Companies use costing systems to determine the cost of a product related to the revenue it generates. There are two widely known costing systems used in business. First there is tradition costing, which assigns manufacturing overhead based on volume of a cost driver, such as direct labor hours needed to produce an item. A cost diver is an aspect that causes cost to be incurred, such as machine hours. Secondly there is activity-based costing, which allocates the costs of manufacturing a product based on the activities needed to produce the item (Johnson, 2015).
Traditional Based Costing in comparison to Activity Based Costing.
With Traditional Based Costing most manufacturing companies assign manufacturing overhead dollars for units produced, which is making an assumption that the volume metric is the driver of overhead costs for manufacturing. While Traditional Based Costing does align with Generally Accepted Accounting Principles (GAAP), it is an outdated costing system. In addition, it does not account for things such as nonmanufacturing costs associated with production (administrative costs). Using the data provided on the Activity Based Costing tab, we can see that the Traditional Based Costing manufacturing overheard for the titanium model is $239,020 and for the CarbonLite model the Traditional Based Costing manufacturing overhead is $232,380, which gives us a total of $471,400 in overhead costs. Using Traditional Based Costing we see that the unit price for the titanium model is $713 and $1359 for the CarbonLite model.
To calculate manufacturing overhead costs using the traditional methods the following calculation is used: $471,400 (Total overhead costs) / $241,600 (total direct labor dollars) which provides us with $1.95 as the total overhead per direct labor dollar figure. We then use the cost per direct labor dollars ($1.95) and multiply it by the cost per unit of direct labor, per model, to find the overhead per unit. The Titanium model cost per unit of direct labor is ($144), and the CarbonLite model cost per unit of direct labor is ($224). Using this model, we calculate the per unit overhead cost of $280.80 for the Titanium model and $436.80 for the CarbonLite model.
The data provided on the spreadsheet for Competition Bikes cost-volume-profit shows us that both costing models have the same direct labor & direct materials costs ($471,400) but we can see that the amount of overhead differs. Using the Traditional Based Costing method, the per unit cost overhead allocated to the Titanium brand comes to $280.80, which is quite a bit larger number than the Activity Based Costing method provides as outlined below.
Using the data from the Activity Based Costing spreadsheet for Competition Bikes, we are able to calculate the per unit activity based cost with the following formula: total activity cost/total number of units. There is a total of 900 units for the Titanium model with a total overhead cost of $188,415 (Titanium model), which calculates out to a unit cost is $209.35. There is a total of 500 units for the CarbonLite model with a total overhead cost of $282,985 (CarbonLite model), which calculates out to a unit cost is $565.97 per unit.
Per Unit Cost – By Costing Method ABC
With Activity Based Costing the company allocates a cost for every activity required to produce the product. Once that activities are identified, we then take the activity and assign it to product that include that specific activity for production, they are now allocated to that activity. With Activity Based Costing there are a few steps to setup the activity costs. We need to identify costs, whether variable or fixed, and then assign each to a category of costs. Each activity will have a cost driver, these activities are the actual activities that cause the total cost within an activity to increase. A few items that could cause an activity cost to