6.2 Describe and Identify Cost Drivers
3 min read•june 18, 2024
Manufacturing are crucial factors that influence business activity costs. These include , , and . Understanding these drivers helps managers allocate accurately and make informed decisions about production processes.
Technology has significantly impacted cost relationships in manufacturing. and have reduced direct labor costs while increasing overhead expenses. This shift towards 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
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- Factors causing changes in business activity costs (, 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 , ,
- Direct labor hours
- Cost drivers influence overhead cost allocation to products
- Chosen cost driver should have strong cause-effect relationship with overhead costs incurred
- should accurately reflect
Technology's impact on cost relationships
- Technological advances alter proportions of direct labor, materials, overhead costs
- Automation and
- 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)
- Automation and
- 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 ()
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- Costs vary directly with units produced (direct materials, direct labor)
- Overhead costs allocated based on unit-level cost drivers (labor hours, machine hours)
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- Costs incurred each time a product batch is produced (, material handling)
- Overhead costs allocated based on number of batches or setup hours
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- 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
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- Costs incurred to support overall manufacturing facility (rent, property taxes, insurance)
- Overhead costs allocated based on square footage or other measures of facility usage
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- Overhead allocation method choice depends on production activities and their contribution to product costs
- (ABC) assigns overhead costs to products based on activities consumed by each product
- Suitable for diverse product mix and varying demands on overhead resources
- methods (direct labor hours, machine hours) may be appropriate for relatively homogeneous production activities and overhead costs correlating well with chosen cost driver
- (ABC) assigns overhead costs to products based on activities consumed by each product
Cost Analysis and Management
- identifies specific activities that drive costs in an organization
- group similar overhead costs for more accurate allocation
- Understanding helps in predicting how costs change with activity levels
Key Terms to Review (29)
Activity analysis: Activity analysis is a method used to identify and evaluate the various activities that a business performs, along with their associated costs. This approach helps organizations understand how resources are utilized, which activities drive costs, and how to optimize operations. By focusing on activities and their cost drivers, businesses can better allocate resources, enhance efficiency, and calculate more accurate product costs.
Activity-based costing: Activity-Based Costing (ABC) is a costing method that assigns overhead and indirect costs to related products and services. It identifies specific activities within an organization and assigns the cost of each activity to all products and services according to the actual consumption by each.
Activity-Based Costing: Activity-based costing (ABC) is a costing methodology that identifies activities in an organization and assigns the cost of each activity with resources to the various products and services according to the actual consumption by each. It is a more accurate way of allocating overhead costs compared to traditional volume-based costing methods.
Automation: Automation refers to the use of technology, control systems, and information technologies to reduce human intervention in processes, operations, and tasks. It involves the application of machines, control systems, and information technologies to operate and manage processes with minimal or no human assistance.
Batch-Level Activities: Batch-level activities are a type of cost driver that are associated with the production of a group or batch of units, rather than individual units. These activities are incurred whenever a batch of products is processed, regardless of the number of units within the batch.
Capital-Intensive: Capital-intensive refers to a business or industry that requires a significant amount of capital, such as machinery, equipment, or infrastructure, to operate and produce goods or services. This term is particularly relevant in the context of understanding cost drivers, as the level of capital investment can be a major factor in determining the costs associated with a business or industry.
Computerized Systems: Computerized systems refer to the use of computer technology to automate and streamline various business processes and operations. These systems leverage digital tools and software applications to enhance efficiency, accuracy, and decision-making capabilities within an organization, particularly in the context of cost management and cost driver analysis.
Cost Allocation Bases: Cost allocation bases are the metrics or factors used to distribute or assign indirect costs to various cost objects, such as products, services, or departments, within an organization. These bases provide a systematic and logical way to link overhead costs to the activities or units that consume those resources.
Cost Behavior: Cost behavior refers to the relationship between a company's costs and its level of business activity or output. It describes how different types of costs, such as variable costs and fixed costs, respond to changes in the volume of production or sales.
Cost behaviors: Cost behaviors describe how costs change in relation to changes in a company's level of activity. These behaviors are essential for budgeting, forecasting, and decision-making processes.
Cost Drivers: Cost drivers are the factors that directly influence the incurrence of costs within an organization. They are the underlying causes that determine the level of resources consumed and the resulting costs associated with business activities or operations. Cost drivers play a crucial role in various managerial accounting concepts, including the estimation of variable and fixed costs, the application of job order and process costing methods, the calculation of activity-based product costs, and the analysis of overhead variances.
