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Activity Based Costing vs Traditional Costing (Labor)

Which system do you have in place, and why did you choose it over the other? Does the global nature (if it exists) change your methodology? Does the method chosen have any tie-in to whether you value inventory using LIFO (not permitted under IFRS), FIFO or other methodology?


Mark Matheny
Title: VP - FInancial Planning and Analysis
Company: Novolex (formerly Hilex Poly)
(VP - FInancial Planning and Analysis, Novolex (formerly Hilex Poly)) |

Traditional and it has been in place for some time. I have not worked anywhere that used ABC on the P&L. It is not really tied to our method for valuing inventory. We also look at labor differently for analytics. Much more of a fixed cost or at a minimum step variable.

Leslie Karnauskas
Title: CFO
Company: BMGI

Traditional as well. To me ABC is an analytical tool to help you understand your costs better. It is not really a method for valuing your inventory or cost of sales under any accounting standard.

Topic Expert
Bob Scarborough
Title: CEO
Company: Tensoft, Inc.
(CEO, Tensoft, Inc.) |

My experience is the driver of the greatest cost or value add is often the best driver of cost allocation for inventory valuation. There are a number of scenarios where labor hours/cost based allocation doesn't work well - including:
1) The manufacturing teams work on multiple lots / pieces of equipment simultaneously.
2) The cost associated with the equipment and related support far exceed the labor cost involved.
3) There is no effective labor tracking system or possible system for the production build process

When I think of Activity Based Costing I don't usually think of inventory valuation - it brings to mind profit and cost center analysis for P&L reporting. Manufacturing inventory valuation is usually done at moving average or standard cost - and the allocation or cost absorption models usually depend on the nature of the process and the cost/analytical data available.

(Financial Analyst) |

I would like to hear from someone who has actually worked with both ABC and traditional.

(Chief Financial Officer) |

I've mostly used Traditional. In my experience, ABC lends itself to Gov't or cost based contracts where you can also support the added accounting costs. The most effective Traditional system was with fewer cost centers and variable costs only: all fixed costs were allocated based on DOH/Turns.

Parveen Bansal
Title: Owner
Company: Manage-My-Business
(Owner, Manage-My-Business) |

ABC is used for management decisions. Traditional costing is used for accounting (including valuation purposes). ABC costing considers only incremental costs and discards past / incurred costs.

Alan Thodey
Title: President
Company: Abelisk, Inc., formerly Argos, Inc.
(President, Abelisk, Inc., formerly Argos, Inc.) |

As a developer of ABC software (ABECAS--Activity Based Enterprise Cost Accounting System by Argos Software), I can look at where it has been used successfully. Where the production process is discrete, workers can charge their labor and equipment hours to the job (product/contract/crop) and the activity along with materials used. This information can then be used to allocate non-allocated expenses based on labor hours, labor cost, total cost, etc.

There are two end results. First, actual unit production costs can be determined and used to cost inventory. And second, it allows a very detailed analysis of production costs, highlights variations and often suggests activities where savings are possible.

(Agent, JKS Solutions, Inc.) |

ABC was developed by German Engineers in Germany and specifically applied to manufacturing. If you have a chart of accounts broken into cost centers you are using elements of ABC. It can be applied in production but it can also be applied in a general sense. It is a non-allocation methodology which means more cost is driven into the accounting process and managers of the cost centers need to have a high level of financial understanding to keep it going.

Topic Expert
Patrick Dunne
Title: Chief Financial Officer
Company: Milk Source
(Chief Financial Officer, Milk Source) |

I have implemented both and actually favor traditional costing. Part of it is the simplicity, but also, the advantages of breaking down ABC sometimes seems more costly than the benefit. We had implemented ABC to uncover low margin products and it just didn't provide the benefit we thought it would.


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