Cost Drivers in Accounting

Nov 09

Both direct and indirect contributions affect total costs in a manufacturing context. Direct costs include direct materials and direct labor. Indirect costs may include clerical staff, rent, utilities, etc. Indirect costs are incurred regardless of whether any manufacturing takes place. Direct costs are incurred in proportion to the amount of product produced.

With increasingly sophisticated manufacturing environments, there is value in associating indirect costs with specific manufacturing activities. The association of a specific indirect cost or activity with a specific manufacturing output gives managers a more accurate picture of the cost of those outputs. The resulting measure is called a Cost Driver.

Cost drivers may include machine setups and maintenance, design changes and special requirements from customers, such as inspections.

Cost driver analysis is not limited to manufacturing. It can also apply in the services sector. Whether in manufacturing or services, meaningful association of indirect costs to output can be complicated and subjective. Whenever possible, objective measurements should be identified that clearly tie an indirect cost to an output in a consistent way.

From Management Accounting:

Cost Driver: A cost driver is an activity or variable that causes a cost. For example, increased production volume causes increased investment in production equipment and, in turn, higher levels of machine depreciation. The number of miles driven in a car is the cost driver for the cost of gasoline. The term cost driver is also used for the activity whose quantity is the denominator for a cost driver rate or predetermined overhead rate.

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