A cost driver is a structural factor which determines the cost of an activity or a change in its cost. The Chartered Institute of Management Accountants defines a cost driver as: although a different meaning is assigned to the term by the business writer

Michael Porter Michael Eugene Porter (born May 23, 1947) is an American businessman and professor at Harvard Business School. He was one of the founders of the consulting firm The Monitor Group (now part of Deloitte) and FSG, a social impact consultancy. ...

, who states:

Approaches

Porter's approach defines a "cost driver" not just as a simple ''variable in a function'', but as something that ''changes the function'' itself. For example, the driver "

economy of scale In microeconomics, economies of scale are the cost advantages that enterprises obtain due to their scale of operation, and are typically measured by the amount of output produced per unit of cost (production cost). A decrease in cost per un ...

" 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 under-utilised and lower costs per unit is the utilisation is high. In general, 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. 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 in ...

(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, ...

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. To carry out a

value chain A value chain is a progression of activities that a business or firm performs in order to deliver goods and services of Value (economics), value to an end customer. The concept comes from the field of business management and was first described ...

analysis, ABC is a necessary tool. To carry out ABC, it is necessary that cost drivers are established for different cost pools. 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 divide cost drivers into two categories:Shank, J. and Govindarajan, V., ''Strategic Cost Management: The New Tool for Competitive Advantage'' *structural cost drivers, which are derived from a business's 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, which are derived from the execution of 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 (maximum output of a firm or nation). It is the relationship between output that ''is'' produced with the installed ...

, plant layout, work-force involvement, etc. Resource cost Driver is a measure of the 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 a measure of the frequency and intensity of demand placed on activities by cost object. It is used to assign activity costs to cost objects.

Examples

If more people eat in a restaurant, the catering cost will increase, although revenue will also increase. 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 Marketing is the act of acquiring, satisfying and retaining customers. It is one of the primary components of Business administration, business management and commerce. Marketing is usually conducted by the seller, typically a retailer or ma ...

, cost drivers include the number of advertisements, number of sales personnel etc. In

customer service Customer service is the assistance and advice provided by a company to those who buy or use its products or services, either in person or remotely. Customer service is often practiced in a way that reflects the strategies and values of a firm, and ...

, cost drivers include the number of service calls attended, number of staff in service department, number of warranties handled, hours spent on servicing etc..

References

{{reflist

Approaches

Examples

References

Further reading

See also