Question

List three factors that are important in selecting activity drivers. Explain why they are important, using examples of activity drivers for a bank.

Answer 1

In activity based costing, the allocation overhead costs is done on the basis of cost drivers. They cause due which cost is incurred. The overhead cost is allocated to the activity according to the amount of cost driver consumed. Three important factors selecting activity drivers are:

1. Cause effect relationship: allocation of cost is done in the proportion of cost driver consumed

2. Benefits derived: allocation of cost in the proportion benefits derived from the activity

3. Reasonableness: when it is not possible to develop cause effect relationship or get details of activity benefits, the overhead allocation should be done reasonably.

In bank, cost drivers used are number of customers, products and services offered and responsibility centers. With increase of number customers bank need to increase staff and staff salary is an example of overhead allocation. If benefits of particular bank services are high, its need the management staff to look after and management cost is also an example of overhead cost.