Activity Based Costing: Time-Based or Driver-Based ABC System?

Understanding the Distinction Between Time-Based and Driver-Based ABC Systems

Activity Based Costing (ABC) continues to evolve as a vital tool for precise cost management and strategic decision-making. While many practitioners tend to compare Time-Driven ABC (TDABC) with traditional Driver Rate Based ABC (DRBABC), it’s essential to explore how these approaches function independently and in tandem, emphasizing their unique benefits.

Challenging the Push-Pull Paradigm in ABC

It’s a common misconception to label TDABC strictly as a “pull” system and DRBABC as a “push” method. These labels oversimplify the dynamics of cost allocation strategies. Instead, consider that each system has distinct advantages that are best suited for specific organizational needs and scenarios.

Why Traditional ABC Methods Outperform Simplicity

Many companies rely on basic variables like machine hours, production units, or square footage to allocate indirect costs. These simplified metrics often fail to represent true activity costs, leading to inaccuracies.

• They ignore the complexity of activities driving costs.
• They can distort product or service profitability.
• They often lead to misguided managerial decisions.

Refining cost allocation—by using activity-based drivers—provides more accurate insights, supporting better strategic choices.

The Push Method in ABC Costing

The push approach involves total absorption, where all incurred costs are allocated to activities and then to cost objects, such as products or services. This method compresses complex activities into a single cost pool, simplifying calculations but risking misrepresentation of actual costs.

Examples include:

• Assigning overheads based on a fixed percentage of direct costs.
• Using broad averages that may overlook activity-specific nuances.

The Pull Strategy for Cost Allocation

The pull model emphasizes user-driven cost recovery. Activities are billed based on predefined rates, often aligned with budgeted costs and estimated usage. This approach offers better control and transparency, especially for internal service departments.

• Internal IT or HR departments might set fixed rates for their services.
• Clients or internal units pay only for the services they consume.

Practical Example of Pull Strategy in Action

An Accounts Receivable (A/R) department might establish a rate of $2.75 per invoice processed. This rate is set based on budget forecasts and expected invoice volumes. Actual costs may fluctuate, but this method simplifies billing and gives clients clarity.

Time-Based vs Driver-Based ABC: Deep Dive

TDABC assigns costs based on the time spent processing each activity, such as invoice handling or customer onboarding. The key features include:

• Utilizing time formulas to estimate activity durations.
• Calculating costs directly from time multiplied by the labor rate.
• Providing insight into capacity utilization and resource efficiency.

This method is especially effective when activity durations vary significantly or processes are complex.

For example, in a manufacturing setting, TDABC can determine the exact time spent on different job orders, enabling precise cost control and process improvement.

Benefits of Time-Driven and Driver-Based Approaches

• Better accuracy in activity cost allocation.
• Enhanced visibility into capacity usage and potential bottlenecks.
• Automated data collection through ERP integration reduces errors.
• Supports strategic decisions like process improvements or pricing.

Integrating Industry-Specific Applications

Different industries can tailor ABC systems to meet unique operational complexities:

• Manufacturing: Use machine hours and setup times as drivers.
• Healthcare: Allocate costs based on patient visits or treatment durations.
• Software Development: Track costs by billable hours or feature complexity.

Choosing the Right Approach for Your Business

There’s no universal solution. Evaluate based on:

• The level of process complexity.
• The availability of accurate activity data.
• The need for capacity planning insights.
• The organizational structure handling shared services.

Experiment with both techniques to see what aligns best with your strategic goals. Many organizations find value in integrating both systems for comprehensive cost management.

To explore tools that enhance your ABC implementation, consider our Activity Based Costing Excel template designed to streamline calculations and analysis.

A Simple Guide to Implementing an Effective ABC System

Step	Action Items	Examples
1	Identify Activities	Order processing, customer support, maintenance
2	Select Cost Drivers	Time, number of transactions, machine hours
3	Collect Data	ERP reports, time tracking records
4	Calculate Activity Costs	Sum of activity expenses / number of drivers
5	Assign Costs to Products/Services	Based on activity consumption per product
6	Review and Refine	Adjust drivers or activities as needed for accuracy

This structured approach helps organize your cost management efforts and improve decision-making precision.

Explore more resources and support to integrate these methodologies into your business processes. For detailed, step-by-step guidance, visit our Financial Statements Templates.