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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% pre


mium

Recently Purple pens were introduced at 10% premiu


m.

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 ti


me

A lot of time spent on scheduling and purchasing activ


ities

Costing system of Classic Pen

All indirect costs were aggregated at plant level and all


ocated 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 over


head rate was only 200% of direct labor cost

Traditional Costing Method


Traditional Income statement

Blue
Black Red
Purpl
e
Sales
$75,00 $60,00 $13,95 $1,65
0
0
0
0
Material costs
$25,00 $20,00 $4,680 $550
0
0
Direct labour
$10,00 $8,000 $1,800 $200
0
Overhead @300%
$30,00 $24,00 $5,400 $600
0
0
Total operating cost $65,00 $52,00 $11,88 $1,35
0
0
0
0
Total operating
$10,00 $8,000 $2,070 $300
income
0
Return on sales
13.60 13.30 14.80 18.20

Total
$150,60
0
$50,230
$20,000
$60,000
$130,23
0
$20,370
13.50%

Activity Based Costing

Indirect labor
50% of the indirect labor costs are caused by Produ
ction run
40% of the indirect labor cost were caused by the p
hysical change from one color to another called set
up costs
10% of the time was used to an activity Parts Admi
nistration (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 produ
ction 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;
Expens Machinery; Maintenance; Energy
es
Indirect labour; Fringe Benefits for DL; Computer System
Cost
Expenses; Machine Expenses
Pool
Machine set up; Production run; Parts Administration
Activiti (Record keeping); Machine Support; Direct Labour Fringe
es
Produc Black; Blue; Red; Purple
ts

Assigning Resources to Activities

Indirect Labour

50
%

Computer
System
Expenses

40
%

10
%

80
%
Production
Run

Machine
Expenses
(Machinery,
Maintenance
and Energy

Setup

Fringe Benefits
for DL

20
%
Parts
Administrati
on

Support

DL Fringe

Resources and Cost Pooling


Indirect
labour
$20,000
$8,000 (50%
Fringe benefit)

$28,000

Resources Cost Pools


DL Fringe Computer
benefit
System
Expenses

$8,000

(50% Fringe
Benefit)

$8,000

$10,000

$10,000

Machine
Expenses

$8,000
$4,000
$2,000
$14,000

Activity Cost Drivers Rate - Total


Activities

Activi Activity cost


ty
driver
cost
($)

Cost driver Activity


quantity
Cost
driver
rate ($)

Production Run

22,00
0
11,20
0

Production runs

150

146.67

Total setup time

526

21.29

Parts
Administration
Support

4,800

Parts
Administration
Machine hours

1200

10000

1.4

Direct labour
fringe

8,000

Direct labour
hours

2000

Set up

14,00
0

Activity Cost Per Unit

Activity cost per unit


Blue
Black
Red

Purple

Total

$1760

$22,00
0

Production run

$7333.3
3

$7333.3
3

$5573.3
3

Set up

$4258.5
5

$1064.6
3

$4,854.7 $1,022.0 $11,20


0
5
0

Parts Administration $1,200

$1,200

$1,200

$1,200

$4,800

Support

$7,000

$5,600

$1,260

$140

Direct labour fringe

$4,000

$3,200

$720

$80

$14,00
0
$8,000

ABC Income statement

Sales
Material costs
Direct labour
Overhead
Production run
Set up
Parts Administration
Support
Direct labour fringe
Total operating cost
Total operating
income

ABC Income statement


Blue
Black
Red
$75,00 $60,000 $13,950
0
$25,00 $20,000 $4,680
0
$10,00 $8,000
$8,000
0
$7333
$4259

$7333
$1064.6
3
$1,200
$5,600
$3,200
$46,398

$1,200
$7,000
$4,000
$58,79
2
$16,20 $13,602
8

Purple
$1,650
$550

Total
$150,60
0
$50,230

$200

$20,000

$5573
$4,854.7
0
$1,200
$1,260
$720
$20,088

$1760
$1,022.0
5
$1,200
$140
$80
$4,952

$22,000
$11,200

-$6,138

-$3,302

$4,800
$14,000
$8,000
$130,23
0
$20,370

ABC Cost per unit vs Selling Price per unit

Blue
ABC
$1.17
cost/unit
Selling
$1.50
price/uni
t

Black
$1.15

Red
$2.23

Purple
$4.95

$1.50

$1.55

$1.65

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