In this assignment a discussion has been held regarding the methods of activity-based costing and traditional costing which are two different methods for allocating indirect (overhead) costs to products. Both the methods estimate overhead costs related to production and then assign these costs to products based on a cost-driver rate. The differences between the two methods arise with respect to accuracy and complexity of the two methods. A discussion has also being held regarding the supremacy between the Time driven ABC costing method and Driver Rate-Based ABC costing methods with respect to the organizational operations.
The article journal of “Activity-Based Costing: Usage and Pitfalls” focuses upon describing the underlying reasons for which h the method of activity based costing has become very popular in recent years. Another important fact upon which the journal article has been focused on is the nature of organization that will be most benefitted from the usage of the activity based costing. It is an essential for the managers and accountants of an organization to understand the condition of the organization in which the application of The ABC costing process will be most effective to apply. The article journal provides a comprehensive guideline regarding the use of the activity based costing and also identifies several pitfall s or drawbacks that are related to the procedure of activity based costing. According to the authors of the chosen Journal article a business organization should think about the ABC costing procedure when the cost structure of the business is changing and the diversity of the number of products manufactured by the business are also changing rapidly. If the cost structure of a business changes from the nature of labour intensiveness to capital intensiveness, then it will be better to adopt the activity based costing for accounting the overhead cost s that are being incurred by the business.
The article journal named “Time driven or Driver Rate-Based ABC: HOW DO YOU CHOOSE? ” is a discussion regarding which method of activity based costing should be chosen depending upon the business situation(Latshaw, & Cortese-Danile, 2002).
The Driver Rate-Based ABC(DRBABC) costing method is used where the importance of the allocation of indirect costs is growing mover time as the proportion of the manufacturing indirect overhead manufacturing cost is growing over time. The costing method is based on the idea that meaningful cost driver must be assigned to the cost pool and the activity driver assigned to the cost pool must change from time to time depending upon the changing business situations. Typically in this ABC method a single meaningful driver is assigned for attaching the costs of the cost pool to the cost object (products, services, channels, customers). Here the cost drivers assigned to the cost pool must be changed from time to time with the growing complexity of the differentiated products and services that are being produced b y the business as output. Thus these drivers replace the other most simple and common cost bases like volume, revenue and similar mother cost allocation base. Thus the DRBABC delivers a substantially better overhead cost allocation accuracy compared to the traditional costing method as this method is capable to capture the effects of output diversity and complexity of the volume of output produced.
On the other hand Time-Driven Activity-Based Costing (TDABC) is a costing method that takes in to account the supply and demand for costs and capacity and use the estimated unit times so that the time and be used as a driver instead of a single driver quantity. The TDABC method use a multi-driver approach to attain a better level of distinction and variability of cost with respect to the different cost objects compared to the methods of DRBABC (CPIM & Paul, 2016).
The most important implication of this method of TDABC is that the method identifies the cost at a deeper level such as invoice, order, order line, shipment, or shipment line. Under the TDABC method the algorithm of time equation is being for the calculation of the total time incurred in the manufacturing process with respect to the different cost objects. Thus the TDABC method allows the management accountant to use multiple drivers (as opposed to the DRBABC method where only a single cost driver is used at a time) and thus offers wide range of flexibility so that a wide range of variability in the behaviour of the cost object can be identified.
The man purpose of studying the article journal of “Activity-Based Costing: Usage and Pitfalls” is to find out or asses the business circumstances where the activity based costing appears as more effective than the traditional costing method for accounting the overhead cost.
One important revelation that can be identified from this journal article is that previously cost structures of most of the manufacturing organizations were labour intensive in nature where direct labour used to constitute 40%-60% of the total manufacturing cost of the different organizations and the overhead cost only accounts for 8-12% of the total manufacturing costs of the organization(Öker & Adigüzel, 2010).
Thus in a labour intensive cost structure the majority of the manufacturing cost incurred is the direct labour cost that can be directly traced back or can be related to the product. In such a situation if the allocation of the overhead cost become inappropriate due to the application of the traditional accounting stems then it will only cause a very little impact over the product costing method.
On the other hand in a capital intensive manufacturing organization where automation has replaced a large number of labourers the manufacturing overheads can cover around 50% of the total manufacturing cost and in such a situation proper allocation of the indirect overhead is essential for making the proper costing as well as products manufactured by the organization. Because when the indirect overhead cost is covering substantial portion of the manufacturing cost then improper allocation of the indirect cost will badly affect the process of product costing and may lead to a distortion in product pricing(Demeere, Stouthuysen & Roodhooft, 2009)
Moreover if a business is engaged in manufacturing a single product or several products that are almost homogenous in nature in such a situation as the indirect over head cost an d the selling an d administrative cost that are incurred by the business are moa are less similar in nature .Therefore the application of the traditional costing method that applies volume based application methods where the overhead cost is allocated generally on the basis of number of units produce creates very little distortion to the ,product costing methods(Baykaso?lu & Kaplano?lu, 2008).
