Activity Based Costing

Competition Bikes management decide to retool and now manufacturing both Titanium and CarbonLite Frames bikes. Competition Bikes was using the Traditional based Costing (TBC) method, however the Activity Based Costing (ABC) may give more insight to management and helpful in analyzing the per unit costing of the different types of frames and pinpoint the area of improvement. Also the management wants to know the Breakeven point caused by the potential increase of fixed cost by $5,000 and increase in direct cost by 10%. A1: Costing Method

Traditional Based Costing Method (TBC)- The allocation of manufacturing overhead (indirect manufacturing costs) to products on the basis of a volume metric such as direct labor hours or production machine hours. As manufacturing becomes more sophisticated the manufacturing overhead costs usually increase while the direct labor hours or production machine hours decrease. Hence, the direct labor or machine hours are unlikely to be the root cause of the manufacturing overhead. (Accounting Coach 2014) The basis of traditional costing system is to calculate the overhead rate and apply that predetermined overhead rate to various products. Traditional costing system is more desirable when the indirect cost is more and the direct cost is less. Traditional costing systems are simpler and easier to implement than ABC systems. However, traditional costing systems are not as accurate as ABC systems. Traditional costing systems can also result in significant under-costing and over-costing. The main steps of the Traditional costing process are-

1. Calculate the total indirect cost and determine a indirect cost for the appropriate period. 2. Choose a cost driver like labor hours, machine hours used for the purpose of allocation 3. Determine the total units of cost driver like total machine hours. 4. Calculate the overhead rate per unit of driver eg $xx per machine hour 5. Apply the calculated overhead rate to the products.

(Strategiccfo.com 2014)
Activity Based Costing (ABC) Method is calculated by allocating indirect cost to different activates based on the actual usage by the different products. As such the ABC costing method is more accurate in determining the overhead cost. ABC costing is more appropriate when the accuracy is more important factor in determining the market factors. Also when the overhead cost is more than the direct cost, then ABC method is more desirable as it shows the correct picture. It is commonly used in manufacturing companies especially with different types of product as the company can clearly see the products which are consuming more resources.

The accuracy of correct costing will help company in making the decisions like determining prices, continuing/discontinuing the products and also will help the company in foreseeing the areas of improvement that can eventually help in reducing the cost. Overall Activity Based Costing is more accurate, precise and the effective way of allocating the overheads to products. However, ABC systems are more complex and more costly to implement. The following are the main steps of the Activity Based Costing Method- 1. Identify the different activates in the production of the product 2. Estimate the total cost per activity

3. Compute a cost driver rate for each activity based on a cost allocation 4. Apply activity costs to products using the appropriate cost-driver rate. (Strategiccfo.com 2014) The spreadsheet provided performs the comparison of per unit cost per Traditional Costing Method and the Activity Based Costing Method. Based on the analysis of per unit cost, we determined that per unit cost of Titanium frames is per TBC $713 per unit while per unit cost based on the ABC is $656 per unit. On the other hand per unit cost of Carbon Lite frame per TBC is $1,359 and per ABC is $1,456. We clearly can see the difference in the cost per unit based on the two different method of overhead allocation. Based on the TBC, Titanium frames were overvalued by $50,605 as the allocation of overhead plus direct cost was $641,320 as against the ABC costing $590,715. The CarbonLite frames were undervalued by $50,605 as the allocated overhead plus direct cost per TBC $679,380 as against the $729,985 per ABC costing method.

We clearly can see that the total overhead cost is same for the company, the difference is allocation of overhead based on two different method. The ABC method, which is more accurate in calculation and estimate the overhead based on the actual resources consumed like factory set up, engineering, quality control, utilities, depreciation etc. for each activity. Based on the analysis above, we concluded that the ABC costing method is more accurate than the traditional costing method. The Carbon Lite bikes are far expensive in producing as compared to the Titanium bikes. The company may be pricing Titanium bikes more based on the TBC while the actual costing is less. Now when the costs are broken out by activities, it’s much easier to compare both bike models and identify possible improvements and deficiencies along the way. By fully understanding the costs to produce, Competition Biking can better budget and position itself in the market against other companies for higher sales and revenue.

