1.

Calculate the revised product costs for the four pens, based on the activity
information collected by Dempsey. Identify the total activity expenses,
individual activity expenses, cost driver quantity, activity base, rate.
2. What actions are stimulated by the ABC product costs?
3. Draw the ABC model.
4. Identify the activities. Its level. Any support activity?

Four new activities:

Run Machines
Handle Production Runs
Set Up Machines
Administer Products

Run Machines is a unit-related activity. The quantity of the activity was

proportional to the total number of pens produced.

The next two activities (Handle Production Runs, Set Up Machines) are batch-
related: the quantity demanded is proportional to the number of batches or
production runs.
The activity, Administer Products, is product-sustaining: the demand for this
activity expands with the number of different products produced in the factory
but is independent of the production volumes or runs of the products.

The Fringe Benefit activity is best viewed as a support activity for the four new
activities plus direct labor:
-----its expenses can be spread back to these five activities as a percentage
markup over direct and indirect labor expense within each activity.

activities
Handle Set up Administe Run Total
Prod Machines r Parts Machines expenses
runs
Indirect 50% 40% 10% 28000
labour & ½
fringe
14000 11200 2800
Computer 80% 20% 10000
expense
8000 2000
Machine 100% 8000
depreciation
8000
Maintenance 100% 4000
4000
Energy 100% 2000
2000
Total activity 22000 11200 4800 14000 52000
expenses
Cost driver 150 526 4 10000
quantity
Unit of Prod Setup No. of Machine
measurement runs hours parts hours
Activity cost 147 21 1200 1.4
driver rate

ABC income statement

Blue black Red purple total
sales 75000 60000 13950 1650 150600
Material 25000 20000 4680 550 50230
costs
Direct 10000 8000 1800 200 20000
labour
40% fringe 4000 3200 720 80 8000
on direct
labour
Machine 7000 5600 1260 140 14000
time
expense
Prod run 7333 7333 5573 1760 22000
expense
Set up time 4259 1065 4855 1022 11200
expense
Administer 1200 1200 1200 1200 4800
parts
expense
Total 58792 46398 20088 4952 130230
expense
Operating 16208 13602 (6138) (3302) 20370
income
Return on 21.6% 22.7% -44% -200.1% 13.5%
sales

Analysis:

The two specialty products, which the previous cost system had reported as the
most profitable, are, in fact, highly unprofitable.

To produce these new products, the company has added large quantities of
overhead resources--a larger computer system and many more indirect and
support employees—to enable these products to be designed and produced.

The high expenses of these additional support resources have not been
compensated by the revenues from sales of RED and PURPLE pens.

The activity-based analysis shows that, contrary to the perspective of the

traditional system, the mainstay BLUE and BLACK pens are the only profitable
products made by Classic Pen.

These products retain the 20+% profit margins that the company had enjoyed
before the new specialty products had been introduced.

Rather than trying to run their production equipment faster (improving the
performance of unit-level activities), Donald should learn how to reduce setup
times (improving the performance of batch-level activities) so that small batches
of the specialty products would be less expensive (require fewer resources) to
produce.

The high cost of the demanding quality specifications for RED pens, in addition
to the engineering change notices, would motivate the Engineering group to
seek ways to design products that would be easier to produce and would require
fewer modifications once introduced (thereby reducing the resource demands by
a product-sustaining activity).

A combination of these action alternatives:

· Pricing
· Process improvements
· Engineering and design improvements

This would significantly increase Classic Pen’s profitability without

compromising its ability to compete in both the high-volume BLUE and
BLACK pen markets as well as the emerging specialty and custom pen
segments.