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Chapter 2: Problem 6

What is a cost driver? Give one example.

Short Answer

Expert verified
A cost driver is an activity or factor that influences the level of cost incurred within an organization, serving as a basis for assigning indirect costs to products, services, or other cost objects. One example of a cost driver is the number of machine hours used in a manufacturing facility, which indirectly influences the total cost of production as more machine hours result in higher costs associated with operating, maintaining, and servicing the machinery.

Step by step solution

01

Define a Cost Driver

A cost driver is an activity or factor that influences the level of cost incurred within an organization. It is a specific measure or event that can be used as a basis for assigning indirect costs to products, services, or other cost objects.
02

Give an Example of a Cost Driver

One example of a cost driver is the number of machine hours used in a manufacturing facility. The more machine hours used, the higher the total cost of production, as it depends on the costs associated with operating, maintaining, and servicing the machinery. In this case, machine hours drive the cost of production indirectly, as more machine hours result in higher costs to the organization.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Indirect Costs
Indirect costs are the expenses that are not directly linked to the production of goods or services. These are costs that cannot be traced back to a single cost object easily.
They include expenses like utilities, rent, and administrative salaries that are necessary for overall operations but are challenging to assign directly to a specific product.
There are two main categories of indirect costs:
  • Fixed Indirect Costs: These remain constant regardless of the level of production or sales, such as rent or executive salaries.
  • Variable Indirect Costs: These fluctuate with changes in production volume, like factory supplies.
Understanding indirect costs is important because it helps in assessing the true cost and profitability of producing a product or service. These costs must be allocated to ensure accurate financial statements.
Cost Allocation
Cost allocation is the process of distributing indirect costs across different products, services, or departments. The purpose is to assign these costs in a manner that reflects the usage of resources.
This process involves selecting a suitable method to apportion costs, ensuring that each product or service is carrying its fair share of the indirect expenses. There are several methods of cost allocation:
  • Direct Allocation: Assigning costs directly to a cost object despite being indirect. This method is used when costs can be linked closely to the cost object.
  • Step-Down Method: Allocates costs in a sequential manner, where once a department's costs are allocated, that department is excluded from future allocations.
  • Activity-Based Costing (ABC): Allocates costs based on actual activities that drive costs, often using multiple cost drivers, like machine hours or labor hours.
Correct cost allocation leads to more precise pricing strategies and profitability analysis. It helps in making informed managerial decisions by depicting an accurate cost structure of the enterprise.
Manufacturing Costs
Manufacturing costs are the expenses incurred in the production of goods. These costs include all the necessary expenditures for creating a product, covering materials, labor, and overheads.
They are generally divided into three categories:
  • Direct Materials: Raw materials that are directly traceable to the finished product.
  • Direct Labor: The cost of employees directly involved in the manufacturing process. Think of wages for workers on an assembly line.
  • Manufacturing Overhead: All the other costs that are not directly traceable to the product. This includes indirect costs like utilities for the production area, equipment depreciation, and a portion of supervisory wages.
For effective management of these costs, it is crucial to understand the breakdown and contribution of each category.
By doing so, businesses can analyze their efficiency, calculate unit costs, and set competitive pricing.
This understanding also ties into cost drivers, as certain activities will influence the level of manufacturing costs incurred, helping refine control and optimization strategies.

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Most popular questions from this chapter

Variable costs, fixed costs, relevant range. Gummy Land Candies manufactures jaw-breaker candies in a fully automated process. The machine that produces candies was purchased recently and can make 5,000 per month. The machine costs \$6,500 and is depreciated using straight-line depreciation over 10 years assuming zero residual value. Rent for the factory space and warehouse and other fixed manufacturing overhead costs total \(\$ 1,200\) per month Gummy Land currently makes and sells 3,900 jaw-breakers per month. Gummy Land buys just enoughh materials each month to make the jaw-breakers it needs to sell. Materials cost \(40 \mathrm{c}\) per jaw-breaker will get a \(10 \%\) discount on price. Rent and other fixed manufacturing overhead costs will remain the same. 1\. What is Gummy Land's current annual relevant range of output? 2\. What is Gummy Land's current annual fixed manufacturing cost within the relevant range? What is the annual variable manufacturing cost? 3\. What will Gummy Land's relevant range of output be nextyear? How, if atall, will total annual fixed and variable manufacturing costs change next year? Assume that if it needs to Gummy Land could buy an identical machine a t the same cost as the one it already has.

Distinguish between inventoriable costs and period costs.

Classification of costs, merchandising sector. Band Box Entertainment (BBE) operates a large store in Atlanta, Georgia. The store has both a movie (DVD) section and a music (CD) section. BBE reports revenues for the movie section separately from the music section. Classify each cost item (A-H) as follows: a. Direct or indirect (D or I) costs of the total number of DVDs sold. b. Variable or fixed (V or F) costs of how the total costs of the movie section change as the total number of DVDs sold changes. (If in doubt, select on the basis of whether the total costs will change substantially if there is a large change in the total number of DVDs sold. You will have two answers (D or I; V or F) for each of the following items: Cost Item A. Annual retainer paid to a video distributor B. cost of store manager's salary C. costs of DVDs purchased for sale to customers D. Subscription to DVD Trends magazine E. Leasing of computer software used for financial budgeting at the BBE store F. cost of popcorn provided free to all customers of the BBE store G. cost of cleaning the store every night after closing H. Freight-in costs of DVDs purchased by BBE

Labor cost, overtime, and idle time. David Letterman works in the production department of Northeast Plastics (NEP) as a machine operator. David, a long- time employee of NEP, is paid on an hourly basis at a rate of \(\$ 24\) per hour. David works five 8 -hour shifts per week Monday-Friday (40 hours). Any time David works over and above these 40 hours is considered overtime for which he is paid at a rate of time and a half \((\$ 36\) per hour). If the overtime falls on weekends, David is paid at a rate of double time (\$48 per hour). David is also paid an additional \(\$ 24\) per hour for any holidays worked, even if it is part of his regular 40 hours. David is paid his regular wages even if the machines are down (not operating) due to regular machine maintenance, slow order periods, or unexpected mechanical problems. These hours are considered "idle time." During December David worked the following hours: Included in the total hours worked are two company holidays (Christmas Eve and Christmas Day) during Week \(4 .\) All overtime worked by David was Monday- Friday, except for the hours worked in Week 3 ; all of the Week 3 overtime hours were worked on a Saturday. 1\. Calculate (a) direct manufacturing labor, (b) idle time, (c) overtime and holiday premium, and (d) total earnings for David in December. 2\. Is idle time and overtime premium a direct or indirect cost of the products that David worked on in December? Explain.

What are three common features of cost accounting and cost management?
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