How cost driver analysis should be made?

A greater number of cost drivers can be identified than should be used for cost accumulation or activity elimination. Management should limit the cost drivers selected to a reasonable number and ascertain that the cost of measuring a driver does not exceed the benefit of using it. A cost driver should be easy to understand, directly related to the activity being performed, and appropriate for performance measurement.

Costs have traditionally been accumulated into one or two cost pools (total factory overhead or variable and fixed factory overhead), and one or two drivers (direct labor hours and/or machine hours) have been used to assign costs to products. These procedures cause few, if any, problems for financial statement preparation. However, the use of single cost pools and single drivers may produce illogical product or service costs for internal managerial use in complex production(or service) environments.

See how activity analysis is combined with cost driver analysis to create a tool for managing costs. While cost driver analysis identifies the activities causing costs to be incurred, the activity analysis highlights activities that are not value-adding and can be targeted for elimination to reduce costs and product prices.