Academic journal article Management Accounting Quarterly

Duration-Based Costing: Utilizing Time in Assigning Costs

Academic journal article Management Accounting Quarterly

Duration-Based Costing: Utilizing Time in Assigning Costs

Article excerpt

What is the best way to assign overhead costs.? The answer depends on the nature of the company and its information needs. For instance, if time greatly affects a company's production of goods and services, then perhaps a time-oriented driver may be more appropriate. From my 2009 dissertation from Oklahoma State University and the published article that was derived from it, I developed Duration-Based Costing (DBC), a type of system that uses a time-oriented driver as an alternative to activity-based costing (ABC). (1) Companies can use DBC to assign costs to any cost object. This article provides practitioners two scenarios to illustrate how DBC works--one on product costing and the other on customer costing. Prior research has shown that DBC has potential to provide cost assignments close to those of ABC.

Before I present the scenarios, a literature review makes sense. Much of the prior research on costing models has considered ABC to have the greatest accuracy. (2) Performed in two stages, ABC was developed to improve the specificity of the systems. (3) This improved specificity, however, causes ABC to be a costly and complex costing model that requires a significant amount of information for the activities. (4)

To improve ABC, researchers created Resource Consumption Accounting (RCA), a combination of ABC and the German costing system, Grenzplankostenrechnung (GPK). (5) Because it requires even more detailed information, however, RCA is more complex than ABC. (6) Gathering this detailed information is time-consuming and, thus, costly. Consequently, one could argue that an ideal costing model provides information for decision making without being overly complex and complicated to implement, maintain, and update. A few researchers have tried to develop simplified costing methods, but those methods not only require a fully implemented ABC system, but they also show that trade-offs exist between cost and accuracy. (7)

So what about creating a system that does not require a fully implemented ABC system and, at the same time, has a good degree of accuracy? In one attempt to achieve this, Robert Kaplan and Steven Anderson introduced time-driven ABC (TDABC), which is simpler than ABC and uses duration drivers that increase cost assignment accuracy. (8) TDABC skips the surveying and interviewing of employees to assign resource costs to activities. Yet a company must still identify all activities for TDABC to develop time equations in which the activities are broken down into smaller ones. (9) Consequently, a good degree of complexity remains in TDABC. In addition, duration drivers are not entirely a new idea. Robin Cooper was one of the first to discuss duration drivers, explaining they are more effective in assigning short-term variable costs than are transaction drivers. (10)

In contrast to the complexity of ABC and TDABC, Duration-Based Costing is a simpler costing model that, similar to TDABC, drives cost based on time. (11) Unlike TDABC and ABC, a practitioner does not have to gather data concerning all activities. DBC uses the production cycle time, which is an observed value, to assign resource (overhead) costs to the product lines. A practitioner determines DBC by clocking how long it takes to do a production run from start to finish--from the time the materials leave inventory to the completion of the production run, which can consist of one to a batch of units of a product.

The DBC model involves only one stage vs. two for ABC, meaning that DBC assigns resource overhead costs to cost objects based on time. First, the DBC model calculates cost per unit of time by dividing the total overhead cost by the total time in the system. It then calculates the total time for the product line by taking the number of production runs and multiplying it by the production cycle time. Finally, the model determines the cost of the product line by multiplying the cost per unit of time by the total time for the product line. …

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