Activity based costing
Activity based costing is a superior cost estimation and allocation method since it allocates specific costs t a certain product not only in batch numbers but also in units form. Competition Biking Company should consider using the method for budgeting and pricing strategies. The method offers a chance to the management to establish linkages and areas that are not efficient; it ensures that certain cost can be attributed to certain commodities especially when a company is dealing with more than one product. When dealing with more than one product: some fixed costs, though incurred by the entire company as a whole, relate more to some products: when accounted for using activity-costing method actual cost to be attributed to a commodity can be precisely known. This makes costs incurred by a certain product to be approximated more precisely.
The price set for a commodity by management is an element of costs incurred when producing the commodity; activity cost methods offers a more precise cost of a product thus manages the price given on the product. For example, when using traditional costing method where cost are only classified as variable and fixed costs; in a company producing more than one products (this is the situation of competition Bikes), then total fixed costs is divided equally among all products; however some products has higher utility of the fixed costs thus undermining their cost. Alternatively, those products that used minimal of fixed costs may be rated high with the assumption that they had used a higher fixed cost.
Competition Biking Company should implement and use activity costing method since it will assist the company get a better costing method for budgetary and futuristic projections of profits, production budgets and finance allocation. The nature of Competition Biking Company calls for a cost allocation a method that recognizes different costs for different brands of bikes. Some bikes require more attention and thus the best way to determine their cost is by an activity costing mechanism.
In 4Ps (Product, Price, Promotion and Place) of marketing, the price of a commodity is given center stage; price should look into two elements. One the need to cover the cost of production and give the producing company a margin of profit and it also looks into the affordability of the product by customers. Price charged by Competition Bike Limited should look into these two aspects thus having a costing method that looks into these two areas is important. Activity costing method offers a company the chance to have a well-balanced cost to all commodities such that Competition Bike Limited will not suffers and their products will be affordable.
Competition Bike Limited should consider adopting an activity based costing method. It will assist in when budgeting as well as when determining costs to charge for their commodities irrespective of the brand name (Noreen, Brewer & Garrison, 2011).
One of the most hindrances that a company has is controlling the costs of its activities; costs can be effectively being controlled if they can be associated with a certain production rather than having common costs. ABC cost management process assists a company get the real costs of a commodity and note if any inefficiencies that can be controlled to decrease the costs. This assists in cost management from a product point of view. Certain areas that can be improved results to an overall improvement in costs of a company.
Break even analysis using activity-based costing
The noble goal of a business is to make profits; before realization of profit, costs both fixed and variable should be catered for by the sales make. Fixed costs are those costs that must be incurred whether production is taking place or not: they are constant in their very nature. As long as a company is operating, those costs have to be incurred; they include security, annual maintenances, management and administrative costs, rent, among others. In CVP method, costs are allocated equally to different products, however in activity-based method, they can be divided and allocation for every product or batch of production realized. Rationally when sales have been made, these are assumed to have been met first by initial sales revenue. At break even, a company does not realize any profit, but it is at the point where fixed costs have been “recouped” from sold products (Noreen, Brewer & Garrison, 2011).
It is calculated as follows:
Breakeven point then total fixed costs = total revenues from sales
Formulae: break even = fixed costs/contribution per unit
Breakeven point is thus affected by changes in contribution margin and changes in fixed costs.
The case of Competition Bike new system at San Diego
In this case, the company acquired a plant that could assist the company manufacture two brands of Bikes: Titanium Bikes and Carbon lite Bikes, sold at different prices. The price of the bikes was 900 and 1495 for titanium and carbon lite respectively. To analyze the breakeven point, let us consider each Bike separately:
- Titanium
With a sales mix of 900:500 for Titanium and carbon Lite respectively, Titanium Bikes had a contribution of 221 and a break-even point of 1415; this meant that for the category of Bikes in the plant to cover the fixed costs attributed to them, then the company needed to produce at least 1451 bikes. With this production it will have made no profit whatsoever from the line of trade. At this point the breakeven point sales, which is a multiple of selling price and number of titanium Bikes is 1,273,585.
When calculation contribution margin; the difference between commodity selling price and variable costs is considered as the contribution margin.
After there is an increase in direct costs by 10% as well as an increase in fixed costs by $50,000, then production line of Titanium will be affected as follows:
The contribution margin will reduce from $221 to $191, then fixed costs will increase, to cover the increase in fixed costs with reduction of contribution margin, then the company needed to produce an extra 677 Titanium Bikes. The new breakeven point stands at 2092 units. The new sales revenue at this breakeven point is at 1,882,456.
- Carbon Lite
The price of the brand of Bikes is 1495 with a contribution margin of $111, the breakeven units are 786; this means for the company to cover effectively all fixed costs that can be associated with production of Carbon Lite Bikes, then it requires producing at least 786 Carbon lite Bikes. At this point, the sales revenue, which is a product of selling price and number of breakeven point units, will be 1,175,314.
When the cost of production is increased with an increase in direct material costs of 10%, then the contribution margin of the brand of Bikes will reduce (contribution = selling price minus variable costs). Secondly, the increase in variable cost comes along with an increase in fixed costs with $50,000; from the break-even formulae, breakeven point is affected by any changes in fixed costs and changes in contribution margin.
In this case, the fixed costs have increased as contribution margin decrease, this mean that the new breakeven point units will need to be increased accordingly to cover the change.
After the change, the new contribution margin will be 44 and breakeven point units will be 1162; the contribution margin has reduced with $67. The number of additional units has increased by 376. At the new breakeven point, the total sales revenue is 1,737,205.
The increase in units was to cover the changes in fixed costs.
- Total plant operation
Before changes in fixed costs and an increase in variable costs, the company required 2201 units of both Titanium and Carbon Lite Bikes, this would have contributed $2,448,899. After the increase in fixed cost by $50,000 and 10% increase in cost of production, the plant required 3254 units with total sale revenue as 3,619,661 (Carlon, 2009).
Conclusion
At breakeven point, there is no profit or loss margin to a production; the units produced cover fixed costs incurred in the production process (total revenue = total costs). Holding commodities selling price constant, an increase in fixed cost and a decrease in contribution margin will result to an increase in number of units required to break even.
References
Carlon, S. et al. (2009). Accounting: Building business skills. New York: John Wiley & Sons.
Noreen, E., Brewer, B., & Garrison, H. (2011). Managerial accounting for managers. New York: McGraw Hill.