Kanupriya Yadav (PGP13112)

Section C

Classic Pen Co.: Developing an ABC Model

Case Solution
Case Overview
Classic Pen Co. is a low-cost pen manufacturer that has traditionally produced blue and
black pens with a profit margin of more than 20%. Around 7 years ago, the sales manager
saw growth opportunities in coloured pens and thus introduced red and purple to their
premium product line. Unfortunately, the financial results show that this strategy, which
should have been driving profitability, is now exhibiting an overall decline in profits. The
margins for the flagship products appear to be declining as well, prompting us to examine
the income statement through an activity-based lens.

Problem Statement
 Profitability: While red and purple pens appear to be more profitable, the company's
overall profitability is declining.
 Production Process: The process for red and purple pens takes longer to set up.
 Internal Processes: A significant amount of time is spent on scheduling and purchasing
activities. There is no capacity to handle additional operational confusion and
complexity.

Classic Pen Company

Traditional Income Statement

  Blue Black Red Purple Total

Sales $ 75,000.00 $ 60,000.00 $ 13,950.00 $ 1,650.00 $ 1,50,600.00

Direct Material $ 25,000.00 $ 20,000.00 $ 4,680.00 $ 550.00 $ 50,230.00

Direct Labor $ 10,000.00 $ 8,000.00 $ 1,800.00 $ 200.00 $ 20,000.00

Overhead (@ 300% of Direct
$ 30,000.00 $ 24,000.00 $ 5,400.00 $ 600.00 $ 60,000.00
labor)
Total Costs $ 65,000.00 $ 52,000.00 $ 11,880.00 $ 1,350.00 $ 1,30,230.00
Operating income $ 10,000.00 $ 8,000.00 $ 2,070.00 $ 300.00 $ 20,370.00
Return on Sales 13.33% 13.33% 14.84% 18.18% 13.53%

Classic Pen Company

ABC Based Income Statement

  Blue Black Red Purple Total

Sales $ 75,000.00 $ 60,000.00 $ 13,950.00 $ 1,650.00 $ 1,50,600.00
Direct Material $ 25,000.00 $ 20,000.00 $ 4,680.00 $ 550.00 $ 50,230.00
Direct Labor $ 10,000.00 $ 8,000.00 $ 1,800.00 $ 200.00 $ 20,000.00
Fringe Benefits (Direct Labor $
$ 3,200.00 $ 720.00 $ 80.00
portion) 4,000.00 $ 8,000.00
 $
Handling Production Runs $ 7,333.33 $ 5,573.33 $ 1,760.00 $ 22,000.00
7,333.33
Machine Set up for $
$ 1,064.64 $ 4,854.75 $ 1,022.05 $ 11,200.00
changeover 4,258.56
$
$ 1,200.00 $ 1,200.00 $ 1,200.00 $ 4,800.00
Parts Administration 1,200.00
$
Running of Machines 7,000.00 $ 5,600.00 $ 1,260.00 $ 140.00 $ 14,000.00
Total Costs $ 58,791.89 $ 46,397.97 $ 20,088.09 $ 4,952.05 $ 1,30,230.00
Operating income $ 16,208.11 $ 13,602.03 $ (6,138.09) $ (3,302.05) $ 20,370.00
Return on Sales 21.61% 22.67% -44.00% -200.12% 13.53%

Unit Sales 50000 40000 9000 1000 100000

$ $ $
ABC Cost per Unit
1.18 1.16 $ 2.23 4.95
$ $ $
Traditional Cost per Unit
1.30 1.30 $ 1.32 1.35
$ $ $
Selling Price
1.50 1.50 $ 1.55 1.65

Observations
 The return on sale varies depending on the traditional costing method and the ABC
method.
 According to ABC, red pens and purple pens are sold for a fraction of their original cost.
 The overhead cost of the red and purple pen was high. Overheads increased significantly
with new products because the company added a significant number of overheads:
Computer hardware and support costs

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