Cost Driver

A cost driver is the source of a cost that has an impact on the overall cost. The most common application of the principle is to allocate overhead costs to the number of units produced. The cost drivers define the cost behavior inside the activities, indicating the connections and interconnections that they have with other activities. Cost-driven plans of action limit cost at every opportunity, frequently through a low-value incentive, most extreme computerization, and broad re-appropriating. Though, esteem-driven organizations center around a superior incentive regularly with a serious level of customized administration.

The cost driver is the variable or factor that has an effect on the overall cost and produces the relationship. This is the root of the problem, and the cost incurred is the result. The Activity Based Costing (ABC) method connects indirect costs to the actions that cause them. Activity Based Costing depends on the conviction that exercises cause costs and consequently a connection ought to be set up among exercises and item. The expense drivers hence are the connection between the exercises and the expense of the item. Examples of cost drivers are as follows:

  • Direct labor hours worked
  • Number of customer contacts
  • Number of engineering change orders issued
  • Number of machine-hours used
  • Number of product returns from customers

Cost is a fundamental predictor of whether there will be continuity or discontinuity in a commercial operation. The cost driver’s analysis entails identifying all potential cost drivers for a specific sort of activity, cost, or other event, and explaining their cause-and-effect relationship with the event. On the off chance that the expense of creation surpasses the income got from a deal, there is an incredible likelihood of the business shutting down. On the off chance that the expenses are not as much as income, there is benefit and a likelihood of extension.

Example of Cost Driver

In general, the volume of output/activity may be the cost driver for short-term indirect variable costs; however, the cost drivers for long-term indirect variable costs will not be related to the amount of output/activity. It’s important to remember that correlation is simply a method of demonstrating a link. Assuming the costs equivalent income, the business is at a state of apathy and it tends to be shut or kept relying upon different factors separated from cost or how expenses can be changed.

If a company’s primary interest is adhering to the bare minimum of accounting rules for allocating overhead to manufactured goods, only one cost driver should be used. You need feasible costing methods to get the correct cost or a figure that is close enough to the actual cost for you to undertake accurate cost/revenue analysis in order to make sensible business decisions. Inability to do so can prompt the end of an undertaking, because of helpless expense calculation, that may really be productive, or possibly conceivably beneficial. In customary costing the expense driver to designate roundabout expense to cost objects was volume of yield.

It was discovered that the volume of output was not the main cost driver as business structures, technology, and thus cost structures changed. The total cost of manufacturing is used to determine the selling price of a product. Consequently, if the expenses are off base, the benefit gauges won’t be precise, and the entire bookkeeping arrangement of the specific association will be dependent upon blunders. In cost accounting, there are many different types of cost drivers. Manufacturing and indirect costs are allocated at a predetermined rate based on the activity done in traditional accounting.

  • Numbers of Set-Ups
  • Number of Machine Hours
  • Number of Processed Orders
  • Number of Orders Completed
  • Number of Labor Hours
  • Number of Deliveries
  • Number of Calls Taken
  • Number of Rides

These are the solitary kinds, however there might be numerous different sorts of cost drivers dependent on the sort of action being performed and the premise of division of that action as far as cost to be designated to different offices. Because the expenses of an activity can be assigned to a specific production lot, activity-based costing is a precise method of assigning both direct and indirect costs. It is a technique for processing costs related with every item or line of creation in an organization dependent on the quantity of assets devoured by every movement.

The number of resources consumed by an activity is measured by the resource cost driver. It’s used to assign a resource’s cost to an activity or cost pool. It is critical in business to determine the cost of a product in order to determine whether the company can generate the requisite profits from the manufacture of those products. Therefore, cost drivers are generally significant in the ABC costing framework. The expense of every movement is allotted to explicit items or lines of creation, in light of assets devoured by cost drivers.

A cost driver is a factor that influences or determines the activity’s cost. It is the underlying reason for a certain cost. In the event that the expense would be higher than the income created from the item deal, at that point it would be in the advantage for the business, though if the expenses are higher than the income created, than the business would need to reevaluate the choice to go for the creation. Customers, products, and manufacturing channels consume resources, while activities use resources. Understanding this is crucial to grasping the concept of cost allocation utilizing cost drivers.

Presently in characterizing the item cost, these expense drivers assume a fundamental part. It builds up the premise on which cost is to be dispensed, which will eventually bring about the all out cost of an item. Cost drivers can also be used to analyze each customer’s profitability, and in circumstances of resource restrictions, the less profitable order can be canceled. The most profitable activities should receive the most resources, or resources should be allocated according to profitability.

Cost Driver is an important source for allocating product costs based on the actions undertaken to generate that product, which ultimately aids in determining the product’s final cost. The cost per hour is another factor that influences total cost. If the cost per hour is high, the cost of the output will be high as well. The complete expense of the item assists the administration with breaking down the choice to create the item and furthermore to decide the selling cost of the item which the clients will acknowledge and be prepared to pay.

Whatever determines a certain activity’s overall cost should be thoroughly examined to verify that the appropriate allocation base is used. A cause-and-effect relationship exists between cost drivers, and if this relationship cannot be proven, a more relevant driver should be sought. It enables that allocation, and it is only then that the true cost of the created product can be calculated. The management would then make the final choice on whether or not to enter the market and whether or not to produce the product.

Information Sources:

  1. wallstreetmojo.com
  2. corporatefinanceinstitute.com
  3. accountingtools.com
  4. wikipedia