White Paper

The 1-2-3 of ABC

Methodologies

u Time Splits, Time Capture, and Time Driven

 Author: Richard Barrett
Contributor: Jennifer Meegan

ii Business Objects • The 1-2-3 of ABC Methodologies: Time Splits, Time Capture, and Time Driven
 Contents

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1

Activity Costing Scenario . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2

Driver Volumes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2
Resources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2
Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2
Time Splits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3
Calculated Example of Costing Using Time Splits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3
Calculation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3
Strengths of Time Splits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4
Weaknesses of Time Splits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4
Time Capture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5
Calculated Example of Costing Using Time Capture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5
Strengths of Time Capture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6
Weaknesses of Time Capture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6
Time-Driven ABC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6
Calculated Example of Costing Using Time-Driven ABC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7
Strengths of Time-Driven ABC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8
Weaknesses of Time-Driven ABC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .11
The Hybrid Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .11
Time-Driven Costing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .11

Business Objects • The 1-2-3 of ABC Methodologies: Time Splits, Time Capture, and Time Driven iii
 Introduction

One of the main deterrents from implementing and maintaining activity-based costing (ABC)
is the amount of time and cost involved in collecting and collating non-system data.1 This often
involves interviewing and paper-based systems, leading people to examine other methodologies
for allocating resource costs to activities.

We recommend basing the choice of methodology on the characteristics of the specific activity
being costed, as well as the availability of reliable and robust data. In practice this means
implementations will rarely, if ever, be based on a single methodology. So organizations should
select software that can easily support all three methodologies and has the tools to facilitate and
expedite the update of their models.

This paper reviews the strengths and limitations of each of the methodologies used in ABC: time
splits, time capture, and time-driven costing.

1 Business Objects • The 1-2-3 of ABC Methodologies: Time Splits, Time Capture, and Time Driven
 Activity Costing Scenario

We created the simple scenario below to demonstrate how an organization can cost specific
activities using a variety of methodologies. We are basing this scenario on a department
that carries out two activities: processing applications and chasing late payments.

Driver Volumes
During the month in question, the department processes 5,000 applications and chases
1,000 late payments.

Resources
There are four people in the department, working seven hours per day, and there are 20
working days in the month, giving 560 hours (33,600 minutes) of available capacity. The
supervisor spends 60% of her time managing this department, and the remainder of her
time managing another department.

Cost
The direct expense (salary, benefits, etc.) incurred by running the department each month is
$16,800. The supervisor’s costs are $5,600. She estimates 60% of her time is spent on “process
applications” activity and 40% on chasing late payments. Additionally, $4,200 is assigned to
the department each month to cover indirect costs such as facilities, IT, and human resources.
These indirect costs are split across the two activities based on the resources they consume.
The “chase late payments” activity involves making extensive outbound phone calls. As a
result, this activity receives a bigger assignment of the cost at 70%, while the “process
applications” activity receives 30%.

Business Objects • The 1-2-3 of ABC Methodologies: Time Splits, Time Capture, and Time Driven 2
 Time Splits
Time splits are the simplest ABC methodology to understand. Managers are simply surveyed
to find out what proportion of their time is spent on various activities. This split is then used
to allocate expenses to activities.

Calculated Example of Costing Using Time Splits

The department manager needs to provide only three numbers: the proportion of time spent
processing applications, the proportion spent chasing late payments, and a figure for any
excess capacity.

The team processes each day’s applications, generally finishing by early afternoon, and chases
late payments until the end of the day. And the manager knows there is little to no excess
capacity and the activities are fairly reliably split into 66% for processing applications and
33% for chasing late payments.

Calculation
The calculation is split into two stages: first we assign resource costs to activities, and then we
assign activity costs to cost objects.

In step 1, time splits are used to assign resource costs to activities. In step 2, volume drivers are
used to calculate activity unit rates.

Step 1: Assigning resource costs to activities.

