How Activity Cost Pool Works

A company uses the activity cost pool primarily to determine the costs of production. It provides both fixed or indirect costs associated with a specific service or product so that a company will ascertain the financial costs of a service, product, or activity. This process of establishing the financial costs, service, or activity is common in industries. A company may ask the industry manager to calculate the financial costs of producing a specific product.

When calculating the financial costs of producing a product, setting up a machine must be added if you plan to use the machine to manufacture that product. You must include the costs of buying the materials for manufacturing that product. In other words, the cost of production materials, the cost of setting up the machine, and other related costs will make up the activity cost pool. By calculating all the financial costs involved in producing a product or carrying out an activity, ascertaining the true cost of a business task becomes easier.

It also allows you to know if a particular product or business task is profitable to make good production decisions that will be effective and profitable at the same time. With an activity cost pool, companies or business owners can determine the spending total for producing a specific product, service or for carrying out a business task. It also allows organizations or companies to know how much producing a specific product, service, or carrying out an activity will cost. It enables them to plan and be aware of the financial costs that they will incur.

Example of Activity Cost Pool

A company that deals in producing clothing and fashion items named Saraphy Inc. has three main departments. The first department is responsible for the research and designing of the fashion items—the second deals with the production of the necessary components. Assembling or finishing of the clothing or fashion pieces goes to the last department.

When calculating the cost of production, you must add the rent for the factory, cost of the machine, cost of purchasing raw materials, and cost of paying the workers. If you add all these, let's say the total cost of production is $40,000. However, the activity cost pool allows the company or business owner to know where costs come from, which will, in turn, will enable the company or business owner to make good decisions that will manage costs effectively.

In this case, you won't add the cost of rent of the factory to the financial costs incurred by the research department. That is because research can be done anywhere and doesn't need the factory for a successful result.

Significance of Activity Cost Pool

Experts commonly use an activity cost pool in all the major manufacturing industries in the world. It helps them divide financial costs according to important needs in creating specific products, services, or business activities. If the financial costs of manufacturing different products are determined, the company or business owner will know how to allocate costs to produce each product or service. It allows companies or business owners to calculate financial costs that are not directly related to the production process.

Companies or business owners can determine the indirect costs of each department in production incurring with the activity cost pool. It helps companies or business owners quickly divide financial costs among all departments. When the costs of producing a product or service are determined, it allows companies and business owners to budget properly.

Besides equipping companies and business owners with the needed information to create a budget, it also allows them to plan for unplanned financial costs or expenses. With the activity cost pool, companies and business owners can manage their financial resources properly. Reducing the waste of financial resources will allow them to know where to allocate money.