Question

Since its introduction, activity-based costing (ABC) has evolved in various ways. In recent years, the evolution has centered on the use of time estimates, leading to a version of ABC called time-driven activity-based costing (TDABC). Under TDABC, burden rates are a function of time, and involves four steps. In step 1, the practical capacity of a given activity are estimated, for example, the number of machine setups the production plant is capable of performing. In step 2, the overhead resource costs associated with the activity (at practical capacity) are estimated. In step 3, the amount of time associated with performing that activity (at practical capacity) are estimated. Finally, in step 4, the estimated overhead resource costs are divided by the estimated total time to determine a time-based burden rate for the activity.

Companies that use TDABC often rely on employees’ subjective time estimates. As a result, a key issue in implementing TDABC is how these time estimates are determined. One approach is a “top-down” approach, in which employees estimate the total time associated with the total practical capacity of the activity. Another approach is a “bottom-up” approach, in which employees estimate the time associated with performing the activity once.

In theory, these two approaches should lead to the same estimates, and thus the same time-based burden rates for a given activity. However, a recent research study finds that the “top-down” approach leads to an over-estimation of time associated with the activity, while the “bottom-up” approach leads to an under-estimation of time associated with the activity. Thus, the accuracy of the reported costs under TDABC may depend critically on how subjective time estimates required by the costing system.

Why do you think this occurs?

Answer 1

Solution:

In top down approach, it is the management that decides the total time associated with practical capacity of activity. Management always tries to be more efficient and expects the minimum time in which employees can do the task/work. So, whenever they plan or take decision sregarding standards, minimum time constraint is always there as this is the basic thinking of management that is visible in every decision. But in reality employees not always work at that efficiency level an ddue to many reasons they end up with more time than expected/standard one. Thus, there is always an over-estimation of time in this approach.
In bottom up approach, employees decides the standard time for an activity. Although every employee want to finish its work in minimum time but they always set more standard time for the same so that they can finish the work slowly, comfortably and as per standard. It gives them satisfaction that they are able to complete the work on time without putting extra effort. Therefore they always under-estimate their capacity and standard time for any task.
Thus, it can be concluded from above that it is basically the way of thinking, behaviour and rationale that leads to difference in result of both approaches.