Competition Bikes Inc. is taking Canadian Biking's Titanium Technology, in this regard the company has to retool its costing method and adopt activity based costing or otherwise known as ABC. This is a technique in which the cost of the given object was accumulated so that the total economic resources consumed by the particular product can be represented (Simprocess.net. N.D.). The difference between ABC and TCA or traditional cost accounting is ABC is more complex, whereas TCA is generally a lot simple.
This method of costing is suitable for manufacturing companies such as CBI, therefore it is beneficial and helpful to the company in such a way that the process doesn't require too much financial resources, time commitment and elaborate special software system to be integrated into general ledger. ABC enables the company to dissect every costing requirement of each product allowing a more defined and precise determination of expenses. To apply this method to CBI's overhead and material costing for Carbon DL and titanium based products, it appears that traditional method only provides a generalized overview of the cost and does not define other items that contributed to the cost amount, therefore the results are not precise and most of the time renders over-budgeting.
However, ABC is more precise by accounting every aspect of manufacturing process especially in the overhead where every cost of resources employed to manufacture the product was included. For example, traditional costing shows that the overhead cost for titanium unit is $713, but in ABC costing it comes out only at $656 per unit. For Carbon Lite products the traditional costing shows $1,359 per unit while ABC costing shows $1,460. The bottom line is the cost is showing the precise amount up to the last item and resources used to manufacture the product like utilities, factory set-ups, engineering, and quality controls among others. The implications of precise costing include improvements the company to make decisions in terms of cost cutting and budgeting, therefore it would be much recommended to use ABC method because the company can determine how low or high the cost of each product and this diversifies options to make adjustments.
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Break-even points is when the net sales and the expenses comes equally, this means the company neither earned or lose in the process. There are basic principles in analyzing break-even points. It is relatively simple what has to be done is to understand the relationship between sales/unit, total sales and units. The relationship is pretty much easy to understand using the formula of fixed cost divided by contribution margin equals break-even point (break-even point = Fixed cost / contribution margin). To calculate the break-even point for Carbon Lite and Titanium products contribution margin has to be determined.
For Carbon Lite the contribution margin is at $55,500 while titanium has $198,900 giving a total of $254,400 contribution margin for the two products. Given that there would be a total of 1,400 units, the contribution cost of each unit would be $181.71 (contribution margin $254,400 / sales mix units 1,400 = contribution margin per unit $181.71). To determine sales price per unit variable cost per unit shall be added to contribution margin, for carbon Lite variable cost is ($1,384 + $111 = sales price $1,495), for titanium it will be $679 + $221 = sales price $900). Sales price multiplied by the number of units for both products (900 titanium + 500 carbons Lite) has a total of $1,557,500. To relate that total with cost and contribution margin we simply multiply variable cost with the number of units for titanium (900 units X $679 variable cost/unit = $611,100), for carbon Lite (500 units X $1,384 = $692,000).
All in all, the total cost for the two products would be $1,303,00, then we add contribution margin per unit multiplied by the number of product units ($181.71 contribution margin per unit X 1,400 units = $254,400). To find out if CBI was able reach the break-even point the variable cost per unit will be added together with the total contribution margin per unit ($1,303,100 variable cost + contribution margin $254,400 = $1,557,500). Let’s compare the outcome to the sales output, for titanium (900 units X $900 sales price per unit = $810,000 total sales), for carbon Lite (500 units X $1,495 = $747,500 total sales). Then we add the total sales of the two products (titanium $810,000 + carbon Lite $747,500 = $1,557,500).
It is clear from the presented calculation that CBI was able to surpass the break-even point as presented in the below table; If the unit volume were increased to 2, 201 sales mix units in San Diego Plant following the given cost percentage/unit at 75.44% on Titanium and 92.58% on Carbon Lite will appear as follows in the below table; **notice how the colored areas appears the same. The results showing on the above tables suggests the relationship between cost against volume and the resulting profit, which means volume determines the amount of profit that can be obtained. In the firs table the unit volume of 1,400 units will bring the company a profit of $254,400 and by increasing the volume by 801 more units will bring additional $145,561 profit bringing it to $399,961.
When the cost is affected by increase in the price of materials, the selling price of product cannot be changed just as easy, otherwise it will cause the company to lose customers for the reason that their product is too expensive for the average consumer. This will also result to drastically low amount of sales and losses for the company. The only way to avoid such thing to happen is to calculate how low the company should reduce the contribution margin in order to at least meet the break-even point. Primarily when the cost went up the only way to get even is to reduce the contribution margin. This means reducing the amount of expected profit because basically the difference in selling price against the variable cost is the company's profits or contribution margin.
When there is an increase of $50,000 on direct cost and 10% increase on direct cost what Competition Bikes Inc. must do is to reduce contribution margin to meet the break-even point. If the original contribution margin per unit is $181.71/unit it will come down to $138.31/unit or a difference of $43.40 or 23.88% decrease per unit. When such decrease applied, the contribution margin will only come out as much as $193,630 from the original $254,400. Regarding fixed cost, the fact that it is fixed, the company cannot change or make adjustment out of it, further deduction in contribution margin will cause much lower sales in the future.
However, losses can also be avoided as a result of fixed cost increase. But the previous break-even point can no longer be changed and the increase in fixed cost will result to losses. This is because the number of manufactured units was already set. However the company can overcome these losses by means of increasing the number of units to be sold. Supposing that the fixed cost is $50,000 and the price per unit is $900 for titanium and $1,495 for carbon Lite with 10% increase in direct cost, therefore the 1,400 units divided by the adjusted contribution margin will have a weighted average contribution margin of $138.31 per unit.
The table below shows how the increase on fixed cost and direct cost affects the outcome of profit and how the increase on unit volume would help to meet the target break-even point; Now, in an event of increases such as direct cost and fixed cost, the price will not be normally affected, however the contribution margins for both products were adjusted to accommodate increase on cost in order to achieve break-even point and make few profits. It is important for the company to understand the factors that affects the break-even point to gain profit so that they could make suitable adjustments on how low they can get in terms of cutting contribution margin and how many units are needed to manufacture to be able to meet the break-even point.
Like for example, originally CBI plans to manufacture 1,400 units however the weighted and reduced contribution margin per unit at $138 only gives very minimal profit after the breakeven point, so what needs to be done is to increase production units from 1,400 to 3,254. By doing so Competition Bikes Inc. would be able to expect a profit of $450,072.40 (titanium 2,092 units X $709.30 variable cost per unit = $1,483,855.60 of total cost), (carbon Lite 1,162 units X $1,451 variable cost per unit = $1,686,062 of total cost (titanium + carbon = $3,169,917.60) less total sales $3,619,990 = $450,072.40 of total profit divided by total number of units sold (3,254) = $138.31 contribution margin per unit.
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