This paper will focus on the applicability of Activity Based Costing in Competition Bikes Inc. Activity Based Costing (ABC) is an accounting practice that provides that activity costs should be identified differently. This way an organization can be able to identify the overhead costs that have a significant impact in the production of certain products. This paper will provide recommendations regarding whether Competition Bikes Inc. should change to ABC or stay in the, current traditional, costing method.
Competition Bikes Inc. Summary Report
Competition Bikes Inc. is a manufacturing Company that deals racing bikes. In a manufacturing Company, it is vital to determine the costs that have a direct impact to the final products. Overhead costs contribute to the determination of the selling price for final products. To determine the specific costs that contribute to success or failure of an organization product, Activity Based Costing can be used. This method evaluates the cost of each activity fundamental in the calculation of overhead costs, unlike the traditional method (Daly, 2001).
Competition Bikes Inc. should change from the current costing method to Activity Based Method (ABC). This ideology can be well explained by evaluation of the benefits that ABC has over the traditional method currently being used by the organization. Activity Based Costing provides a clear overview of manufacturing overhead costs incurred by the Company (Daly, 2001).
Unlike the traditional method being used currently, ABC accumulates manufacturing overhead costs for every activity. This method shows the causal factor of a particular overhead costs hence facilitating identification of activities that can be fundamental in cost reduction. Production cost reduction is essential in the operations of a manufacturing Company such as Competition Bikes Inc. It enables the organization to determine critical success factors that can promote a competitive edge within the business environment. This can only be achieved by identifying activities that increase the overhead costs. Costs such as engineering costs, utility and services, can be mitigated once their impact on the total overhead costs has been identified (Daly, 2001).
In financial reporting, it is necessary for an organization to show items by their costs. For example, ABC shows overheads such as factory setups, quality control, engineering services, product movements, utilities and depreciation by their costs. In financial reporting, overhead costs such as depreciation enable the Company to determine disposal items that are no longer valuable for the Company. Therefore, this method is the best in recognition of financial items (Hicks, 2002).
Activity Based Costing will enable the management to determine overhead activities that are not cost effective hence reducing losses. Reduction of overhead costs will enable the Company to set the products of their bikes at competitive prices within the market environment. Therefore, changing to ABC will enable the management to make effective decisions in regard to the costs drivers. It will enable the management to effectively allocate resources and identify under-priced items that may lead to losses. ABC will also facilitate identification of over priced items that may result to loss of bids (Daly, 2001).
Activity Based Costing will provide clear and well detailed information to users of Competition Bikes Inc. financial information. This will enable the Company to build its reputation and gain a larger market share. This method will enable the management to accurately allocate individual goods and services mainly because of its flexibility. Once the Company changes to this costing method, it will be capable of identifying the complex classification of customer needs. Since traditional method makes it difficult to determine the specific manufacturing costs, achieving customer satisfaction becomes difficult. This is primarily because direct labor is being replaced by automated appliances that can perform faster (Hansen, Mowen & Guan, 2007).
The dynamic changes in technology have led to increased obsolesce and life cycle of some products. As a result, the Company’s accounting department is faced with a major challenge of updating and making adjustments to inventory books. In order to cope with these challenges, it will be beneficial for Competition Bikes Inc. to change their current costing method to Activity Based Costing (Hicks, 2002).
Activity Based Costing has minimal errors when it comes to the calculation of overhead costs. This reduces the time wasted in making adjustments due to errors that were made in the past. The other critical reason as to why Competition Bikes should adopt Activity Based Costing is principally because it’s easier to identify where changes need to be made in the production process. The management will be capable of identifying the activities that add value to the production process. Thus, allocation of resources can be done according to the order of priority (Hicks, 2002).
Activity Based Costing provides a clear view of the activities that add value to the final product. Therefore, by adopting this method the management of this Company will be capable of identifying ways in which to increase shareholder value. Maximization of shareholder value is a fundamental issue that seriously organization must consider in its operations. As a public trading Company, Competition Bikes Inc. needs to identify these needs and improve its performance. This can be substantially achieved through the use of ABC costing method since it provides a clear overview of the potential success factors that can place the Company at a competitive edge. Activity Based Costing facilitates identification of profits and costs essentials related to dynamic variations in the production process (Daly, 2001).
The management of this Company can easily trace the background causes of poor performance. This is mainly because ABC provides a clear overview of overhead cost changes during the previous years of business. As a result, the Company will maintain a sustainable and stable growth within the market environment. This method will benefit the Company by facilitating disclosure of valuable information. ABC costing method crosses both organizations departments and functional sections to identify contributors on overhead costs (Hicks, 2002).
