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Time-Driven Activity-Based Costing - An Integral Part of Management Accounting

Posted by Stephen King
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TDABC

Attributed to Benjamin Franklin, most people are familiar with the popular saying, “Time is money.” In management accounting, time-driven activity based costing (TDABC) proves the saying holds true – not only in life, but in all industries and for all sizes of businesses.

Using and applying TDABC metrics and key performance indicators in your business can help you see how much money your company spends on wasted time, lost value and outdated processes, and it can show you how to reduce these unnecessary expenses.

Before you can begin to face your company’s top challenges, improve cash flow and generate increased profits, you should understand what time-driven activity-based job costing is and how to use it in your business.

What Is Time-Driven Activity-Based Job Costing?

Time-driven activity-based job costing gives owners of small, medium and large business alike a clear understanding of the actual cost of product production, delivery of service offerings and individual tasks performed inside their companies. To accomplish this, TDABC focuses on the relationship between time and cost measurement to determine costs for the products or services a company produces. Time-driven activity-based job costing shows the actual resources these offerings consume.

Using TDABC, business owners can calculate the cost of one unit of time for an activity in the business, whatever that unit is. For example, a unit of time could be as small as one minute of performing a credit check on a client. For most service businesses and non-profits, however, that unit is usually defined as a client or a job.

You implement TDABC by recording time on a timesheet, allocating fully-loaded labor costs (based on where people spend their time) and by posting allocated payroll back into the general ledger. When you can analyze labor cost by product or service, customer, job or by department, you can analyze profitability the same way. This ability to understand unit economics enables management reporting.

The possibilities of practical applications of time-driven activity-based job costing are nearly endless.

In business, time-driven activity-based job costing can be used to:

  • Identify and reprice less profitable customer relationships
  • Evaluate and improve pricing structure
  • Improve processes to increase profit margins
  • Reduce the cost of product design and production
  • Optimize your product or service offering to maximize revenue
  • Tighten your payroll strategy to reduce overhead expenses

Can TDABC Realistically (and Accurately) Be Implemented in Everyday Business Practices?

The accuracy of TDABC calculations directly depends on the approach to calculation and how measurements are taken within a company.

With traditional activity-based costing models, many businesses attempt to estimate time spent on particular activities by surveying employees regarding the amount of time they spend or would expect to spend on certain tasks throughout the day.

For example, an individual working in a service business might report spending 45% of their time on Client A, 30% on Client B and 25% on Client C. Although this might appear like an accurate estimate of time expenditure, this employee’s reported time on work adds up to 100%.

In reality, most employees (even the hardest workers), on average, only spend 80% to 85% of paid hours on revenue generating related tasks (this is called productive time or practical capacity). The other 10% to 15% of the time workers might spend in training, staff meetings, paid time off, transitioning between tasks, talking with co-workers, clarifying instructions, responding to email or handling other non-specific tasks.

The difference between productive time and non-productive time is referred to as the utilization rate, which shows the amount of time employees generate revenue for the company. The utilization rate also reveals where margins shrink and profit loss occurs.

In addition to the issue of determining unused capacity, when using traditional activity-based costing, business owners also need to consider the difference between tasks on a more granular level.

For example, in an IT company, all clients might appear equal, but not all jobs are the same. Handling clients who only purchase a computer setup requires much less time than handling clients who purchase additional services, such as a server setup and configuration, training or security implementation. To take this idea even further, some jobs are on-going or long-term.

As you can see, with the wrong approach, obtaining accurate TDABC data quickly becomes an overwhelming, time-consuming (and therefore expensive) accounting task in its own right.

By simply estimating practical capacity of workers’ time, as about 80% to 85% of theoretical full capacity (an employee’s complete shift), the concern over estimate accuracy and even job particulars becomes non-important.

For example:

  • In one month an employee’s theoretical capacity is 173 hours (100% of their work time)
  • Assuming employees are utilized 85% of this time, the practical capacity equals 147 hours or 8,823 minutes per month of work time.
  • Total cost of 10 employees in one month = $600K (average salary of $50K + 20% fringe benefits = $60K per person per year x 10 employees)

Calculating the Cost-Driver Rate:

  • Take the Cost per month $60K / 88,230 minutes per month of work time = $0.68 labor cost per minute for an employee

Now, to calculate the cost-driver rates of various tasks, one would simply need to determine the unit of time each single task requires, either by observation or survey. If a computer setup requires 60 minutes, then the cost-driver rate for the computer setup equals:

  • 60 minutes x $0.68 cost per minute for an employee = $40.80

You don’t divide by the total hours because you can only get paid by clients and recapture your labor costs, from your billable hours.

How Does Time-Driven Activity-Based Job Costing Fit into Your Management Accounting Strategy?

Time-driven activity-based costing allows you to look at your profit and losses by client, job, product or service, department or team, which can help you streamline your entire business for optimal profitability and management.

With time-driven activity-based job costing, you can:

  • Identify less profitable jobs, clients or services
  • Improve pricing structure to increase profit
  • Increase profit margins with better processes
  • Reduce overall costs
  • Optimize offerings to maximize revenue
  • Reduce overhead expenses with a flawless payroll strategy

To learn more about time-driven activity-based job costing, we invite you to schedule a free consultation with a GrowthForce expert today. We will be happy to show you how automated TDABC can help you optimize your payroll systems, operations and accounting strategies to maximize your company’s cash flow and profits.

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