CLASSIC PEN COMPANY

DEVELOPING AN ABC MODEL

GROUP V1 (SECTION 4)
HARISH B 13419
ANINDYA GANGULY 13406
ANURAG BOTHRA 13411
PRAGATI CHAUHAN 13435
RENJIT THOMAS 13440

Cost Accounting Case analysis

 Case Background

Classic Pen was a low-cost producer of traditional Blue and

Black pens

Profit margins were over 20% of sales

Five years earlier Red pens were introduced at 3% premium

Recently Purple pens were introduced at 10% premium.

 Issues faced by Management

Red and Purple pens seem more profitable, but overall margin
is coming down

Process for Red and Purple pens require more set up time

A lot of time spent on scheduling and purchasing activities

 Costing system of Classic Pen

All indirect costs were aggregated at plant level and allocated

to products based upon the direct labor cost

The overhead rate is 300% of direct labor cost

Before Red and Purple pens were introduced, the overhead

rate was only 200% of direct labor cost
 Traditional Costing Method
Traditional Income statement
Blue Black Red Purple Total

Sales $75,000 $60,000 $13,950 $1,650 $150,600

Material costs $25,000 $20,000 $4,680 $550 $50,230

Direct labour $10,000 $8,000 $1,800 $200 $20,000

Overhead @300% $30,000 $24,000 $5,400 $600 $60,000

Total operating cost $65,000 $52,000 $11,880 $1,350 $130,230

Total operating income $10,000 $8,000 $2,070 $300 $20,370

Return on sales 13.60% 13.30% 14.80% 18.20% 13.50%

 Activity Based Costing
Indirect labor
50% of the indirect labor costs are caused by Production
run
40% of the indirect labor cost were caused by the physical
change from one color to another called setup costs
10% of the time was used to an activity Parts
Administration (Book keeping)
Computer Expenses
20% allocated to support activities (Parts admin.)

80% of computer resources were used to produce batches

and are closely related to handling of production batches
 Activity Based Costing
Three categories of indirect cost remained:
Machine
Machine maintenance
Energy
These costs were incurred for activities Support
 Activities and Cost Drivers
Indirect labour; Fringe Benefits; Computer Systems; Machinery;
Expenses Maintenance; Energy

Indirect labour; Fringe Benefits for DL; Computer System Expenses;

Cost Pool Machine Expenses

Machine set up; Production run; Parts Administration (Record keeping);

Activities Machine Support; Direct Labour Fringe

Black; Blue; Red; Purple

Products
 Assigning Resources to Activities

Machine Expenses (
Computer System E Fringe Benefits for
Indirect Labour Machinery, Mainten
xpenses DL
ance and Energy

50% 40%
20%
10%
80%

Parts Administra
Production Run Setup Support DL Fringe
tion
 Resources and Cost Pooling
Resources Cost Pools
Indirect labour DL Fringe Computer System Machine Expenses
benefit Expenses
$20,000
$8,000 (50% $8,000 (50%
Fringe benefit) Fringe Benefit)

$10,000
$8,000
$4,000
$2,000
$28,000 $8,000 $10,000 $14,000
 Activity Cost Drivers Rate - Total
Activities Activity Activity cost driver Cost driver Activity
cost quantity Cost driver
($) rate ($)

Production Run 22,000 Production runs 150 146.67

Set up 11,200 Total setup time 526 21.29

Parts Administration 4,800 Parts Administration 4 1200

Support 14,000 Machine hours 10000 1.4

Direct labour fringe 8,000 Direct labour hours 2000 4

 Activity Cost Per Unit
Activity cost per unit
Blue Black Red Purple Total

Production run $7333.33 $7333.33 $5573.33 $1760 $22,000

Set up $4258.55 $1064.63 $4,854.70 $1,022.05 $11,200

Parts Administration $1,200 $1,200 $1,200 $1,200 $4,800

Support $7,000 $5,600 $1,260 $140 $14,000

Direct labour fringe $4,000 $3,200 $720 $80 $8,000

 ABC Income statement
ABC Income statement
Blue Black Red Purple Total
Sales $75,000 $60,000 $13,950 $1,650 $150,600

Material costs $25,000 $20,000 $4,680 $550 $50,230

Direct labour $10,000 $8,000 $8,000 $200 $20,000

Overhead
Production run $7333 $7333 $5573 $1760 $22,000
Set up $4259 $1064.63 $4,854.70 $1,022.05 $11,200

Parts Administration $1,200 $1,200 $1,200 $1,200 $4,800

Support $7,000 $5,600 $1,260 $140 $14,000
Direct labour fringe $4,000 $3,200 $720 $80 $8,000
Total operating cost $58,792 $46,398 $20,088 $4,952 $130,230

Total operating income $16,208 $13,602 -$6,138 -$3,302 $20,370

Return on sales 21.6% 22.6% -44% -200% 13.5%

ABC Cost per unit vs Selling Price per unit

Blue Black Red Purple

ABC $1.17 $1.15 $2.23 $4.95
cost/unit
Selling $1.50 $1.50 $1.55 $1.65
price/unit
 Observation
Return on sale varies based on the traditional costing method and ABC
method

Red color pens are sold at price less than its cost

Purple color pens are sold at much less price than its cost

Company is making loss in selling Red and Purple color pens as the
overhead cost is high

Overheads increased significantly with new products

 Recommendation based on ABC analysis

Increase the sales price of red and purple pens.

Minimize overhead cost