Question

what are cost drivers? What is their role in an activity-based costing system? What are important factors in selecting cost drivers for an ABC system? b

Answer 1

Traditionally, costs were allocated on the basis of absorption costing method. However, there have been significant trends since the past few years. Many new Scientists have come up with different new ideology for estimation & costing techniques. The economy is shifting towards more modern approach of costing such as Just-in-time method, Lean Accounting, Total Quality Management, Theory of constraints, Activity based costing, etc.,

One such technique that has got significant views is the activity based costing.

Under activity based costing costs are allocated on the basis of cost drivers. Cost driver is an accounting term that influences costs of indirect costs, labor, maintenance & other variable costs. In simple terms, cost drivers are the activities that influences & controls cost pool or allocation of cost.

Under ABC system, costs are allocated on the basis of cost drivers rather than absorption or standard costing. The costs are allocated on the basis of cost drivers that are directly solely responsible for a particular production. Under ABC it is said that 80% of costs are driven by 205 of cost drivers. Therefore it is important to identify the cost drivers and allocate costs on the basis of drivers. Cost drivers help to identify correct cost of a product by allocating only that cost which has been incurred by the cost driver.

The important factors to be considered while selecting cost drivers for an ABC System are:-

1. Number of set-ups
2. Number of machine hours
3. No. of orders completed
4. No. of processing orders
5. Nature of Processing or manufacturing
6. Proper identification of cost drivers
7. Batch level activities.

It is pertinent to note that ABC is useful for only those enterprises where there are more than one products or activity. In case of single product or activity ABC will not work.