Cost Driver

1. COST DRIVERS COST DRIVERS
& &
COST BEHAVIOURCOST BEHAVIOUR
Dr. Rana SinghDr. Rana Singh
www.ranasingh.orgwww.ranasingh.org

2. COST DRIVER - DEFINITIONCOST DRIVER - DEFINITION
An activity which generates costAn activity which generates cost
A factor such as the level of activity or volume A factor such as the level of activity or volume
that causally affects cost.that causally affects cost.
Existence of a cause-and-effect relationship Existence of a cause-and-effect relationship
between a change in the level of activity or between a change in the level of activity or
volume and change in the level of total costs of volume and change in the level of total costs of
that cost object.that cost object.
Thus cost drivers signify factors, forces or Thus cost drivers signify factors, forces or
events that determine the costs of activitiesevents that determine the costs of activities

3. COST DRIVER - IDENTIFIEDCOST DRIVER - IDENTIFIED
Direct costs do not need cost driversDirect costs do not need cost drivers
They are themselves cost drivers since they can They are themselves cost drivers since they can
be traced directly to a product.be traced directly to a product.
All other factory or manufacturing costs need All other factory or manufacturing costs need
cost drivers.cost drivers.

4. COST DRIVERS – WHY?COST DRIVERS – WHY?
They are the links between a pool of costs in an They are the links between a pool of costs in an
activity centre and the productactivity centre and the product
Therefore in order to trace overhead costs to Therefore in order to trace overhead costs to
products, appropriate cost drivers should be products, appropriate cost drivers should be
identified.identified.

5. COST DRIVER - TYPESCOST DRIVER - TYPES
There are two categories of cost driver:There are two categories of cost driver:
Resource Cost Driver: A measure of the Resource Cost Driver: A measure of the
quantity of resources consumed by an activity. quantity of resources consumed by an activity.
Used to assign the cost of a resource to an Used to assign the cost of a resource to an
activity or cost pool.activity or cost pool.
Activity Cost Driver: Measure of the frequency Activity Cost Driver: Measure of the frequency
and intensity of demand, placed on activities by and intensity of demand, placed on activities by
cost objects. Used to assign activity costs to cost cost objects. Used to assign activity costs to cost
objects.objects.

6. ACTIVITIES & COST DRIVERSACTIVITIES & COST DRIVERS
FUNCTIONAL
AREAS
ACTIVITIES SUITABLE COST
DRIVERS
Materials
Management
• Issue of purchase orders• Number of purchase orders
• Inspection of materials• Number of purchase orders
Stores
Management
• Storing of materials• Value of materials stored
• Servicing of requisitions• Number of requisitions
• Inspection & Verification• Number of times inspected
• Stock Taking • Value of stock
Quality Control• Testing of Samples• Number of batches produced
Marketing • Demand Creation • Increase in sales
• Advertising • Increase in sales
• Despatches •Number of orders

7. ACTIVITIES & COST DRIVERSACTIVITIES & COST DRIVERS
FUNCTIONAL
AREAS
ACTIVITIES SUITABLE COST
DRIVERS
Personnel
Management
• Recruitment of
employees
• Number of employees
recruited
• Maintenance of leave
records & attendance
• Number of employees
Research &
Development
• Research • Number of research Projects
Machining • Setup Cost • Number of production runs
• Power cost •Machine hours

8. ACTIVITIES-CLASSIFICATIONACTIVITIES-CLASSIFICATION
In manufacturing organizations, activities are In manufacturing organizations, activities are
grouped on the basis of different levels at which grouped on the basis of different levels at which
activities are performed and hence are identified activities are performed and hence are identified
and classified into broadly four different and classified into broadly four different
categories:categories:

9. UNIT LEVEL ACTIVITIESUNIT LEVEL ACTIVITIES
Activities performed each time a unit is Activities performed each time a unit is
produced.produced.
They are repetitive activitiesThey are repetitive activities
Example: Direct labour hours, Machine hours, Example: Direct labour hours, Machine hours,
Power are used each time a unit is producedPower are used each time a unit is produced
Costs of unit level activities vary with the Costs of unit level activities vary with the
number of units producednumber of units produced

