Question

Cost driver is an important concept related to cost allocation. How is cost driver defined? Please provide some examples.

Answer 1

Sol:

Cost driver- A cost driver is the unit of an activity that causes the change in activity's cost.

cost driver is any factor which causes a change in the cost of an activity.

Cost drivers are the structural determinants of the cost of an activity, reflecting any linkages or interrelationships that affect it. Therefore we could assume that the cost drivers determine the cost behavior within the activities, reflecting the links that these have with other activities and relationships that affect them.

Examples of Cost Driver

Some common costs drivers that affect businesses:

• Direct labor: this is exactly what the name indicates - the employees needed to work for a business
• Setting up equipment: Many businesses need machines in order to conduct business, often required to manufacture a product
• Special instructions: Sometimes customers have specific demands about products. When this happens, a company incurs costs.
• Handling and storage: if a company needs to store its products, it may have to pay for that storage. If a company has to pay employees or companies to handle products, like getting them ready to ship, there are also costs.
• Components: A company may be incurring costs based on the components in the products it produces. Obviously, the more components in a product, the higher the costs. From our example earlier, stereos have a lot of components, which means they cost more money to produce than, say, a rubber ball.
• Machine hours: Like mentioned earlier, machines are often used to produce goods. The amount of hours that a machine runs to make those products is often a cost driver for companies.
• Returns: When customers return products, businesses have to endure costs, such as restocking the item.