Cost Drivers Examples In Service Industry

A cost driver triggers a change in the of an activity. The concept is most commonly used to assign costs to the number of produced units. It can also be used in analysis to determine the causes of overhead, which can be used to minimize overhead costs. Examples of cost drivers are as follows: • hours worked • Number of customer contacts • Number of issued • Number of machine hours used • Number of product returns from customers If a business is only concerned with following the minimum accounting requirements to allocate overhead to produced goods, then just a single cost driver will be used. Related Courses.

Page/Link: Page URL: HTML link: The Free Library. Retrieved Mar 10 2019 from The current accounting literature is filled with activity based costing ABC~ articles about cost drivers in manufacturing settings but very few examples of cost driver applications in service firms or industries exist. A number of the applications of cost drivers in manufacturing plants, however, involve service functions rather than a manufactured product. Since cost driver and ABC concepts improve the cost measurement and allocation information for service departments within manufacturing firms, service firms (such as accounting or law firms) could also use cost driver and ABC concepts.

A change to cost driver techniques will provide better cost information for service firms as it has for manufacturing firms. Activity based costing will help accounting firms answer questions such as: What does it cost to prepare a tax return? What is the cost of doing an audit? How should the common costs be allocated to a particular engagement? Can costs be measured better and used for pricing of services? Cost Allocations Cost allocations are arbitrary and cannot be proven correct (or incorrect) because they depend on subjective judgement and not on a verifiable cause/effect relationship.

All these activities will become cost drivers. Examples of these cost drivers are given below: 1st: No. Of Purchase Orders When we have to make any product, we issue the order. This is a simple activity. Its cost can be calculated one the basis of no. Of purchase orders. So, number of purchase order is an example of cost driver. Overhead costs have soared to 60 percent or more of total product costs in heavily automated. Traditional Overhead Allocation and ABC - An Example. Manufacturing companies, it has gained widespread acceptance in the service sector.

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Even though arbitrary, allocations are done in practice because the advantages outweigh the disadvantages. The methodology for making cost allocations involves two separate issues: 1.

The pools or categories of indirect costs that should be identified, aggregated and allocated together. The basis over which the costs in any given pool should be allocated. It is the second issue that gives rise to the search for cost drivers or allocation bases. A number of criteria are used by companies for evaluating cost allocation methods.

Most authorities agree allocations should be made on the basis of the factors that caused the cost to be incurred. This criterion is most useful for variable costs like direct labor in an accounting or a law firm. It is less useful for fixed costs--like office rent or building depreciation--that represent a capacity decision by the firm to provide facilities for a particular level of service. Cost Drivers The most acceptable method of assigning costs to a product or service is to select drivers that approximate the underlying behavior of the costs to be allocated.

This causal relationship is generally regarded as the best method for allocating indirect costs. It is the theory behind 'cost driver' methods.

A cost driver is used to allocate costs based on a common measure of the quantity of the resource used by the product (or service, department, contract or unit). The cost driver concept focuses on the activity that drives or causes the consumption of cost. This is in contrast to the concept of allocating costs just because they were incurred and must be assigned to the products or services to satisfy external users. Since fixed costs do not vary with changes in activity in the short run, there are no 'cost drivers' that reflect usage, and any allocation is arbitrary. If fixed costs are to be allocated, a firm will need to develop some common capacity measure for all cost centers. Variable costs vary with a change of activity and it is precisely this variation, and the activity that causes the variation, that gives rise to the search for cost drivers.