Cost Hierarchy: The cost hierarchy is a classification system that groups costs based on their behavior and relationship to the level of activity or volume within an organization. It helps identify and analyze the different types of costs incurred in the production or delivery of a product or service.
Cost Pools: Cost pools are groups of indirect costs that are accumulated and then allocated to cost objects, such as products, services, or departments, based on a common cost driver. They are an essential component in various costing methods, including job order costing and activity-based costing, as they help to accurately assign overhead costs to the appropriate cost objects.
Direct Labor Hours: Direct labor hours refer to the total number of hours worked by employees directly involved in the production of a specific product or service. This metric is crucial in job order cost systems, traditional overhead allocation methods, cost driver identification, and activity-based costing, as it serves as a key input for various cost accounting calculations and analyses.
Facility-Level Activities: Facility-level activities refer to the operational and maintenance tasks required to support the overall functioning of a production facility. These activities are not directly tied to the production of individual products but rather contribute to the general upkeep and operation of the entire manufacturing plant or facility.
Inventory Management: Inventory management is the process of overseeing and controlling the ordering, storage, and use of components and finished products within an organization. It is a critical function that ensures the right amount of inventory is available to meet customer demand while minimizing costs and waste.
Labor Hours: Labor hours refer to the total number of hours worked by employees in the production of goods or services. It is a fundamental cost driver that directly impacts the overall cost of a product or service, as labor is a significant component of the total cost of production.
Machine Hours: Machine hours refer to the total number of hours that a production machine is in operation during a specific period. This metric is crucial in various managerial accounting contexts, as it helps understand and analyze the relationship between machine usage, costs, and production efficiency.
Manufacturing overhead costs: Manufacturing overhead costs are indirect costs associated with the production process but not directly traceable to a specific product. They include expenses like utilities, depreciation, and factory supplies.
Material Handling: Material handling refers to the movement, protection, storage, and control of materials and products throughout the manufacturing, distribution, consumption, and disposal processes. It is a critical component in both cost drivers and activity-based costing within an organization.
Overhead Costs: Overhead costs are indirect expenses incurred by a business that cannot be directly attributed to the production of a specific product or service. These costs support the overall operations of the organization but are not directly related to the manufacturing or delivery of a particular item. Overhead costs are an important consideration in various cost accounting topics, including traditional cost allocation methods, cost driver identification, and activity-based costing systems.
Product-Level Activities: Product-level activities refer to the specific tasks and processes involved in the production and delivery of a particular product or service. These activities are directly related to the creation, manufacturing, and distribution of a company's products, and they play a crucial role in determining the costs associated with each product.
Quality Control: Quality control is the process of ensuring that a product or service meets predetermined standards of quality, accuracy, and completeness. It is a critical component in the management of cost drivers, as it helps identify and mitigate factors that can impact the overall cost of production or service delivery.
Resource Consumption: Resource consumption refers to the utilization and depletion of various resources, both tangible and intangible, required for the production of goods and services. It is a fundamental concept in understanding the efficiency and cost structures of an organization's operations.
Robotics: Robotics is the field of study that encompasses the design, construction, operation, and application of robots. It involves the integration of various disciplines, including mechanical engineering, electrical engineering, computer science, and artificial intelligence, to create machines capable of performing tasks autonomously or semi-autonomously.
Setup Costs: Setup costs refer to the expenses incurred to prepare a production process or system for operation. These costs are typically one-time or infrequent expenditures required to get a new product, service, or operation up and running, and are distinct from the ongoing costs of production or service delivery.
Traditional Costing: Traditional costing is an approach to cost accounting that allocates overhead costs to products based on a single volume-based cost driver, such as direct labor hours or machine hours. This method is in contrast to activity-based costing, which utilizes multiple cost drivers to more accurately assign overhead costs to products.
Unit-Level Activities: Unit-level activities refer to the cost drivers that are directly related to the production of individual units or products. These activities are influenced by the volume of production and have a direct impact on the overall cost of manufacturing a specific unit or product.
Units Produced: Units produced refers to the total number of units or items that are manufactured or created during a specific period of time. This metric is a fundamental measure in cost accounting and is closely tied to the concept of cost drivers, which are the factors that influence the costs associated with producing goods or services.