The traditional costing method is a distribution of manufacturing overhead costs to the actual products manufactured. By using this method the factory’s indirect costs are assigned, on a scale of volume, to the items manufactured (Averkamp, 2013). This may include items such as the direct hours of labor or the number of bikes produced.
This volume metric, however, is not the driving factor for manufacturing overhead expenses in fact this method is designed more for departmental focus. It can also be very inaccurate as there is little to no relations between the actual costs and the activity these costs are being signed to. This method often causes inaccuracies. It is in the company’s best interest to switch, as many companies are doing, to an activity-based costing system.
Activity-based costing system will be used to identify the costs of Competition Bikes, Inc.’s activities and services based on actual consumption. This system consists of four steps in order to build its cost point. First, Competition Bikes, Inc. must recognize activities guesstimate their overall costs. Second, the cost driver must be estimated for each activity and done so on the basis of the overall quantity of the driver’s allotment. Third, Competition Bikes, Inc. must calculate how much of the costs should be distributed to each activity. Fourth, costs must be distributed to the cost object.
Although this method is time consuming and costly the activity-based costing method will generally earn this money back plus some as it has a much more precise prognosis of the correct costs that are related with each activity. This system often generates more overheads into direct costs then compared to the traditional costing method. It is believed by switching from a traditional costing system to an activity-based costing system, Competition Bikes, Inc. will gain greater knowledge and be able to define the driving forces and costs of the products being manufactured.
According to the overhead analysis, while using the traditional costing method the Titanium models costs $713 per unit and the CarbonLite models costs $1,359 per unit. Under the activity-based costing method Titanium models cost $656 per unit to produce and CarbonLite models cost $1,460 per unit. This shows us the difference in the two costing methods.
Traditional costing method over-valued the costs of Titanium bikes and under-valued the costs of CarbonLite bikes, which is apparent when looking at the activity-based costing method. Again due to the way activity-based costing method breaks down the activities and allocates each one, this method is much more accurate than that of the traditional.
Competition Bikes, Inc. can now analyze these costs and look for ways to improve operational results now that the costs have been broken down and allocated to different activities. Using the activity based costing method the CarbonLite models is at a much higher rate than that of the traditional costing method yet the Titanium models have the opposite affect as the total product costs are lower using the activity based costing system than that of traditional costing methods.
Prices vary greatly between the two bike models, which were not seen before under the traditional costing method. The company should be able to now evaluate these costs and find ways in which they can lower them to get them more in line with one another.
As stated above the activity-based costing method also allows Competition Bikes, Inc. to simply identify variations in product costs and pinpoint the variation directly to the source. This helps the company keep control of the company’s costs and expenses. This assists in keeping profits relatively steadily.
The current operations can also be improved by implementing a just-in-time inventory management system. This is where the company only buys the materials that it needs to produce the units that are actually sold. This cuts down on dollars that are tied-up in inventory held in raw materials inventory. This is a considerable amount for Competition Bikes, Inc. and will be lowered enormously as fewer materials are placed in raw materials.
This will be billed in the same month in which they are produced creating fewer dollars to be tied up in inventory. This will then be converted to cash to be used as working capital.
According to Investopedia the breakeven point is the point at which gains equal losses. For Competition Bikes, Inc. achieving the breakeven point is a leap in the right direction. This will allow them to be one step closer to being a profitable business. Here we will analyze the sales units and the sales dollars of the Titanium and CarbonLite bike models in order to configure the breakeven point.
In order to construct the breakeven point we must use the weight average contribution margin. This is calculated by dividing the combined contribution margin (sales price per unit subtracted by the variable cost per unit) by the total sales mix-in units. The contribution margin per unit is equal to $221 for the Titanium models and $111 for the CarbonLite models. Now we multiply these numbers by the total sales mix-in units to reach the contribution margin. The total contribution margin ($127,200) is divided by the total sales mix-in units (700) in order to receive a weight average contribution margin of $181.71.
At breakeven the total contribution margin subtracted by the fixed costs will equal 0. The sales units multiplied by the weight average contribution margin equals the fixed cost. From the data given the estimated fixed costs is $400,000. The fixed costs divided by the weight average contribution margin of $181.71 can help Competition Bikes, Inc. determine the breakeven point of 2,201 sales units.
Now Competition Bikes, Inc. can calculate sales units and sales dollars with these numbers calculated. By parting the sales at the breakeven point by the product mix-in does this. Competition Bikes, Inc. must sale 1,415 Titanium and 786 CarbonLite models in order to hit their breakeven point and gain profitability.
The sales dollars at the breakeven point are computed by multiplying the breakeven sales units by the sales price per unit. This equals $1,273,584 for Titanium and $1,175,314 for CarbonLite models giving us a overall amount of $2,448,899.
Breakeven Analysis Change
We will now discuss how the changes in direct materials and fixed costs to the production facility based on an evaluation of cost-volume-profit will affect the breakeven analysis.
If the costs of direct materials increased by 10%, Competition Bikes, Inc. will notice a change in the breakeven point as the variable costs would then increase from $679 per unit to $709 per unit for the Titanium models and $1,384 per unit to $1,451 per unit for the CarbonLite models. Because the variable cost per unit has changed so will the contribution margin per unit.
This will have a large decrease on both the Titanium and the CarbonLite models as Titanium bikes would have a contribution margin of $191 per unit and CarbonLite bikes would also have a contribution margin to $44 per unit.
We then multiply these changes by the sales mix in values. The contribution margin for the Titanium bikes is $85,950 and $11,000 for the CarbonLite bikes. This gives Competition Bikes, Inc. a total contribution margin of $96,950.
The weight average contribution margin is now calculated by dividing the contribution margin of $96,815 by 700 the total number of sales mix-in units. This totals to $138.5. Before the 10% increase this number was much higher at $181.71.
If Competition Bikes, Inc. added $50,000 in the fixed costs towards the production facility, changes would occur in the sales units at the breakeven point. The calculation would be $450,000 compared to $400,000 divided by the new weight average contribution margin of $138.5. This totals to 3,249 units. Titanium models would total 2,089 in sales units at the breakeven point and CarbonLite would total 1,160 sales units at the breakeven point. The total breakeven point in sales dollars now increases to $3,614,620. This is an extra $1,165,721.
Competition Bikes, Inc. would need to stay on top of these additional costs and in order to do so they must increase their sales each quarter. Based on direct materials increase of 10% and the additional $50,000 in fixed costs, Competition Bikes, Inc. will need to manufacture 1,048 additional units in order to breakeven.
Averkamp, Harold. (2013). Accounting Coach. What is the Traditional Method used in Cost Accounting? Retrieved from
Investopedia. (2013). Breakeven Point-BEP. Retrieved from
Johnson, Rose. (2012). EHow Money. The Cost-Volume-Profit Analysis. Retrieved from http://www.ehow.com/info_10040118_costvolumeprofit-cvp-analysis.html
Wikipedia. (2013). The Free Encyclopedia. Activity-based Costing. Retrieved
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