Activity Cost Driver
What Is a Cost Driver for an Activity?
An activity cost driver is a word used in accounting. The cost of various business activities is influenced by a cost driver. An activity cost driver affects labour, maintenance, or other variable costs in activity-based costing (ABC). ABC, a branch of managerial accounting that assigns an activity's indirect costs, or overheads, requires cost drivers.
What Are Activity Cost Drivers and How Do They Work?
A cost driver has a direct impact on a company's operations. An activity may be connected with many cost factors. Most operations in product manufacture, for example, are driven by direct labour hours. If labour costs are high, all of the company's products or services will be more expensive to produce. If the cost of storage is high, it will also raise the costs of making products or providing services.
IMPOTANT : The cost of an activity is increased or decreased by an activity cost driver, also known as a causative factor. A change in the cost of storage or the amount of production is an example.
Machine hours, the number of engineering change orders, the number of customer interactions, the number of product returns, the number of machine setups necessary for production, and the number of inspections are other technical cost factors. If a business owner can identify the cost drivers, the real cost of manufacturing for the company may be estimated more precisely.
TAKEAWAYS IMPORTANT
· ABC (activity-based costing) is a system of accounting that allocates both direct and indirect expenses to company activities.
· A cost driver makes allocating industrial overheads, such as factory space and power, more easier.
· Cost drivers are chosen by management depending on the linked variables of the expense incurred.
Allocation of Costs
When a production machine requires routine maintenance, the cost of the maintenance is deducted from the machine's output. The cost driver chosen, for example, is machinery hours. A $500 maintenance cost is incurred after every 1,000 machine-hours. As a result, based on the cost driver of machine-hours, every machine hour results in a 50 cent (500 / 1,000) maintenance cost given to the product being created.
Overhead Costs Distribution
The allocation of production overhead is made easier with the use of a cost driver. The proper allocation of production overhead is critical for determining a product's genuine cost. The cost of a product is used by internal management to decide the prices of the items they create. As a result, selecting proper cost drivers has a direct influence on an entity's profitability and operations.
FAST FACT ABC (activity-based costing) is a more precise method of assigning direct and indirect expenses. ABC determines the real cost of each product by calculating the resources used by a company activity, such as power or man hours.
Special Considerations: Cost Drivers' Subjectivity
Manufacturing overhead allocation is based on cost factors chosen by management. There are no industry standards that specify or require the identification of cost drivers. Cost drivers are chosen by company management depending on the determinants of production expenditures.
