Classic Pen Company Case

CLASSIC PEN COMPANY
DEVELOPING AN ABC MODEL

GROUP 10 (SECTION D)
ARIJIT NAYAK
15P189
CHANDRIMA DHAR
15P194
MIHIR UPASANI
15P212
NIDIHIN G THOMAS
15P215
SAMBIT DASH
15P225
SHIVI SHARMA
15P230
VIVEK AGGARWAL
15P240
Case Background
Originally, Company 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 using same technology at
10% premium
Company only has one factory where all production is carried out
Issues faced by Management
Issue 1 Profitability
While Red and Purple pens seem to be more profitable,
overall profitability of the company is falling
Issue 2 - Pricing
Can the products be priced better
Issue 3 Production Process

Process for Red and Purple pens requires more set-up time
Issue 4 Internal Processes

A lot of time spent on scheduling and purchasing activities
No capability to handle additional confusion and
complexity in operations
Costing system of Classic Pen

All indirect costs were aggregated at plant level and
allocated to products based upon the direct labor cost
The current 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

Classic Pen Company
Traditional Income Statement
Blue
Black
Red
Purple
Total
Sales
$ 75,000.00 $ 60,000.00 $ 13,950.00 $ 1,650.00 $ 150,600.00
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 labor)
$ 30,000.00 $ 24,000.00 $ 5,400.00 $
600.00 $ 60,000.00
Total Costs
$ 65,000.00 $ 52,000.00 $ 11,880.00 $ 1,350.00 $ 130,230.00
Operating income
$ 10,000.00 $ 8,000.00 $ 2,070.00 $
Return on Sales
13.33%
13.33%
14.84%
300.00 $ 20,370.00
18.18%
13.53%
Activity Based Costing

Before:
Production primarily manual
Classic Pens two products were identical with respect to volume and
batch size
Direct labor cost and indirect labor cost has decreased due to
automation
As low volume products were introduced the result was
increased demand for:
Increased planning
More setups of machines
More quality control
Computers to keep track of jobs and product specifications

Same physical output, same cost of direct material
The firm has much higher indirect and support costs due to
the larger and more diversified product mix and more
complex production
One unit of the high volume standard product (blue or
black) uses approximately the same amount of direct labor
as one unit of red or purple
The use of indirect and support activities by the special
products are higher that the use by the standard products

Indirect labor
50% of the indirect labor costs are caused by Handling
Production runs
40% of the indirect labor cost were caused by the physical
change from one color to another called Machine Setup
costs
10% of the indirect labor was used to an activity Parts
Administration (Record keeping)
Computer Expenses
20% allocated to keep records (Parts administration)
80% of computer resources were used to produce batches
and are closely related to Handling production runs

Three categories of indirect cost remained:
Machine Depreciation
Machine Maintenance
Energy
These costs were incurred for production of pens and were a
function of the machine hours taken to produce the pens
(Running of Machines)
Fringe Benefits were 40% of both direct and indirect labor
expenses, and were to be applied as a percentage markup to
both
Activities and Cost Drivers

Indirect labour; Fringe Benefits; Computer Systems; Machinery;
Expenses Maintenance; Energy
Cost Pool
Indirect labour; Computer System Expenses; Machine Expenses
Machine set up; Production run; Parts Administration (Record keeping);

Machine Support
Activities
Products
Black; Blue; Red; Purple
Assigning Resources to Activities

Activity
Cost
Handling
production
runs
Machine
Set Up for
Parts
changeover Administration
Indirect Labor
50%
40%
Fringe benefits (40%

of Indirect Labor)
50%
40%
Computer Systems
80%
Total
Total
Expense
10%
100%
$ 20,000.00
10%
100%
$ 8,000.00
20%
100%
$ 10,000.00
100%
100%
$ 8,000.00
100%
100%
$ 4,000.00
100%
100%
$ 2,000.00
Machine
Depreciation
Machine
Maintenance
Energy
Activity Expense
$ 22,000.00
$ 11,200.00 $ 4,800.00
Running of
machines
$ 14,000.00
$ 52,000.00
Activity Cost Drivers Rate

