Definition: An activity cost driver, also called a casual factor, is an element that causes the cost of an activity to increase or decrease. In other words, it’s a factor associated with a production process or activity that can cause volatility in the cost of production or activity time.
What Does Activity Cost Driver Mean?
Activity cost drivers are associated with the managerial accounting concept of activity based costing where job activities are divided in to cost pools based on their cost driver in an effort to properly allocate indirect costs to products based on the amount of activities required to produce them. The cost driver can be anything in the pool that causes the cost of the activities to increase or decrease.
An example of an activity cost driver in a manufacturing plant is the number of orders that must be produced. Take the Ford plant for example. Everyday thousands of cars are ordered into the production line by management. Each department from painting to assembly has a set amount of cars that must be completed each day. If this number changed, the cost of production would also change.
Increased levels of production would require more paint, more parts, and more workforce labor time to assemble. The opposite is true if production decreased. Thus, number of units required to produce is one cost driver in the vehicle production process.
Since “production” is a very large cost pool, it would most likely be split into smaller cost pools in a real system. For instance, the painting process would be split into its own cost pool including activities like bodywork, sanding, buffing, and spraying. A cost driver for the painting department might be the increased wages in accordance with the new union agreement. Since preparing car bodies is a fairly labor intensive operation, an increase in wages can drastically increase the cost of the activity.