Activity-Based Costing vs Traditional Methods - Research Paper Example

CBI Cost Method Introduction Costing systems are significant to companies and organization as they help in determining the cost ofproducts produced by the companies and closely related to the revenue generated by the company. Businesses used to forms of costing systems namely the activity-based costing and traditional costing. The traditional costing method relies on the volume of a cost driver including direct labour time required for an item while assigning manufacturing overhead. It is essential to comprehend that a cost driver is a factor that leads to the occurrence of a cost among others direct labour, machine time, as well as direct material hours consumed. On the other hand, activity-based costing apportions the costs incurred during manufacturing of a particular product or service based on the activities required during their production. It is crucial for managers to comprehend the merits and demerits of the two systems to satisfy the needs of their business operations. Concerns from the Budget The budget presented entails schedules that raise various concerns leading to the recommendation that the company should switch to the activity-based costing system of accounting. The first concern is the quarterly budget that in my opinion requires further subdivision to generate quarters. Mainly, cycling takes place in temperate weather conditions. Buying materials for bicycle production for the start of sales hikes demand therefore, requires the producer to incur a quarter before the demand. Another concern regards accounts that remain uncollectable. The master budget for the company is not specific it its cash budget line. It closely refers to the uncollectable receivables. Variable factors in this context emanate from economic features among them limited sponsorship and carry the capacity to result in wrong accounts. From the budget, the company is setting aside a budget for 140 bikes inclusive of labour costs. It is appropriate to cut down on the level of production of extra parts in the inventory. Activity-Based Costing Vs. Traditional Methods The method of distributing manufacturing overhead by activity-based costing (ABC) to products is efficient compared to the traditional method of costing. Precisely, activity-based costing assigns the right percentage of resources to particular products. While monitoring and allocating organizational costs to products and objects, activity-based costing remains a more sophisticated and logical method as opposed to the traditional costing system. It is possible to distribute overhead costs based on machine-hours as the only criteria in the traditional system of costing. On the contrary, activity-based costing highlights the various activities entailed in cost accounting. The method puts into consideration all the resources a company has the potential to use during the production process. Here, the activity-based costing method computes the activity cost consumed during the production of the product in question only. The importance of this difference appears because certain products go through various activities before being released to the market while others need few activities. Activity-based costing is more precise and multifaceted, bringing together only resources and activities applied in producing particular products. As opposed to the traditional cost accounting, the activity-based method helps in understanding the correct cost to produce diverse products in a single factory. The traditional cost accounting system is straightforward as much as it is lees competent. Since it separates expenses, activity-based costingmethod helps in isolating surplus raw material that closely in line with the just-in-time plan of action. This will minimize the accumulation of irrelevant and obsolete raw materials and crucial to the whole process of streamlining the entire production process. Experts developed the activity-based costing system in 1981. In terms of accuracy, the method is still going through provisional verification. The method provides a detached overhead and differs in product and activity. The activity-based costing method is more than two hundred years apart from the traditional cost accounting system invented in the early years of the ninetieth century. Calculating the specific cost of products is ineffective using the traditional costing technique. To give birth to bone activity, experts divide the cost of goods and the finished products. Professionals get the exact expense incurred in line of production using many activities when applying the activity-based costing system. The company Vice President (VP) needs to understand that the current business environment has stiff competition therefore, adopting and executing the new systems of production and accounting lies at the foundation of the company enjoying appropriateprofits. The Competition Bikes, Inc. (CB) should apply two strategies that are replacing the activity-based accounting method and the just-in-time strategy to enhance the company’s return on investment. The two strategies will minimize excess inventory to great percentages. The systems will enhance consistency in various parts of production while eliminating the accumulation of excess parts in the whole exercise of production. The just-in-time strategy will concentrate on improving the production process if executed correctly. Streamlined areas would include efficiency, manufacturing lines, and quality. However, the VP ought to comprehend and embrace the fact that enhancing production requires and encompasses the involvement of employees to facilitate quality and flow. Accuracy in costing finished products only requires the application of activity-based costing. Professional accountants prefer using the activity-based accounting technique during high amounts of overhead costs with too many of the parts remaining. Clearly, the accuracy of products costing remains of the essence. Once the evaluation of final figures of costs of goods remains low, then the assumption is that