Activity Cost Driver

What Is an Activity Cost Driver?

An activity cost driver is an accounting term. A cost driver influences the cost of specific business activities. In activity-based costing (ABC), an activity cost driver impacts the costs of labor, maintenance, or other variable costs. Cost drivers are essential in ABC, a branch of managerial accounting that designates the indirect costs, or overheads, of an activity.

How Activity Cost Drivers Work

A cost driver directly impacts a business activity. There might be various cost drivers associated with an activity. For instance, direct labor hours are a driver of most activities in product manufacturing. On the off chance that the cost of labor is high, this will increase the cost of delivering all company products or services. Assuming that the cost of warehousing is high, this will likewise increase the expenses incurred for product manufacturing or offering types of assistance.

An activity cost driver, otherwise called a causal factor, makes the cost of an activity increase or decline. A model is a change in the cost of warehousing or a change in the level of production.

More technical cost drivers are machine hours, the number of engineering change orders, the number of customer contacts, the number of product returns, the machine arrangements required for production, or the number of assessments. In the event that a business owner can distinguish the cost drivers, the business owner can all the more accurately estimate the true cost of production for the business.

Cost Allocation

At the point when a factory machine requires periodic maintenance, the cost of the maintenance is allocated to the products created by the machine. For instance, the cost driver chose is machinery hours. After each 1,000 machine-hours, there is a maintenance expense of $500. In this way, every machine hour brings about a 50 penny (500/1,000) maintenance cost allocated to the product being manufactured based on the cost driver of machine-hours.

Distribution of Overhead Costs

A cost driver improves on the allocation of manufacturing overhead. The right allocation of manufacturing overhead is important to determine the true cost of a product. Internal management utilizes the cost of a product to determine the prices of the products they produce. Consequently, the selection of accurate cost drivers straightforwardly affects the profitability and operations of an entity.

Fast Fact

Activity-based costing (ABC) is a more accurate approach to dispensing both direct and indirect costs. ABC works out the true cost of every product by recognizing the amount of resources consumed by a business activity, like power or worker hours.

Special Considerations: The Subjectivity of Cost Drivers

Management chooses cost drivers as the basis for manufacturing overhead allocation. There are no industry standards specifying or commanding cost driver selection. Company management chooses cost drivers based on the variables of the expenses incurred during production.

Highlights

• Management chooses cost drivers based on the associated variables of the expense incurred.
• A cost driver improves on the allocation of manufacturing overheads, for example, the costs of factory space and power.
• Activity-based costing (ABC) is an accounting method that distributes both direct and indirect costs to business activities.