Time-Driven or Driver Rate-Based ABC: How Do You Choose?

TIME-DRIVEN
OR
DRIVER
RATE-BASED
ABC:
HOW DO
YOU
CHOOSE?

February 2016 / STRATEGIC FINANCE / 21
By GARY COKINS, CPIM, AND DOUGLAS D. PAUL

22 / STRATEGIC FINANCE / February 2016
debate has been going on for years about
which method of activity-based costing
(ABC) is better to use for assigning costs:
Time-Driven or Driver Rate-Based. The
answer: It depends on the circum-
stances. There’s a great deal of confusion
regarding which one to use and around
terms such as “push” vs. “pull” and “top-
down” vs. “bottom-up” in which the latter perspective of
both terms is one where a product isn’t consuming all of the
supplied capacity expenses, and the former perspective is
one where the capacity expense, including unused or idle
capacity, is being fully traced into the product, thus over-
costing products. This raises several questions: How are the
approaches similar? How are they different? Is one method
superior to the other? Can a company start with the former
method and transition to the latter method as informational
needs increase? What are the conditions when one or the
other method might suffice?
To discuss the merits, we need a starting point to estab-
lish clarification. It’s an incorrect simplification to refer to
Time-Driven ABC (TDABC) as the “pull” basis and its pred-
ecessor, the conventional Driver Rate-Based ABC
(DRBABC), as the “push” approach. The decisions to use the
push vs. pull or Time-Driven vs. Driver Rate-Based method
are independent of each other, so their merits should be
evaluated independently. Figure 1 displays a two-by-two
matrix where either method can be used with either a push
or pull approach.
Before contrasting and debating these two methods, we
want to emphasize that both types of ABC methods
described in this article are vastly superior to the common
and misleading practice of allocating indirect and shared
expenses (i.e., overhead) using a single “cost pool” and its
associated “cost allocation factor.” Such a practice violates
costing’s “causality principle,” which is “the relation
between a managerial objective’s quantitative output and
the input quantities consumed if the output is to be
achieved.” (See “The Conceptual Framework for Managerial
Costing” by Larry R. White and B. Douglas Clinton at
www.imanet.org/MCCF.) Simple cost allocation factors
(e.g., number of input labor/machine minutes, units pro-
duced, units sold, full-time equivalent employees, and
square feet) don’t reflect a proportional relationship of the
product cost and the work activity costs it consumes. Using
simplistic factors is often referred to as “peanut butter
spreading” with broad noncausal relationship averages that
result in inaccurate costs.
Before diving deeper, we want to make a comment
about expenses and costs. We view them as different things.
Expenses are defined as when an organization exchanges
money with third parties, such as paying suppliers or pay-
ing employees’ salaries. An expense is synonymous with
“spending” to acquire resources. Examples of resource
expenses are salaries, supplies, electrical power, or pur-
chased components. (Expenses may also be “near-cash” to
reflect the obligation to pay cash in the near future.) In
short, with expenses, currency exits the treasury bank
account. In contrast, costs reflect the consumption of the
spending of the expenses. They are always “calculated”
using modeling, and modeling translates expenses into
costs.
THE ASSIGNMENT METHOD
VS. ABSORPTION-TYPE
MATRIX
For the “Absorption Type” rows in Figure 1, the terms push
vs. pull refer to whether all of the expenses incurred are
fully allocated (pushed) to products as product costs or
whether only a measurement of the consumed amount of
those expenses is pulled into the products.
For the “Assignment Method” columns, the terms Time-
Driven vs. Driver Rate-Based represent a unit of method
cost assignment difference: time vs. quantities. We want to
make it clear that either assignment method can be used
with either absorption type.
This article describes both the Time-Driven and the
Driver Rate-Based methods and the push vs. pull
approaches and their respective merits. It also describes the
conditions where a Time-Driven cost assignment method
A
Figure 1
TWO-BY-TWO MATRIX
ABSORPTION TYPE
ASSIGNMENT METHOD
TIME-DRIVEN DRIVER RATE-BASED
4 4
4 4
FULL (PUSH)
PARTIAL (PULL)
ASSIGNMENT METHOD

