Cost drivers also refer to factors or events that have some type of direct or indirect impact on the cost

related to a specific activity. Activity-based costing approach considers all the relevant factors or events associated with the activity and determine their cumulative effect. A production activity may have the following cost drivers a machine, machine operator(s), floor space occupied, power consumed, and the quantity of waste and/or rejected output. Cost driver is any activity that causes a change in costs over a given period of time. These activities are also called activity bases or activity drivers. Cost driver is a cost accounting term. A business engages in many different activities. The cost driver for an activity is the factor that influences the amount of the resources that will be consumed by a particular activity. A cost driver is designed to allocate the activity cost pool (or related costs) to the cost objects. 1. The activity is the work that is done. 2. The resource is what the activity uses to do the work, i.e., people, equipment, services. Resources cost money. 3. The cost of the activity depends on the quantity of resources used to accomplish the activity. 4) The cost object is whatever it is you wish to cost. It could be a product, service, process, job or customer. Example: One part of the Ace Trucking's business operation involves making deliveries by truck. The activity is delivering goods. The costs of this activity include the truck drivers wages, fuel, depreciation of the truck, insurance, etc. The quantity of the resources that will be consumed by this activity are influenced by the number of deliveries made per year. Hence the cost driver could be the number of deliveries. A cost driver is the reason why the cost is incurredin other words, the cost is incurred in producing the driver. For each of the activity cost pools, a cost driver must be determined. There are basically three types of cost drivers: Volume: The cost driver is based on units of work (e.g., number of orders.) The cost of the activity increases as more units are processed.

Time: The cost driver is based on the length of time taken to complete the activity. The cost of the activity increases based on the length of time required to complete the activity. It

does not matter how many products are produced (e.g., when retooling machines, the cost driver is the length of time required to complete the retooling of machines).

Charge: The cost for the entire activity is charged directly to the cost object (e.g., all costs associated with the retooling of machines for a product is charged directly to the end-product).

In general, a charge-type cost driver is used very rarely. The most common drivers are volume and time. The driver used depends on the nature of the activity. The cost of the activity may increase based on the number of units handled or based on the length of time required to complete the activity. It could also be a combination of these two driver types. For example, the time required to test a product may vary based on the product under test and the number of units to be tested. The costs of testing increase as more products are tested. As well, the testing time will vary based on the complexity of the products (e.g., a complex software program takes longer to test the a simple software program). Say it takes four hours to test a simple program and ten hours to test a complex program, and all other costs are the same with respect to testing the two types of programs. The cost of testing two simple programs (i.e., 2 programs * 4 hours/program = 8 hours) is less the cost of testing one complex program (i.e., 1 program * 10 hours/program = 10 hours).

SIGNIFICANCE OF COST DRIVERS The most important advantages of applying contemporary cost driver concepts are the following: 1. Improving enterprise performances: Because many companies still use traditional management accounting and cost calculation methods using non causal cost drivers, they produce unrealistic, inaccurate and flawed cost information. But based on new contemporary approaches to cost drivers and using advanced management accounting and cost calculation methods, as with the ABC method, reliable information is obtained that can be the basis for Intermediate and long-term decisions. 2. Improving employee and manager awareness: Each employee or manager of a company can become aware of the benefits that the knowledge of the causes of costs has on obtaining

improved performance. Managing enterprise performance based on cost drivers can contribute to individual wage gains, such as bonuses, premiums, etc. 3. Periodically reviewing costs: Understanding cost drivers and their effect on cost behavior can help in the analysis of production costs in the short term as well as the long-term. Many resource expenses, typically considered as period costs or fixed costs in the short-term, may be examined to determine if some of the resources (and their capacity level) are adjustable up or down in as the planning horizon extends, thus resulting in classifying them as variable costs rather fixed costs. Thus all costs are subjected to a better control. 4. Controlling costs with better calculations: To have better control of costs we must control the causes, namely cost drivers. If one can reduce the quantity, frequency, or intensity of a cost driver, then its activity cost will be lowered. Using traditional cost calculation methods causalbased cost drivers are hidden. Consequently, with the desire to reduce indirect costs, managers and employees may be mislead to reduce a non-causal cost driver (e.g., number of labor input hours) and have no impact on reducing the indirect costs. Using however causalbased cost drivers, the accountant will provide visibility to the work activities and their cost drivers that consume activity costs and in turn resource expenses. 5. Eliminating costs: Identification of cost drivers of non-value-adding activities (e.g., the number of inspections) facilitates the elimination of the activity cost if its purpose can be eliminated by removing the root cause. The indirect costs allocation method on products using cost drivers contributes to this effect. 6. Actual costs to individual products: Compared with traditional cost allocation methods (i.e., non-causal), the most important advantage offered by cost drivers is far more accurately calculating total and per-unit costs of products, channels, and customers. Accurate determination of total and per-unit costs is invaluable when evaluating selling prices and profit margin layers to strategically rationalize types of products, channels, and customers to sell to. 7. Reexamining long-term costs: American management and accounting practice often are criticized for focusing on the short run. The cost-driver approach, with its focus on cost causes and behavior, leads one to examine not only short-term variable production costs but also longterm costs that were considered committed or fixed. Indeed, many costs often considered fixed often do vary, however gradually, over the long term and are therefore subject to better control. 8. Highlighting cost of complexity: Maintaining an elaborate product line is costly, particularly when it results in short and numerous production runs. Usually these costs are not separated and thus are hidden. In the search for cost drivers, they will be disclosed and associated with

individual products. Though marketing strategy may continue to call for having an elaborate product line, the costs will be more apparent.

In conclusion we can say that a cost driver is the key element around which revolves cost behavior. This then ensures the viability and accuracy of information obtained for aiding a company to make better long-term strategic decisions and intermediate-term operational decisions. Both types of decisions will improve the companys level of profitability and its success in future periods.