What is Activity Driver Analysis?

Activity driver analysis is a formal review of the activity drivers built into an activity-based costing system. An activity-based costing system is a highly-refined method for assigning overhead costs to products, product lines, sales regions, and other cost objects.

The intent of the analysis is to evaluate whether there is an actual causal relationship between the drivers and their associated cost objects. If not, the drivers must be replaced. The analysis also investigates whether different drivers can be used, for which data accumulation is easier and/or less expensive. This can be a major issue, since some drivers require customized data collection systems that are quite expensive. Finally, the analysis should investigate whether costs can be reduced by minimizing certain activities. In total, these analysis activities can result in a much more cost-effective activity-based costing system.

Advantages of Activity Driver Analysis

There are several reasons why a business should conduct a periodic activity driver analysis. They are as follows:

More accurate cost allocation. Shifting to activity drivers with a strong causal relationship with cost objects results in a more accurate and defensible assignment of overhead costs. This can result in better costing of cost objects.
Better decision-making. Since overhead costs are being assigned more accurately with activity drivers, management has better costing information that it can use as the basis for its decision-making. This could lead to pricing changes or the termination of some products.
Tighter focus on value-added activities. Activity driver analysis shows the most accurate costs of value-added and non-value-added activities. This can result in targeted management decisions to eliminate or better manage the most expensive non-value-added activities.
Better customer analysis. When activity drivers are used to assign costs to individual customers, management can determine which customers are the most and least profitable. This can result in decisions to eliminate the least-profitable customers, while drawing attention to those customers that generate the most profits for the company.