Jet2 Task 4
Competition Bikes management decide to retool and now manufacturing both Titanium and CarbonLite Frames bikes. Competition Bikes was using the Traditional based Costing (TBC) method, however the Activity Based Costing (ABC) may give more insight to management and helpful in analyzing the per unit costing of the different types of frames and pinpoint the area of improvement. Also the management wants to know the Breakeven point caused by the potential increase of fixed cost by $5,000 and increase in direct cost by 10%. A1: Costing Method
Traditional Based Costing Method (TBC)- The allocation of manufacturing overhead (indirect manufacturing costs) to products on the basis of a volume metric such as direct labor hours or production machine hours. As manufacturing becomes more sophisticated the manufacturing overhead costs usually increase while the direct labor hours or production machine hours decrease. Hence, the direct labor or machine hours are unlikely to be the root cause of the manufacturing overhead. (Accounting Coach 2014) The basis of traditional costing system is to calculate the overhead rate and apply that predetermined overhead rate to various products. Traditional costing system is more desirable when the indirect cost is more and the direct cost is less. Traditional costing systems are simpler and easier to implement than ABC systems. However, traditional costing systems are not as accurate as ABC systems. Traditional costing systems can also result in significant under-costing and over-costing. The main steps of the Traditional costing process are-
1. Calculate the total indirect cost and determine a indirect cost for the appropriate period. 2. Choose a cost driver like labor hours, machine hours used for the purpose of allocation 3. Determine the total units of cost driver like total machine hours. 4. Calculate the overhead rate per unit of driver eg $xx per machine hour 5. Apply the calculated overhead rate to the products.
Activity Based Costing (ABC) Method is calculated by allocating indirect cost to different activates based on the actual usage by the different products. As such the ABC costing method is more accurate in determining the overhead cost. ABC costing is more appropriate when the accuracy is more important factor in determining the market factors. Also when the overhead cost is more than the direct cost, then ABC method is more desirable as it shows the correct picture. It is commonly used in manufacturing companies especially with different types of product as the company can clearly see the products which are consuming more resources. The accuracy of correct costing will help company in making the decisions like determining prices, continuing/discontinuing the products and also will help the company in foreseeing the areas of improvement that can eventually help in reducing the cost. Overall Activity Based Costing is more accurate, precise and the effective way of allocating the overheads to products. However, ABC systems are more complex and more costly to implement. The following are the main steps of the Activity Based Costing Method- 1. Identify the different activates in the production of the product 2. Estimate the total cost per activity
3. Compute a cost driver rate for each activity based on a cost allocation 4. Apply activity costs to products using the appropriate cost-driver rate. (Strategiccfo.com 2014) The spreadsheet provided performs the comparison of per unit cost per Traditional Costing Method and the Activity Based Costing Method. Based on the analysis of per unit cost, we determined that per unit cost of Titanium frames is per TBC $713 per unit while per unit cost based on the ABC is $656 per unit. On the other hand per unit cost of Carbon Lite frame per TBC is $1,359 and per ABC is $1,456. We clearly can see the difference in the cost per unit based on the two different method of overhead allocation. Based on the TBC,...
References: (Accounting Coach 2014) – Definitions Accounting coach retrieved on September 19, 2014 from http://www.accountingcoach.com/terms/T/traditional-costing
Investopedia 2014 – Definition retrieved on September 19, 2014 from http://www.investopedia.com/terms/c/cost-volume-profit-analysis.asp
Strategiccfo.com 2014- Activity based costing and Traditional costing steps retrieved on September 19, 2014 from http://strategiccfo.com/wikicfo/activity-based-costing-abc-vs-traditional-costing/
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