Question

While we are talking about costs, what is the meaning of the term "cost driver"? Why is it important to correctly identify the cost drivers in different situations?

Answer 1

Solution:

Cost driver is a term widely used in costing. Cost driver is used to allocated various cost over the products. A cost driver is activity that is main reason for incurring a cost. There may more than one cost driver for a single expense. Cost driver help in allocation of cost in a systematic manner to provide more accurate result of cost of product manufactured. Some example of cost drivers are labor hours, machine hours, setups, Area of warehouse etc.

Cost driver help us in allocating cost to products in a systematic manner. Therefore it is very important to identify cost drivers in different situations. For example we are paying rent for a warehouse and we store 3 types of products in the warehouse. Therefore rent of warehouse to be allocated on 3 products in a systematic manner using correctly identified cost driver. In this example, we can allocated cost to 3 products on the basis of area occupied in warehouse by respective product. Therefore cost driver in this example is area occupied by products.