10. BATCH LEVEL ACTIVITIESBATCH LEVEL ACTIVITIES
Activities performed each time a batch of goods Activities performed each time a batch of goods
or products is producedor products is produced
Costs of batch level activities vary with the Costs of batch level activities vary with the
number of batches but are fixed with respect to number of batches but are fixed with respect to
the number of units in each batchthe number of units in each batch
Example: Machine setups, inspections, Example: Machine setups, inspections,
production scheduling, materials handlingproduction scheduling, materials handling

11. PRODUCT LEVEL ACTIVITIESPRODUCT LEVEL ACTIVITIES
Activities performed to support the production Activities performed to support the production
of each different type of productof each different type of product
Example: Maintenance of equipment, Example: Maintenance of equipment,
engineering charges, testing routines, engineering charges, testing routines,
maintaining bills of materialsmaintaining bills of materials

12. FACILITY LEVEL ACTIVITIESFACILITY LEVEL ACTIVITIES
Activities needed to sustain a factory’s general Activities needed to sustain a factory’s general
manufacturing processmanufacturing process
These are common to a variety of productsThese are common to a variety of products
Most difficult to link to product specific Most difficult to link to product specific
activitiesactivities
Examples: Factory management, maintenance, Examples: Factory management, maintenance,
security, plant depreciationsecurity, plant depreciation

13. EXAMPLESEXAMPLES
Examples of costs driven by activities at each level:Examples of costs driven by activities at each level:
ACTIVITY LEVEL EXAMPLES OF ACTIVITY COST
1. Unit Level • Cost of raw materials
• Cost of inserting a component
• Utilities cost of operating equipment
• Some costs of packaging
• Sales Commissions
2. Batch Level • Cost of processing sales order
• Cost of issuing and tracking work order
• Cost of equipment setup
• Cost of moving batch between workstations
• Cost of inspection (assuming same number of units
inspected in each batch)

14. EXAMPLES…EXAMPLES…
ACTIVITY LEVEL EXAMPLES OF ACTIVITY COST
3. Product Level • Cost of Product Development
• Cost of Product marketing such as advertising
• Cost of specialized equipment
• Cost of maintaining specialized equipment
4. Facility Level • Cost of maintaining general facilities such as buildings and
grounds
• Cost of non-specialized equipment
• Cost of maintaining non-specialized equipment
• Cost of real property taxes
• Cost of general advertising
• Cost of general administration such as the plant
manager’s salary

15. COST BEHAVIOURCOST BEHAVIOUR

16. COST - CLASSIFICATIONCOST - CLASSIFICATION
Costs can be classified into fixed, variable and Costs can be classified into fixed, variable and
Semi-variable costs on the basis of:Semi-variable costs on the basis of:
VariabilityVariability
Changes in cost behaviour in relation to change Changes in cost behaviour in relation to change
in output, activity or volume where activity may in output, activity or volume where activity may
be indicated in any form such as units of output, be indicated in any form such as units of output,
hours worked, sales etc.hours worked, sales etc.

17. FIXED COSTFIXED COST
Cost which does not change for a given period Cost which does not change for a given period
of time despite wide fluctuations in output or of time despite wide fluctuations in output or
volume of activityvolume of activity
Also known as standby costs, Capacity costs or Also known as standby costs, Capacity costs or
Period Costs.Period Costs.
Accrues with the passage of time and not with Accrues with the passage of time and not with
the production of the product or the job, which the production of the product or the job, which
is why they are expressed in time such as per day is why they are expressed in time such as per day
per month and not in terms of unitper month and not in terms of unit
Examples: Rent, Property Taxes, advertising etc.Examples: Rent, Property Taxes, advertising etc.

18. CHANGES IN FIXED COSTSCHANGES IN FIXED COSTS
Fixed costs remain fixed only in the short run Fixed costs remain fixed only in the short run
and so it is improper to say Fixed Costs do not and so it is improper to say Fixed Costs do not
change.change.

