Activity Based Costing and Time Driven Activity Based Costing: A Comparative Study

This report discusses the advantages and disadvantages of Activity Based Costing and Time Driven Activity Based Costing. It also analyzes two research journal articles to reflect the real-life business scenario and how ABC costing helps the organization in the real-life business conditions.

Managerial
Accounting
Assignment

1
By student name
Professor
University
Date: 5th Sep, 2018.
1 | P a g e

2
Executive Summary
Activity based costing has emerged as one of the latest technologies and cost accounting tool for
the management accountants with a lot of enhancements and refinements. The report has been
prepared on the topic of activity based costing and two research based journal articles has been
studied and analysed to reflect the real life business scenario and how ABC costing helps the
organization in the real life business conditions. The report also shows what were the advantages
of the Activity Based costing over the traditional costing methods and what its disadvantages are.
The shortcomings in the activity based costing was overcome by Time Driven Activity based
costing and the same has been discussed through the case studies and the results in real life
scenario. The similarities and difference in the two studies has been mentioned along with the
key learnings from both the research articles. Finally, towards the end, the conclusion and
recommendation has been given to the entire study and research.
2 | P a g e

3
Contents
Executive Summary.....................................................................................................................................2
Introduction.................................................................................................................................................4
Disadvantages of ABC costing technique.....................................................................................................5
Discussion on the two journals....................................................................................................................5
Explanation of the Selected Management Accounting Topic..................................................................5
Purpose of the studies and the research questions set out to be explored............................................6
Similarities and differences between the findings of the 2 studies.........................................................7
Conclusion...................................................................................................................................................8
Specific outcomes and relevant learnings from the research findings....................................................8
References.................................................................................................................................................10
3 | P a g e

4
Introduction
Activity based costing may be defined as one of the concepts which is being used by the cost and
management accountants in their day to day operational activity to allocate the indirect cost of
the business processes to different activities, divisions and products as the direct cost is generally
allocated in the ratio of the sales of the company. It is one of the widely accepted costing
technique in the industry whereby the total pool of resources are being allocated to the different
activities and divisions and then these activities are allocated or distributed to the cost objects
which are further being allotted to the cost drivers (Appelbaum, Kogan, & Vasarhelyi, 2018).
The cost driven can be defined as the base on the basis of which the entire cost is being booked
and charged. The units of cost driver define as to what will be cost charged to each activity or
product, more the no. of units, more will be the total cost. Furthermore, costs can basically be
divided into 3 parts namely fixed cost, variable and semi variable. Some of these costs are
divided on basis of area (like rent), some of basis of machine hours (like electricity) and some of
the basis of labour hours. There can be many other allocation bases which can be used (Bae,
2017). This method is effective in utilising the minimum available resources of the company in
the best possible manner.
Advantages of ABC costing technique
Activity based costing has been playing an instrumental role in the cost control mechanism and
has been continuously helping the cost and management accountants all across in increasing and
improving the effectiveness and efficiency of the cost. Some of the major advantages has been
listed below:
1. It helps in proper determination and accurate costing of the products thereby leading to
the proper analysis of all the costs heads and also the individual product costing.
2. Since the market is extremely competitive and there is always a price pressure, activity
based costing helps to price the product in a better and effective way.
3. It leads to realistic preparation and presentation of the financial data and reports, or else
in the absence of the proper data on costs, wrong information will be captured and passed
on to the shareholders and the investors (Axelsen, Green, & Ridley, 2017).
4. The process of activity based costing is also effective in showing the inefficient activities
and the same can be eliminated or even outsourced. This will lead to cost savings for the
company and shortening of the processes.
5. The correct computation of the overheads as well as the costs can lead to better cost
control measures and also lowering of the manufacturing overheads.
4 | P a g e

