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.
Activity Cost Pool Explained
One example of the use of activity costs is in manufacturing. A manager may be asked to evaluate production costs of each product produced by a factory. Activity-based costing (ABC) is a common method for determining those production costs. 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 the production of a particular product. The cost of set-up would be one cost included in an activity cost pool. Purchasing materials might be another cost assigned to the pool. Assigning costs accurately is important to determine the profitability of products and subsequently to make rational production decisions.
Activity-Based Costing vs. Traditional Methods
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. Allocating these costs to the production of products can produce distorted estimates, according to some managers, especially if a factory produces many different products. For a company with a single product, however, 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. 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.