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According to the most simple definition, a cost driver is the unit of an activity that causes a change in the activity's cost: A different meaning is assigned to the term by Michael Porter: "cost drivers are the structural determinants of the cost of an activity, reflecting any linkages or interrelationships that affect it". This defines 'cost drivers' not just as a simple ''variable in a function'', but as something that ''changes the function'' itself. For example, the driver 'economy of scale' leads to different costs per unit for different scales of operation (a small cargo vessel is more expensive per unit than a large bulk carrier), and the driver 'capacity utilisation' leads to greater costs per unit if the capacity is uder-utilised and lower costs per unit is the utilisation is high. The
Activity Based Costing Activity-based costing (ABC) is a costing method that identifies activities in an organization and assigns the cost of each activity to all products and services according to the actual consumption by each. Therefore, this model assigns more ind ...
(ABC) approach relates
indirect cost Indirect costs are costs that are not directly accountable to a cost object (such as a particular project, facility, function or product). Like direct costs, indirect costs may be either fixed or variable. Indirect costs include administration, pe ...
to the activities that drive them to be incurred. Activity Based Costing is based on the belief that activities cause costs and therefore a link should be established between activities and product. The cost drivers thus are the link between the activities and the cost of the product. Generally, the cost driver for short term indirect
variable costs Variable costs are costs that change as the quantity of the good or service that a business produces changes.Garrison, Noreen, Brewer. Ch 2 - Managerial Accounting and Costs Concepts, pp 48 Variable costs are the sum of marginal costs over all un ...
may be the volume of output/activity; but for long term indirect variable costs, the cost drivers will not be related to volume of output/activity. In traditional costing the cost driver to allocate indirect cost to cost objects was volume of output. With the change in business structures, technology and thereby cost structures it was found that the volume of output was not the only cost driver. John Shank and Vijay Govindarajan list cost drivers into two categories:''Strategic Cost Management: The New Tool for Competitive Advantage'' by Shank and Govindarajan Structural cost drivers that are derived from the business strategic choices about its underlying economic structure such as scale and scope of operations, complexity of products, use of technology, etc., and executional cost drivers that are derived from the execution of the business activities such as
capacity utilization Capacity utilization or capacity utilisation is the extent to which a firm or nation employs its installed productive capacity. It is the relationship between output that ''is'' produced with the installed equipment, and the potential output whic ...
, plant layout, work-force involvement, etc. Resource cost Driver is measure of quantity of resources consumed by an activity. It is used to assign cost of a resource to activity or cost pool. Activity Cost Driver is measure of frequency and intensity of demand placed on activities by cost object. It is used to assign activity costs to cost objects. To carry out a
value chain A value chain is a progression of activities that a firm operating in a specific industry performs in order to deliver a valuable product (i.e., good and/or service) to the end customer. The concept comes through business management and was firs ...
analysis, ABC is a necessary tool. To carry out ABC, it is necessary that cost drivers are established for different cost pools.


Examples

Some examples of indirect costs and their drivers are: indirect costs for maintenance, with the possible driver of this cost being the number of machine hours; or, the indirect cost of handling raw-material cost, which may be driven by the number of orders received; or, inspection costs that are driven by the number of inspections or the hours of inspection or production runs. In marketing, cost drivers are Number of advertisements, Number of sales personnel etc. In Customer service, cost drivers are Number of service calls attended, number of staff in service department, number of warranties handled, Hours spent on servicing etc..


References

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Further reading

* “Cost Accounting: a managerial emphasis”, 12th Edition (2005) by Charles T. Horngren, George Foster and
Srikant Datar Srikant Datar is an Indian-American economist and the Dean of Harvard Business School. At Harvard, he concurrently serves as the Arthur Lowes Dickinson Professor of Business Administration. In 2021, he was awarded the Padma Shri, the fourth-highe ...


See also

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Activity-based costing Activity-based costing (ABC) is a costing method that identifies activities in an organization and assigns the cost of each activity to all products and services according to the actual consumption by each. Therefore, this model assigns more ind ...
*
Fixed cost In accounting and economics, 'fixed costs', also known as indirect costs or overhead costs, are business expenses that are not dependent on the level of goods or services produced by the business. They tend to be recurring, such as interest or r ...
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Variable cost Variable costs are costs that change as the quantity of the good or service that a business produces changes.Garrison, Noreen, Brewer. Ch 2 - Managerial Accounting and Costs Concepts, pp 48 Variable costs are the sum of marginal costs over all u ...
*
Value chain A value chain is a progression of activities that a firm operating in a specific industry performs in order to deliver a valuable product (i.e., good and/or service) to the end customer. The concept comes through business management and was firs ...
Management accounting Costs Production economics