Activity
Machine Set
Handling
Up for
Parts
production runs changeover Administration
Cost Driver
Production runs Setup Time
Running of
machines
No. of products Machine Hours
Cost Driver Quantity
150
526
10000
Activity Cost Driver

Rate
$ 146.67
$ 21.29
$ 1,200.00
$ 1.40
Cost Driver
Activity Cost Driver

Rate
Blue
Black
Red
Purple
Production Runs
50
50
38
12
$ 146.67
Set up time
200
50
228
48
$ 21.29
$ 1,200.00
5000
4000
900
100
Products
Machine Hours
$ 1.40
ABC Income statement

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 $ 150,600.00
Direct Material
$ 25,000.00 $ 20,000.00 $ 4,680.00
550.00 $ 50,230.00
Direct Labor
Fringe Benefits (Direct Labor
portion)
Handling Production Runs
Machine Set up for
changeover
$ 10,000.00 $ 8,000.00 $ 1,800.00
200.00 $ 20,000.00
$ 4,000.00
$ 3,200.00 $
$ 7,333.33
$ 7,333.33 $ 5,573.33
$ 1,760.00 $ 22,000.00
$ 4,258.56
$ 1,064.64 $ 4,854.75
$ 1,022.05 $ 11,200.00
Parts Administration
$ 1,200.00
$ 1,200.00 $ 1,200.00
$ 1,200.00 $
Running of Machines
$ 7,000.00
$ 5,600.00 $ 1,260.00
Total Costs
$ 58,791.89 $ 46,397.97 $ 20,088.09 $ 4,952.05 $ 130,230.00
Operating income
$ 16,208.11 $ 13,602.03 $ (6,138.09) $ (3,302.05) $ 20,370.00
Return on Sales
21.61%
22.67%
720.00 $
-44.00%
80.00 $
8,000.00
4,800.00
140.00 $ 14,000.00
-200.12%
13.53%
Cost per unit vs. Selling Price per unit

Blue
Black
Red
Purple
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
Return on sale varies based on the traditional costing method and

ABC method
Red color pens are sold at price less than its cost as per ABC
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 as company has

added large quantity of overheads: computer systems and support
expenses
Recommendations based on ABC analysis

Increase the sales price of red and purple pens
Improve processes to reduce setup times, especially
for Red pens
Look for new product designs and efficient methods
of preparing and mixing inks

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CLASSIC PEN COMPANY

DEVELOPING AN ABC MODEL

Issues faced by Management

Issue 3 Production Process

Issue 4 Internal Processes

Costing system of Classic Pen

Traditional Costing Method

$ 75,000.00 $ 60,000.00 $ 13,950.00 $ 1,650.00 $ 150,600.00

$ 25,000.00 $ 20,000.00 $ 4,680.00 $

$ 10,000.00 $ 8,000.00 $ 1,800.00 $

Overhead (@ 300% of Direct labor)

$ 30,000.00 $ 24,000.00 $ 5,400.00 $

$ 65,000.00 $ 52,000.00 $ 11,880.00 $ 1,350.00 $ 130,230.00

$ 10,000.00 $ 8,000.00 $ 2,070.00 $

Activity Based Costing

Activity Based Costing

Activity Based Costing

Activity Based Costing

Activities and Cost Drivers

Indirect labour; Computer System Expenses; Machine Expenses

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

Black; Blue; Red; Purple

Assigning Resources to Activities

Fringe benefits (40%

Activity Cost Drivers Rate

Production runs Setup Time

No. of products Machine Hours

Cost Driver Quantity

Activity Cost Driver

Activity Cost Driver

ABC Income statement

$ 75,000.00 $ 60,000.00 $ 13,950.00 $ 1,650.00 $ 150,600.00

$ 25,000.00 $ 20,000.00 $ 4,680.00

$ 10,000.00 $ 8,000.00 $ 1,800.00

$ 58,791.89 $ 46,397.97 $ 20,088.09 $ 4,952.05 $ 130,230.00

$ 16,208.11 $ 13,602.03 $ (6,138.09) $ (3,302.05) $ 20,370.00

Cost per unit vs. Selling Price per unit

ABC Cost per Unit

Traditional Cost per

Return on sale varies based on the traditional costing method and

Overheads increased significantly with new products as company has

Recommendations based on ABC analysis

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