Content
Cost drivers are defined as a unit of activity that causes a business to endure costs. For example, machine hours are an activity that cause costs such as machine maintenance and electricity costs. Cost drivers are often used as an allocation base to allocate overhead among products. Essentially, each normalized cost incurred from the start of production to the finished product falls in the cost driver category. This varies somewhat, based on the business model, but many manufacturing companies have similar cost drivers, such as buying raw materials and assembling the products. These costs are almost always recurring and necessary to operate the production side of the business. A cost driver is a unit of activity that has a strong, positive correlation with the cost for that activity.
What is cost pool and cost drivers?
Your cost drivers are all the activities that you do that cost you money to make your product. Your cost pools are your cost drivers divided into groups of related costs.
We estimate there will be 20 product designs , 500 orders , 20,000 direct labor hours , and 25 customers . Next, we find the application rates for each activity by dividing the estimated cost for the activity by the volume of cost driver activity for each activity.
Types of Drivers in Cost Accounting
Only those costs should be assigned to a product that includes a particular activity in its production. As mentioned above in the application of cost drivers, it is evident to know the cost of the product before entering the market to pre-identify whether the company can make profits out of the products they propose to sell.
What is the meaning of cost driver?
Cost drivers are the direct cause of a business expense. A cost driver is any activity that triggers a cost of something else. An example of this could be how the amount of water your office uses in a month determines the price of your water bill. The units of water are the cost drivers, and the water bill is the cost.
Use cost drivers to allocate variable and indirect costs to production activities or output. Include both indirect costs and direct costs to compute the full cost of production. Because indirect cost driver meaning costs, such as variable overhead, are not directly traceable to production activities, allocate them according to a cost driver rate to apply these costs to production activities.
What is a Cost Driver?
Investigation follows and involves finding out if there is any relationship between the cost and activity. Next, we look at the correlation between the cost and the activity. If there is a strong positive correlation between the cost and the activity, we then analyze measures for the activity which are our cost drivers. Finally, during the wrap-up step, a company determines if the measure it chose to manage the cost driver is working.
- It makes that allocation possible, and only then the real cost of the product being manufactured will be determined.
- Cost outlier means services provided during a single visit that have an extraordinarily high cost as established in paragraph “g” and are therefore eligible for additional payments above and beyond the base APC payment.
- For example, an electricity bill is based on the amount of electricity units consumed in the particular period.
- It provides a competitive edge to the business as they give a precise distribution of cost based on activities performed.
- It helps management see a business’s various departments as one single business unit as these drivers create a relationship between the departments.
Finally, the system uses pointers and implicit pointers to identify the quantitative measures on which drivers are based. Best single measure of the quantity of resources consumed by an activity. An example of a resource cost driver is the percentage of total square feet occupied by an activity.
Cost Account
Each machine is capable of producing a specific number of units in a given time period. To grow that number, additional machinery must enter the cost driver equation.
Production is impossible without the raw materials and this is an activity that will always factor into the overhead structure. Fixed costs like the yearly rent of a factory can’t have a cost driver simply because the factory rent would not increase with an increase in production, especially in the short run like a year or 2. But, if we consider a long term of 10 years, we may find some co-relation with production. In the long run, we can assume the quantity of production as a cost driver for factory rent. Fixed costs remain fixed until a range of activity, and then they shoot up to a different level. For example, this business may increase the area of the factory to 1.5 times, and rent increases from $100,000 to $150,000.
