WGU – JET2 Finical Analysis Task 4
To: Vice President
This report has been prepared to argue the case that the company’s current costing method should be changed to the activity based costing method. This report will review; the difference between traditional based costing and activity based costing; traditional split and allocations with activity based costing; and discusses the breakeven point for Competition bikes Inc. with regards to sales units and sales dollars for both CarbonLite and Titanium bikes. The first item at hand is what kind of detail does activity based costing provide that is different than traditional costing? The main difference between activity based costing and the traditional system is that activity based costing requires four steps to build its cost point. Traditional costing uses one rate where first, activity based costing must identify each activity and estimate its total and indirect cost. Second for activity based costing is that the cost driver for each activity must be estimated along with the total quantity of each driver’s allocation base. Third the cost allocation for each activity must be computed. Fourth costs to cost object are allocated. Activity-based costing focuses on activities. The costs of those activities become the building blocks for measuring (allocating) the costs of products and services. (Horngren, Harrison, Jr & Oliver, 2008) This method of costing does require more time to compute the cost to the activity yet it earns that money back plus dividends by having a more accurate forecast of the true costs that are associated with each activity. The second item is understanding how to define the difference between the traditional split and the allocations with activity cost pools. In traditional costing there was a wide acceptance that the much of the overhead cost had come from direct labor costs. This assumption was satisfactory when direct labor when direct labor was a major portion of the total manufacturing costs. With activity based costing the activity cost pools are assigned to product or services via means of cost drivers. So any factor that would have a cause-effect relationship with the resources being consumed would be calculated and grouped based on the event or action that incurs cost when producing a product or providing a service (Hilton, R.W., 2009). In traditional costing the assumption is made that the volume metric is the underlying driver of manufacturing overhead cost. This fails to account for nonmanufacturing costs that also are associated with the production of an item such as administrative costs. Third and last the question to answer is; with all this detail on specific cost will that actually lead to improved results? Simply the answer is, yes! By looking at each activity and what drives its specific costs the true cost of the item can thus be realized thus having a better idea what the price should be to consumers and wholesalers alike. By moving to the activity based cost system Competition Bikes could realize that the company has been overpricing items thus losing market share or under pricing an item, thus loosing precious revenue to further fund research and development to improve the product for the future. One major example is that of airlines that began to look at the cost to carry luggage, and then passed that cost onto the customers. Airlines realized that all the tagging, bagging, moving, loading, unloading was extremely labor intensive and costing them lots of money. Many passengers now opt to pack more simply and only bring a bag that passengers carry onto the plane. This is exactly what the airline is hoping for as that extra room in the plane can be used to carry cargo. Airlines can charge a premium for cargo as same day cargo delivery demands a premium price. This was only figured out once airlines analyzed the costs of luggage using the activity based costing...