Pooling of Costs – Basic Understanding

Pooling of costs is an accounting trick used to facilitate better matching of costs against the respective revenue stream or predicted cost for the respective product or function. In layman’s terms, it means that costs are grouped together for one value and then divided by an objective (sometimes subjective) value to help management understand what it costs to get something done.

Pooling of costs is also known as aggregating costs. This aggregating concept is well-developed in cost accounting and used with manufacturing analysis. For example, many consumer products go through two basic steps, production and packaging. Pooling of costs is done with both steps. Labor is separated for the two steps and included in both aggregated groups. Other costs include materials, supplies, facility utilization, equipment usage and so forth. The goal is to understand how much it cost per unit in each step.

For small business, the pooling of costs is beneficial with understanding functional areas of operations. For example, some companies have many vehicles they use to service their clients/customers. Owners/Management want to know how much it costs to run the vehicles on a per mile basis. To successfully find out, any expense related to a vehicle is assigned to a particular ledger account and at the end of an accounting cycle (usually yearly) the total value is divided by the total number of miles driven on those vehicles and the result is cost per mile.

Common groupings or pooling of costs exist for:

There are many others, but in general the idea is to gather all the costs related to that respective function and then use the aggregated value as the numerator against some pertinent criterion. The following is an illustration:

Pooling of CostsBrown’s Pool and Spas is a small business company that retails pool and spa supplies as well as selling the actual spas. In addition, Brown’s installs pools and does backyard modifications. The owner wants to know what it costs in the form of marketing and advertising including the associated costs of discounts/coupons and other campaigns to generate a dollar of revenue. To do this, the accountant combines the following expenses and revenue adjustments into a single pool to obtain a single aggregated value for an entire year:

 

 

In the revenue adjustments section the accountant uses the following:

    • Discounts
    • Campaign Coupons

In a separate marketing account in the expenses section, the accountant accumulates costs such as:

  1. Website Costs
  2. Newspaper and Magazine Advertising
  3. Direct Mailers
  4. Door Hangers/Hand Delivered Fliers
  5. Display Booths/Trinkets
  6. Signage
  7. Information packages
  8. Product Guides
  9. Postage
  10. Printing and Design
  11. Business Cards
  12. Inserts
  13. Labor Time Assigned From Payroll
  14. Labor Burden Tied to Labor Time

All of the above costs are accumulated into one value. This value is the numerator and the denominator are total sales. The result is the cost of marketing/advertising per dollar of sales.

There are several drawbacks to the pooling of costs concept. The number one drawback is misapplication of the concept. I’ve seen this multiple times whereby management makes a decision to charge a customer based on a poor formula. In effect, the owner failed to include all the costs related to the particular item and thus used a lower value of cost to charge his customer. This ended up costing the company money.

A second drawback and the most common is its use with break-even analysis and the relation to the business financial profit. Here, the user creates the pool of costs and applies this value as either the cost of the product sold or as a sub-component of the item sold. Therefore the price to the buyer is based on this cost analysis. The fallacy is that the pricing model assumes all the products are sold. All pricing models need to take into consideration more than just the actual cost per unit sold. The final price should take into consideration other factors: 1) economy of scale, 2) unsold product, 3) waste, 4) overhead and 5) profit desired. The final formula is much more complicated than the simple cost of the product and some mark-up value.

In conclusion, pooling of costs is an excellent management tool to assist owners/managers in understanding functional or production costs against a known value. It is used with both financial and cost accounting. With proper application, it can be quite beneficial with understanding and improving the bottom line. ACT ON KNOWLEDGE.

Value Investing

Do you want to learn how to get returns like this?

Then learn about Value Investing. Value investing in the simplest of terms means to buy low and sell high. Value investing is defined as a systematic process of buying high quality stock at an undervalued market price quantified by intrinsic value and justified via financial analysis; then selling the stock in a timely manner upon market price recovery.

There are four key principles used with value investing. Each is required. They are:

  1. Risk Reduction – Buy only high quality stocks;
  2. Intrinsic Value – The underlying assets and operations are of good quality and performance;
  3. Financial Analysis – Use core financial information, business ratios and key performance indicators to create a high level of confidence that recovery is just a matter of time;
  4. Patience – Allow time to work for the investor.

If you are interested in learning more, go to the Membership Program page under Value Investing section in the header above. 

Join the value investing club and learn about value investing and how you can easily acquire similar results with your investment fund. Upon joining, you’ll receive the book Value Investing with Business Ratios, a reference guide used with all the decision models you build. Each member goes through three distinct phases:

  1. Education – Introduction to value investing along with terminology used are explained. Key principles of value investing are covered via a series of lessons and tutorials.
  2. Development – Members are taught how pools of investments are developed by first learning about financial metrics and how to read financial statements. The member then uses existing models to grasp the core understanding of developing buy/sell triggers for high quality stocks.
  3. Sophistication – Most members reach this phase of understanding after about six months. Many members create their own pools of investments and share with others their knowledge. Members are introduced to more sophisticated types of investments and how to use them to reduce risk and improve, via leverage, overall returns for their value investment pools.

Each week, you receive an e-mail with a full update on the pools. Follow along as the Investment Fund grows. Start investing with confidence from what you learn. Create your own fund and over time, accumulate wealth. Joining entitles you to the following:

  • Lessons about value investing and the principles involved;
  • Free webinars from the author following up the lessons;
  • Charts, graphs, tutorials, templates and resources to use when you create your own pool;
  • Access to existing pools and their respective data models along with buy/sell triggers;
  • Follow along with the investment fund and its weekly updates;
  • White papers addressing financial principles and proper interpretation methods; AND
  • Some simple good advice.

Value Investment Club

Please Signup
*
Username
Username can not be left blank.
Please enter valid data.
This username is already registered, please choose another one.
This username is invalid. Please enter a valid username.
*
First Name
First Name can not be left blank.
Please enter valid data.
This first name is invalid. Please enter a valid first name.
*
Last Name
Last Name can not be left blank.
Please enter valid data.
This last name is invalid. Please enter a valid last name.
Website (URL)
Website (URL) can not be left blank.
Invalid URL
Invalid URL
*
Email Address
Email Address can not be left blank.
Please enter valid email address.
Please enter valid email address.
This email is already registered, please choose another one.
*
Password
Password can not be left blank.
Please enter valid data.
Please enter at least 6 characters.
    Strength: Very Weak
    Select Your Payment Gateway
    How you want to pay?
    Payment Summary

    Your currently selected plan : , Plan Amount :
    , Final Payable Amount:
    Submit