Question

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DQ 17 What is an activity cost driver?

Answer 1

Meaning:

Activity Cost Driver influence the cost of labour, maintenance, or other variable costs and it is also known as a Casual Factors, causes the cost of an activity to increase or decrease. For Example cost of labour, cost of warehousing or change in level of production.

This Term is being used in Activity Based Costing (ABC Analysis). Cost Drivers are essential in ABC that allocate the indirect costs, or overheads of an activity.

A cost Driver simplifies the allocation of manufacturing overheads, such as the costs of factory space and electricity. Management selects the cost drivers based on the associated variables of the expenses incurred.

Impact on profitability:

A cost driver simplifies the allocation of manufacturing overheads. The correct allocation of manufacturing overheads is important to determine the true cost of production. Internal Management uses the cost of a product to determine the prices of the products they produce. For this reason, the selection of accurate cost drivers has a direct impact on the profitability and operations of an entity.

Example:

Let's Say a Factory machine requires periodic maintenance, the cost of the maintenance is allocated to the products produced by the machine.

Now the cost driver selected is machine hour ( number of hours required to produce a product by a machine). After 100 machine hours, there is a maintenance expense of Rs,10000 required. Therefore, every machine hour results in Rs.100 (10000/100) maintenance cost allocated to the product being manufactured based on cost drivers of machine hour.