Activities

Process Applications Chase Late Payments Total

Time-Split 66.7% 33.3% 100.0%

($16,800 × 66.7%) ($16,800 × 33.3%)
Assignment of Direct Cost $16,800
$11,200 $5,600
($5,600 × 60% × 60%) ($5,600 × 60% × 40%)
Assignment of Supervisor Cost $3,360
$2,016 $1,344
($4,200 × 30%) ($4,200 × 70%)
Assignment of Indirect Cost $4,200
$1,260 $2,940
Total Cost of Activity $14,476 $9,884 $24,360

3 Business Objects • The 1-2-3 of ABC Methodologies: Time Splits, Time Capture, and Time Driven
 Step 2: Calculating activity unit rates.

Activities

Process Applications Chase Late Payments Total

Total Cost of Activity $14,476 $9,884 $24,360

Volume Driver 5,000 1,000

Calculation ($14,476 / 5,000) ($9,884 / 1,000)

Activity Unit Rate Assigned to

$2.90 $9.88
Cost Object

Strengths of Time Splits

Ease of Implementation
Costing with time splits is a straightforward process requiring little data other than the general
ledger and the time it takes to interview and collect data from each responsibility center. As a
result, it is frequently used for pilot studies where the imperative is to deliver early results to
the business, prior to refining methodologies and adding refinements to models.

Involving the Organization

Implementing ABC based on time splits involves working with each responsibility center to
develop a dictionary of the activities they carry out and allowing them to routinely report on
the amount of time they spend on each activity. This allows managers to directly participate in
the project and review the results knowing they contributed to them. As such, there is likely to
be greater commitment to overall project success.

Weaknesses of Time Splits

Data Collection and Collation
It can be laborious to resurvey contributors every time a model is refreshed. However, the advent
of web-based ABC applications that allow data to be entered directly into the database, and the
deployment of work management tools that expedite routine data collection, have removed
many of these issues.

Failure to Identify Excess Capacity

When asked to submit time splits, few responsibility managers will willingly reveal large amounts
of excess capacity and idle time. Typically this means substantial excess capacity is rarely revealed
when time splits are used.

Business Objects • The 1-2-3 of ABC Methodologies: Time Splits, Time Capture, and Time Driven 4
 Supposed Lack of Accuracy
Because of its simple empirical approach, time splits are viewed as being less accurate than other
methodologies. However, in responsibility centers where reliable data exists on how staff members
spend time, take customer contact centers for example, managers will use the information and
produce results no less reliable than those generated using other methodologies.

Time Capture
Time capture is particularly useful for determining how staff members split time between projects
and customers. Time capture is particularly useful when applied to functions such as research and
development, IT, or in professional service organizations. As a rule of thumb, wherever time capture
is already being deployed in an organization—either for billing or cross charging—it should be
reviewed as the possible basis for ABC costing before any other methodology is considered. This
is especially the case where capture of time data is already automated.

Calculated Example of Costing Using Time Capture

The amount of time staff spends on each activity could be captured from the systems they are
using, via a specific time capture application or from time sheets. In this instance, figures show
336 hours spent on processing applications, 168 hours on chasing late payments, and 56 hours
unaccounted for—which the manager records as excess capacity.

Calculation
In this instance, the actual hours are used to assign resource costs to activities in step 1. But in
step 2, volume drivers are used to calculate activity unit rates, the same as in the first example.

Step 1: Assigning resource costs to activities.

Activities
Process Chase Late Excess
Applications Payments Capacity Total
Time Spent (hrs) 336 168 56 560
Assignment of ($16,800 × 336 / 560) ($16,800 × 168 / 560) ($16,800 × 56 / 560)
$16,800
Direct Cost $10,080 $5,040 $1,680
Assignment of ($5,600 × 60% × 60%) ($5,600 × 60% × 40%)
$3,360
Supervisor Cost $2,016 $1,344
Assignment of ($4,200 × 30%) ($4,200 × 70%)
$4,200
Indirect Cost $1,260 $2,940
Total Cost of Activity $13,356 $9,324 $1,680 $24,360

5 Business Objects • The 1-2-3 of ABC Methodologies: Time Splits, Time Capture, and Time Driven
 Step 2: Calculating activity unit rates.

