Competition Bikes, Inc. Should the Company Change

Competition Bikes, Inc.

Should the company change to activity-based costing?

Before deciding whether the company should change to activity-based costing (ABC), it is critical to understand what ABC is. ABC is a "special costing model that identifies activities in an organization and assigns the cost of each activity with resources to all products and services according to the actual consumption by each. This model assigns more indirect costs (overhead) into direct costs compared to conventional costing models" (The Economist, 2009). The real benefit to ABC costing for Competition Bikes, Inc., is that it would permit the company to see what part of the overhead expenses were being used for the Titanium Xl and the CarbonLite modes. Each Titanium XL uses $136 in direct labor and $240 in manufacturing overhead. Each CarbonLite uses $294 in direct labor and $420 in manufacturing overhead. However, the models have significantly different selling prices. Therefore, just knowing that the second model uses a greater proportion of the overhead expenses is not sufficient to know whether or not its production is an efficient use of company resources. Using ABC to assign the costs helps determine the real manufacturing costs of each item.

ABC is particularly applicable in a situation like that at Competition Bike, where the two products have dramatically different engineering and labor needs. Currently, machine hours and labor hours are how Competition Bikes looks at overhead costs. However, that might not reflect the true overhead costs. Engineering, testing, and setup activities can all impact a business' true overhead costs (Accounting Coach, 2011). Assuming that all products have a proportional share of the overhead costs can result in a "miscalculation of each product's true costs of manufacturing overhead" (Accounting Coach, 2011). However, "activity-based costing will overcome this shortcoming by assigning overhead on more than the one activity, running the machine" (Accounting Coach, 2011). In fact, "activity-based costing recognizes that the special engineering, special testing, machine setups, and others are activities that cause costs- they cause the company to consume resources. Under ABC, the company will calculate the costs of the resources used in each of these activities. Next, the cost of each of these activities will be assigned only to the products that demanded the activities" (Accounting Coach, 2011).

Looking specifically at the two products marketed by the company, one can see critical differences in the needs for both products. The Titanium XL's setup costs 15 times the cost of a CarbonLite setup, but only one setup is required for 500 frames, while each CarbonLite frame requires its own frame. Moreover, there is one quality inspection per 100 completed Titanium XL frames, while every CarbonLite frame is tested. Likewise, engineering checks are done after 400 produced units for the Titanium XL, while they are done after every 50 units on the CarbonLite. Therefore, ABC accounting would permit the

2. Based on an evaluation of cost-volume-profit:

a. Analyze the breakeven point for Competition Bikes Inc. with regard to sales units and sales dollars for both CarbonLite and Titanium bikes.

To calculate the breakeven point, one considers Fixed Costs/Price-Variable Costs (Contribution Margin per Unit). What makes this calculation more difficult is that fixed costs are not supposed to change with the level of sales, however, the fixed costs given in the worksheet show variability with the number of units sold. This complicates the calculation of the break-even point. At first, it may be confusing that fixed costs could vary, but the greater the production, the greater the staffing needs to handle the product. In the Budgeted Contribution Margin Income Statement, the numbers are divided into standard output and actual output. The total fixed expenses for the standard output is 1,199,526. The total fixed expenses for the actual output was 1,197,949. To examine the break-even point, I did not look at actual output, because the actual output showed a loss for the company.

For the Titanium bikes, the breakeven point was calculated by taking the fixed costs / contribution margin. 1,199,526 / 221= 5427.72, or 5428 bikes. Titanium bikes sell for $900 each, and $900 x 5428= $4,885,200 in sales.

For CarbonLite bikes, the breakeven point was calculated by taking the fixed costs / contribution margin. 1,199,526/111= 10,806.54 or 10,807 bikes. Carbonlite bikes sell for $1,495 each, and $1,495 x 10,807= $16,156,465.

Titanium

CarbonLite

Fixed Costs

1,199,526

1,199,526

Contribution Margin

BE Units to be Sold

10,807

Sales Price

$900

$1,495

BE Sales

$4,885,200

$16,156,465

b. Describe what would happen to the breakeven analysis if company management needed to add $50,000 in fixed costs to the production facility and the direct materials had a 10% cost increase.

The breakeven analysis increases when costs increase, assuming a consistent sales price. "Break-even analysis is a supply-side analysis; that is, it only analyzes the costs of the sales. It does not analyze how demand may be affected at different price levels" (Investopedia, 2011).

Adding $50,000 to fixed costs to the production facility would make the fixed costs increase from 1,199,526 to 1,199,576. If the direct materials increase by 10%, that will change the contribution margin. A 10% increase in direct material costs for the Titanium takes those direct costs from $303, adds $30.30, to make those costs $333.30. A 10% increase in direct material costs for the CarbonLite bike takes those materials from $670, adds $67, to make those costs $737. The change in costs changes the contribution margin: