Activity Cost Driver

What is Activity Cost Driver?

An activity cost driver is that element that causes the cost of an activity to increase or decrease. It is that element that is associated with the production process or activity that can cause changes in the cost of production.

It is an Accounting concept that is related to Activity-Based Costing (ABC). It is a method of accounting, wherein one can employ to derive the total cost of activities involved to make a product. This method assigns costs to each activity that is employed in production. This could be the number of hours employed, the number of workers testing a product, machine setup, etc. The cost driver can be anything from the group of activities that causes the cost of the activities to rise or fall.

The activity cost driver makes the allocation of the Manufacturing overhead simpler. The allocation of manufacturing overhead is important to determine the cost of the product.

Example of Activity Cost Driver

Company XYZ is manufacturing chocolate bars for sale and consumption. It deals with thousands of orders every day. There are various departments within the company to deal with the production of chocolate bars, wrapper designing, wrapper printing, etc. The change in the number of orders will result in a change in the cost of production of the chocolate bars.

More orders will require more raw material to make the chocolate, more wrappers will need to be manufactured and more labour will be put into place. The same will be affected if the orders are reduced and vice versa.

Production of the chocolates is a big group of activities and those activities will be split into smaller parts so that the activity cost driver for each part can be identified.

More technical cost drivers are machine hours, number of customers who have sent the orders, number of product return and machine setups required for production.