What is a cost driver – Troubleinthepeace


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Compared with the traditional methods, ABC (Activity-Based Costing) method firstly aggregates all indirect costs (costs other than direct material costs, and direct labor costs) for each activities of the organization, and then allocate costs according to this activity to each product, service, or object that generates that activity, through cost drivers. In the traditional approach, the proportion of total indirect costs allocated to the finished product is often proportional to the total direct labor hours required to produce the finished product. In ABC, notable indirect activities (such as machine running, assembly, quality control, etc.) are identified by the operations manager. The costs for indirect resources consumed to perform those activities are then traced back to the activity through the appropriate cost driver. Finally, the set of costs of each activity is further allocated to finished products through other reasonable cost drivers. More figuratively speaking, the ABC system breaks down the indirect cost pie into pieces that correspond to a given activity. At this point, you probably still feel quite confused about ABC. An example would perhaps shed more light on the matter. Since the late 1980s, the North American company Elgin Sweeper has adopted ABC as follows: The first step is to study the fee generating activities, making a list of possible charge units, for each activity. . Elgin’s units of charge include: labor wages ($), labor hours, quantity dispatched, quantity of finished products, number of orders, revenue, working days, technical change notices technical, technical labor time, etc. Costs that vary with each charge unit are identified and calculated. Next, Elgin establishes a production line report that allows to evaluate the effectiveness of resource allocation decisions. The result of adopting a costing system is the involvement of production managers in the identification of cost drivers and the elimination of non-value-added activities. Suggested steps to set up ABC system: Identify the cost generators, activities, resources, and associated cost drivers. This work requires the help of professionals. The cost driver is selected based on two criteria: A reasonable causal relationship between the cost driver and the amount of resource consumption. Data on cost drivers can be obtained. Develop a process diagram, showing the flows of activities, resources, and their interrelationships. Determining the reciprocal relationship is a very important, much-needed step through professional staff. Collect cost-related data and tangible cost drivers between resources and activities. Through the guidance of the prepared diagram, the accountant can gather information about the necessary costs and operational data. Data sources can be accounting records, special studies, interviews, and estimates of operating managers. Calculate and interpret new information based on activity. It can be seen that the ABC method can turn an indirect cost into a direct cost with a specified fee-generating object. Choosing the right activities and cost drivers allows managers to trace as many indirect costs as they do to direct materials or direct labor costs. Because more direct costs are identified than in the traditional way, ABC helps managers get product and service cost reports with much greater confidence. The ABC method is complicated and of course more expensive than the traditional methods, so not every company is eligible to apply. However, ABC will be an inevitable trend for management because: Reduced cost-based competitiveness requires more accurate data on costs, avoiding fake profits. The increasing diversification of products and services coupled with the complexity of market segments. Thus, the consumption of resources will also vary by products and services. Product life cycles become shorter as the speed of technology development leaves the company insufficient time to adjust prices and costs. Determining the right costs is an important part of business decision making. Without it, the accuracy of the decision is reduced. The revolution in computer technology has reduced the time and money costs of developing and operating a cost-setting system that is traceable to multiple activities. (Collect)

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