Activity Driver Analysis
Activity driver analysis is the process of identifying, evaluating, and selecting the most appropriate activity drivers for allocating overhead costs in an activity-based costing (ABC) system. An activity driver is a factor that causes a change in the cost of an activity and is used to assign the costs of that activity to the products or services that consume the activity resources.
The purpose of activity driver analysis is to gain a better understanding of the relationship between activities, their cost drivers, and the products or services that consume resources. By doing so, organizations can allocate overhead costs more accurately, improve cost management, and make informed decisions about resource allocation, pricing, and process improvements.
Here are the steps involved in activity driver analysis:
- Identify activities: List all the activities performed within the organization that consume resources and contribute to overhead costs.
- Determine cost pools: Group the identified activities into cost pools, which are categories of related activities that share similar cost drivers.
- Select activity drivers: For each cost pool, identify potential activity drivers that have a strong causal relationship with the costs of the activities in the pool. These drivers should be measurable and capable of accurately reflecting the consumption of resources.
- Collect data: Collect data on the activity drivers, such as the number of units produced, machine hours, or the number of setups.
- Analyze the data: Analyze the data to determine the relationship between the activity drivers and the costs of the activities. This may involve statistical analysis or other methods to verify the strength of the relationship between the driver and the activity costs.
- Allocate costs: Use the selected activity drivers to allocate overhead costs to the products or services that consume the resources associated with each activity.
By performing activity driver analysis, organizations can improve the accuracy of their cost allocations and make more informed decisions about resource allocation, process improvements, and pricing strategies.
Example of an Activity Driver Analysis
Let’s consider a manufacturing company that produces three types of products: A, B, and C. The company wants to analyze its overhead costs and identify the most appropriate activity drivers to allocate these costs accurately.
Step 1: Identify activities The company identifies the following activities that consume resources and contribute to overhead costs:
- Machine setups
- Quality inspections
- Material handling
Step 2: Determine cost pools The company creates three cost pools corresponding to the identified activities:
- Setup cost pool
- Inspection cost pool
- Material handling cost pool
Step 3: Select activity drivers The company identifies the following potential activity drivers for each cost pool:
- Setup cost pool: Number of setups
- Inspection cost pool: Number of inspections
- Material handling cost pool: Number of material movements
Step 4: Collect data The company collects data on the activity drivers for each product type:
Product A:
- 40 setups
- 30 inspections
- 50 material movements
Product B:
- 20 setups
- 40 inspections
- 30 material movements
Product C:
- 10 setups
- 20 inspections
- 20 material movements
Step 5: Analyze the data The company analyzes the data and confirms that the selected activity drivers have a strong causal relationship with the costs in each cost pool.
Step 6: Allocate costs Using the selected activity drivers, the company allocates overhead costs to each product type. For example, if the total cost in the setup cost pool is $6,000, the company can allocate the costs as follows:
Product A: (40 setups / 70 total setups) * $6,000 = $3,429 Product B: (20 setups / 70 total setups) * $6,000 = $1,714 Product C: (10 setups / 70 total setups) * $6,000 = $857
The company would perform similar calculations for the inspection and material handling cost pools.
By performing activity driver analysis and using the identified drivers to allocate costs, the manufacturing company can accurately determine the overhead costs associated with each product type, enabling better decision-making about resource allocation, pricing, and process improvements.
