Cost Driver Analysis
an analysis of any expense that changes or affects the cost of an activity. In other words, cost driver analysis is the evaluation of activity-based costing.
How Cost Driver Analysis Works
When you understand what a cost driver is and what it does, you can understand how cost driver analysis also works. A cost driver represents any factor that affects an activity's cost — especially an activity related to manufacturing products. The combination of several cost drivers dictates the actual cost of whatever you manufacture. It's helpful to know that different industries have different, strategic cost drivers.
Cost driver analysis is an in-depth review of the cost drivers to make sure that your company correctly allocates production costs to all goods and services. There are different cost driver analysis methods, including a cost accounting system review, industry analysis, and internal activity analysis.
Managerial accountants are the people mainly responsible for handling cost driver analysis. These individuals can make suggestions for introducing better cost drivers for your company's cost allocation process. Making educated decisions about your cost drivers can help you keep your profit margin on-target.
Example of Cost Driver Analysis
As an example of cost driver analysis, let's say you have an ice cream company named Donnie's. Imagine that you are considering purchasing a new ice cream machine. Based on the machine's capacity, you would need to clean the ice cream machine after every 200 ice cream cones you make and sell. In this case, your cost driver would be the number of ice cream cones your company produced.
The cost of cleaning the ice cream machine is $50. Looking at this, we can tell that it costs $50 for every 200 ice-cream cones you make. This means with every ice cream cone your company sells, 25 cents of your revenue is being allocated to each ice cream cone.
Now you know the activity cost driver here, helping you to determine the margin that Donnie's would make on each ice-cream cone. With this information, you might consider a machine that would allow you to produce more ice cream cones before it required maintenance.
Cost Accounting Analysis Vs. Cost Driver Analysis
It's easy to confuse cost accounting and cost driver analysis. While the two are different, they share an important role in helping a company get a handle on its expenses. A cost accounting system is how a company captures correct cost information and places the data into allocation pools. Cost accounting analysis is important because your company needs to guarantee that it uses the right cost accounting system for its production process. For instance, batches of specific products, like baby bibs, probably need a job order cost system. In this case, your company's Managerial accountant will gather costs for every batch of booties produced.
Cost driver analysis is an internal activity too. For instance, managerial accountants usually review every action in a production process. The accountants list all current cost drivers and assess the ability to allocate costs to each batch or good produced. If your company has changed its production method, you might need recommendations for better or new cost drivers. The cost driver analysis outcome then dictates what new driver is a better fit for your company's internal production system.
Under cost driver analysis, an external review process is also possible. Companies in the same industry usually use similar cost accounting systems. It may be better for your company to use your competitors' cost drivers than opt for its current cost drivers. However, you should be careful here since production processes can significantly vary between multiple companies. Managerial accountants can conduct a review to confirm if a new cost driver will work for your company's production system based on industry analysis.