On the contrary under the flexible manufacturing process when a business is manufacturing several products and services for selling purposes that are largely differentiable in nature the corresponding overhead manufacturing cost incurred is also largely different in terms of quality and quantity. In such a situation the application of the ABC costing technique for the allocation of the overhead cost will be most appropriate as under this costing method the cost allocation is done as per the importance and the proportion of cost incurred by that activity.
In case of allocation of the overhead cost following the ABC costing method the sequences of the actions are the identification of the direct material and direct labour cost incurred, then grouping of indirect costs in to the four major categories (namely output unit level cost, batch level cost, product sustaining cost and facility sustaining cost).The third step of the process is that identification of the cost drivers or activities for the allocation of the indirect costs .The fourth step of the process is the grouping of costs according to the different activities and finally the last and fifth stage of the costing process is the determination of costs rates as per activity and assigning them to the product and services. Thus an important purpose of studying the article is to understand the indirect cost allocation process in details as per the ABC costing method(Tse, & Gong, 2009).
But the underlying assumption that justifies the ABC costing method for overhead allocation often appears as drawback of the procedure. According to the procedure the cost drivers or activities that drives the costs in particular category of pool must be homogenous in nature. The second assumption of the method is that the costs of each cost pool are strictly proportion to the activity or cost driver. Thus the main drawback of the system is that if the drivers are correlated with each other then changes in one cost driver activity results in change in other cost driver activities(Stout & Propri, 2011).
One important purpose of studying the journal article of “Time driven or Driver Rate-Based ABC: HOW DO YOU CHOOSE? Is that the article describes that both types of ABC methods(DRBABC & TDABC) are immensely superior compared to the common and misleading practice of allocating indirect cost and shared expenses or say overhead using a single “cost pool” and the associated “cost allocation factor.” The underlying reason is that a such a practice violates “causality principle,” of cost allocation which defines the relation between a managerial objective’s quantitative output and the input quantities consumed if the output that has to be achieved.
A push approach refers to the costing method where full cost absorption takes place; which means 100% of the expenses incurred during a time period are being allocated to the different the activities performed. All of those activity costs are in turn reassigned to the recipients or “cost objects” that have consumed those expenses. All expenses are accounted in Gen-eral Ledger (GL) , employee payroll, and accrual-type journal, entries like depreciation) that are being incurred .
The pull approach refers to the partial absorption of the resources that are being incurred. The pull approach describes that the senders of expenses can be identified as mini profit centres in which agreed-upon rates are being applied for the allocation of the over head costs which are the budgeted or the planned expenses(Horngren, 2009)
The DRIVER RATE-BASED ABC describes under the pull approach the method of costing generates financial under recovery or over recovery.
The DRIVER RATE-BASED ABC describes under the pull approach the method of costing is capable to solve the financial variance problem but the factors of different cost rtaes that must be applied for cost allocation an d the measurement of efficiency in cost allocation with respect to the different departments is completely ignored
On the other hand the Time driven-ABC is capable to solve some of the challenges in DRBABC because the costing method is capable to provide both a full assignment of the expenses as costs and also offers meaningful capacity utilization measure under both the pull and push approach.
From the above discussion it is clear that that the journal article “Activity-Based Costing: Usage and Pitfalls” describes the superiority of the activity based costing over the traditional costing method i n those organization where manufacturing over head is a substantial part of the total costing and the organization is engaged in producing differentiated products.
Aging the journal article “Time driven or Driver Rate-Based ABC: HOW DO YOU CHOOSE? Describes that when a management accountant is looking for applying the activity based costing then he have to choose between the time driven approach and driver rated approach depending upon the operational structure of the organization(Hill, 2017)
Thus the first article describes the superiority of the ABC costing method over traditional costing method and the second article describes the best approach to be chosen between the two different ABC approach as per the operational structure and shortcomings of the respective approach.
The above discussion regarding the journal article of “Activity-Based Costing: Usage and Pitfalls” helps us to identify the following two outcomes from the research findings:
If the manufacturing process of a business organization is changing from labour intensive method to capital intensive method then the manufacturing overhead covers a bigger portion of the total manufacturing cost and in such a situation instead of traditional costing the activity based costing should be followed for more accurate allocation of overhead cost among the units produced. Otherwise the unit costing and pricing process will be badly affected. The activity based costing identifies the different activity drivers and accordingly divides or assign the cost pool to the different activities in portion in which they have been incurred with respect to the different activities(DRURY, 2013).
