classic pen company_group 07_v1

8/6/2019 Classic Pen Company_Group 07_v1

1/16

Classic Pen CompanyCase Analysis Activity Based Cost System

Group -07


2/16

The Classic Pen Company

Introduction

Classic Pen Company waslow-cost producer of traditional

Blue and Black ink pens

Profit margins were over 20% ofsales

As part ofproduct diversification introduced Red and Purplecolored pens

5 years earlier- introduced Red Pens using same technology

expected to sold at 3%premium

A year back, introduced Purple Pens using same technology

expected to sold 10%premium


3/16

Company Operation

The major task was preparing & mixing the ink for the different color

pens

The Ink was inserted into the pens in asemi automated process

A final packing & shipping stage was performed manually

Each product had a bill of materials that identified the

quantity & cost of direct materials required for the product

All the plants indirect expenses were aggregated at the plant level &

allocated to product based on their direct labour content

The sequence of operations for each operating steps were identified

through routing sheet which is used to calculate the labour expenses

for each of the four products based on the direct labour content


4/16

Management Concern

Red & Purple pensseem to be more profitable but

overall profitability of the company is falling

Better pricing due to global competition

To process Red and Purple pen, it requires moreresource(more setup time)

Scheduling and purchasing activities takeslot of time

All the 4 products failed to generate expected return

Overhead burden rate 300% of the direct labour


5/16

Views From SalesMgr,ManufacturingMgr & Controller

DENNIS SELMOR (Sales Manager) Opportunities to expand the business by extending the

product line into new products that offered premium

selling price over traditional Blue & Black

Consumersare willing to pay higher prices for the special

colors

JEFFRYDONALD(ManufacturingManager) Making blue and black pen wassimple

Purple pen having demanding specification nut not as

much as Red

Concerned about the future rumorslike

introducing of new colors would hamper the

operations in the company

Jane Dempsey (Controller)

Disappointed afterseen the financial results of thecompany

Wanted to put Activity based Costing( termed asABC here

after) Approach into practice

Identified the six categories ofsupport expenses that were

currently being allocated to pen production


6/16

Exhibit 1

Exhibit 1 Traditional Income Statement

Blue Black Red Purple Total

Sales 75,000 60,000 13,950 1,650 1,50,600

MaterialCost 25,000 20,000 4,680 550 50,230

Direct La bour 10,000 8,000 1,800 200 20,000

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

Income 10,000 8,000 2,070 300 20,370

Return on Sales 13.33% 13.33% 14.84% 18.18% 13.53%


7/16

Exhibit 2

Exhibit 2 Direct Costs and Activity Cost Drivers

Blue Black Red Purple Total

Production Sales

Volume 50,000 40,000 9,000 1,000 1,00,000

Unit selling Price 1.50 1.50 1.55 1.65

Materilas-unit cost 0.50 0.50 0.52 0.55

Direct Labor 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

PartsAdministration 1 1 1 1 4


8/16

Assumptions While UsingABC

Fringe benefits - 16000 (40% of direct and indirect labour)

1st Approach :

Allocating fringe benefits equally - 20% or 8000 to direct labourand

8000 to indirect labour

So, indirect labour is treated as 20000 + 8000 (FB) = 28000

2nd Approach :

Allocating entire fringe benefits (16000) separately.


9/16

Considering 1stApproach

Cost pool underAB

CIndirect Labour 20,000

40 % of direct labour 8,000

28,000

Computer Systems 10,00010,000

Machinery 8,000

Maintenance 4,000

Energy 2,000

14,000

Total 52,000


10/16

CostAllocation underABC

Indirect

labour

Computer

Exp Machine Exp Total Activity Rate

Handle Production

Run 50% 14,000 80% 8,000 22,000 150 146.7

Setup time 40% 11,200 11,200 526 21.3

Parts

Administration 10% 2,800 20% 2,000 4,800 4 1,200.0

Machine Support 100% 14,000 14,000 10,000 1.4

Total 28,000 10,000 14,000 52,000


11/16

Cost SheetBlue Black Red Purple Total

Production Sales Volume 50,000 40,000 9,000 1,000 1,00,000

MaterialCost 25,000 20,000 4,680 550 50,230

Direct La bour 10,000 8,000 1,800

40% Fringe Benefits 4,000 3,200 720 80 8,000

Overheads

Machine Support 7,000 5,600 1,260 140 14,000Prod Run Exp. 7,333 7,333 5,573 1,760 22,000

Set up Exp. 4,259 1,065 4,855 1,022 11,200

Admin Exp 1,200 1,200 1,200 1,200 4,800

TotalOverheads 19,792 15,198 12,888 4,122 52,000

Total Cost 58,792 46,398 20,088 4,952 1,30,230

CPU 1.18 1.16 2.23 4.95Sales 75,000 60,000 13,950 1,650 1,50,600

1.5 1.5 1.55 1.65

Profit 16,208 13,602 -6,138 -3,302 20,370

Profit/unit 0.32 0.34 -0.68 -3.3

Profit Margin 22% 23% -44% -200% 14%


12/16

Using 2ndApproach

* Cost of labor per hour: $10


13/16

Over HeadBreakup

Activity Based CostingTraditionalCosting

Return on Sales BLUE BLACK RED PURPLE TOTAL

Traditional 13.3% 13.3% 14.8% 18.2% 13.5%

ABC 21.6% 22.7% -44.0% -200.1% 13.5%


14/16

Tradeoff between red and purple

Red runs Purple runs Red cost Purple cost

38 12 2.23 4.97

37 15 2.22 4.69

36 18 2.21 4.5

35 21 2.2 4.35

34 24 2.19 4.23

33 27 2.18 4.13

30 36 2.16 3.91

25 49 2.15 3.69

20 64 2.15 3.5

15 78 2.19 3.36

10 92 2.32 3.24

5 106 2.8 3.13

ProductMix Simulation

2

2.5

3

3.5

4

4.5

5

12 15 18 21 24 27 36 49 64 78 92 106

38 37 36 35 34 33 30 25 20 15 10 5

Red cost

Purple cost

If you reduce the production of red pens and use the capacity to produce purple

pens this slide shows the trend of cost of purple pen.

This can be extended to find the optimal product mix.


15/16

Observations and suggestions

Return on Sales ofBlue, Black, Red ,Purplepens are 21.6% ,22.7%,- 44.0% ,- 200.1% respectively

To produce the new product the company hasadded large quantity of overhead such asComputer

System & Support Expenses

T

he overhead to the new product are high underABC method which is positive reflect ofcost determination

Conclusion 1:

As Red & Purple incurring huge amount of loss hence the production should be stopped given

the current demand and plant capacity. Since we do not know the fixed cost we cannot take a

decision based on marginal cost of producing red and purple pen.

Conclusion 2:

If plans to continue all the product line the following pointsshould be explored further

More marketing for Purple pen to increase the customer base

Changing product mix to take advantage of Economy of Scale

Increasing the capacity in terms of no. of lines and Quantity per batch .

Increase the selling price for the Purple and Red


16/16

Group 07Team Members AdbulAhad

Ananth Rao

Ashish Nair

Ankit Rustagi

Anupriya Sen

Dushyant Singh

Hudson Moses

Subrahmanyam Chavali

THANKYOU !!!

classic pen company_group 07_v1

Documents