Final answer:
In choosing cost drivers, one must ensure the driver has a strong relationship with cost behavior, explains changes in cost over the relevant activity range, and can be measured in a cost-effective manner.
Step-by-step explanation:
When evaluating cost functions and choosing cost drivers in a business context, three important criteria to consider are:
- The relationship between the cost driver and the cost behavior
- The ability of the cost driver to explain changes in the cost over the relevant range of activity
- The cost and practicality of measuring the cost driver
Cost drivers should have a clear and direct correlation to costs, enabling businesses to predict and control their expenses effectively. A strong cost driver should account for changes in costs as the driver itself changes, providing insight into cost behavior. Additionally, it is crucial that the driver chosen can be easily and affordably measured to ensure that the monitoring process does not become prohibitively expensive or complex.
An understanding of the relationship between production and costs, as well as the insights gained from breaking down total costs into various categories like fixed cost, marginal cost, average total cost, and average variable cost, is central to choosing appropriate cost drivers.