If you’ve read my article titled “Top Tips for Making Your Cost Model a Total Disaster”, you’ll know that one of the factors that can kill a cost model is complexity, which translates to a herculean effort to keep the model updated each period. But don’t worry, there is hope and it’s called TDABC, which stands for “Time Driven Activity Based Costing.” This method offers the best of both worlds, allowing you to handle complexity with relatively low effort.
Origin
The truth is, the idea is not new. Back in 1997, Steven R. Anderson formulated the first TDABC solution, which he perfected over the years, and by 2006, this concept had been successfully applied to more than 200 Fortune 1000 companies.
In a traditional ABC costing model, a large number of people across various departments need to submit their time records, and then all that information needs to be processed. This usually involves hiring full-time staff to capture and process these data. (If you want to learn more about ABC costing, I recommend my article “What is ABC Costing?”)
Moreover, traditional ABC models do not handle complexity well. Let me explain with an example: To send an order to a customer, the company might simply cost the activity “send order,” assuming that all orders are the same. But if the company sends the order by a large truck, a pickup, a motorcycle, or contracts out the service, each of these variables constitutes a different cost. In a traditional ABC model, each must be mapped separately, exponentially increasing the model’s complexity.
To make matters worse, traditional ABC costing assumes that resources are always utilized at 100% capacity, and it does not consider or measure idle capacity.
TDABC solves all these problems in a relatively easy-to-implement manner, and consequently, it is easier to maintain over time. Let’s explain this with two examples.
Example of Traditional ABC
Suppose a human resources department with 6 people has a cost per period of $33,000.00, and to build a traditional ABC model, it defines the following activities:
When asked how much time they spend on each of these activities, the HR staff provided the following answers:
Multiplying the department cost by the activity percentages gives us the cost of each activity. Dividing that cost by the executed quantity gives us the unit cost of each transaction.
In the above example, each personnel action costs us $27.14. This model assumes that the department is working at 100% capacity, which in practice is rarely the case.
Same Example with TDABC
Now let’s see the difference when performing the same exercise with TDABC. First of all, this method eliminates the tedious task of surveying staff on how much time they dedicate to each activity. Instead, it uses time equations as criteria to allocate costs.
To implement TDABC, we need to calculate two parameters: the Capacity Cost Rate and the Time per Transaction.
Step 1: Capacity Cost Rate
Calculating the Capacity Cost Rate, or in other words, how much one minute of the HR department costs, involves defining the following variables:
1. Capacity Cost:
This value is given by the cost of the HR department during the study period, which in this case is $33,000.00.
2. Practical Capacity of Resources:
We understand Total Theoretical Capacity as the number of minutes worked by one person per period (usually a month) multiplied by the number of people in the department. In this department, there are 6 full-time employees. For simplicity, they work 40 hours per week for 4 weeks = 160 hours per month. Multiplying by 6 people = 960 hours available, equivalent to 57,600 minutes.
3. Capacity Cost Rate:
The practical capacity would be adjusted by subtracting non-productive minutes (e.g., breaks, idle times). Let’s consider 120 non-productive minutes daily, representing 14,400 minutes (120 min x 20 days per month x 6 people). So, the practical capacity is 43,200 minutes (57,600 - 14,400).
Capacity Cost Rate = Capacity Cost / Practical Capacity = $33,000.00 / 43,200 = $0.76
A minute of work in the HR department costs $0.76.
Step 2: Time per Transaction
To determine the time per transaction, the team is asked to estimate the time in minutes required to perform each transaction: hiring personnel, conducting training, or performing personnel actions. The result is as follows:
Now, determining the unit and total cost per activity, we get the following table:
The first thing we notice is that the total cost changes; it is lower. Why? Because TDABC also determines idle capacity.
Note:
With these examples, you might not be convinced that TDABC is more practical than traditional ABC due to the number of calculations we had to do initially. However, this is where its utility lies. From now on, to update it, we only need the transaction volumes, whereas with traditional ABC, we would need to update the percentage of time in each model run.
Conclusions
As we have explored in this article, the Time Driven Activity Based Costing (TDABC) methodology represents a true revolution in ABC costing. Unlike traditional ABC costing, which can be incredibly complex and laborious to maintain, TDABC simplifies the cost allocation process by focusing on time and practical resource capacity.
One of the most significant advantages of TDABC is its ability to handle complexity with ease. By eliminating the need to continuously collect detailed time and activity data from multiple departments, TDABC drastically reduces administrative burden. Additionally, the use of time equations allows for more precise and realistic cost allocation, taking idle capacity into account and providing a clearer and more useful view of operational costs.
Another key advantage is the flexibility and ease of updating the TDABC model. Once established, maintaining the model requires only adjusting transaction volumes without the constant need to recalculate time percentages for each activity. This not only saves time and resources but also improves the accuracy and relevance of cost data.
By adopting TDABC, you can simplify your company's cost management, reduce inefficiencies, and evolve costing in the future without an excessive effort burden. In the next article, I will discuss “What are time equations? and how they can simplify your cost model”.