Abstract
The Traditional Activity-Based Costing model has been difficult for many organizations to implement because of the high costs incurred to interview and survey people. The Time Driven Activity-Based Costing requires estimates of only two parameter (i) the unit cost of supplying capacity and (ii) the time required to perform a transaction or an activity. Given the debate in both the professional and scholarly literature on the effectiveness of activity based costing (ABC) systems in the contemporary business environment, there is now a need to understand more about the impact of - a lieu, and revised approach to activity-based costing (ABC). This new approach is called time-driven activity based costing, systems (TDABC). This article aims to bring out the relevance of TDABC to the Indian industry. This paper aims at uses simple numerical examples to articulate the fundamentals of TDABC and provides several examples of companies that have implemented the approach and enjoyed rapid and significant profit improvements. It also discusses the traditional approach to ABC and compares it with the revised approach. The Indian industry, which is familiar with the various performance measurement systems, now needs to familiarize with TDABC and see how suitable a to the present dynamic business environment.
Key Words: Time Driven Activity - Based Costing, Overheads, Fixed Costs
Introduction
Traditional cost accounting procedures were developed years ago and were built around three product expenses: direct material, direct labour and overhead. During trial period, overhead was low when compared to direct labour and material, resulting in products costs that were dominantly variable. Over the last few decades, changes in manufacturing and business
environments, global competition and other developments have forced Companies to develop in all aspects of their business, including performance measurement and cost management. Automation and other radical technological changes have decreased is hour costs and increased the overhead costs. During the past few decades, there have been many to seek a balanced approach Miller and Volkmann were one of the earlier researchers who pointed out that traditional cost accounting provide good insight into how to control direct labour and direct material but are inadequate in helping companies to manage their overhead costs. Noting that overhead casts are becoming an increasing percentage increasing of a company's total value added, they encouraged companies to undertake a transaction-based analysis of overhead costs as a means of controlling such costs. The study conducted by Miller and Volkmann can be described as seminal because it offered challenge to management accounting scholars and researchers to think in creative and unconventional ways. This challenge was taken up successfully by Cooper and Kaplan with their development of activity-based coating (also popularly, known as ABC) which offered substantial insights into drives overhead cost.
Since then Activity-based costing-has become popular in business writings and management circles and numerous articles and cases for and against ABC appeared in both academic and professional publications. It became all increasingly important tools for a large majority of organizations throughout the world. However, though spread rapidly, it did not spread as rapidly as its proponents had hoped. Many companies started abandoning ABC because it did not capture the complexity of their operations, took too long time to implement to build and was too expensive to build and maintain. Consequently, the time-driven activity based costing was developed by the Harvard professor Kaplan along with Anderson who was his student. They claimed that this approach was simpler, less costly and faster to implement, and allows the cost driver rates to be based on the practical capacity of the resources supplied. This paper reviews the activity based costing system and discusses the alternate concept known as time-driven activity based costing (TDABC). The Indian industry is now familiar with the various performance measurement systems and methodologies. In fact most companies in India are already familiar with the mechanics of activity based costing (ABC). There is a now a need to familiarize with the new and improved version of ABC and to see how suitable it is in the dynamic Indian business environment. The main objective of this paper is to bring out the relevance of time-driven activity based costing, (TDABC) to the Indian industry
The Optimal Costing System
Newly developed paradigms in cost accounting methodologies often add to the complexity as to which system providers the best information for decision making. However cost accounting, systems do not usually rank high in organizational hierarchies, even though the information they generate plays a major role in decision-making process. A significant portion of the managerial accounting literature contrasts the benefits and importance of ABC systems over the traditional cost accounting systems. The basic argument for superiority of ABC is that, while traditional costing systems are much less expensive to implement, these systems can introduce considerable distortions in product costing. Managers, consultants and academics generally accept this notion of superiority of ABC over traditional systems.
However, research sponsored in the UK by the Chartered Institute of Management Accountants (CIMA) found that there was significant management accounting change in UK in the last decade. But the change took place primarily in the way management accounting is used and not necessarily in the introduction of new systems or techniques. The redesign of a firm's product costing- system is a significant decision that requires the approval of top management and involves, a major effort to accomplish. Designing optimal information involves tradeoffs between the costs and benefits of increased accuracy. This tradeoff can be depicted graphically.
Activity Based Costing (ABC)
It was in 1954, that Peter Ducker, the renowned management scholar, mentioned the importance of understanding activities in his famous book "The practice of Management". General Electric has also introduced some form of activity based accounting in the 1960's. But it was in 1980's that activity based costing was actually introduced by Dr Robert Kaplan of the Harvard University. Activity Based Costing (ABC)
Was developed from a feeling that the traditional approach to treatment of overheads failed to deliver cost information that was useful and relevant in a dynamic operating environment. ABC systems are based on the belief that activities causes costs and that a link should therefore be made between activities and products by assigning costs of activities to products based on individual product's demand for each activity.
Figure 1
: The TThe Optimal Product Costing System: A Cost Benefit Trade-Off Cost
High
Total Cost
Cost of Design
Implementation,
And maintenance of the information system
Cost of inferior decisions resulting from inaccurate information, such distorted product costs
Low
High
Low
Optimal System
Information System Accuracy
The heart of ABC is the activity concept and the basic premise of the ABC approach in that a form's products or services are the results of activities and activities uses resources which incur costs. Thus, the fundamental principle upon which ABC is based, is understanding cost behaviour in relation o the products or services, coupled with recognition of the fact that, in the long term, all costs are variable.