A2a: Breakeven Point
A method of cost accounting used in managerial economics. Cost-volume profit analysis is based upon determining the breakeven point of cost and volume of goods. It can be useful for managers making short-term economic decisions, and also for general educational purposes. (Investopedia, 2014). Breakeven point is the point where the company has no profit no loss by selling a certain number of products. Competition Biking is looking to determine the break-even point for the San Diego plant. We need to determine the Sales mix i.e. the Titanium bikes and Carbon Lites sold by the company having no profit and no loss position. To calculate the break-even point, the company need to determine Sales price per unit, Variable cost per unit, contribution margin per unit, and weighted contribution margin per unit To determine the break-even point is important for the Competition Bilking Company to analyze the Cost Volume Profit analysis. In the Analysis below, we calculate the total number of units for both Titanium and Carbon Lite bikes to be sold to achieve e the break-even point. In order to calculate the break-even point, first we need to calculate the contribution margin per unit.

The sales price per unit for Titanium bikes is $900 and variable cost is $679 per unit. The contribution margin per unit is calculated by deducting the variable cost from the sales price per unit. Contribution margin represents the amount remains after paying the variable cost. The contribution margin per unit is calculated based on the assumption that the sales price and variable cost per unit remains the same for any number of units. Same way mentioned above, we have calculated the contribution margin per unit for carbon Lite bikes which is $111 ($1,495 (-) 1,384. We calculated the weighted average contribution margin per unit, which is arrived by multiplying the contribution margin per unit to sales mix. The Sales mix time CM for titanium bikes is $1,989 and for Carbon Lites bikes is $555. The total comes to $2,544. The totals of sales mix times contribution margin per unit for $2,544 is divided by total sales mix in units of 14 to arrive at the weighted average margin per unit of $181.71.

The Break-even is the point where the fixed cost is met by the contribution margin resulting in the no profit/ no loss situation. For Competition Biking, the fixed cost is for $400,000 and the weighted average contribution margin as calculated above is $181.71. Base on the provided information, we divide the fixed cost of $400,000 to $181.71 to arrive at the total units to be sold to reach at break-even point. We determine that the 2,201 units is the breakeven point for the completion biking. To determine the breakeven point for each type of model, we divide the total breakeven unit of 2,201 units to proportionate sales mix.

The total break even sale is calculated at $2,448,900 as shown above. A2a: Breakeven Point
The Break-even point for the San Diego unit will change drastically with the increase of $50,000 and 10% increase in variable cost. The break-even analysis is based on the calculation of weighted average contribution margin per unit which is arrived by deducting variable cost from the sales price and multiplying the sales mix. Therefore the increase in variable cost negatively impacts the weighted average contribution margin per unit. The variable cost of the Titanium and the Carbon Lite bikes will increase from $679 to $709 and from $1,384 to 1,451 respectively. This increase will result in the reduction of contribution margin per unit of Titanium bikes from $221 to $191 and for Carbon Lite bikes from $111 to $44 per unit. As such, with the increase in 10% variable cost, sales margin reduces by 30 or 14% for Titanium Bikes and 67 or 60% for CarbonLite bikes, which is a big decline in terms of percentage. The sales mix remains the same.

The new sales mix times CM per unit is calculated at 1,719 and 220 for Titanium bikes and Carbonlites, which leads to the weighted average contribution margin per unit at 138.50 per unit. Weighted average contribution margin/unit decreases from 181 to 138.50 per unit, which is decline of 43.21 or 24%. This decrease in weighted average contribution margin per unit requires the additional sales by the company to obtain the break-even analysis. The break-even point further impacted by the increase of $50,000 in fixed cost. The new break-even point after increase of $50,000 in fixed cost and 10% increase in direct material cost is 3249 units. This shows an increase of breakeven units by 1,048 units or 48%, as such the company needs to ensure the additional manufacturing resources and marketing plan to sell the additional productions. The new product mix is now 2,089 units and 1,160 units for Titanium and Carbon Lite as shown in the spreadsheet provided.

Based on the analysis the completion bikes need to fabricate additional 1,048 units after increase $50,000 in fixed cost and 10% increase in variable cost to achieve the break even. With this increase the position of the company is on edge and changed drastically. Competition Bikes needs to explore the opportunities to reduce the cost by looking the areas of improvement or considering the various alternatives. At the same time, the company requires to prepare for the increase in cost by ensuring the availability of the resources like the labor, material, machinery and financial resources to fabricate the additional units and at the same time prepare a marketing plan to sell the additional units in the market to achieve no profit no loss position.

References
(Accounting Coach 2014) – Definitions Accounting coach retrieved on September 19, 2014 from http://www.accountingcoach.com/terms/T/traditional-costing Investopedia 2014 – Definition retrieved on September 19, 2014 from http://www.investopedia.com/terms/c/cost-volume-profit-analysis.asp Strategiccfo.com 2014- Activity based costing and Traditional costing steps retrieved on September 19, 2014 from
http://strategiccfo.com/wikicfo/activity-based-costing-abc-vs-traditional-costing/