Activity Cost Pools: Definition & Examples

Activity Cost Pools: Definition & Examples
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  • 0:02 Activity Cost Pools Defined
  • 1:36 Example 1
  • 3:08 Example 2
  • 5:13 Lesson Summary
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Lesson Transcript
Instructor: Sarah Bilant

Sarah has taught QuickBooks classes, has a Bachelor of Science degree in Accounting, and is a licensed CPA.

Activity cost pools are used in activity-based costing systems to allocate manufacturing overhead to specific products. Learn what activity cost pools are and how to use them in this lesson.

Activity Cost Pools Defined

Manufacturing companies use product costing techniques to determine how much it costs to manufacture each product it produces. One such technique is activity-based costing. Activity-based costing systems allocate manufacturing overhead by assigning indirect costs to activity cost pools, then dividing each cost pool by a cost driver to obtain the rates used for allocation. Manufacturing overhead costs are the expenses incurred in the manufacture of a product that cannot be directly allocated to that product. These costs are also known as indirect costs. Activity cost pools are groups of individual costs influenced by the same cost drivers , which are activities that control the amount of costs incurred.

Activity-based costing allows for more accurate product costing than other types of costing method because it requires the calculation of multiple rates to allocate manufacturing overhead to products. Activity cost pools are an important part of activity-based costing as they enable companies to group similar overhead costs together and divide by a common cost driver. This enables the companies to have multiple criteria for allocating overhead instead of just one like in traditional costing systems. For example, instead of allocating overhead based on machine hours alone, the use of activity cost pools would allow a company to allocate overhead based on machine hours, direct labor hours, number of inspections, and other criteria as their specific processes required.

Now let's look at a couple of examples.

Example 1

OJW Company manufactures two types of widgets: Widget A and Widget B. The company has asked you to evaluate its process expenses to determine its activity cost pools. You have been given the following information:

Expenses:

  • Payroll taxes
  • Fringe benefits
  • Electricity
  • Factory rent
  • Equipment maintenance
  • Factory maintenance

The first step to creating activity cost pools is to determine what drives each individual cost; that is, what factor influences how much is spent in that expense category. For example, the amount spent on electricity depends on how many hours a machine is running. Therefore, the cost driver for electricity would be machine hours. Here are the drivers for each of the expenses:

  • Payroll taxes - Direct Labor Hours
  • Fringe benefits - Direct Labor Hours
  • Electricity - Machine Hours
  • Factory rent - Square Feet
  • Equipment maintenance - Machine Hours
  • Factory maintenance - Square Feet

Once the cost drivers are determined, the expenses influenced by the same cost drivers are grouped into activity cost pools.

Direct Labor Hours:

  • Payroll taxes
  • Fringe benefits

Machine Hours:

  • Electricity
  • Equipment maintenance

Number of Square Feet:

  • Factory rent
  • Factory maintenance

Upon completion of your project, you'll be able to tell OJW Company that they will need three activity cost pools for the following cost drivers: direct labor hours, machine hours, and number of square feet.

Example 2

Two years later, OJW Company has added a third widget to its production - Widget C. The manufacturing process is now more complex and the company has asked you to reevaluate its process expenses to determine its activity cost pools. You have been given the following information:

Expenses:

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