February 2016 / STRATEGIC FINANCE / 23
provides superior information compared to
the Driver Rate-Based method.
Push vs. Pull
A push approach to costing means full
absorption in which 100% of the expenses
incurred during a time period are assigned
to the activities performed, and all of those
activity costs are in turn reassigned to the
recipients or “cost objects” that consume
them. All expenses are accounted for in
which the expenses collected in the Gen-
eral Ledger (GL) accounting system (pri-
marily from payments for purchases,
employee payroll, and accrual-type journal
entries like depreciation) equal the total
amount when adding up all of the activity
costs and the ultimate final cost object
costs. Examples of final cost objects are
products, standard service lines, types of
orders (e.g., special vs. standard or domes-
tic vs. international), channels, customers,
and business-sustaining cost objects. Other
more advanced examples of final cost
objects can include individual orders and
order lines, shipments, deliveries, medical
patient encounters (such as a visit to the
doctor), or any other type of individual
customer-related transactions. Business-
sustaining cost objects are those that aren’t
related to making products, distributing
them, or serving customers. Some people
may consider them cost assignments from
support departments (e.g., legal expenses)
and not include them with the other final
cost objects just mentioned.
The push approach proportionately
traces costs based on consumption rela-
tionships and is like a complete electrical
circuit from the provider to the receiver.
The benefit of this approach is that there’s
a 100% complete reconciliation of the
expenses to the officially reported financial
results in total. Therefore, the cost amounts
are credible overall and reasonably accu-
rate. With the push approach, estimates of
driver quantities are acceptable since each
assignment must normalize to 100%.
A downside of the push approach is
that the supplier of the resource capacity
expenses (i.e., the “sending” spender of
expenses) always recovers 100% of its
incurred expenses. Therefore, if a support
group such as information technology (IT)
or Finance spends more than its budget, it
becomes the receiving internal depart-
ment’s problem, not theirs. This doesn’t
provide an incentive to the support group
to reduce its expenses. For example, if
resources were added or paid overtime by
WHAT IS DRBABC?
Driver Rate-Based Activity-Based Costing (DRBABC) is
representative of the Activity-Based Costing (ABC) methodology that has
been formally in use to various degrees since the 1980s. It is based on the
concept that assignment of costs has grown in importance because of the
ever-increasing proportion of indirect and shared support expenses to the
total, which, in large part, has been caused by the emergence of greater
variation and complexity of product and service offerings.
DRBABC leverages operating metrics as meaningful drivers to assign
costs to “cost objects,” be they products, services, channels, or
customers. Typically, a single driver is employed in any given cost
assignment, and it’s a driver that replaces volume, revenue, or otherwise
simplistic approaches.
DRBABC provides substantially higher cost accuracy compared to
traditional costing by capturing the effects of output diversity and
complexity as well as volume.
WHAT IS TDABC?Time-Driven Activity-Based Costing (TDABC) is a costing
method that reflects the supply and demand for costs and capacity that
leverages estimated unit times to calculate time as a driver in lieu of a
single driver quantity. It employs a multidriver approach to obtain an even
greater level of distinction and variability of cost between different cost
objects than DRBABC.
TDABC typically calculates costs to a more granular level, such as
transaction, invoice, order, order line, shipment, or shipment line. With
TDABC, a total time is calculated based on the rendering of an algorithm,
also known as a “time equation,” on every cost object record. This time
equation allows the use of multiple drivers (as opposed to the single
DRBABC driver) with if/then logic, thus providing the flexibility to capture
more nuance and variability of a cost object’s behavior.
The TDABC methodology was presented by Steven R. Anderson and
Robert S. Kaplan in November 2004 in their article, “Time-Driven Activity-
Based Costing” (Harvard Business Review, Volume 82, No. 11). The two
expanded their views in their 2007 book, Time-Driven Activity-Based
Costing, published by the Harvard Business School Press.