Question

Explain what a cost driver is and how management accountants use past history of costs and cost drivers to predict future costs. There are six or more different ways; this is not a superficial question.

Answer 1

COST DRIVER :- It is the direct cause of a cost and its effect is on the total cost incurred. For example, if you are to determine the amount of electricity consumed in a particular period, the number of units consumed determines the total bill for electricity. In such a scenario, the number of units of electricity consumed is a cost driver.

In order to make business decisions, managers can utilize past cost data to predict future costs employing 4 methods:

(1) scatter graphs,

(2) the high-low method,  

(3) least-squares regression analysis, and

(4) Account Analysis.

Types of Drivers in Cost Accounting

In a traditional system of accounting, the indirect costs or manufacturing overheads are allocated to the production cost based on a predetermined rate.

• Number of set-ups

• Number of machine hours

• Number of processed orders

• Number of orders completed

• Number of labor hours

• Number of orders packed and delivered, etc.

Therefore, above cost drivers can be used in following for estimation:-

(1) Standard cost accounting

(2) Activity based costing

(3) Economic value added

(4) Resource consumption Accounting

(5) Throughput Accounting

(6) Cost volume profit analysis