Implementing Time-Driven Activity-Based Costing at a Medium-Sized Electronics Company (2011)

A recent Management Accounting Quarterly article told the story of a domestic consumer-electronics manufacturer, referred to as XYZ Company, that redesigned its internal accounting system. (1) At the time, XYZ was experiencing increased foreign competition, escalating manufacturing support costs (associated with an expanded product line), increased inventory holdings (and associated holding costs), and diminishing cash flow. The company's existing cost accounting system was considered rudimentary at best. XYZ took action. It implemented a simple activity-based costing (ABC) system, which provided the company's management with valuable insights and real, but modest, financial benefits. For example, the new cost system allowed XYZ to estimate return on sales (RoS) and return on investment (ROI) results for its major product lines and its individual customers, neither of which was possible under the former cost system. Because of this, the company was able to control inventory more effectively, improve budgeting, and increase the bottom line through increased sales volume, better product-mix decisions, and greater cost control. Although the company realized some success with its ABC system, we wondered how much better it could do if it were not bound by the limitations of traditional ABC systems. Thus, we decided to revisit XYZ with the idea of applying time-driven activity-based costing (TDABC) principles to the company's existing ABC cost structure. The goal was not to fully implement a TDABC system but to focus on applying TDABC to a subset of business processes at XYZ. In short, we performed a pilot implementation. In this article, we examine the results of this pilot implementation, including the effect that TDABC had on cost allocations from two cost centers. For comparative purposes, we present cost-allocation results for these two cost centers using the approach described in the 2007 article. Our pilot implementation demonstrates both the potential power of TDABC and the important role of enterprise resource planning (ERP) systems in implementing modern cost accounting systems. TRADITIONAL ABC SYSTEMS: A REVIEW ABC systems have been around since the mid-1980s. When implemented properly, they can provide managers with more accurate product-cost data that can be used to make more informed decisions about process improvements, pricing, and managing customer relationships. The overall goal of an ABC system is to allocate indirect (support) costs in such a way that the resulting cost information reflects more accurately the resource demands/resource consumption of an organization's cost objects (products, services, and customers). A schematic representation of a traditional ABC system is shown in Figure 1. (2) Although traditional ABC systems provide management with valuable information, many have been abandoned or never were implemented fully. one problem with traditional ABC systems is that they rely on employee surveys of time spent on specified activities; typically, these surveys must be submitted each month prior to processing and calculating product costs. A large financial services firm utilizing a traditional ABC system collected monthly surveys from 700 employees at more than 100 facilities; the firm employed 14 full-time employees just to process the data! Justifiably, this process was viewed as burdensome: Employees were falling further and further behind in updating the system. (3) Such complexity probably would inhibit a full-scale ABC implementation at most small to medium-sized organizations and at many large ones as well. Another challenge for companies that want to implement an ABC system is the need to accurately handle the granularity of activities for certain operations, such as ship an order to a customer. Traditional ABC uses a single cost-driver rate for this activity, regardless of type of shipment. What if the order in question, however, required, say, special handling, less-than-truckload (LTL) processing, or overnight delivery? …