Glossary term
Activity Cost Driver
An activity cost driver is a measurable factor that causes or explains the cost of an activity in an activity-based costing system.
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What Is an Activity Cost Driver?
An activity cost driver is a measurable factor that causes or explains the cost of an activity. In activity-based costing, cost drivers are used to assign activity costs to products, services, customers, or channels based on how much of the activity each one uses.
The phrase sounds technical, but the idea is practical: if purchase orders create purchasing department work, the number of purchase orders may be a cost driver. If machine setups create setup labor, the number of setups may be a cost driver.
Key Takeaways
- Activity cost drivers link activity costs to the things that consume those activities.
- Good drivers have a clear cause-and-effect relationship with cost.
- Common examples include machine hours, setup counts, purchase orders, inspections, and support tickets.
- Weak drivers can distort product, customer, or service profitability.
- Drivers should be useful enough to justify the data collection effort.
How It Works
Suppose a company has a $200,000 annual quality-inspection cost pool and expects 10,000 inspections. The inspection driver rate is $20 per inspection. A product line requiring 1,500 inspections would receive $30,000 of inspection cost.
The driver matters because it changes the story. If costs are assigned by direct labor hours, a high-complexity product may look profitable when it is actually consuming a disproportionate share of inspection, setup, and engineering work.
Examples of Activity Cost Drivers
Activity | Possible cost driver |
|---|---|
Machine setup | Number of setups. |
Purchasing | Number of purchase orders. |
Customer support | Number of support tickets or call minutes. |
Quality control | Number of inspections or defect reviews. |
Shipping | Number of shipments, packages, or weight handled. |
Choosing a Good Driver
A good activity cost driver is understandable, measurable, and economically related to the activity. It should explain why the cost exists, not merely be convenient. The number of invoices may be a strong driver for billing work but a weak driver for warehouse cost.
Managers should also avoid false precision. A driver that is perfectly theoretical but impossible to track may be less useful than a simpler driver that captures most of the cost behavior.
The Bottom Line
An activity cost driver is the link between work and cost in an activity-based costing model. Better drivers produce better cost insight; poor drivers can make a detailed model misleading.