A- Define the term "cost driver" and discuss the factors that are important in the

selection of appropriate cost drivers.

B- In discussing the operation of her automobile, Dr. Lawson once observed that
gasoline is a fixed cost because the cost per gallon is relatively stable. Insurance, on
the other hand, is a variable cost because the cost per mile varies inversely with the
number of miles driven. Comment on the Dr. Lawson’s observation.

C- Layman, Inc., has just completed job nos. 78 and 79, which were similar in terms
of complexity, production processes, and units manufactured. Job no. 78 was
manufactured by Joe Bingham who earns $14 per hour, whereas job no. 79 was
completed by Susan Fortner who earns $20 per hour. If Joe and Susan are equally
efficient, would the company be better off using direct labor cost or direct labor
hours as the cost driver in its predetermined oerhead rate? Briefly explain

Expert Answer

(a) cost driver means factor which causes a change at cost level. ( strategic purpose)
For accounting purpose cost driver is the cause factor which changes the nature of
cost to be allocated.
Important factor for selecting of cost driver:-
Two criteria for selection
Optional but very important:-
(1) easy identification, use and understanding
(2) existence of a direct relationship between indirect cost and cost driver
(3) positive or negative influence on staff.
Particularly important:-
(1) degree of complexity, diversity and variation of product
(2) degree of accuracy of calculation. Rational number of cost drivers should be
selected not less not more.
(3)degree of usefulness of information.
(b) dr. Lawson`s observation is incorrect. Gasoline is a variable cost and insurance
is a fixed cost. Gasoline cost will increase with the number of miles driven but
insurance cost will remain same.if he does not drive no cost of gasoline but insurance
cost will remain same.
Per unit cost behaviour is the base of variable cost which applies on gasoline but not
on insurance cost.
(c) both jobs are same in production processes , in complexity and units
manufactured and both mr. Joe bingham and mr. Susan fortner are equally efficient
i.e. Both will take same hour in production of number of units.if company will pay
hourly basis it has to pay more to mr. Susan hence it is better to pay direct labour
cost i.e. Same amount on equal units. Cost driver in its predetermined overhead rate
suggest that direct labour hours is more expensive than direct labour cost.