Activity driver refers to an activity driver analysis that identifies and analyses the factors involved in the costing of goods and services as a part of activity-based costing. This system understands the relationship between costs, overhead activities, and manufactured products. Through this relationship, it establishes indirect costs. The ADA factors in the different sources through which cost is driven. Its analysis includes the relationships between activities and factors that drive the cost of such activities and ultimately provides management the tool to measure whether certain activities are more costly and whether certain drivers are easier to measure.
An activity cost driver in a cloth manufacturing business is the number of orders placed. Now every department, from sourcing the fabric to sewing to the finished product, has a set amount of orders that must be completed every day. If the amount of order changes, the cost of production would change too.
An increased number of orders would require the purchase of more fabric, additional workforce, and time required for assembly of the product. Thus one of the factors that drive cost is the number of units of a product being produced.
An activity driver analysis allows the management to evaluate a company’s expenses. By pinpointing the exact source of different expenses, companies can analyze the unnecessary expenses and eliminate them. If one does not allocate cost to the factors driving activity, then the comparison between the costs of different products and services remains meaningless.
Activity cost drivers are also important in project costs. There are, however, no accounting standards for the exact calculation of cost drivers. They are only used as a tool by the management in order to understand which activities are causing certain expenses and arriving at the accurate cost of producing particular products or businesses. Cost drivers are always an estimate.
Accountants who evaluate cost drivers must possess a thorough understanding of the costs involved in the production of a particular good or service. Then they can determine an activity’s impact on the production of the product.