A cost driver is anything (it can be an activity, an event or a volume of something) that causes costs to be incurred each time the driver occurs. Examples of cost drivers are set-ups, moving, number of parts, casting, packaging and handling.

A cost-allocation base is anything that an overhead cost allocation is based upon. In order for overhead costs to be allocated realistically, a strong cause-and-effect relationship should exist between each particular overhead cost and the allocation base used to allocate it. In fact, when there is a strong cause-and-effect relationship between the cost and its allocation base, the allocation base is the cost driver for the overhead cost to be allocated.

And this is the case in a refined costing system such as Activity Based Costing. The allocation base is the cost driver for each overhead cost being allocated. In a traditional costing system which is less refined, the allocation base usually is not the cost driver for the overhead costs being allocated, and that is the weakness of traditional cost systems.

For example, under an ABC costing system, the overhead costs of setting up batches of different products might be accumulated in a cost pool. Then, the total costs would be allocated among the different products manufactured according to the number of setups performed for each product or perhaps according to the number of minutes or hours of setup time spent on each product.

On the other hand, in a traditional costing system, setup costs would probably not be segregated in a cost pool the way they would be in an ABC system. Instead, setup costs would be lumped together with all other overheads. The total overhead costs would then be allocated on some general basis such as direct labor hours spent on each product, or machine hours used for each product. Under a traditional costing system, these general cost allocation bases would not be the cost drivers for many of the costs being allocated according to them.