What is an 'Activity Cost Driver'

An activity cost driver is a factor that influences or contributes to the expense of certain business operations. In activity-based costing (ABC), an activity cost driver drives the costs of labor, maintenance or other variable expenses. Cost drivers are essential in ABC, a branch of managerial accounting that allows managers to determine the costs to perform an activity at various activity levels.

BREAKING DOWN 'Activity Cost Driver'

A cost driver is an activity that is the root cause of why a cost occurs. It must be applicable and relevant to the event that is incurring a cost. There may be multiple cost drivers responsible for the occurrence of a single expense. A cost driver assists with allocation expenses in a systematic manner that theoretically results in more accurate calculations of the true costs of a producing specific products.

Examples of Cost Drivers

The most common cost driver has historically been direct labor hours. Expenses incurred relating to the layout or structure of a building or warehouse may utilize a cost driver of square footage to allocate expenses. More technical cost drivers include machine hours, the number of change orders, the number of customer contacts, the number of product returns, the machine setups required for production or the number of inspections.

Example of Cost Allocation

A factory has a machine that requires periodic maintenance. This maintenance incurs costs to be allocated to the products produced by the machinery. Therefore, the cost driver is identified and used as a base to distribute the costs. In this example, the cost driver selected is machinery hours. It is determined that after every 1,000 machine hours, maintenance costing $500 is performed. Therefore, every machine hour results in an eventual 50 cents in maintenance costs that can be allocated to the product being manufactured based on the cost driver of machine hours.

Distribution of Overhead Costs

A cost driver exists to allocate manufacturing overhead. The correct allocation of manufacturing overhead is important for determining the true cost of a product. Internal management utilizes the cost of a product in the determination of the product's price. For this reason, the selection of accurate cost drivers has a direct impact on the profitability and operations of an entity.

Subjectivity of Cost Drivers

Management selects cost drivers as the allocation base for distributing manufacturing overhead. There are no industry standards or regulations stipulating mandating cost driver selection. A cost driver is selected at management's discretion based on the associated variables relating to the expense being incurred.

RELATED TERMS
  1. Driver

    A driver is a factor that has a material effect on the activity ...
  2. Activity Center

    An activity center is a designated cost accounting area where ...
  3. Nonstandard Auto Insurance

    Nonstandard auto insurance is offered to drivers considered to ...
  4. Preferred Auto Coverage

    Auto insurance offered to drivers considered to fall into the ...
  5. Cost Accounting

    Cost accounting is an accounting method that aims to capture ...
  6. Full Costing

    The full costing technique is a managerial accounting method ...
Related Articles
  1. Insurance

    Why Millennials Are the Riskiest Drivers

    New research shows that Millennials are the worst drivers, which may be linked to higher accident rates and overall rising insurance premiums.
  2. Investing

    Understanding Marginal Cost of Production

    Marginal cost of production is an economics term that refers to the change in production costs resulting from producing one more unit.
  3. Insights

    How to Become an Uber Driver: A Step by Step Guide

    Becoming a personal driver with Uber is a popular way to make money at home. Here's everything you need to know before you become an Uber driver.
  4. Taxes

    Is Uber The Future Of The Taxi Industry?

    More specifically, can the taxi industry survive the growth of Uber?
  5. Investing

    Key Financial Ratios for Manufacturing Companies

    An investor can utilize these financial ratios to determine whether a manufacturing company is efficient, profitable and a good long-term investment option.
  6. Investing

    Uber Has Not Reduced Taxi Jobs: Report

    Uber doesn't limit the number of traditional taxi jobs, but it does change the pay situation.
  7. Investing

    Are You Ready for Uber's IPO? 2 Things to Consider

    Learn why ongoing litigation from drivers along with state and local governments could put a damper on what is likely an impending Uber IPO.
  8. Investing

    GM Introduces Self-Driving Technology in Cadillac

    Honey I just wonder what you do there in back of your (self-driving) Cadillac.
  9. Insurance

    Top 5 Insurance Companies for Uber and Lyft Drivers

    Once only given the option of expensive commercial insurance, Uber and Lyft drivers are now afforded much more affordable and expansive options.
  10. Insurance

    What is Adverse Selection in the Insurance Industry?

    Adverse selection impacts the markets for health insurance and automobile insurance, but interfering with actuarial work has consequences.
RELATED FAQS
  1. What are the differences between period costs and product costs?

    Find out why GAAP separates all company expenses into either period or production costs and how this impacts the way expenses ... Read Answer >>
  2. How does fixed overhead differ from varied overhead?

    Learn about overhead costs and the two types of overhead costs, and discover the difference between fixed and variable overhead ... Read Answer >>
  3. What is the prime cost formula?

    Learn about the prime cost formula and how to determine which costs are included in this calculation, including the difference ... Read Answer >>
  4. What is the difference between direct costs and variable costs?

    Learn about variable costs and direct costs, how direct costs and variable costs are classified and the differences between ... Read Answer >>
  5. How Do Fixed and Variable Costs Affect the Marginal Cost of Production?

    Learn about the marginal cost of production and how it is affected by changes in fixed and variable costs. Read Answer >>
  6. Why is overhead cost allocation sometimes manipulated on an income statement?

    Learn why companies sometimes manipulate overhead costs to boost the appearance of overall profitability, and other reasons ... Read Answer >>
Hot Definitions
  1. Return on Assets - ROA

    Return on assets (ROA) is an indicator of how profitable a company is relative to its total assets.
  2. Fibonacci Retracement

    A term used in technical analysis that refers to areas of support (price stops going lower) or resistance (price stops going ...
  3. Ethereum

    Ethereum is a decentralized software platform that enables SmartContracts and Distributed Applications (ĐApps) to be built ...
  4. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
  5. Financial Industry Regulatory Authority - FINRA

    A regulatory body created after the merger of the National Association of Securities Dealers and the New York Stock Exchange's ...
  6. Initial Public Offering - IPO

    The first sale of stock by a private company to the public. IPOs are often issued by companies seeking the capital to expand ...
Trading Center