A different approach to activity-based costing (ABC)

2. Time-driven activity-based costing

The traditional ABC system uses transaction cost drivers (e.g., number of invoices processed), while the time-driven ABC system uses duration cost drivers (e.g., minutes or hours).  This is the major difference between the two systems.

The time-driven ABC system involves the following two steps:

  • Cost estimation of involved resources.
  • Unit times for activities which are to be assigned to customers or products.

The first step is similar to that of the traditional ABC system.  The cost of resources grouped together in a logical way (e.g., related to an activity or set of related activities) is calculated.  In addition, the ABC system designer also determines the practical capacity of the resources supplied.

The practical capacity is based on the theoretical capacity which shows the possible output if all resources were utilized to the fullest extent.  In real life, it is hard to achieve, so the practical capacity is used. The practical capacity is below the theoretical capacity.  If it’s hard to determine the practical capacity, it could be estimated as 75%-85% of the theoretical one.  For example, if the accounts receivable clerk is estimated to have 2,080 work hours annually, that’s 124,800 minutes.  This is the theoretical capacity.  The clerk, however, does not spend all this time on productive activities: the clerk may take a quick personal call, come late to work sometimes or leave early for an appointment, etc.  Suppose the ABC system designer estimates the clerk’s practical capacity is 85% of the total time; the practical capacity is then calculated as 124,800 minutes x 85% = 106,080 minutes.  Using this information, the ABC system designer can estimate the unit cost:

Unit Cost =

Cost of Resources



= $0.94/minute

Practical Capacity


The next step is to determine the time it takes to perform specific activities.  This process does not typically exist in the traditional ABC system.  For example, through observation or discussion with the accounts receivable clerk, the ABC system designer notes that it takes 3.5 minutes to prepare an invoice and 3.0 minutes to apply cash.  Using this information, the analyst calculates the cost of preparing an invoice and applying cash:

Prepare an invoice = 3.5 minutes x $0.94/minute = $3.29

Apply cash = 3.0 minutes x $0.94/minute = $2.82

Compare these costs to those determined under the traditional ABC system: $5.0 per invoice and $3.0 per cash application.  The difference is due to the nonproductive time which is allocated to cost objects under the traditional ABC system, but is not allocated to cost objects under the time-driven ABC system.

The ABC system designer can calculate the actual productive time of the accounts receivable clerk (considering the clerk prepares 14,000 invoices and makes 10,000 cash applications annually):

Productive time = 14,000 x 3.5 + 10,000 x 3.0 = 79,000

This leads us to the nonproductive time.  The total practical time of the clerk is 106,080 minutes while the actual productive time is 79,000 minutes.  The difference – 27,080 minutes or $25,455.2 – is the nonproductive time.  Management may be interested in knowing this metric because it indicates that the accounts receivable clerk has an unused capacity of roughly 25% (27,080 ÷ 106,080).  Is it good or bad?  It depends.  It may be a very reasonable unused capacity especially if there is seasonality in the business or if management is expecting sales growth in the future.  On the other hand, for a non-growing company with a steady sales stream the 25% of unused capacity may indicate that the clerk should help in other areas to utilize the unused 25% of time.  It’s a management’s decision in each case.

Time Equations in Time-driven ABC System

Sometimes activities are not homogeneous even though they fall within the same pre-defined area.  For example, if the accounts receivable clerk prepares invoices for domestic and international customers, the domestic ones may take less time than the international ones (e.g., more paperwork).  In such cases, the time-driven ABC system calls for time equations.  For example:

Domestic Invoice = Prepare Invoice (3.5)

International Invoice = Prepare Invoice (3.5) + Attach Additional Documentation (1.0) = 4.5 minutes

The time-driven ABC system allows for such variations in durations of activities because the ABC system designer only needs to know the additional time needed while the cost per minute is already available.

Potential Issues with Time-driven ABC System

The time-driven ABC system provides a simplified way to apply the ABC concepts.  In effect, the time-driven ABC system is a traditional ABC system with only one cost driver (i.e., time).  This implies that the cost for labor components and non-labor components is driven by time.  This assumption may not always be true especially in industries where non-labor components (e.g., hardware, equipment) dominate cost pools.  A better approach may be to utilize the traditional ABC system to some areas and the time-driven ABC system to others.

Further, the time-driven ABC system does not allocate the total cost to cost objects.  This may provide great information (e.g., management can assess unused capacity); however, on the other hand, the unused capacity still represents cost, so management may actually want to allocate it fully to cost objects to see how much it costs to manufacture a product or service a customer with supplied (committed) resources.

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