Question

1. The term “cost” is simply puzzling to people who do not have a background
in accounting.
Explain the following
(a) Cost Driver
(b) Cost Function
(c) Cost Object

Answer 1

1. Cost Driver – Cost driver can be defined as a factor that can cause a change in the cost of an activity. An activity can have more than one cost driver. Cost Driver triggers a change in the cost an activity. This concept is most commonly used to determine the cause of an overhead, which can be used to minimize the overhead costs.

Examples of Cost Drivers

• Direct Labor Hours
• Number of customer contract
• Number of Machine Hours
• Number of product returns
• Number of change orders issued on engineering front.

In accounting cost driver is a factor that incurs cost, based on the activity of the cost driver, the cost driver rate is identified at which indirect costs are allocated to production activities.

2. Cost Function – It’s a mathematical formula used to predict the cost associated with a certain action or certain level of output. It is used to forecast cost and expenses associated in production, to determine the pricing strategies to achieve desired profit. Management uses it to run different production scenarios and help predict what the total cost would be to produce a product at different levels of output. The cost function is expressed as C(x) = Fixed Cost + V(x)

Where is C(x) is total cost of production and V(x) is the variable cost of the production.

3. Cost Object – A cost object is the product or a department for which the cost is accumulated and measured. For example, a product is the cost object for direct material, Direct Labor and Manufacturing Overhead. The factory maintenance department is the cost object for cost of employees in maintenance department and maintenance related supplies. A cost object can also be a batch of product, a customer, a machine or group of it or a group of employees etc.