Competition Bikes

In contemplating whether the company should change its costing method to activity-based costing (ABC), one must first understand what ABC is, as well has how it differs from the current method. ABC focuses on activities. The costs of those activities become the building blocks for measuring (allocating) the costs of products and services. ABC was created to help show more of the true cost of an item or service. The basic principle is that the more activities that are used in making a product, then more costs should be allocated to that item or service. ABC uses a separate allocation rate for each activity, while traditional systems do not. That is the main difference. Traditional systems usually use one rate. (Horngren et al., 2009, pp. 902-904).

The second important aspect that the company would undoubtedly want to know is how is it beneficial? When a company uses ABC, it helps them manage costs better as they can now be more precisely allocated to the products. It provides more accurate data by highlighting costs incurred by each activity within the production function. It helps the company better set their prices, as they now know better about what the product or service costs them to produce. For example, if a company makes different products in the same production environment, traditionally, they just split the indirect costs evenly across all the products. This leads to an inflated cost on items that don't use as many of the resources, and does not allocate enough cost to those that do. When priced, this inflates the former and deflates the latter. This is important as products do not sell the same quantity, so it is important that their price and cost are allocated properly to maximize revenues and profits for the company.

Now that the definition and benefits have been shared, the company will want to know if this will benefit their specific situation. In looking at the overhead analysis for Competition Bikes Inc., it is apparent that the two methods give the user different results. This is seen in many of the categories. The first category is Total Manufacturing Overhead. In this category, the Traditional method yields $239,020 for Titanium, and $232,380 for Carbon Lite. ABC has these totals as $188,415 and $232,380 respectively. This is a difference of -$50,605 for the Titanium product, and $50,605 for the Carbon Lite product. Another area where a discrepancy is seen is in the Total Product Cost. ABC has Titanium at $590,715 and Carbon Lite as $729,985. The traditional method has these as $641,320 and $679,380, again showing the difference of $50,605, positive and negative. The most useful data for managers is the unit cost. ABC has the Titanium unit at $656, while Traditional had it at $713, a difference of -$57. This shows that the company had allocated too much cost to this product, and most likely where overpricing it, or not pricing it enough to make a good margin. ABC has the Carbon Lite unit at $1460, while Traditional has it at $1359, a difference of $101. Obviously, Competition Bikes also misrepresented the true cost of the item, and could not have