Question

Determine the difference between a cost object and a cost driver by giving an example of each within the context of a manufacturing plant of your own choosing. Be specific. Explain why this differentiation is important in activity-based costing (ABC).

Answer 1

Definition: A cost object is a managerial term for a product, process, department, or customer that costs originate from or are associated with. In other words, it’s something that costs can be identified with and traced back to.

Take a production process for example. When a company makes a product, it spends money on raw materials. This cost can be traced back to the products that the materials went into. Thus, the product is the cost object. It generates the costs and all the expenses can be traced back to it or associated with it.

Other direct costs for a product can include salaries for production employees, equipment purchased to produce the products, and maintenance done on assembly line.

Keep in mind that anything that generates costs or has expenses associated with it can be considered a cost object. This isn’t reserved to just products. A department like the sales department can be an object. There are many selling expenses that are traceable back to the sales department including rent for selling space, sales staff salaries, and displays for promotion and selling purposes.

Even customers can be considered objects if they have cost and expenses attributed to them. For instance, special delivery costs can be associated with specific customers.

Managerial accountants use all of these costs and their cost objects to analyze activity based costing models and identify ways that the company can be more efficient.

A cost driver triggers a change in the cost of an activity. The concept is most commonly used to assign overhead costs to the number of produced units. It can also be used in activity-based costing analysis to determine the causes of overhead, which can be used to minimize overhead costs. Examples of cost drivers are as follows:

• Direct labor hours worked

• Number of customer contacts

• Number of engineering change orders issued

• Number of machine hours used

• Number of product returns from customers

If a business is only concerned with following the minimum accounting requirements to allocate overhead to produced goods, then just a single cost driver should be used.