5
Disadvantages of ABC costing technique
Besides the advantages the system of activity based costing also suffers from a number of
disadvantages which have been listed below:
1. It may not be cost effective for the small companies as the cost of implementation of the
activity based costing is not cheaper and thus the organization may not be able to afford
the same (Arnott, Lizama, & Song, 2017).
2. It also requires the expertise of the professional people who have the knowledge and skill
base of costing and the costing terms like cost centres, cost allocation, cost element, etc.
and the same may be a bottleneck for many of the organizations.
3. For activity based costing to be fully accurate and give effective results, the input data
must be accurate and there should be no ambiguity. Thus, the quality of the data is one of
the bottlenecks.
4. Activity based costing reports can only help the management in determining the cost and
prices of the goods at which it needs to be sold. Since it is not in conformity with the
Generally Accepted Accounting Principles, therefore another report needs to be prepared
for external reporting purposes (Werner, 2017).
5. The results which are derived from activity based costing can lead to conflicts within the
organization as the same may not be in line with the traditional costing results used by the
managers and based on which the past performance was being measured.
Discussion on the two journals
The above topic of activity based costing has been discussed and analysed using the two research
journal articles. The first of which is “The Measurement and Management of Unused Capacity in
a Time Driven Activity Based Costing System” which has been written by Hasan Özyapici and
Veyis Naci Tanis and the second journal article is “The Value of Activity-Based Costing in
Competitive Pricing Decisions” written by Warlop Luk, Eddy Cardinaels and Filip Roodhooft.
Explanation of the Selected Management Accounting Topic
Activity based costing has a number of benefits especially in the manufacturing industry as the
industry has heavy price competition due to a number of competitors and the new entrants
entering into the sector every other day (Eddy, Filip,R, & Warlop, 2004). The first journal paper
discusses broadly on this topic and how the activity based costing benefits over the traditional
volume based costing approach as the old traditional method leads to biased allocation of the
costs and sometimes the product or the division or department which is not loss making seems to
5 | P a g e

6
be loss making because of incorrect pricing. ABC costing has this advantage of removing or
eliminating the irrelevant competitor feedback from the competitors and thereby affect the
decision making process (Delone & Mclean, 2004).
Purpose of the studies and the research questions set out to be explored
The study researches on the topic as to determine how much cost system is significant in
decision making where limited information is available with accountants for price fixation
purpose. Due to competitive market it is very difficult task to determine the correct price of
output because it directly effect to the price of the product however as per market norms cost
system plays a minimal role and usually the price is output is completely depends upon the
market feedback which do not consider accounting data for decision making purpose. However
from the in depth study of the traditional system one thing that is clear that in the multimarket
setting, these system of costing gives an incorrect result where the product dealt in
heterogeneous market and when the cost of the product is either under allocated or over allocated
which gives a biased result. Due to all these inefficiency the firm may suffer accounting loss
which affect their financially position which are actually profitable in the business environment
(Jefferson, 2017). In 1999 Briers et al. examine the major impact on biased costing system in the
multiproduct market and analysed that biased accounting data may led to improved pricing
decisions and benchmark report received by the company but it did not involve any direct
competition not they examine through the ABC system to review the effectiveness of the result.
However, later on to check the reliability one test were conducted in the experimental market
conditions with 2 hypotheses being assumed were the price and profit of the product are
optimum when the business house receive informative and positive market feedback rather than
in informative and negative market feedback. As per 2nd hypothesis the benefits of ABC system
over the biased cost data setting fall as and when the firm receive informative and positive
feedback. Here in the given experiment, 2 groups of participants were made consisting of 131
management accounting and cost accounting qualified students who were given cost data and
instruct them to allocate the data using two different cost system that is the traditional costing
systems and the ABC costing system. In ABC system the allocation of the customer costs was
done with the help of 3 activities namely ordering, delivery and software handling. Then the
system allocate the cost of activities across 2 market segments based on the respective cost
drivers like number of orders, deliveries and software handling. At last the result were reviewed
by expert to check whether the primary objective that is to see the impact on the profits over ten
different periods and to check the reliability of the system (Guragai, Hunt, Neri, & Taylor, 2017).
From the averaging of 1st five result it was concluded that that the interaction between the market
feedback and the accounting report on allocations have neither effect on market nor on pricing
decisions. Hence the 2nd hypothesis was proved wrong and resulted in competition are effective
where competitor exist and the information is limited. If the companies allocated their indirect
cost among appropriate activity under accurate cost delivers it gives the reliable and competitive
cost information for the product. Hence the price become more competitive at market place and
helps in correct price fixation of the output.
6 | P a g e

