Exhibit 1 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 labor 10,000 8,000 1,800 200 20,000
Overhead @300% 30,000 24,000 5,400 600 60,000
Total optg income $10,000 $8,000 $2,070 $300 $20,370
Return on Sales 13.3% 13.3% 14.8% 18.2% 13.5%

Overhead costs
Indirect labour 20,000
Fringe benefits 16,000
Computer systems 10,000
Machinery 8,000
Maintenance 4,000
Energy 2,000
Total overheads $60,000

Exhibit 2 Direct Costs and Activity Cost Drivers

BLUE BLACK RED PURPLE Total
Production sales volume 50,000 40,000 9,000 1,000 100,000
Unit selling price $1.50 $1.50 $1.55 $1.65
Materials - unit cost $0.50 $0.50 $0.52 $0.55
Direct labour - hrs/ unit 0.02 0.02 0.02 0.02 2,000
Machine hrs/ unit 0.10 0.10 0.10 0.10 10,000
Production runs 50 50 38 12 150
Setup time/run 4 1 6 4
Total setup time (hrs) 200 50 228 48 526
Parts administration 1 1 1 1 4 Cost per each
Cost allocation bases
Direct labour - hours 1,000 800 180 20 2,000 $10
Machine hours 5,000 4,000 900 100 10,000
Production runs 50 50 38 12 150
Total setup time (hrs) 200 50 228 48 526
Parts administration 1 1 1 1 4

Traditional Costing report on profitability

Classic Pen Company Cost 50,000 40,000
Income statement hierarchy BLUE pens BLACK pens
Sales revenue $150,600 $75,000 $1.50 $60,000 $1.50
Direct expenses
Material cost $50,230 Unit level 25,000 0.50 20,000 0.50
Direct labour cost 20,000 Unit level 10,000 0.20 8,000 0.20
Fringe benefits to Direct labor 8,000 Unit level 4,000 0.08 3,200 0.08
Contribution 36,000 0.72 28,800 0.72
Indirect expenses
Indirect labour $20,000 Batch level 10,000 0.20 8,000 0.05
Fringe benefits 8,000 Orgn level 4,000 0.08 3,200 0.08
Computer systems 10,000 Batch level 5,000 0.10 4,000 0.10
Machinery depreciation 8,000 Batch level 4,000 0.08 3,200 0.08
Maintenance expenses 4,000 Batch level 2,000 0.04 1,600 0.04
Energy 2,000 Batch level 1,000 0.02 800 0.02
Total indirect expenses 26,000 0.52 20,800 0.52
Total expenses $130,230 65,000 $1.30 52,000 $1.30
Operating profit (EBIT) $20,370 $10,000 $0.20 $8,000 $0.20
Return on Sales 13.5% 13.3% 13.3% 13.3% 13.3%

Activity-based Costing report on profitability

Classic Pen Company Cost 50,000 40,000
Income statement hierarchy BLUE pens BLACK pens
Sales revenue $150,600 $75,000 $1.50 $60,000 $1.50
Direct expenses
Material cost $50,230 Unit level 25,000 0.50 20,000 0.50
Direct labour costs 20,000 Unit level 10,000 0.20 8,000 0.20
Fringe benefits to direct labor 8,000 4,000 0.08 3,200 0.08
Contribution $72,370 $36,000 0.72 $28,800 0.72
Indirect expenses
Indirect labour 20,000 Batch level 6,875 0.14 4,594 0.11
Fringe benefits 8,000 Orgn level 2,750 0.06 1,838 0.05
Computer systems office 10,000 Batch level 3,167 0.06 3,167 0.08
Machinery depreciation 8,000 Batch level 4,000 0.08 3,200 0.08
Maintenance expense 4,000 Batch level 2,000 0.04 1,600 0.04
Energy bills 2,000 Batch level 1,000 0.02 800 0.02
Total indirect costs 52,000 19,792 0.40 15,198 0.38
Total costs $130,230 $58,792 $1.18 $46,398 $1.16
Operating profit $20,370 $16,208 $0.32 $13,602 $0.34
Return on Sales 13.5% 21.6% 21.6% 22.7% 22.7%

