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Homogeneous Cost Pool

A way of logically grouping together related costs

What is a Homogeneous Cost Pool?

A homogeneous cost pool is essentially an accounting term used by the management of a company to group together costs that show a similar cause and effect or benefits received relationship in terms of the allocation base of costs. In short, homogeneous cost pools are a way of logically grouping together related costs. The more similar the cost pools are, the more easily they can be attributed to a specific cost.

 

Homogeneous Cost Pool

 

An activity cost pool is one of the most common forms of homogeneous cost pools. It involves the grouping together of all costs that are associated with a given task within a company, such as the making of a specific product. Pooling together all the costs associated with all activities required to complete a given task makes it easier to obtain a solid estimate of how much the task will actually cost the company.

 

Breaking Down Homogeneous Cost Pool

The allocation base of cost determines how cost is assigned to a cost pool. For example, the costs associated with maintaining machinery would likely be assigned based on hours of operation. The longer the machinery runs, the higher the estimated maintenance cost that is assigned to the cost pool.

The cause and effect relationship focuses on the reasons why resources need to be used or consumed, and on identifying what specifically drives the cost of one activity or another. For example, say that the number of hours being spent on quality control is a cost allocation base. A manufacturer producing a good that is intricately designed and requires a lot of parts all working together perfectly – such as a high-technology product – would need to spend a substantial amount of time ensuring that the quality of each product was up to standards. For this reason, quality control, then, is a significant cost driver in the manufacturing process.

The benefits part of cost pools is related to the departments in a company that benefits from the allocation base. For example, consider advertising expenses. A company’s advertising produces benefits for the entire company, not just for a single department. For such reason, it seems appropriate that a company would distribute such expenses evenly across all departments.

 

The Good and the Bad of a Homogeneous Cost Pool

The larger the number of cost drivers within a company, the bigger the number of homogeneous cost pools there will likely be. Identifying such cost pools can genuinely help a company better estimate and account for costs, ultimately helping improve its bottom line.

The primary difficulty with costs pools, especially when there are a lot of them, is that they can require a significant amount of effort and time to establish what should be included within them and then to maintain tracking them in the long-term.

Therefore, in most cases, it’s advantageous for a company to limit the number of its cost pools as much as possible. However, doing so may mean that each cost pool may become less homogeneous, or the costs within it may not be as similar. While it can make establishing accurate cost estimates more difficult, in the end, it can save companies a good deal of time and money when it comes to establishing and maintaining the cost pools themselves.

For smaller, activity-based costing projects, there is less of an issue with costing pools. There is a smaller number of costs to be considered, and therefore the pool’s accuracy level can be more easily monitored and estimated.

Homogeneous cost pools, while they come with some inherent difficulties, can make a huge difference for companies in accurately determining and managing costs. Using cost pools can help companies more effectively anticipate and plan for expenditures.

 

Additional Resources

CFI is the official provider of the global Financial Modeling & Valuation Analyst certification program, designed to help anyone become a world-class financial analyst. For more information, check out the following resources:

  • Cost of Goods Manufactured (COGM)
  • Cost of Goods Sold (COGS)
  • Marginal Cost Formula
  • Variable Costing

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