Activity Cost Pool

What Is an Activity Cost Pool?

An activity cost pool is an aggregate of all the costs associated with performing a
particular business task, such as making a particular product. By pooling all costs
incurred in a particular task, it is simpler to get an accurate estimate of the cost of
that task. An activity cost pool includes both fixed and variable costs and is a
temporary account, used only to get an idea of how much a certain activity costs
a business.

KEY TAKEAWAYS

 An activity cost pool is an aggregate of all the costs associated with

performing a particular business task.
 A temporary account, an activity cost pool, includes fixed costs and
variable costs and allows a business to estimate the cost of a specific task
accurately.
 Activity cost pools are used in activity-based costing, an accounting
method that is commonly used in production and manufacturing.
 Activity cost pools help to accurately assign costs, which is important in
determining the profitability of products and making production decisions to
improve profit margins.
Understanding an Activity Cost Pool
Activity cost pools are used in activity-based costing (ABC), a common method
for determining production costs. This method assigns fixed and variable costs,
or overhead and indirect costs, to related products and services, allowing a
company to realize the true cost of a product, service, or task.

One example of the use of activity costs is in manufacturing. A manager may be

asked to evaluate the production costs of each product produced by a factory.
ABC defines production as consisting of a variety of activities, and it assigns
costs to those activities.

For example, machine set-up might be one activity associated with producing a
particular product, and the set-up cost would be one cost included in an activity
cost pool. Purchasing materials might be another cost assigned to the pool.
Those two costs and any others would comprise the activity cost pool.

Assigning costs accurately is important to determine the profitability of products

and subsequently to make rational production decisions, particularly to
improve efficiency and profit margins.
Activity-Based Costing vs. Traditional Costing
ABC differs from traditional costing methods. Traditional costing is product-based
and period-based. Product-based costs include materials, labor, and overhead
while period-based costs include sales, general costs, and administration (SG&A).

These are charged against revenue for each accounting period. According to
some managers, allocating these costs to the production of products can
produce distorted estimates, especially if a factory produces many different
products. However, for a company with a single product, traditional costing and
ABC would produce similar product cost estimates.

The advantage of ABC is that it ties activity costs more directly to production. It
achieves this by removing the distinction between product and period-based
costs. In addition, under ABC, products are not allocated costs of unused
capacity. The comparison between traditional costing methods and ABC provides
an opportunity for insights related to areas of waste, underutilized capacity, and
any other cost that does not directly support productivity—and making
decisions about these insights.

Under traditional costing methods, some portion of purchasing costs might be

assigned to a product regardless of how much actual purchasing activity was
required. ABC would seek to assess actual purchasing activity associated with a
particular product. In addition, unused capacity might also be assigned to a
product, potentially distorting its cost.

ABC is not used only in manufacturing businesses. It may also be applied to

service businesses.
Example of an Activity Cost Pool
Cobbler and Sons manufacture high-quality leather shoes. It is a family business
of a few employees that creates handmade shoes. The main divisions of the
company include the research and development of the shoes, the production of the
shoes' components, and the assembly of the shoes.

The costs of making the shoes include the rent for the factory, the cost of the raw
materials, the cost of machines, and the cost of labor. The total costs for the
month are $35,000.

The total cost can then be allocated to the different divisions as activity cost
pools based on what makes sense. For example, the rent for the factory wouldn't
be included in the research and development cost pool as research and
development would not be using factory space. The activity cost pool allows
Cobbler and Sons to better understand where its costs come from, which in turn
allows it to better manage its costs.