# What Is an Activity Cost Driver?

![Activity Cost Driver](https://www.investopedia.com/thmb/jpIqECKr2KQ-J1j-YArC6OlulSI=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/activity-cost-driver_final-f989e9fe789a4912be2f38434160eadd.png)

*Activity cost drivers are a key part of activity-based costing, which helps companies to accurately allocate their indirect costs. — Jessica Olah / Investopedia*

> **Definition**
>
> An activity cost driver is a measurable event or factor that leads to a change in the cost of a business activity.

## What Is an Activity Cost Driver?

An activity cost driver is something that drives the costs of a business. Put simply, it's anything that causes a company's variable costs to change. These drivers help companies (and their investors) understand why they spend money on certain business functions so they can make better decisions. Companies can monitor activity cost drivers to boost efficiency and company profits, price their products, and eliminate waste.

### Key Takeaways

*   An activity cost driver triggers higher or lower variable costs for a business.
*   Companies can monitor these drivers to help them make better decisions.
*   Activity cost drivers can help companies boost efficiency and profits.

## Accounting for Cost Drivers

In ABC, an activity cost driver influences the costs of labor, maintenance, or other variable costs. ABC is a branch of [managerial accounting](https://www.investopedia.com/terms/m/managerialaccounting.asp) that allocates the indirect costs, or [overheads](https://www.investopedia.com/terms/o/overhead.asp), of an activity. Multiple cost drivers may be associated with an activity. Types of cost drivers include:

*   **Direct labor hours:** A driver of most activities in product [manufacturing](https://www.investopedia.com/terms/m/manufacturing.asp). If the expenditure on labor is high, this will increase the cost of producing all products or services.
*   **Warehousing costs:** If the cost of warehousing is high, it increases the expenses incurred for product manufacturing or providing services.
*   **Machine hours:** A technical [cost driver](https://www.investopedia.com/articles/basics/04/100804.asp) that includes machine setups required for production.
*   **Engineering change orders:** Costs incurred when a [specification](https://www.investopedia.com/terms/m/make-to-order.asp) is revised.
*   **Machine setups:** Costs required for production and the number of production inspections.

> **Tip**
>
> If business owners can identify the cost drivers, they can more accurately estimate the true cost of production and determine the per-item and batch-level costs.

## Example

When a factory machine requires periodic maintenance, the maintenance cost is allocated to the products produced by the machine. For example, the cost driver selected is machinery hours.

After every 1,000 machine hours, there is a maintenance expense of $500. Therefore, every machine hour results in a $.50 (500 ÷ 1,000) maintenance cost allocated to the product being manufactured based on the cost driver of machine hours.

Using cost drivers simplifies the allocation of manufacturing overhead and helps determine the true cost of one product. Management uses the cost of a product to determine the price of the product. For this reason, the selection of accurate cost drivers directly affects an entity’s profitability and operations.

> **Important**
>
> Activity-based costing (ABC) is a more accurate way of allocating direct and indirect costs. ABC calculates the cost of each product by identifying the resources consumed by a business activity, such as electricity or man-hours.

## How Do Businesses Select Cost Drivers?

Management selects cost drivers as the basis for manufacturing overhead allocation. No industry standards are stipulating or mandating cost driver selection. Company management selects cost drivers based on the variables of the expenses incurred during production.

## What Is the Benefit of Identifying Cost Drivers?

Cost drivers are the activities that trigger business expenses and variable costs associated with the driver can be tied directly to each product or service.

## What Is the Benefit of the Activity-Based Costing Method?

Activity-based costing (ABC) is a method of assigning overhead and indirect costs—such as salaries and utilities—to products and services. Doing this helps to get a better grasp on costs, allowing companies to form a more appropriate pricing strategy.

## The Bottom Line

Examining activity cost drivers helps companies reduce unnecessary expenses and pinpoint the costs of an individual product or service. Businesses that can assign variable costs may develop a better pricing strategy and increase profits.

> **Article Sources**
>
> 1.  Harvard Business Review. "[Tapping the Full Potential of ABC](https://hbr.org/1995/07/tapping-the-full-potential-of-abc)."