.
Enhances cost control. By identifying specific cost drivers for each pool, businesses can better understand which activities drive costs and take targeted actions to control or reduce them.
Reduces fluctuations in cost allocation. Using a pool rate smooths out temporary fluctuations in individual cost items, providing a more stable basis for allocating overhead across periods.
By focusing on these benefits, businesses can achieve more precise cost management and enhance their overall financial performance.
Example of a Pool Rate Calculation
A factory overhead cost pool contains a total of $100,000 of factory overhead costs. These costs are assigned to units produced based on the amount of machine time consumed by each unit. The factory has 10,000 hours of practical machine hour capacity available, so the pool rate is calculated as follows:
$100,000 Factory overhead cost pool ÷ 10,000 Hours of machine hour capacity
= $10 Pool rate per hour of machine time used