Cost distribution under ABC system

Cost head Cost Proportion Amount
Nature of activities performed
Indirect labour $20,000 50% $10,000 handling pdn runs
40% $8,000 Physical changeover
10% $2,000 Maintaing records
$20,000 Indirect labor costs
Fringe benefits 8,000 100% $8,000 Paid to indirect labor
Computer systems 10,000 80% $8,000 Scheduling production runs
20% $2,000 to keep records
$18,000 Computer systems charge
Machinery 8,000 100% $8,000 Depreciation due to wear&tear
Maintenance 4,000 100% $4,000 General maintenance
Energy 2,000 100% $2,000 Electric power consumption
Total expenses $52,000 $52,000
versus traditional cost allocation
Traditional alloc - ABC allocati
Inference: manufacturing OH wa
 proportion proportion proportion proportion
BLUE BLACK RED PURPLE Total

50% 40% 9% 1% 100%

Cost per each

9,000 1,000
RED pens PURPLE pen alloc rate
$13,950 $1.55 $1,650 $1.65

4,680 0.52 550 0.55

1,800 0.20 200 0.20
720 0.08 80 0.08
6,750 0.75 820 0.82

1,800 0.02 200 0.20 $10

 720 0.08 80 0.08 $4
900 0.10 100 0.10 $5
720 0.08 80 0.08 $4
360 0.04 40 0.04 $2
180 0.02 20 0.02 $1
4,680 0.52 520 0.52
11,880 $1.32 1,350 $1.35
$2,070 $0.23 $300 $0.30
14.8% 14.8% 18.2% 18.2%

9,000 1,000
RED pens PURPLE pen
$13,950 $1.55 $1,650 $1.65

4,680 0.52 550 0.55

1,800 0.20 200 0.20
720 0.08 80 0.08
$6,750 0.75 $820 0.82

6,501 0.72 2,030 2.03

2,600 0.29 812 0.81
2,527 0.28 1,140 1.14
720 0.08 80 0.08
360 0.04 40 0.04
180 0.02 20 0.02
12,888 1.43 4,122 4.12
$20,088 $2.23 $4,952 $4.95
($6,138) ($0.68) ($3,302) ($3.30)
-44.0% -44.0% -200.1% -200.1%

Allocation basis BLUE BLACK RED PURPLE CA rate

Production runs 3,333 3,333 2,533 800 $66.67
Total set up time 3,042 760 3,468 730 $15.21
Number of parts 500 500 500 500 500
$6,875 $4,594 $6,501 $2,030
40% of indirect labour 2,750 1,838 2,600 812
Production runs 2,667 2,667 2,027 640 $53.33
Number of parts 500 500 500 500 500
systems charge $3,167 $3,167 $2,527 $1,140
Machine hours 4,000 3,200 720 80 $0.80
Machine hours 2,000 1,600 360 40 $0.40
Machine hours 1,000 800 180 20 $0.20
$19,792 $15,198 $12,888 $4,122
versus traditional cost allocation 26,000 20,800 4,680 520
Traditional alloc - ABC allocatio 6,208 5,602 (8,208) (3,602)
Inference: manufacturing OH was over-allocateover-alloca under-allo under-allocated
 Aggregate Blue pen Black pen
Sales revenue $150,600 $75,000 $60,000
Direct expenses $70,230 $35,000 $28,000
Contribution $80,370 $40,000 $32,000
Indirect cost allocation with
one-fourth to each pdt 52,000 13,000 13,000
No. of units produced 52,000 26,000 20,800
Material cost as basis 52,000 25,881 20,705
Direct labour hours 52,000 26,000 20,800
Machine hours as basis 52,000 26,000 20,800

Production runs 52,000 17,333 17,333

Total setup time (hrs) 52,000 19,772 4,943
RED pen Purple pen
$13,950 $1,650
$6,480 $750
$7,470 $900

13,000 13,000
4,680 520
4,845 569
4,680 520
4,680 520

13,173 4,160
22,540 4,745