Manufacturing cost drivers are crucial factors that influence business activity costs. These include direct labor hours, machine hours, and units produced. Understanding these drivers helps managers allocate overhead costs accurately and make informed decisions about production processes.
Technology has significantly impacted cost relationships in manufacturing. Automation and computerized systems have reduced direct labor costs while increasing overhead expenses. This shift towards capital-intensive production methods has altered the traditional cost structure, making it essential for managers to adapt their costing approaches.
Cost Drivers in Manufacturing Processes
Key cost drivers in manufacturing
- Factors causing changes in business activity costs (labor hours, machine hours, units produced)
- Common manufacturing cost drivers
- Direct labor hours
- Increasing labor hours raises overhead costs allocated based on labor hours
- Machine hours
- Higher machine usage increases overhead costs (energy consumption, maintenance)
- Units produced
- Larger production volumes can increase overhead for quality control, material handling, inventory management
- Cost drivers influence overhead cost allocation to products
- Chosen cost driver should have strong cause-effect relationship with overhead costs incurred
- Cost allocation bases should accurately reflect resource consumption
Technology's impact on cost relationships
- Technological advances alter proportions of direct labor, materials, overhead costs
- Automation and robotics
- Reduces direct labor costs by replacing manual tasks with machines
- Increases overhead costs (equipment depreciation, maintenance, energy consumption)
- Computerized systems and software
- Streamlines processes reducing direct labor costs (inventory management, quality control)
- May increase overhead costs (software licenses, updates, IT support)
- Advanced manufacturing technologies shift production from labor-intensive to capital-intensive
- Direct labor costs decrease as percentage of total product costs
- Overhead costs increase as percentage of total product costs due to higher technology and equipment investments
Production activities and overhead allocation
- Production activities classified as unit-level, batch-level, product-level, facility-level (cost hierarchy)
- Unit-level activities
- Costs vary directly with units produced (direct materials, direct labor)
- Overhead costs allocated based on unit-level cost drivers (labor hours, machine hours)
- Batch-level activities
- Costs incurred each time a product batch is produced (setup costs, material handling)
- Overhead costs allocated based on number of batches or setup hours
- Product-level activities
- Costs related to specific products but not directly tied to units produced (product design, engineering)
- Overhead costs allocated based on number of product lines or engineering hours
- Facility-level activities
- Costs incurred to support overall manufacturing facility (rent, property taxes, insurance)
- Overhead costs allocated based on square footage or other measures of facility usage
- Overhead allocation method choice depends on production activities and their contribution to product costs
- Activity-based costing (ABC) assigns overhead costs to products based on activities consumed by each product
- Suitable for diverse product mix and varying demands on overhead resources
- Traditional costing methods (direct labor hours, machine hours) may be appropriate for relatively homogeneous production activities and overhead costs correlating well with chosen cost driver
Cost Analysis and Management
- Activity analysis identifies specific activities that drive costs in an organization
- Cost pools group similar overhead costs for more accurate allocation
- Understanding cost behavior helps in predicting how costs change with activity levels