Review Notes (Chap 3 to Chap 6)

1. Important Concepts:
Cost Drivers and Cost Pools. A cost driver is any factor that has the effect of changing the level of total cost. In cost leadership, managing cost drivers is essential. A firm incurs a cost when it uses a resource for some purpose. Often costs are collected into meaningful groups called cost pools. Since individual costs can be group in several different ways, cost pools can be defined in several different ways as well (by cost type, source, or responsibility).
Cost Allocation: Direct and Indirect Costs. A direct cost can be conveniently and economically traced to a cost object or pool. In contrast, there is no convenient or economical way to trace indirect costs from cost or cost pool to the cost pool or cost object. Indirect costs are caused by two or more cost pools or objects, but cannot be directly traced to either one. Because of this difficulty, indirect costs are traced using cost drivers. The result is that indirect costs are assigned to the cost pool or object that caused the costs in the manner that is fairly representative of the way the cost was incurred. This assignment of indirect costs is known as cost allocation, which is a form of cost assignment used when direct tracing is not possible. The cost drivers used in the allocation are called allocation bases.
Cost Drivers: activity-based and volume-based. Activity-based drivers are developed at a detailed level of operations and are associated with a given manufacturing activity. Volume-based cost drivers are developed at an aggregate level.
Activity-Based Cost Drivers. Activity-based cost drivers are identified by using activity analysis, a detailed description of the specific activities performed in the firm’s operations. For each activity, a cost driver is developed to explain how the costs incurred for that activity