Activities
Process Chase Late Excess
Applications Payments Capacity Total
Total Cost of Activity $13,356 $9,324 $1,680 $24,360

Volume Driver 5,000 1,000

Calculation ($13,356 / 5,000) ($9,324 / 1,000)

Activity Unit Rate
$2.67 $9.32
Assigned to Cost Object

Strengths of Time Capture

Dedicating Blocks of Time to Specific Projects or Customers
In situations where activities are far from repetitive and time capture is already in use, it is the
preferred methodology for allocating resource costs to activities.

Weaknesses of Time Capture

Exposing Excess Capacity
Unless time capture is completely automated and is not reliant on an individual triggering a
recording, it is unlikely to accurately expose excess capacity (though it is more likely to do so
than the time splits methodology).

Staff Resistance
If a time-capture system is already in use for billing or cross charging, using the data for ABC
costing is unlikely to generate dissent among staff. However, introducing a time-capture system
where none previous existed will require delicate handling.

Time-Driven ABC
Time-driven costing is where cost driver rates are based on the practical capacity of the resources
supplied, measuring or estimating the amount of time taken to perform an activity. The volume
of transactions is fundamental to the calculation of time-driven costing:

u Transactional cost drivers count the number of times an activity is performed. Examples
include the number of purchase orders processed, the number of inbound phone calls
answered, and the number of deliveries made. By definition, a transactional driver is used
whenever the activity takes about the same amount of time to complete.

Business Objects • The 1-2-3 of ABC Methodologies: Time Splits, Time Capture, and Time Driven 6
 u Duration drivers are measurements or estimates of the time required to perform the task or
activity. Examples of duration drivers are the time taken to answer a phone call or process
an application. In certain responsibility centers, such as a customer contact center, duration
drivers may be easily and reliably accessed from automated call handling software. In
logistics operations, duration drivers may be captured from hand wands at the time of
collection and delivery.

The original exponent of ABC, Dr. Robert Kaplan, promotes time-driven costing as “Simpler
for estimating and maintaining an ABC model, and also more accurate.” While time-based
costing undoubtedly has a place in ABC and is the preferred methodology in certain situations,
it has its limitations.

Calculated Example of Costing Using Time-Driven ABC

Here the duration drivers for two activities are system generated. The processing system provides
the average duration time for processing applications (four minutes) and the phone systems
provide the average duration driver for the time needed to chase a late payment (10 minutes).

Calculation
In this instance, the department’s resource consisted of a team of four working seven hours
per day for 20 days. The supervisor has tracked holidays and sickness and has calculated the
available time should be reduced by 10% in order to accurately reflect the true resource.

Step 1: Calculating the unit cost of available time.

Total
Direct Cost $16,800

Time Available (4 × 20 × 7 × 60) × 90%

(Minutes) 30,240

($16,800 / 30,240)
Cost Per Minute
$0.555

1
For further information, download the white paper titled “Transactional Activity-Based Costing” from www.algsoftware.com

7 Business Objects • The 1-2-3 of ABC Methodologies: Time Splits, Time Capture, and Time Driven
 Step 2: Calculating activity unit rates.

Activities
Process Applications Chase Late Payments Total

Volume Driver 5,000 1,000

Cycle Time (mins) 4’00 10’00

(4 × 5,000) (10 × 1,000)
Total Time Used (mins) 30,000
20,000 10,000
(20,000 × $0.555) (10,000 × $0.555)
Cost of Time Used $16,650
$11,100 $5,550
Assignment of ($5,600 × 60% x 60%) ($5,600 × 60% × 40%)
$3,360
Supervisor’s Costs * $2,016 $1,344
Assignment of ($4,200 × 30%) ($4,200 × 70%)
$4,200
indirect Cost * $1,260 $2,940
($11,100 + $2016 + $1260) ($5,500 + $1,344 + $2,940)
Total Activity Cost $24,210
$14,376 $9,834
($14,376 / 5000) ($9,834 / 1000)
Activity Unit Rate
$2.88 $9.83
(30,240 – 30,000)
Excess Capacity (mins)
240
(240 × $0.555)
Cost of Excess Capacity
$133

* Please note while time-driven ABC is effective, it is unrealistic to expect to use it in isolation. In this example, the
supervisor and indirect costs are not suited to time-driven costing, therefore the cost assignment has been based on
the resource consumed by each of the activities.

