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Exercise – Activity-Based Costing (ABC)

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This exercise asks you to apply Activity-Based Costing to Colorado Ricardo Mountain Bikes.

The Scenario: Colorado Ricardo Mountain Bikes

Colorado Ricardo Mountain Bikes was founded by Ricardo Francisco, a keen off-road cyclist who grew frustrated with bikes breaking down under the strain of the Colorado mountains. After years of trial and error, he built a bike tough enough to survive the terrain and named it the “Colorado Ricardo”. Word spread quickly among local riders, and Ricardo gave up his day job to build and sell bikes full-time from a small workshop outside Denver.

Colorado Ricardo currently spreads its $150 per-bike overhead evenly across every bike it makes, regardless of how much work each one actually causes. Ricardo is now considering adding an e-mountain bike alongside the existing off-road bike. The e-mountain bike requires extra battery safety testing and software calibration on every unit, and needs more frequent machine setups because it is produced in smaller batches than the established off-road bike.

Your task: Explain why spreading overhead evenly per bike (traditional costing) could understate the true cost of the e-mountain bike, and describe how Activity-Based Costing would allocate overhead differently, using machine setups and quality inspections as example cost drivers.

Activity-Based Costing: overhead assigned to products via cost drivers, not a flat rate

Once you have drafted your own answer, compare it with Marketing Teacher’s suggested answer.