Question

"Use of a single cost driver rate when an indirect cost pool includes costs that have different cost drivers (causes of costs) leads to distortions in job costs." Do you agree with this statement? Explain.

Answer 1

In accounting, the cost driver is the unit of an activity which leads to the change in cost of activity. When multiple cost drivers a separate cost driver rate must be determined for each cost pool. When separate cost driver rate is determined it can eliminate the cost distortions because it develops cost drivers which reflect the cause-and-effect relationship with the performed activities. The separate cost driver has its own cost pool, which includes the group of individual costs connected with an activity. Instead of just one cost driver such as machine hours, it is better to use multiple cost drivers to allocate a manufacturer's indirect costs. A few of the cost drivers that can be used include the cost of material purchased or used, the number of machine setups involved, counting the number of engineering change orders, and the number of machine hours. A rise in measurement costs for a widely detailed cost system need to be traded off against the benefit of enhanced accuracy in estimation of the product costs.