The second important outcome that is note worthy to mention is that in case of a manufacturing organization that is working under the flexible manufacturing process and producing products or services that are not homogenous in nature, it is better to use the ABC costing method for the allocation of the indirect overhead cost as here the overhead costs including the selling and distribution cost that have been incurred for manufacturing the different output units that are not homogenous in nature also different both in terms of quality and quantity(Zott & Amit, 2010).
The above discussion regarding the journal article of “Time driven or Driver Rate-Based ABC: HOW DO YOU CHOOSE?” helps us to identify the following two outcomes from the research findings:
Both the methods of Time driven ABC costing and Driver Rate-Based ABC costing are better that the traditional costing methods as superior compared to the common and misleading practice of allocating indirect cost and shared expenses or say overhead using a single “cost pool” and the associated “cost allocation factor.” The underlying reason is that such a practice violates “causality principle,” of cost allocation(Cooper 2017)
The Driver Rate-Based ABC(DRBABC) costing method is used where the importance of the allocation of indirect costs is growing mover time as the proportion of the manufacturing indirect overhead manufacturing cost is growing over time(Abdel-Kader & Luther, 2008).
The TDABC method use a multi-driver approach to attain a better level of distinction and variability of cost with respect to the different cost objects compared to the methods of DRBABC(Garrison et al ., 2010).
The study journal article of “Activity-Based Costing: Usage and Pitfalls” is quite relevant for the accounting professionals of Australia as the study offers an important revelation that the accounting professional who are working in the different business organizations must monitor the nature of the costing structure of the organization. If they observe that the costing structure of the business is going to be highly capital intensive then they should notify the management of the business organization that it is the time to change the overhead costing method to ABC costing system. Moreover if the accountants observe that the business is producing differentiated output units then also they should suggests to the management that perusing the ABC costing method should be most appropriate for allocation of indirect costs as here indirect manufacturing costs incurred vary from one unit of output to other that are largely different from each other(Dale & Plunkett, 2017).
The study journal article of “Time driven or Driver Rate-Based ABC: HOW DO YOU CHOOSE?” is quite relevant for the accounting professionals of Australia as the study offers an important revelation that the Both the methods of Time driven ABC costing and Driver Rate-Based ABC costing are better that the traditional costing methods .The The Driver Rate-Based ABC(DRBABC) costing method should be used in a manufacturing organization where the proportion as well importance of the overhead cost out of the total manufacturing cost is increasing over time. The accounting professional of Australia should use The TDABC method as it uses multi-driver approach to attain a better level of distinction and variability of cost with respect to the different cost objects compared to the methods of DRBABC in case where volume of overhead cost is quiet big and allocation is quite complex(Zimmerman, & Yahya-Zadeh, 2011).
Thus ABC costing is a valuable tool that the management accountants can successfully use for improving the process of management decision making as well as management reporting. But the application of the ABC costing technique should be necessarily based on the organizational operating structure and product diversity. If the organization has a highly complex capital intensive cost structure where multiple products or services are produced that are differentiated in nature then the application of the time driven AB C costing method will be the best selection for an accounting professional that uses several activity drivers for the most accurate allocation of the overhead cost (Hilton, & Platt,2013).
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Cooper, R. (2017). Target costing and value engineering. Routledge.
CPIM, G. C., & Paul, D. D. (2016). Time-driven or driver rate-based ABC: how do you choose?. Strategic Finance, 97(8), 20.
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Demeere, N., Stouthuysen, K., & Roodhooft, F. (2009). Time-driven activity-based costing in an outpatient clinic environment: development, relevance and managerial impact. Health policy, 92(2-3), 296-304.
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Hill, T. (2017). Manufacturing strategy: the strategic management of the manufacturing function. Macmillan International Higher Education.
Hilton, R. W., & Platt, D. E. (2013). Managerial accounting: creating value in a dynamic business environment. McGraw-Hill Education.
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Öker, F., & Adigüzel, H. (2010). Time?driven activity?based costing: An implementation in a manufacturing company. Journal of Corporate Accounting & Finance, 22(1), 75-92.
Stout, D. E., & Propri, J. M. (2011). Implementing time-driven activity-based costing at a medium-sized electronics company. Management Accounting Quarterly, 12(3), 1.
Stouthuysen, K., Swiggers, M., Reheul, A. M., & Roodhooft, F. (2010). Time-driven activity-based costing for a library acquisition process: A case study in a Belgian University. Library Collections, Acquisitions, and Technical Services, 34(2-3), 83-91.
Tse, M., & Gong, M. (2009). Recognition of idle resources in time-driven activity-based costing and resource consumption accounting models. Journal of applied management accounting research, 7(2), 41-54.
Zimmerman, J. L., & Yahya-Zadeh, M. (2011). Accounting for decision making and control. Issues in Accounting Education, 26(1), 258-259.
Zott, C., & Amit, R. (2010). Business model design: an activity system perspective. Long range planning, 43(2-3), 216-226.
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