Identifying and Measuring Cost Drivers

Identifying and Measuring Cost Drivers

Craig Borysowich (Chief Technology Tactician)

For each of the activity cost pools, a cost driver must be determined.

There are basically three types of cost drivers:

· Volume: The cost driver is based on units of work (e.g., number of orders.) The cost of the activity increases as more units are processed.

· Time: The cost driver is based on the length of time taken to complete the activity. The cost of the activity increases based on the length of time required to complete the activity. It does not matter how many products are produced (e.g., when retooling machines, the cost driver is the length of time required to complete the retooling of machines).

· Charge: The cost for the entire activity is charged directly to the cost object (e.g., all costs associated with the retooling of machines for a product is charged directly to the end-product).

In general, a charge-type cost driver is used very rarely. The most common drivers are volume and time. The driver used depends on the nature of the activity. The cost of the activity may increase based on the number of units handled or based on the length of time required to complete the activity. It could also be a combination of these two driver types. For example, the time required to test a product may vary based on the product under test and the number of units to be tested. The costs of testing increase as more products are tested. As well, the testing time will vary based on the complexity of the products (e.g., a complex software program takes longer to test the a simple software program). Say it takes four hours to test a simple program and ten hours to test a complex program, and all other costs are the same with respect to testing the two types of programs. The cost of testing two simple programs (i.e., 2 programs * 4 hours/program = 8 hours) is less the cost of testing one complex program (i.e., 1 program * 10 hours/program = 10 hours).

Measure the Cost Drivers

Once the cost drivers have been identified for the various activities, they must be quantified. For the same period that the costs were captured, the count for the activity driver must be determined. For example, if the driver for the Purchasing process is Purchase Orders, determine the number of Purchase Orders processed during the period for which costs have been captured.

Look to existing systems for cost driver measurements. For example, if the purchasing function uses a computer system, it should be fairly easy to determine the number of purchase orders processed in a given period.

Tips and Hints

Identifying cost drivers can be difficult. The key thing to remember is what is driving the activity or process. What causes this process to happen? For example, the business process of Purchasing is driven by Purchase Orders. The drivers may not be apparent if only the costs from the general ledger (G/L) are used. Look back at the process maps and flowcharts.