Time-Driven Activity Based Costing
Activity-based costing (ABC) is a costing method that is usually used as a supplement to a company’s usual costing system, and is therefore used for internal decision-making. It is designed to inform managers of costing information for decisions (strategic and others) that potentially affect capacity and consequently “fixed” as well as variable costs. In addition, ABC can also be used to pinpoint activities that would benefit from process improvements.
Traditional ABC problems
The traditional Activity-Based Costing is implemented using the following steps [1]:
Define activities, activity cost pools, and activity measures.
Assign overhead costs to activity cost pools.
Calculate activity rates.
Assign overhead costs to cost objects using the activity rates and activity measures.
Prepare management reports.
Implementing a traditional ABC system is a substantial project requiring a lot of resources. It works well in a smaller setting such as a single department, plant or location; however, it becomes quite cumbersome on a large scale for use on an ongoing basis. Once implemented, ABC is costly to maintain and update since it consists of data concerning many activity measures that are periodically collected, checked and entered into the system.
As a result, systems that are put in place for ABC are updated infrequently and the model’s estimates of process, product and customer costs soon become inaccurate. In addition, the complexity of actual operations tends to get overlooked by traditional ABC models.
Furthermore, estimated cost-driver rates in traditional ABC models are usually overstated, since cost driver rates are often calculated assuming that resources are ...
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... and cheaper to implement, but also much more accurate. The time-driven ABC approach therefore better allocate the costs to a given activity, customer, location or product. In addition, time-driven ABC allows for unused capacity to be identified, therefore enabling operational improvements, and detection of non-value added activities.
References:
[1] Noreen, Eric W., Brewer Peter C., et al., Managerial Accounting for Managers, Second Edition, McGraw-Hill/Irwin, New York, NY, 2011.
[2] Stout, David E., Propri, Joseph M., Implementing Time-Driven Activity-Based Costing at a Medium-Sized Electronics Company, Management Accounting Quarterly, Vol. 12, No. 3, Spring 2011.
[3] Robert S. Kaplan and Steven R. Anderson, Time-Driven Activity-Based Costing: A Simpler and More Powerful Path to Higher Profits, Harvard Business Publishing, Boston, Mass., 2007.
At the outset, any organisation requires details and analyses while adopting ABC system as an ongoing system. Due to the rapidly-changing technological environment, the ABC models are proactively required to be updated in order to escape from obsolete and irrelevant information. However, the cost of updating that information is very expensive (Langfield-Smith, Thorne, Smith, & Hilton, 2015). If the ABC system is meant for activity management and product costing purposes, then the level of complexity will escalate significantly because such costing system entailed a vast analysis of costs and activities (Weygandt, Paul, & Donald, 2015).
Conventional Activity Based Costing (CABC) was first introduced by Robert Kaplan and Robin Cooper in the late 1980s through a series of papers published in the Harvard Business Review. The method aimed to correct deficiencies with the standard cost systems; the systems which attempted to cram all of a company’s costs into three broad categories – labor, materials, and overhead (Kaplan, 2007, p. 15). Such a system lacked the resiliency and versatile data management that was necessary to adapt to market demand changes that came with the twentieth century. While businesses improved to meet the market demands with services such as increased product variety, smaller order sizes, direct delivery, and specialized technical support, their traditional cost systems could not support efficient resource allocation for the rising costs to provide all those services. CABC sought to fix these issues. Cooper and Kaplan’s ABC system improved efficiency by assigning costs down to the product/orders level, enabling managers to better recognize where money was being wasted and where it needed to be invested. The basic model looked like this:
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