7
In the second case study, it is discussed that how to manage nd measure the unused capacities in
the companies by taking the help of time driven activity based costing. In current day there are
many companies all over the globe which are working 24 hours a day and it might be difficult for
them to evaluate what are the unused capacities and which increases the overall cost. To examine
the unused capacities, they should be considering 2 new concepts which are real and compulsory
unused capacities. The main focus of the research paper is to increase the efficiency of ABC and
TDABC system by measuring the actual unused capacities per shift (Kim, Schmidgall, &
Damitio, 2017) (Schoenberger, 2016). The prime objective of this research to dismiss or
employed the employees to other productive areas based on the per shift rather than looking at
unused capacity throughout the day. This is very difficult through traditional system of costing
because of their rigidity. Hence the many companies were looking for more advanced methods
that can give more efficient results to them in cost management. In care of ABC system the
major drawback was the selection of the cost drivers for the allocation of the costing element
within appropriate segment and did not optimised the limited resources that the management of
the company had which is shown in the given case.
The time driven activity based costing is the undated version of ABC costing that was introduced
to eliminate the limitation of the existing processes. The main significance of this approach is
managers are able to recognise what are the resources and what is the amount of resources that
will be required to complete a given activity (Dan, 1995). There are two major element are there
for the implementation of TDABC which are the cost per unit of resources required and what is
the number of units of those resources being consumed by the customers, activities or services.
The primary objective of this costing system is to improve the efficiency in costing of goods
accurately in the competitive environment and even consider those costs which get eliminated or
ignored under the ABC system. Apart from all it all takes into account the time and number of
resource units required to complete the process. Here the cost per unit is calculate by considering
the practical capacity of the resources. For example the machine actually works for 40 hours a
week as per records but the machine effectively work only for 80-85% of this which amounting
to 32-34 hours per week. Hence for the effective cost allocation it is necessary to consider
practical and effective capacity (Naci & Hasan, 2012). The 2nd important element is the
calculation of the number of units of resources being used. For this the manager conducted
interview the employees or do estimates through direct observation procedures. In many
organisation to get the appropriate estimation employee survey was done. However these
interviews and serves not given the exact result but provide a rough estimate. By the extensive
study of these two element we can get the reliable allocation keys.
Similarities and differences between the findings of the 2 studies
There have been various similarities and differences in the 2 journal articles which have been
discussed above. Some of these similarities are:
7 | P a g e

8
1. Both the techniques of ABC costing and the time driven activity based costing are agile
and show the inefficient activities which are there in the process and aims to eliminate
them. Thus, the common objective of both the techniques is cost savings and elimination
of wasteful activities (Marques, 2018).
2. Both the studies were done to find the better cost allocation technique and thereby doing
correct costing of the material based on the correct indirect costs allocation. Both the
studies aimed to overcome the shortcomings of the traditional and volume based costing
techniques.
Few of the major differences which were noted in the studies are:
1. Activity based costing majorly focused on the allocation of the minimum possible
resources with the organization in the correct manner so as the reduce the impact of poor
management of resources and the cost was optimized whereas on the other hand, the time
driven activity based costing focused mainly on determining the time taken for doing any
given activity and the no. of units of resources being utilised (Vieira, O’Dwyer, &
Schneider, 2017). It was a revised and refined version of the ABC costing and aimed to
optimise the cost further and make accurate allocation. It is because of this reason that the
time driven ABC has been accepted widely by the global companies and is in operation
now. It can therefore be mentioned that both the approaches has its own advantages and
disadvantages, and it is upon the organization to judge and derive the maximum benefit
out of it.
2. The 2nd major point of difference in both the research articles was that the 1st study also
focused on the determination of the correct cost drivers to allocate the costs correctly on
the other hand the second case study focused on the better time management processes.
Therefore, both these techniques are applicable and beneficial depending on the type of the
company, if the company is facing the time constraint and is having issues with respect to time,
they can opt for the time driven activity based costing whereas on the other hand if the
companies are facing issues in determining the correct and apt cost drivers, it can opt for the
activity based costing. Both these techniques do overcome the disadvantages posed by the
traditional costing methods (Félix, 2017).
Conclusion
Specific outcomes and relevant learnings from the research findings
There have been significant and critical learnings from both the case studies and it will be
instrumental in minimising the cost impact and improving the efficiency of operations and the
same can be replicated and used by the management accountants all over the world. This will
8 | P a g e

9
help in improving the profitability of the companies and in making the pricing of product
competitive. Some of the major learnings from the 1st case study has been listed below:
1. The price being set by the industry leader or the conglomerate is stronger than the cross
pricing made by the competitors. This is due to the fact that other market players in the
industry will be left with very minimal demand in case the rival company lowers the
prices again (Lavassani & Movahedi, 2017).
2. The new companies which enter the market often follow the trend which is being used by
the industry players. This can be seen especially with the small companies and firms who
tend to follow the path of the industry leader.
3. From the study, it was also being observed that the prices being computed by the
companies on the basis of the traditional costing methods is highly inaccurate and is far
from the optimal prices and therefore the prices are inappropriately charged. Even if the
product would have been profitable, the same seems to be unprofitable and the company
can see the accounting losses. Due to this, there is a significant impact on both the top
line as well as the bottom-line. On the other hand, activity based costing leads to the
optimal price allocation and thus, correct price determination can be done. This makes
the product competitive as well as profitable in the marketplace. And therefore, leads to
increase in sales as well as the accounting profit (Meroño-Cerdán, Lopez-Nicolas, &
Molina-Castillo, 2017).
4. Previously, when these methods and techniques of costing were not available, people
used to use market feedback for pricing and costing of the goods and where the market
feedback was not informative then all those participants using the activity based costing
technique were found to outdo the companies using the volume base costing technique.
Some of the key learnings from the 2nd case study are mentioned below:
1. Time driven activity based costing was the refinement of the old process and aimed to
overcome the issues posed by the old ABC costing. ABC costing technique had the issue
with selection of correct cost drivers and so TDABC focused mainly on the time aspect
and the practical and theoretical capacity of the given machine to calculate the possible or
the expected output (Zhou, 2018).
2. ABC costing had different variables to deal in and different companies used the different
allocation kept for the same propose and therefore there was no standardization. It is
because of this reason that that the accounting reports and the costing reports did not
matched. TDABC costing has been instrumental in removing these differences and
making the reports standardised and comparable all across the world by using only 2
variable, the time and the no. of resource units per activity. TDABC costing is the refined
version and will surely help the companies in better pricing and cost estimation for the
product.
9 | P a g e