Identification of functional areas where costs reduction can be made will become easier with adoption of ABC hence increasing profits. Therefore, this method is likely to increase the integration and coordination of functional areas towards achieving the common organization goal. Since Competitive Bikes Inc. is a manufacturing Company, it is essential to identify overhead costs and their contribution to pricing of the bikes. This will facilitate allocation of resources and detection of their contribution towards the performance of the product at the market value. To achieve this, Company should adopt Activity Based Costing method (Hicks, 2002).
Breakeven Point Analyzes
The breakeven point provides the Company with an opportunity of comparing and contrasting the value added by each unit of Titanium and carbon lite frame bikes. Breakeven points enable the management of an organization to determine the level of resource utilization that can lead to maximization of profits. In relation to the cost volume profit analysis, it is possible to conclude that more titanium units are sold compared to Carbon Lite. At the breakeven point, 1415 units of Titanium are equivalent to 786 units of Carbon Lite. Competition Bikes Inc. generates most of its sales revenue from Titanium bikes compared to Carbon Lite bikes (Hansen, Mowen & Guan, 2007).
The breakeven point shows that the costs incurred, and revenue generated from 1415 units of titanium is equivalent to the 786 units of Carbon Lite. The production of these units covers all the costs associated to distribution and production of the final product. Therefore, revenue generated from the sale of Titanium bikes contributes a higher percentage to the net profits of the Company compared to Carbon Lite bikes. Since at breakeven point Titanium units are more than Carbon Lite units, the cost of Carbon Lite bikes is higher compared to that of titanium bikes. This is mainly because at the breakeven point 1415 units of titanium are likely to produce the same revenue as 786 units of Carbon Lite (Hansen, Mowen & Guan, 2007).
Sales dollars for Carbon Lite bikes are higher than those of Titanium in order to generate more revenue that covers the total costs. At breakeven point, each model can be used to generate higher profits depending on its impact to the customers’ preferences. The breakeven point shows that Titanium bikes are likely to give the Company a competitive edge if their prices are increased. This is because this model has the greatest number of sales hence a higher revenue generation compared to Carbon Lite model (Hicks, 2002).
The breakeven point shows of the units that can be sold at higher prices during stiff competition to cover the research and development costs. Carbon lite bikes can be used by the organization to enter into new markets given their rate of demand. This will enable the business to gain profits through the use of cross border listing. As a result, the organization can lower the costs of titanium bikes to increase their demand within the market environment (Hansen, Mowen & Guan, 2007).
Increase in fixed costs by $50,000 and 10% direct materials will increase the sales units of both the titanium and Carbon Lite models given the fact that revenue per unit will remain the same. This can be attributed to the fact that the increment affects direct production costs. Fixed costs and direct materials have a direct impact to the final product. Addition of fixed costs and direct materials adds value to the final product. Since the value and quality of the product will increase without affecting the price of the product, demand for these products is likely to increase. These changes will also increase the total revenue of the product. This is because of improved quality hence increasing customer satisfaction (Hicks, 2002).
Increasing the fixed costs will enable the Company to determine the profit territory in which it can compete with others profitably. Minimizing the fixed costs reduces the breakeven figure hence leading to higher production costs. As a result, the Company may run into losses. Therefore, to enable the variable costs will be covered with increasing the fixed costs hence revenue (Hicks, 2002).
The more the volume of direct material during the input the more the output generated. The same ideology can be applied where by additional direct materials and fixed costs will increase the output generated for Titanium and carbon lite bikes. Additional materials will also cover the variable costs hence increasing revenue (Hicks, 2002).
Activity Based Costing is more appropriate to enable the Company to price its products and identify overhead activity costs that are not fundamental to the production process. Being a manufacturing Company, Competition Bikes Inc. should change from its current costing method to increase efficiency in error retrieval. Overhead costs contribute a key role in the determination of final products costs. Therefore, it is necessary to identify these costs according to their order of priority. As a result, Competition Bikes Inc. should change their current costing method to Activity Based Costing.
Daly, J. L. (2001). Pricing for Profitability: Activity-Based Pricing for Competitive Advantage. New York: John Wiley & Sons.
Hansen, D.R., Mowen, M.M & Guan, L. (2007). Cost management: accounting & control. Florence, KY: Cengage Learning
Hicks, DT. (2002). Activity-Based Costing: Making It Work for Small and Mid-Sized Companies. 2nd Ed. New York: John Wiley & Sons.