A1. Costing Method Recommendation
This study has been prepared to analyse the current costing method at Competition Bikes, Inc. ( CBI ) and supply a recommendation for betterment. To back up this analysis, the differences between traditional based costing and activity based costing will be examined, along with the benefits and drawbacks for each method. A cost-volume-profit rating with break-even analysis for both gross revenues units and gross revenues dollars for the CarbonLite and Titanium motorcycle lines will besides be provided. The chief differences between activity-based costing and the traditional costing: Traditional costing includes both direct and indirect constituents. Indirect costs ( overhead ) are grouped together. There’s merely one cost driver ( such as direct labour hours ) used to cipher costs irrespective of what they are. Activity-based costing interruptions down the operating expense costs into activity cost pools. All overhead costs are so allocated into these activity cost pools. This method of costing does necessitate more clip to calculate the cost to the activity yet it earns that money back plus dividends by holding a more accurate prognosis of the true costs that are associated with each activity. In add-on to a better apprehension of costs, execution of activity-based costing can drive improved fiscal consequences in the long tally.
By looking at each merchandise and what drives its specific costs, direction can hold a much more elaborate sense of the true costs involved in bring forthing each merchandise. They can so compare the activity-based costs with the bing system they have been utilizing to detect what merchandises they may be overpricing, or dumping for sale in the market. They can besides descry possible money blowing activities in their fabrication procedure, and work to do those activities more efficient. If direction has a better apprehension of costs, they can show a stronger concern instance to acquire future capital undertakings funded. The downside to activity-based costing is that it requires a significant committedness of forces and fiscal resources up front. Management must be willing to analyze their operations strictly and the information that is gathered may be hard to accept, peculiarly by those who are believe the current costing system is merely all right and are immune to alter.
Traditional costing, on the other manus, is much easier to cipher than activity-based costing, and this makes manager’s occupations easier. However, traditional costing is so by and large calculated that it may be concealing inefficiencies in the supply concatenation. Merchandises may be overpriced or underpriced, and this can negatively impact the company’s underside line in the long tally.
By traveling to the activity-based cost system, CBI could nail if they have been overpricing points, losing market portion to rivals. On the impudent side, if they underprice an point, they are likely losing money as the monetary value may be lower than what it costs to bring forth the motorcycle. They would lose possible gross to farther fund research and development to better the merchandise for the hereafter. If monetary values are significantly lower than those of the competition, clients may even waver to buy the merchandise, as they could inquire why the motorcycle is priced so much lower than all the others in the market and have a perceptual experience that sub-par stuffs or fabrication procedures have been used. Since these motorcycles are a forte merchandise built to order, clients are by and large non as monetary value medium as shoppers looking for ready-made motorcycles.
By exchanging to the activity based costing ( ABC ) method, CBI is besides taking advantage of the in-depth cognition of costs that will ensue in nest eggs for the company. In the overhead analysis, six fabrication overhead points and their cost drivers are identified, with a comparing provided between ABC costing, and Traditional bing presuming 900 units produced for the Titanium line, and 500 units produced for the Carbonlite line. The cost driver for fabricating overhead utilizing the traditional method is non identified, but the sums are given in the Competition Bikes spreadsheet and are reflected below. Traditional costing method
-Titanium line fabricating overhead cost: $ 239,020
-Carbonlite line fabricating overhead cost: $ 232,380
Entire traditional fabrication operating expense cost: $ 471,400
ABC bing method
-Titanium line fabricating overhead cost: $ 188,415
-Carbonlite line fabricating overhead cost: $ 282,985
Entire traditional fabrication operating expense cost: $ 471,400
It’s of import to observe that the fabricating overhead sums are indistinguishable when calculated utilizing both traditional and ABC methods. This is because it’s non a difference in operating expense, but alternatively a alteration in where the operating expense is allocated. In the instance of CBI, the allotment is rather different between methods.
For the Titanium line, the entire fabrication operating expense cost with ABC bing is $ 50,605 lower than with traditional bing – a difference of 21 % . In other words, CBI has overestimated fabricating operating expense for the Titanium line by 21 % utilizing traditional costing. Looking at unit costs, the traditional method per unit cost is $ 713, while the ABC unit cost is $ 656. The higher unit cost in the traditional costing method makes sense given that the allotment for fabricating operating expense was higher. CBI may be overpricing this motorcycle, which could ensue in a negative consequence on gross revenues. If they could take down the monetary value to a figure closer to the true unit cost, they will probably see gross revenues lift.
