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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 incurred—in 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

g... Say it takes four hours to test a simple program and ten hours to test a complex program. For example. Improving enterprise performances: Because many companies still use traditional management accounting and cost calculation methods using non causal cost drivers. inaccurate and flawed cost information. SIGNIFICANCE OF COST DRIVERS The most important advantages of applying contemporary cost driver concepts are the following: 1. 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. In general. the time required to test a product may vary based on the product under test and the number of units to be tested. The cost of testing two simple programs (i. 2. when retooling machines. and all other costs are the same with respect to testing the two types of programs. the testing time will vary based on the complexity of the products (e. 1 program * 10 hours/program = 10 hours). It could also be a combination of these two driver types. a complex software program takes longer to test the a simple software program). a charge-type cost driver is used very rarely. The most common drivers are volume and time.e. all costs associated with the retooling of machines for a product is charged directly to the end-product).does not matter how many products are produced (e.. as with the ABC method.e. But based on new contemporary approaches to cost drivers and using advanced management accounting and cost calculation methods. the cost driver is the length of time required to complete the retooling of machines).g. The costs of testing increase as more products are tested. · Charge: The cost for the entire activity is charged directly to the cost object (e.. reliable information is obtained that can be the basis for Intermediate and long-term decisions. As well. The driver used depends on the nature of the activity. they produce unrealistic..g. 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 . 2 programs * 4 hours/program = 8 hours) is less the cost of testing one complex program (i.

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

the costs will be more apparent.individual products. Though marketing strategy may continue to call for having an elaborate product line. 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 company’s level of profitability and its success in future periods. In conclusion we can say that a cost driver is the key element around which revolves cost behavior. .