Classic Pen Company

Introduction:

• Low-cost producer of traditional Blue and Black ink pens

• Profit margins of over 20% of sales

• 5 years earlier introduced Red pens using same technology at 3% premium

• Recently introduced Purple pens using same technology at 10% premium

Issue facing the management:

• Profitability: While Red & Purple pens seem to be more profitable, overall profitability of the company is falling

• Pricing: “Tough Global Competition”, “Can the products be priced better?”

• Product mix: Process for Red & Purple pens requires more resources (set-up time etc.)

• Internal Processes: A lot of time spent on scheduling and purchasing activities

Define activities and activity drivers:

Activities Drivers

Handle Production Runs Production Runs

Set-up time Setup hours

Parts Admin. No. of Parts

Machine Support Machine Hours

Direct Labor Fringe Direct Labor

Understanding Activities:

• Machine exp.: unit level activity

• Handle production runs: batch level activity

• Setup exp.: batch level activity

• Admin exp.: product level activity

• Fringe exp.: Facility level

Forming Cost Pools: Under ABC

Indirect Labor 28000 20000+8000 (40% of DL)

Computer exp. 10000

Machine exp. 14000 (8000+4000+2000)

These expenses to be apportioned over the activities mentioned earlier using the appropriate drivers.

Cost Allocation: under ABC

Indirect Labor Computer exp. Machine exp. Total Activity Rate

Handle production Run 50% 14000 80% 8000 22000 150 146,7

Setup time 40% 11200 11200 526 21,29

Parts Admin. 10% 2800 20% 2000 4800 4 1200

Machine support 100% 14000 14000 10000 1,4

Total 28000 10000 14000 52000

How can the Classic Pen Company discover what its true costs are?

ABC Cost Sheet

Blue Black Red Purple Total

Volume 50000 40000 9000 1000 100000

DM 25000 20000 4680 550 50230

DL 10000 8000 1800 200 20000

Overheads

Machine Support 7000 5600 1260 140 14000

Production Run...