ACCA MA Syllabus C. Cost Accounting Techniques - Identifying Cost Drivers - Notes ^{2 / 7}

Absorption costing focuses on the product in the costing process.

Costs are traced to the product because each product item is assumed to consume the resources.

However, in many modern-manufacturing operations, overheads are not homogeneous in terms of being primarily influenced by volume.

In fact, the majority of overheads in a modern manufacturing operation are largely unaffected by changes in production volume.

ABC links overhead costs to the products or services that cause them by absorbing overhead costs on the basis of activities that ‘drive’ costs (cost drivers) rather than on the basis of production volume.

In ABC, activities are the focus of the costing process.

Costs are traced from activities to products based on the products demands for these activities during the production process.

Activities may include equipment preparation, order handling, quality control.

'Cost driver' is the term used for an activity which influences the amount of total expenditure on a particular cost.

For some costs, volume will be the cost driver, but for many other costs, volume will be a very poor indicator.

By grouping costs on the basis of cost drivers, we will be able to both manage costs better (by managing the activity) and to calculate the cost of production.

Examples of cost drivers would be:

1. Ordering costs – no. of orders

2. Set-up costs – no. of set-ups

3. Packing costs – no. of packing orders