19. CHANGES IN FIXED COSTCHANGES IN FIXED COST
Between 20,000 & 80,000 units of production, fixed cost is Rs. Between 20,000 & 80,000 units of production, fixed cost is Rs.
50,00050,000
In excess of 80,000 units, fixed cost becomes Rs. 60,000. This In excess of 80,000 units, fixed cost becomes Rs. 60,000. This
assumes that increase in production after a certain level requires assumes that increase in production after a certain level requires
increase in fixed expenses such as additional supervision, increase in fixed expenses such as additional supervision,
increase in quality control costs.increase in quality control costs.

20. CHANGES IN FIXED COSTCHANGES IN FIXED COST
Between 20,000 & 80,000 units of production, fixed cost is Rs. Between 20,000 & 80,000 units of production, fixed cost is Rs.
50,00050,000
From 0 units (shut down) to 20,000 units, fixed cost is Rs. From 0 units (shut down) to 20,000 units, fixed cost is Rs.
25,000. If the level of activity comes to less than 20,000 units 25,000. If the level of activity comes to less than 20,000 units
some fixed costs may not be incurred such as costs on some fixed costs may not be incurred such as costs on
accounting functions, supplies, staff and so on.accounting functions, supplies, staff and so on.

21. EXAMPLEEXAMPLE
Costs of testing personal computers may not Costs of testing personal computers may not
change with a change in the volume of change with a change in the volume of
production and would be fixed in the short run.production and would be fixed in the short run.
In the long run organization may need to In the long run organization may need to
increase/ decrease testing department’s increase/ decrease testing department’s
equipment & staff to the levels needed to equipment & staff to the levels needed to
support future production volumes . support future production volumes .
So in the long run, volume of production or So in the long run, volume of production or
activity becomes cost drivers of these testing & activity becomes cost drivers of these testing &
staff costs.staff costs.

22. FIXED COST-CLASSIFICATIONFIXED COST-CLASSIFICATION
1.1.Committed costs: Incurred to maintain Committed costs: Incurred to maintain
Company’s facilities & physical existence. Company’s facilities & physical existence.
Management has little or no discretion. Management has little or no discretion.
Examples: Plant & equipment depreciation, Examples: Plant & equipment depreciation,
taxes, insurance premium rate, rent charges etc.taxes, insurance premium rate, rent charges etc.
2.2.Managed Costs: Related to current operations. Managed Costs: Related to current operations.
Paid to ensure the continued operating existence Paid to ensure the continued operating existence
of the company. Example: Management & Staff of the company. Example: Management & Staff
salariessalaries

23. FIXED COST-CLASSIFICATIONFIXED COST-CLASSIFICATION
3. Discretionary costs: Result from special policy 3. Discretionary costs: Result from special policy
decisions, management programmes, new decisions, management programmes, new
researches etc. Example: R&D Costs, Marketing researches etc. Example: R&D Costs, Marketing
Programmes, new system development costs.Programmes, new system development costs.
4. Step Costs: Constant for a given amount of 4. Step Costs: Constant for a given amount of
output and then increases in a fixed amount output and then increases in a fixed amount
after a higher output level.after a higher output level.

24. STEP COSTS - EXAMPLESTEP COSTS - EXAMPLE
In a manufacturing Company:In a manufacturing Company:
One supervisor required at a salary of Rs. 10,000 p.m. for every 50 One supervisor required at a salary of Rs. 10,000 p.m. for every 50
workers.workers.
As soon as 51As soon as 51
stst
worker is employed, cost of supervision increases to Rs. worker is employed, cost of supervision increases to Rs.
20,00020,000
Cost of supervision will go up if more than 100 workers are working.Cost of supervision will go up if more than 100 workers are working.