For the Carbonlite line, the entire fabrication operating expense cost with ABC bing is $ 50,605 higher than with traditional costing. CBI had underestimated fabrication operating expense for the Carbonlite line by 18 % utilizing traditional costing. Looking at unit costs, the traditional method per unit cost is $ 1,359, while the ABC unit cost is $ 1,460. The unit cost calculated utilizing ABC costing was higher than CBI had realized ; they are likely dumping this motorcycle, losing out on possible grosss. A reappraisal of competitors’ monetary values may be in order, to measure what the market will bear, every bit good as an analysis of the impact of raising monetary values and how that affects gross revenues. Once they have this information, CBI direction can do an informed determination whether or non to set the Carbonlite gross revenues monetary value, and by how much.
A2a. Cost-volume-profit and break-even point rating: Current scenario CVP
Analysis:
Cost-volume-profit ( CVP ) analysis is a tool that directors and concerns frequently use to gauge future degrees of operational activity needed to avoid fiscal losingss, to interrupt even, and to bring forth a net income. This analysis besides helps to aim future grosss. CVP analysis can besides be used to gauge production degrees needed to bring forth grosss sufficient to reimburse capital outgos such as operational enlargement. CVP analysis examines alterations in net incomes in response to alterations in gross revenues volumes, costs and monetary values. The basic CVP equation is gross revenues minus variable costs = part border. Gross saless grosss per unit for the Titanium merchandise are set at $ 900. The variable cost per unit ( costs that vary straight with volume ) for the Titanium merchandise is $ 679. Based on these Numberss, the ensuing part border ( gross revenues gross minus variable cost ) per unit is $ 900 – $ 679 = $ 221. Contribution border is the sum of net income left after variable costs are subtracted ; therefore they can be considered the ‘contribution’ to gain for each unit sold.
For the Carbonlite merchandise, the gross revenues gross per unit is higher at $ 1,495 due to the specialised stuffs and increased sum of labour required to fabricate the merchandise. Variable cost is $ 1,384. The ensuing part border per unit is $ 1,495 – $ 1,384 = $ 111. It’s worth observing that the part border for this merchandise is much smaller than that for the Titanium line. A smaller part border by and large means the merchandise is non as profitable. When multiple merchandise lines are included in the analysis, to cipher entire break-even gross revenues units, a leaden mean part border ( WACM ) must be calculated. This is of import because assorted merchandises in the gross revenues mix contribute different sums of net income. The WACM is calculated by multiplying the unit part border by the per centum of the entire gross revenues mix for each merchandise. Expressed as a expression: WACM = Product one unit part border ( merchandise one gross revenues mix per centum ) + merchandise two unit part border ( unit two part border per centum )
Integrating the CBI informations, with the gross revenues mix proportion of 9 units of Titanium for every 5 units produced of Carbonlite, the WACM is calculated as 221 ( .643 ) + 111 ( .357 ) = $ 181.71. This figure is what the mean unit contributes to CBI’s net income on a per unit footing.
When the WACM is known, the Entire Contribution Margin Dollars can be calculated. This is the sum of money that the company has to pay fixed costs. Any money left over after fixed costs are paid is net income. If entire part border dollars equal fixed costs, the company is at break-even. If entire part border dollars are less than fixed costs, that represents a loss for the company. The equation for this figure is: Entire Contribution Margin Dollars: Unit of measurements sold multiplied by the WACM
Break-even analysis
Break-even gross revenues units can be calculated if the WACM and Total Contribution Margin Dollars needed to break-even are known, as follows: Entire Contribution Margin Dollars/WACM. To cipher gross revenues units and gross revenues dollars required for break-even, a few stairss are required. The first measure is to cipher the break-even point in units of gross revenues mix. Break-even point in units of gross revenues mix = Total fixed cost/WACM per unit For CBI, break-even point in units of gross revenues mix is $ 400,000/ $ 181.71 = 2201 The following measure is to cipher the figure of units of Titanium and Carbonlite units at the break-even point. The equation is as follows: Number of units at break-even point = Gross saless mix ratio ( entire interruption even units ) Break-even point in units for Titanium: 0.643 ( 2201 ) = 1415
Break-even point in units for Carbonlite: 0.357 ( 2201 ) = 786 The last measure is to cipher the break-even point in dollars. The equation is as follows: Break-even point in dollars = Product units at break-even point ( gross revenues monetary value per unit ) Break-even point in dollars for Titanium: 1415 ( 900 ) = $ 1,273,500 Break-even point in dollars for Carbonlite: 786 ( 1495 ) = $ 1,175,070 Total gross revenues needed to break-even: $ 1,273,500 + $ 1,175,070 = $ 2,448,570.
To sum up, CBI would necessitate to sell 1415 units of Titanium and 786 units of Carbonlite, bring forthing gross revenues grosss of $ 2,448,570 to break-even ( grosss and costs are equal ) . A2b. Cost-volume-profit and break-even point rating: Variable and fixed cost addition scenarios Suppose direction needed to increase the cost of direct stuffs by 10 % every bit good as add $ 50,000 in fixed costs to the production installation. What consequence would this hold on the break-even point?
