Activity-based costing is a cost allocation method that uses various production activities to track manufacturing costs. A cost driver is the unit within the activity that applies the corresponding rates to goods produced. Factors that can affect cost driver rates include machine operators, floor space within a production facility, or the utility consumption for a production activity. Waste or rejected goods due to quality defects can also affect these rates. In most cases, the rates increase due to these factors, though some companies may experience slight decreases instead.
Machine hours are a common cost driver a company can use to allocate production costs to goods or services produced. Costs related to the machine operator — whether human or otherwise — represent the cost driver rates applied to individual product costs. Whenever the machine operator rates increase, the cost driver rate will most likely change as well. Some increases may come from inefficient production processes, where more machine hours used to produce the same amount of goods or services increase the individual cost of each finished product. Multiple machines may have different cost driver rates associated with them.
Cost drivers may also be affected by the floor space a company uses for production activities. For example, manual labor activities may require a large workspace in a warehouse. The only way to create a cost driver here is to determine the amount of square feet the activity requires for use in the building. Multiple activities in each building with their own floor space factor for computing cost driver rates. Altering the floor space will most likely change the rates associated with each individual activity within a company’s production facilities.
Utility consumption is another type of cost driver, though less common. Cost drivers here may relate to both a company’s equipment, facilities, or both in some cases. The obvious change in the rate here will occur when a company’s utility rate changes. Additionally, multiple cost driver rates can also exist due to the use of electricity, natural gas, or other utility source in a business. Accountants may decide to use the cost driver rates directly from a company’s utility bill when allocating costs.
Wasted and rejected units may also affect cost driver rates. The units here all require some inputs, whether direct or indirect in nature. More time, effort, and money spent on these units will increase the company’s overall production costs, affecting cost drivers.