Completing the calculation reveals that $133 worth of resource cost, equivalent to 240 minutes
(four hours) of the available resource, must be excess capacity.

Strengths of Time-Driven ABC

Surfacing Excess Capacity
When people estimate how much time they spend on a pre-prepared list of activities, they
invariably supply percentages adding up to 100%. This is because very few people will say any of
their time is unused or idle. Cost-driver rates calculated from this process may incorrectly assume
resources are working at full capacity. Time-driven ABC effectively overcomes this issue and
automatically reveals differences between the total amount of time needed to carry out activities
in a responsibility center, and the actual amount of time available given current resources. Keep in
mind, this can lead to time-driven ABC becoming closely associated with time and motion
studies, which are viewed unfavourably by many workforces.

Business Objects • The 1-2-3 of ABC Methodologies: Time Splits, Time Capture, and Time Driven 8
 Weaknesses of Time-Driven ABC
Availability of Reliable and Robust Duration Drivers
Unless data is readily available, robust, and reliable, time-driven ABC can generate as many
problems as it purports to solve. If data comes from reliable systems, like automated call handling
systems, and is regularly updated, it will be infallible. However, if it is out-of-date or based on
estimates, this could result in substantial errors. The difference between an estimate of four
minutes and four minutes ten seconds to handle an inbound telesales call may not seem like
much, but factored over 100,000 calls it becomes substantial. A time-driven methodology requires
as much data collection as any other methodology if it is to be robust and reliable.

In any organization there will be responsibility centers, such as marketing, legal, research, and
areas of IT, where activities are far from homogeneous and repetitive and duration drivers are
unavailable. In these instances, organizations must use a different methodology.

Understanding Variances in Duration Drivers

Duration drivers can be used at the aggregated or individual level. Where duration drivers are
available for each individual transaction, a time-driven methodology can be used to calculate a
unique cost for each instance. For example, if the system logs that it takes an agent eight minutes
to handle an inbound call, it would pick up twice as much cost as a more typical call which takes
only four minutes to handle.

The cost is valid if this is a more complex call for a different type of service: the type that would
be identified as a separate activity under any other ABC methodology. However, if the call took
eight minutes because it was handled by an inexperienced agent, the charge is invalid and will
result in erroneous results.

Be sure to exercise care when using time-driven ABC for costing in logistics operations. If you
can capture the amount of time spent waiting on a customer’s premises to collect or deliver a
consignment, you may have some valid data to work with. This is because there is considerably
less cost involved in collecting from a customer who routinely has consignments already labelled
and waiting at the front desk, and collecting from one who keeps the courier waiting. However, in
many instances the only time captured is the moment the bar code on each consignment is read at
a customer site. So data may include a substantial amount of time spent driving between
customers.

If this data were used as the basis for time-driven costing, it would result in lower costs for
customers in close proximity, and higher costs for more remote customers. Similarly, costs would
vary depending on the route the courier chose to make the collections. An additional complexity
of time-driven costing in logistics operations is dealing with “stem time,” the amount of time
between the courier leaving the depot and making their first stop. One way to deal with “between
time” is to calculate its cost and apportion it equally across all customers on the route.

This is not intended to provide definitive answers to the use of time-driven costing, but to simply
illustrate how even in situations where hard and fast data such as duration times and cycle times
is available, its use in calculating costs and profitability need to be carefully considered in order
to avoid inappropriate allocations.