the operations of the company remained efficient. On the contrary, when the company remained with many parts, then a lot of money was lost. The traditional cost accounting method is inadequate when the Competition Bikes, Inc. aims at understanding the actual cost incurred during the whole production process especially for particular clients. The reason behind the development of the activity-based accounting method was to eliminate the shortcomings of the traditional method of costing. In place of one cost driver used by the traditional method such as machine time, the activity-based method will apply several cost drivers in apportioning the indirect costs of the manufacturer. The new method will use cost drivers including the total number of machine time, the number of engineering modification orders, and the weight of materials used in the production process. Increase in overhead costs as well as a range of various products in the line of production influences the continuing increase among professional accountants and companies using the activity-based accounting method. In fact, modern companies and organizations do not apply the direct labour hours and machine time in accounting, which is also evidence that activity-based costing is the present standard accounting method. The Competition Bikes, Inc. should use the activity-based method because of the reasons summarised below. First, it offers a more precise overhead cost position for the company; it provides valuable data to the company management regarding important operations with value to the company and those without, apart from the method being at the centre of pricing, capital investments, product mix, and organizational modifications. Furthermore, it is easy to highlight production resources and activities when using the activity-based approach and the method with evidence is effective in managing costs, enhancing productivity and costs. Competition Bikes, Inc. does not have to reinvent a wheel because the activity-based costing system works. The illustration for the company shows the difference where using the traditional method costing, the cost of Titanium unites was a staggering $ 239, 020 while the company recorded $ 232, 340 when experts applied the activity-based cost accounting technique. While it cost the company, $713 dollars on the titanium frame using the traditional method, the cost stood at $ 656. The total cost of production using the traditional technique was $ 1, 460 while the activity-based costing stood at $ 1, 359.The more precise activity-based method puts each unit of titanium at $ 57. Under the same costs, the cost of Carbon Late went down by $ 101 when applying the activity-based method. Primarily, this report recommends to the VP of Competition Bikes, Inc. because the traditional system of accounting applies a portion of the total while the proposed activity-based accounting technique puts into use aspects of the precise activities required only in the production process. The product line for Competition Bikes, Inc. primarily comprises of the line of titanium- 900 that equals sixty-five percentile of the entire product sales. The Carbon Lite line for the company stands at 500 of the entire product sales representing thirty-five percent. While the Carbon Lite accounts for forty-nine point three percent of the company manufacturing overhead, the titanium line takes care of the remaining fifty point one percent. The results realised using the traditional method of accounting are less effective as they give fifty-one point four percent to the Carbon Lite with the titanium line accounting for forty-eight percentile. Changing the methodology from the traditional method of costing to the activity-based technique brings real operations into focus. The company will spend $ 116, 896 in managing carbon Liteand the control of the quality of titanium consumed $ 2, 104.Understanding the actual production cost helps in precisely figuring out the breakeven point as well as the entire process of pricing specific products. The Breakeven Point The breakeven represents the distinction between a business that follows the profit making path and the one that is on the insolvency way. Competition Bikes, Inc. should consider carrying out breakeven analysis it is fundamental to its growth and success or the company failure. It is likely that the company could have an incorrect breakeven point if it has in accurate or incorrect information and in the process end up having units sold at a loss. Such practices ultimately result in the insolvency of the business organization. Accountants apply the excel spreadsheet when determining the breakeven point for Competition Bikes Inc. Fixed Cost / (Unit Price - Variable Unit Cost) Sales price – variable costs = input margin. (Harold, 2012) Fixed Costs + Variable Costs = Breakeven Sales Dollars The process of analysing the breakeven point constitutes various variables: The selling price of every products; the pre-designed market value for sales form all the units Totals of Fixed Costs; the activity-based technique of production for every unit. It is necessary for the company to know that this amount is always fixed. Totals of Variable Costs; they include anticipated total costs of production among them all the variables. Unit Cost variables; they are all expenses beyond management production that always remain unanticipated. Forecast of net profit; they constitute total revenue less total cost. . (Harold, 2012) It remains critical to know that production cost represents the breakeven point. When Competition BikesInc.releases to the market many products that are also different, its middling margin of contribution(input)for every unit applies in determining the fixed cost of the product in question. It is crucial to realise that the weighted average as well as the average carries a contribution margin. The weighted average weighs the expenses the company would invest to generate the products and release them to the market including conducting all marketing aspects. The contribution margin ration and the contribution