Because the equations are based on the part border every bit good as the WACM, an addition in the cost of direct stuffs ( variable costs ) by 10 % will hold a important impact. Let’s foremost analyze how cost-volume-profit and break-even point would be impacted if direction needed to increase direct stuffs cost by 10 % . I will analyse the $ 50,000 fixed cost addition individually.
Variable cost addition ( 10 % direct stuffs addition ) scenario
CVP Analysis:
Contribution Margin per unit for Titanium: $ 900 – $ 709 = $ 191 Contribution Margin per unit for CarbonLite: $ 1495 – $ 1451 = $ 44
The part borders for both merchandise lines decreased. Titanium decreased by 13 % , and of peculiar note is the humongous 60 % decrease in part border for Carbonlite. This makes sense given that Carbonline has a higher variable cost and lower volume, so a per centum addition in variable cost has a greater impact. This merchandise is even more expensive to bring forth in this scenario, and bring forthing really low net incomes for the company at this point.
With the gross revenues mix proportion of 9 units of Titanium for every 5 units produced of Carbonlite, the WACM per unit is calculated as 191 ( .643 ) + 44 ( .357 ) = $ 138.50. CVP Summary: the 10 % addition in direct stuffs resulted in a 24 % lessening in WACM per unit. The motorcycles are lending 24 % less net income towards net incomes.
Break-even Analysis:
Break-even point in units of gross revenues mix is $ 400,000/ $ 138.50 = 2888 Break-even point in units for Titanium: 0.643 ( 2888 ) = 1857
Break-even point in units for Carbonlite: 0.357 ( 2888 ) = 1031 Break-even point in dollars for Titanium: 1857 ( 900 ) = $ 1,671,300 Break-even point in dollars for Carbonlite: 1031 ( 1495 ) = $ 1,541,345 Total gross revenues needed to break-even: $ 1,671,300 + $ 1,541,345 = $ 3,212,645
Break-even sum-up: the 10 % addition in direct stuffs cost resulted in a decreased part border per unit for both merchandises. Given that fixed costs in this illustration were unchanged at $ 400,000, it makes sense that an addition in variable costs would necessitate an addition in the break-even point to cover the extra disbursal. In this scenario, the break-even point in units and entire gross revenues need to break-even increased by 24 % from the current scenario. It’s clear that an addition in variable costs can hold a disproportional impact on net incomes and the break-even point.
Fixed cost addition ( $ 50,000 ) scenario
For this scenario, I assumed that variable costs remained unchanged from the current scenario ( no 10 % addition in variable costs ) and that fixed cost for the production installation increased from $ 400,000 to $ 450,000.
CVS Analysis:
Contribution border per unit for Titanium: $ 900 – $ 679 = $ 221 Contribution border for per unit for Carbonlite: $ 1,495 – $ 1,384 = $ 111
With the gross revenues mix proportion of 9 units of Titanium for every 5 units produced of Carbonlite, the WACM per unit is calculated as 221 ( .643 ) + 111 ( .357 ) = $ 181.71. CVS Summary: Since variable costs did non alter in this scenario, the part border per unit and leaden mean part margin/unit are at the same degree as the original illustration.
Break-even Analysis:
Break-even point in units of gross revenues mix is $ 450,000/ $ 181.71 = 2476 Break-even point in units for Titanium: 0.643 ( 2476 ) = 1592
Break-even point in units for Carbonlite: 0.357 ( 2476 ) = 884 Break-even point in dollars for Titanium: 1592 ( 900 ) = $ 1,432,800 Break-even point in dollars for Carbonlite: 884 ( 1495 ) = $ 1,321,580 Total gross revenues needed to break-even: $ 1,432,800 + $ 1,321,580 = $ 2,754,380
Break-even sum-up: Compared to the current scenario, the $ 50,000 addition in fixed costs ( 11 % over the $ 400,000 illustration in the current scenario ) had an impact of increasing the break-even point in units of gross revenues mix by 275 units, or 11 % . Since the part border was unchanged in this illustration, the addition is less than in the scenario with 10 % addition in direct stuffs. The break-even point in dollars besides increased by 11 % . The fact that the addition in the break-even point precisely matches the addition in fixed costs illustrates that as fixed costs rise, the break-even point will lift in proportion presuming the gross revenues mix remains unchanged.
Comparing all three scenarios, the CVP and break-even analysis provides insight on how additions in variable and fixed costs affect part borders and break-even Numberss. Variable cost additions have a disproportional impact on increasing borders and break-even Numberss, while the fixed cost additions result in a proportionate impact on increasing these steps. CBI’s direction should see these impacts when sing cost additions for their merchandise lines.
