Time‐Driven Activity‐Based Costing: An Implementation in a Manufacturing Company

• Date: 01 March 2016
• DOI: http://doi.org/10.1002/jcaf.22144
• Author: Hümeyra Adıgüzel,Figen Öker
• Published date: 01 March 2016

39

© 2016 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).

DOI 10.1002/jcaf.22144

75

© 2010 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).

DOI 10.1002/jcaf.20646

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Figen Öker and Hümeyra Adıgüzel

Activity-based

costing (ABC)

was developed

in the 1980s to solve

the problems caused

by inaccurate alloca-

tion of overhead costs

using traditional cost

accounting systems.

Although ABC can

lead to a better picture

of profitability, implementing

ABC can be fraught with prob-

lems. To address these problems,

time-driven activity-based cost-

ing (TDABC) was developed.

It links general ledger costs

directly to departments rather

than activities, allocating over-

head and indirect costs to prod-

ucts or services according to the

actual work demanded from the

departments by the products or

services.

This article discusses how

TDABC can be used in a manu-

facturing company. TDABC may

be more appropriate and easier to

implement for service companies

than manufacturing companies,

yet it can still prove appropriate

and useful for manufacturing

companies in which capacity

commonly can be expressed as a

time measure.

INTRODUCTION

It had become clear by the

1980s, when activity-based

costing systems were first

introduced, that standard cost

accounting systems often provide

inaccurate costs. Because stan-

dard costing systems typically

allocate overhead costs to prod-

ucts based on a single volume-

based cost driver, they provide

distorted information about the

relative profitability of products,

especially in industries in which

the direct labor con-

tent of products has

decreased significantly

over the years.

ABC systems

were designed to solve

this problem, because

ABC assigns overhead

costs and indirect

costs (using various

cost drivers) first to

activities and then to products or

services, thus providing better

information for making decisions

about process improvements,

customer relationships, and

pricing.

Despite the benefits of ABC,

it never gained widespread accep-

tance, largely because of prob-

lems in implementing it. ABC

usually requires time-consuming

surveys and high data-processing

costs; in addition, there are sig-

nificant behavioral and organiza-

tional hurdles.

The surveying problem lies

in having to interview employees

to determine how they spend

their time between all the various

activities they help perform. This

This article demonstrates the implementation

of time-driven activity-based costing (TDABC)

in a manufacturing company, showing how it

can provide far more relevant information about

product profitability and capacity utilization than

standard costing.

© 2010 Wiley Periodicals, Inc.

Time-Driven Activity-Based Costing:

An Implementation in a Manufacturing

Company

This article was originally published in Volume 22, Number 1 of The Journal of Corporate Accounting & Finance.

40 The Journal of Corporate Accounting & Finance / March/April 2016

DOI 10.1002/jcaf © 2016 Wiley Periodicals, Inc.

76 The Journal of Corporate Accounting & Finance / November/December 2010

DOI 10.1002/jcaf © 2010 Wiley Periodicals, Inc.

cost rate (the unit cost of sup-

plying capacity) for the depart-

ment and the capacity usage by

each transaction processed in the

department—in other words, the

consumption of capacity by the

activities the organization per-

forms for products, services, and

customers.

The capacity cost rates

are calculated as the ratio of

departmental costs to practi-

cal capacity. Calculation of the

cost of supplying a department’s

resource capacity is made by

aggregating all the costs asso-

ciated with a department. For

example, the cost of resources

supplied to an operating depart-

ment may consist of elements

such as:

compensation of front-•

line employees and their

supervisors;

occupancy, technology, •

and other equipment

costs; and

the cost of supporting •

functions that support

the work performed in

the department (Kaplan

& Anderson, 2007).

Estimating practical

capacity (which is the denomina-

tor of the formula) is an impor-

tant consideration in calculating

unit costs. Practical capacity can

be assumed to be a percentage of

theoretical capacity, or it can be

calculated analytically (Kaplan

& Anderson, 2007).

One of the estimates

required by TDABC is the con-

sumption of capacity (time) by

the activities performed for prod-

ucts, services, and customers.

Estimates of the time required to

perform a specific activity can

be made through direct observa-

tion, by interviewing and survey-

ing employees, or through engi-

neering techniques.

(ERP) and customer relation-

ship management systems.

It drives costs to transactions •

and orders using specific

characteristics of particular

orders, processes, suppliers,

and customers.

It can be run monthly to •

capture the economics of the

most recent operations.

It provides visibility to pro-•

cess efficiencies and capac-

ity utilization.

It forecasts resource demands, •

allowing companies to budget

for resource capacity on the

basis of predicted order quan-

tities and complexity.

It is easily scalable to enter-•

prisewide models via enter-

prise-scalable software and

database technologies.

It enables fast and inexpen-•

sive model maintenance.

It supplies granular infor-•

mation to assist users with

identifying the root cause of

problems.

It can be used in any indus-•

try or company with com-

plexity in customers, prod-

ucts, channels, segments,

and processes, as well as

large amounts of people and

capital expenditures.

Taking Capacity Into Account

TDABC systems require

only two estimates: the capacity

interviewing is time-consuming

and costly. Employees have to

estimate how much time they

spend on a list of activities by

reporting percentages that must

add up to 100 percent. Such esti-

mates can be biased, of course,

because few employees report

that any percentage of their time

is idle or unproductive. Hence,

cost-driver rates are calculated,

assuming that resource capaci-

ties are fully used (Kaplan &

Anderson, 2003).

Another problem associ-

ated with ABC implementa-

tions occurs because of the high

cost of continually updating an

ABC model, since processes,

activities, and product lines often

change. Because of this high

cost, many ABC systems are

rarely updated, thus leading

to out-of-date activity cost-

driver rates and inaccurate

estimates of processes,

product, and customer

costs (Kaplan & Anderson,

2003).

TIME-DRIVEN ACTIVITY-

BASED COSTING

To solve these prob-

lems, Kaplan and Ander-

son introduced the concept of

time-driven activity-based cost-

ing. The concept was originally

developed by Steven Anderson

in 1997 and practiced through

his company, Acorn Systems,

Inc. In 2001, Anderson worked

with Robert Kaplan, a professor

at Harvard Business School, to

improve the approach.

The expected benefits of the

TDABC approach are highlighted

by Kaplan and Anderson (2007):

It is easier and faster to build •

an accurate model.

It integrates well with data •

already available from

enterprise resource planning

TDABC systems require only two

estimates: the capacity cost rate (the

unit cost of supplying capacity) for

the department and the capacity

usage by each transaction processed

in the department.