10
References
Appelbaum, D., Kogan, A., & Vasarhelyi, M. (2018). Analytical procedures in external auditing: A
comprehensive literature survey and framework for external audit analytics. . Journal of
Accounting Literature, 40(1), 83-101.
Arnott, D., Lizama, F., & Song, Y. (2017). Patterns of business intelligence systems use in organizations.
Decision Support Systems, 97, 58-68.
Axelsen, M., Green, P., & Ridley, G. (2017). Explaining the information systems auditor role in the public
sector financial audit. International Journal of Accounting Information Systems, 24(1), 15-31.
Bae, S. (2017). The Association Between Corporate Tax Avoidance And Audit Efforts: Evidence From
Korea. Journal of Applied Business Research, 33(1), 153-172.
Dan, S. (1995). The benefits of activity-based cost management to the manufacturing industry. Journal
of Management Accounting Research, 7, 167.
Delone, W., & Mclean, E. (2004). Measuring e-Commerce Success: Applying the DeLone & McLean
Information Systems Success Model. International Journal of Electronic Commerce, 9(1).
Eddy, C., Filip,R, & Warlop, L. (2004). The Value of Activity-Based Costing in Competitive Pricing
Decisions. Journal of Management Accounting Research, 16, 133-148.
Félix, M. (2017). A study on the expected impact of IFRS 17 on the transparency of financial statements
of insurance companies. MASTER THESIS, 1-69.
Guragai, B., Hunt, N., Neri, M., & Taylor, E. (2017). Accounting Information Systems and Ethics Research:
Review, Synthesis, and the Future. Journal of Information Systems: Summer 2017, 31(2), 65-81.
Jefferson, M. (2017). Energy, Complexity and Wealth Maximization, R. Ayres. Springer, Switzerland .
Technological Forecasting and Social Change, 353-354.
Kim, M., Schmidgall, R., & Damitio, J. (2017). Key Managerial Accounting Skills for Lodging Industry
Managers: The Third Phase of a Repeated Cross-Sectional Study. International Journal of
Hospitality & Tourism Administration, , 18(1), 23-40.
Lavassani, K., & Movahedi, B. (2017). Applications Driven Information Systems: Beyond Networks toward
Business Ecosystems. International Journal of Innovation in the Digital Economy.
Marques, R. P. (2018). Continuous Assurance and the Use of Technology for Business Compliance.
Encyclopedia of Information Science and Technology, 820-830.
10 | P a g e

11
Meroño-Cerdán, A., Lopez-Nicolas, C., & Molina-Castillo, F. (2017). Risk aversion, innovation and
performance in family firms. Economics of Innovation and new technology, 1-15.
Naci, T., & Hasan, O. (2012). The Measurement and Management of Unused Capacity in a Time Driven
Activity Based Costing System. Journal of Applied Management Accounting Research, 10(2), 43-
55.
Schoenberger, E. (2016). Environmentally sustainable mining: The case of tailings storage facilities.
Elsevier, 119-128. doi:http://dx.doi.org/10.1016/j.resourpol.2016.04.009
Vieira, R., O’Dwyer, B., & Schneider, R. (2017). Aligning Strategy and Performance Management Systems.
SAGE Journals, 30(1).
Werner, M. (2017). Financial process mining - Accounting data structure dependent control flow
inference. International Journal of Accounting Information Systems, 25(1), 57-80.
Zhou, C. &. (2018). Developing creativity and learning design by information and communication
technology (ICT) in developing contexts. Encyclopedia of Information Science and Technology,
4178-4188.
11 | P a g e