margin The contribution margin ratio and contribution margin are significant calculations when applying the Cost-Volume-Profit (CVP) analysis. Either the profit made by the Competition Bikes, Incur profit earned before subtracting the fixed costs constitutes the contribution margin. Similarly, it is the quantity of sales dollars obtainable to influence the fixed costs. It remains a percentage of sales dollars available to insulate the fixed costs. It is definite that the company generates income from the sale of the next dollar immediately after covering the fixed costs. To get the contribution margin, experts subtract all the variable costs from the sales revenue. Professionals have the liberty to either use the every unit or apply the dollar to generate the contribution margin. Competition Bikes, Inc. It is essential that the activity-based costing analysis technique applied in calculating the breakeven even point have figures with utmost accuracy. The breakeven point of a good rises with increase in the production of the same product. Scholars utilise new variable cost inputs and new fixed costs to determine a new breakeven point. (Harold, 2012) Evaluating the product mix helps in generating the individual breakeven point for every unit. In the context of Competition Bikes, Inc., we divide the titanium line by the totals as well as dividing the Carbon Late with the totals. The result is the $ 181.71 as the weighted margin. The required sales of every unit is 2201 arrived at after dividing the fixed cost $399, 943 by $ 181. 71 representing the value for the breakeven point. The weighted mean with titanium line covering sales of 900 is also almost twice the sales of Carbon Lite at 500.For every titanium sale the individual unit costs $ 221 while the Carbon Lite sale for each unit is $ 111. On the other hand, the mean contribution margin stands at $ 181. 71. For the net earnings to remain regular, the company would have to engage in more sales that would lead to a breakeven point. Analysing the Change in Breakeven Increase in the company variable and fixed expense relates in a rather direct way to the price of the product. The scenario in question is increasing the fixed costs by fifty thousand dollars and the supply-vendors hiking the cost of their materials by ten percent. In this case, Competition Bikes, Inc. does not have any other alternative but to increase their unit sales price if it has to attain a similar breakeven point. However, the company can avoid the occurrence of this situation by negotiating a reduction in supplies in the process of purchasing higher quantities. Care must be taken to avoid having accumulated inventory after the financial trading period. The company shall apply the cost-volume-analysis (CVP) in evaluating the increase in raw materials and decreased production as well as how the two factors influence the performance of the company. The cost-volume-profit analysis takes into consideration administrative costs, sales, and costs of manufacturing. The accountant ought to label the factors as either fixed or variable. Sales price for every unit is invariable for every schedule, in most cases fixed The technique applies constant and fixed variable costs for every unit The total fixed costs also constant and invariable The analysis makes an assumption that all the products released from the company go on sale Changes in activities are the only influences on costs Products produced by Competition Bikes, Inc. go on sale in the same mix Illustration The example makes use of the cost-volume-profit criteria. Increasing fixed costs by fifty thousand dollars and hiking the raw materials by ten percent results to a reduction in the contribution margin for the titanium line down to $ 191 from $221. Similarly, the Carbon Late dropped from $ 111 to a mere $ 44. The same transactions affected the weighted breakeven that creased to $ 690 from the initial $ 871. A reduction in input-profit sales price degenerates into a definite increase inthe volumes of sales.When the company increases the overhead costs by fifty thousand dollars, then the new breakeven point will stand at 3254 additional units considering the ten percent increase in the price of raw materials. The more specific activity-based method puts each unit of titanium at $ 57. Under the same costs, the cost of Carbon Late went down by $ 101 when applying the activity-based method. First, this report recommends to the VP of Competition Bikes, Inc. because the traditional system of accounting applies a portion of the total while the proposed activity-based accounting technique puts into use aspects of the precise activities required only in the production process. Calculations will show that it represents an almost fifty percent increase. The tab representing the cost profit indicates that the changes increase the price of the titanium from nine hundred dollars to one thousand four and fifteen dollars. Along the same line, the contribution margin drops from $ 221 to $ 191 whereas the variable cost shoots to seven hundred and nine dollars and thirty cents. A carbon Lite of $ 1495 entails a variable cost of $1451 whose input margin drops to $ 44 from the earlier estimation of $ 111. Since the company records the mean weight sales contribution of $ 138 for every unit, then it will have to record 2092 in sales of titanium and Carbon Lite amounting to 1162. The situation will warrant an additional 362 units in terms of sales because of the increased figure of $ 50 000 that resonates with a weighted mean of $ 138 dropping sharply from the initial $ 181.This will minimize the accumulation of irrelevant and obsolete raw materials and crucial to the whole process of streamlining the entire production process. Increase in both the price of supplies vendors and increased overhead of $ 50 000, the Competition Bikes, Inc. will take the initiative of upping its sales from the current 2201 to the 3254 mark to continue enjoying the same breakeven point or even higher. References Harold, A. (2012). Cost-Volume-Profit Analysis.London; McGraw-Hill. Read More