25. VARIABLE COSTVARIABLE COST
Costs which vary directly or proportionately Costs which vary directly or proportionately
with the output.with the output.
Direct materials cost & direct labour cost are the Direct materials cost & direct labour cost are the
costs which are generally variablecosts which are generally variable
Total variable costs change as more units are Total variable costs change as more units are
produced, per unit variable cost remains produced, per unit variable cost remains
constantconstant
Example: factory supplies, indirect materials, Example: factory supplies, indirect materials,
sales commission, office suppliessales commission, office supplies

26. VARIABLE COSTVARIABLE COST
If a factory is shut down, variable costs are If a factory is shut down, variable costs are
eliminatedeliminated
Expressed in terms of units or percentage of Expressed in terms of units or percentage of
volumevolume
Cannot be stated in terms of timeCannot be stated in terms of time

27. VARIABLE COST-BEHAVIOURVARIABLE COST-BEHAVIOUR
Behaviour pattern of direct material costBehaviour pattern of direct material cost
For every increase in units produced, there is a proportionate For every increase in units produced, there is a proportionate
increase in costsincrease in costs
Cost of direct materials increases at a constant rate of Rs. 50 per Cost of direct materials increases at a constant rate of Rs. 50 per
unit.unit.

28. VARIABLE COST – LINEAR?VARIABLE COST – LINEAR?
Variable cost may be linear only over the normal Variable cost may be linear only over the normal
range of activity levelsrange of activity levels
Beyond the normal range of activity, variable Beyond the normal range of activity, variable
cost per unit may show non-linear or curvi-linear cost per unit may show non-linear or curvi-linear
line implying variable costs are not varying in line implying variable costs are not varying in
direct proportion to output or activity changesdirect proportion to output or activity changes

29. VARIABLE COST - CONVEXVARIABLE COST - CONVEX
Where each extra unit of output causes a less Where each extra unit of output causes a less
than proportionate increase in cost i.e., than proportionate increase in cost i.e.,
economies of scale operateeconomies of scale operate

30. VARIABLE COST - CONCAVEVARIABLE COST - CONCAVE
Where each extra unit of output causes a more Where each extra unit of output causes a more
than proportionate increase in cost i.e., than proportionate increase in cost i.e.,
diminishing returns operatediminishing returns operate

31. VARIABLE COST–CURVI VARIABLE COST–CURVI
LINEAR ?LINEAR ?
In some production process, the amount of In some production process, the amount of
waste materials remain more & more constantwaste materials remain more & more constant
So when production increases, unit variable cost So when production increases, unit variable cost
for material decreases due to economies of scalefor material decreases due to economies of scale
On the other hand:On the other hand:
Diminishing returns will operate when it Diminishing returns will operate when it
becomes necessary to pay increasing differential becomes necessary to pay increasing differential
piece rates to increase productionpiece rates to increase production
A form of concave curvi–linear relationship will A form of concave curvi–linear relationship will
emerge.emerge.

32. MIXED COSTMIXED COST
Combination of semi-variable and semi fixed Combination of semi-variable and semi fixed
costs.costs.
Because of variable component – fluctuate with Because of variable component – fluctuate with
volumevolume
Because of fixed component – do not change in Because of fixed component – do not change in
direct proportion to output.direct proportion to output.

33. SEMI-FIXED COSTSSEMI-FIXED COSTS
Costs which remain constant upto a certain level Costs which remain constant upto a certain level
of output after which they become variable.of output after which they become variable.

34. SEMI-VARIABLE COSTSSEMI-VARIABLE COSTS
Cost is basically variable but whose slope may Cost is basically variable but whose slope may
change abruptly when a certain output level is change abruptly when a certain output level is
reached.reached.

35. MIXED COSTSMIXED COSTS
Mathematically mixed costs can be expressed as Mathematically mixed costs can be expressed as
follows:follows:

36. EXAMPLEEXAMPLE
Worker is paid a salary of Rs. 1500 per week Worker is paid a salary of Rs. 1500 per week
(fixed) plus a bonus of Re 1 for each unit (fixed) plus a bonus of Re 1 for each unit
completed (variable). If he increases his weekly completed (variable). If he increases his weekly
output from 1000 units to 1500 units what is the output from 1000 units to 1500 units what is the
effect on his earnings?effect on his earnings?
Units produced1,000 1,500
Fixed Component Rs. 1,500 Rs. 1,500
Variable
Component
Rs. 1,000 Rs 1,500
Total Rs. 2,500 Rs. 3,000

37. THANK YOUTHANK YOU