Figure 2 shows that by identifying activities and the Costs of performing each activity, ABC systems seek a greater level to understand how an organization uses its resources.
ABC systems were designed to provide more accurate information about production and support activities and products costs so that the management can focus its attention on the products and processes with the most leverage for increasing profits. The original exponents of ABC promoted ABC as being able to help managers make better decisions about product design, pricing. marketing mix and encouraging continual operating environments.
Figure 2: Activity Based Costing Systems
Fundamental Cost Objects Assignments to Other
Costs Objects
Activities
Cost of
Activities
Cost of
Product
Service
Customer
Activity Based Costing Practices in Industries
The topic of ABC has received a great deal of coverage, as mentioned earlier, from a technical and theoretical standpoint; experiences of actual implementation have revealed mixed results. Industries that have adopted ABC most rapidly are those experiencing a rapid reduction in market pricing, which in turn requires a rapid reduction in cost. High-tech industries fill into this category, and Motorola is often cited as an exemplary company. Even though ABC started in manufacturing industry, many service and not-for-profit organizations like American Express, U.S Postal Services, Union Pacific Railroad, Alexandria Hospital etc. have developed and implemented ABC systems. In fact, Kaplan and Cooper have suggested that service companies are ideal candidates for ABC, even more than manufacturing.
Hewlett-Packard was one of the first companies to use activity-based costing successfully. Advanced Micro Devices, a major semiconductor manufacturer, completed an activity based costing project at its test and assembly facility in Penang, Malaysia. ABC was also adopted by Dell, and Southwest Airlines.
Traditional ABC Models
The standard procedure for estimating a simple ABC model starts with identifying a collection of resources that perform a variety of activities Once the major organizational activities are identified, the next step is to create cost pools,(or cost centre) and determining cost drivers for each major activity. For each cost pool the base rate is developed on the relevant activity's cost driver. Finally the overhead cost per unit of output is computed. The time and cost demands of creating and maintaining an ABC model is a major barrier to widespread adoption at most companies. Since the systems that are put in place are updated infrequently because of the costs of reinterviewing and resurveying, the model's estimates of process product and customer costs become in accurate. Thus, traditional ABC models often fail to capture the complexity of actual operations.
As the activities in an organization expand, the management and calculation of the data generated becomes a problem. The system could take days to process one month's worth of data. These problems were becoming obvious to both the creators and the implementers of ABC system.
Time-Driven Activity Based Costing
Time Driven ABC simplifies the traditional ABC by removing the need for time consuming interviews and employee surveys that were open to
error and expensive to maintain. The concept of Time-driven activity based costing (TDABC) was developed by Kaplan and Steve Anderson from the Harvard Business School. Kaplan and Anderson were aware that many companies abandoned ABC because it did not capture the complexity of their operations, took too long to implement and was too expensive to build and maintain. However, they ague that the solution to the problem is not to abandon ABC. This is because ABC has helped many companies identify important cost and profit enhancement opportunities. Instead of abandoning ABC, the authors went for a revised approach which they call time-driven ABC. This approach, they claim, overcome the difficulties of traditional ABC by offering a transparent scalable methodology that is easy to implement and update. It provides managers with meaningful cost and profitability information, quickly and inexpensively.
Time-Driven ABC Models
The feasibility of a particular cost system and its usefulness to a manager depends on many different factors. The heart of a time-driven activity based costing system is capacity and so the first step in TDABC is to estimate the cost of supplying activity. The next step is to estimate the consumption of capacity (unit times) by the activities the organization performs for products, services and customers.
Kaplan sees this approach as simple and faster to calculate when compared to the traditional ABC model. In the revised approach, managers directly estimate the resource demands imposed by each transaction, product or customer. While time-based costing undoubtedly has a place in ABC and is the preferred methodology in certain situations, it has its limitations. The assumption underlying TDABC that most expenses are fluid and can be assigned to time-driven activities seem to ignore non-assignable expenses and profit; overlook the basis of cost upon which mark-ups are applied in cases where no market price already exists and bypass the fixed nature of assignable expenses such as complaints and the need to spread them across the total time available.
The above limitations were outlined by Keith Cleland while comparing TDABC with the contribution-based activity (CBA) approach. Cleland advocates CBA, which can establish capacity utilization and give an overview of the contribution of services, products and customers from a sample of invoices in a matter of minutes.
Advantages of Time Driven Activity Based Costing Model:
It can be estimated and installed quickly.
It can be data fed from transactional ERP and CRM systems.
It is easily updated to reflect changes in processes, order variety and resources costs.
It can be validated by direct observation of the model's estimates of unit time.
Figure 3: Traditional and time-driven approaches of ABC
Traditional ABC
Time-driven ABC
Estimate the practical capacity of the resources supplied as a percentage of the theoretical capacity
Identify major organisational activities and create cost pool (cost centre) for each major activity
For each major activity, determine the cost driver
Determine the time taken to carry outside of each kind of activity
For each cost pool, develop rates based on the relevant activity's cost driver
Computer the overhead cost per unit of output
Conclusion
The debate regarding traditional costal location systems and the modern
ABC systems continues. The debate has now shifted from traditional ABC models to 'he new and revised TDABC models. However companies still continue to use the traditional cost system especially in the Indian context. There is now a need to focus on the ever changing and dynamic business and introduce new management models like Kaplan has done. It is important than, new management accounting models and tools are created in an Indian context for Indian Companies.