9 Business Objects • The 1-2-3 of ABC Methodologies: Time Splits, Time Capture, and Time Driven
 Data Collection
It is frequently suggested that time-driven costing eliminates the need for surveys and data
collection. But this is not the case. Each time a model is refreshed and recalculated, the duration
drivers should be updated. Even the most repetitive processes change. Contact center agents are
frequently provided with new scripts to help them up-sell and cross-sell other products and
services, and this impacts the length of each call. These process changes need to be collected and
collated meaning either extracting the data from a transactional system, or asking process owners
to provide an update. This is easily achieved with web-based ABC applications and work
management tools that expedite data collection.

Keep in mind that if reliable systems are not in place to capture cycle times, it can create a
dependency upon surveys and the people being surveyed are likely to relax their normal working
patterns. And consider what happens if the computation of driver volumes and activity cycle times
suggests a department is working above its theoretical capacity. This would certainly cast doubt on
the reliability of any ABC model and lead managers to question the validity of the reports.

Data Volume
Costing individual transactions with a timed-based methodology quickly generates enormous
amounts of data. Analyzing and generating management reports will require large databases and
powerful analysis and reporting tools.

Before going to this level of granularity, by using a time-driven methodology to calculate the cost
of every transaction for every customer, for example, it is worthwhile to understand exactly how
managers in the organization intend to use information to influence decision making. Other than for
key accounts, the focus of most strategic and operational decisions is at the customer segment level
and it may be more useful, and involve considerably less effort, to provide analysis at this level.

Business Objects • The 1-2-3 of ABC Methodologies: Time Splits, Time Capture, and Time Driven 10
 Conclusion

The Hybrid Model

While each of the methodologies discussed has its own particular strengths, none is perfect for
every activity in every responsibility center. In practice, most models are hybrids, with different
methodologies used in different responsibilities centers. Even then, it is unlikely appropriate and
reliable data is available for every activity and in certain instances, it may be necessary to resort
to approximations using weightings.

Nevertheless, whichever methodology is chosen, it is essential to refresh non-system driver data

each time a model is calculated. Web-based ABC applications such as BusinessObjects™ Activity
Analysis and Predictive Planning make this remarkably easy and there is no reason why ABC
data should not be produced every month as part of the traditional reporting pack.

Time-Driven Costing
It is unlikely a single methodology will be appropriate for all activities in a model, so it is
essential organizations choose an ABC application capable of supporting all the methodologies,
together with the flexibility to incorporate any special requirements for unique situations. In
Activity Analysis or Predictive Planning, the ABC model builder can easily develop a set of rules
to clearly reveal unallocated resources or unproductive capacity, using time spent, unit times,
and transaction volumes to model each activity in the most appropriate way.

Excess capacity should be identified and costed, but it is also important that future periods where
capacity may be exceeded are identified early enough to do something about it. Both Activity
Analysis and Predictive Planning include the ability to model capacity, so under used resource
can be redeployed and future capacity constraints addressed.

To make a time-driven costing model even more realistic, times should be allowed to vary across
model dimensions. For example, imagine a “packing” activity needs to be assigned to products
and customers based on the amount of time it takes to fulfil an order. In most cases the time taken
per order is 1.5 minutes per unit volume, but for products classified as “hazardous” and sold to
customers in the “chemical” sector, the unit time is taken from a user-entered driver representing
“Product Packing Time.” For other hazardous products, packing might take 2.5 minutes per unit
volume. Writing such a rule could be potentially complex, but Activity Analysis and Predictive
Planning include a wizard that allows the model builder to easily create such a rule by simply
completing a series of screens.

These applications not only deal with large volumes of data, but also include powerful modeling
tools making it easy to manage models employing a range of approaches to cost allocation.
Without such tools, model management would rapidly become difficult and error-prone.
Applications from Business Objects can work with modeling tools to develop and maintain
realistic models of an enterprise, and deliver powerful, insightful, and detailed analysis.

2
Institute of Financial Services (2006), “Customer Value—Is there an information deficit?”

11 Business Objects • The 1-2-3 of ABC Methodologies: Time Splits, Time Capture, and Time Driven
 Printed in the United States – December 2006 PT#WP3064-A.

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