1. 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
2. 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%
premium
Recently Purple pens were introduced at 10% premium.
3. 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
time
A lot of time spent on scheduling and purchasing
activities
4. Costing system of Classic
Pen
All indirect costs were aggregated at plant level and
allocated 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
overhead rate was only 200% of direct labor cost
5. Traditional Costing
Method
Traditional Income statement
Blue
Black Red
Sales
Material costs
Direct labour
Overhead @300%
Total operating cost
Total operating income
$75,00
0
$25,00
0
$10,00
0
$30,00
0
$65,00
0
$10,00
0
Purple Total
$60,00
0
$20,00
0
$8,000
$13,95
0
$4,680
$1,650 $150,600
$550
$50,230
$1,800
$200
$20,000
$24,00
0
$52,00
0
$8,000
$5,400
$600
$60,000
$11,880 $1,350 $130,230
$2,070
$300
$20,370
6. Activity Based Costing
Indirect labor
50% of the indirect labor costs are caused by
Production run
40% of the indirect labor cost were caused by the
physical change from one color to another called
setup costs
10% of the time was used to an activity Parts
Administration (Book keeping)
Computer Expenses
20% allocated to support activities (Parts admin.)
80% of computer resources were used to produce
batches and are closely related to handling of
production batches
7. Activity Based Costing
Three categories of indirect cost remained:
Machine
Machine maintenance
Energy
These costs were incurred for activities Support
8. Activities and Cost
Drivers
• Indirect labour; Fringe Benefits; Computer Systems; Machinery;
Expens
Maintenance; Energy
es
Cost
Pool
• Indirect labour; Fringe Benefits for DL; Computer System
Expenses; Machine Expenses
• Machine set up; Production run; Parts Administration (Record
Activitie
keeping); Machine Support; Direct Labour Fringe
s
Product • Black; Blue; Red; Purple
s
9. Assigning Resources to
Activities
Indirect Labour
50%
Computer System
Expenses
40%
10%
Machine Expense
s (Machinery, Mai
ntenance and En
ergy
Fringe Benefits fo
r DL
20%
80%
Production Ru
n
Setup
Parts Administ
ration
Support
DL Fringe
11. Activity Cost Drivers Rate Total
Activities
Activit Activity cost driver
y cost
($)
Cost driver
quantity
Activity
Cost
driver rate
($)
Production Run
22,000 Production runs
150
146.67
Set up
11,200 Total setup time
526
21.29
4
1200
Parts Administration 4,800
Parts Administration
Support
14,000 Machine hours
10000
1.4
Direct labour fringe
8,000
2000
4
Direct labour hours
12. Activity Cost Per Unit
Activity cost per unit
Blue
Black
Red
Purple
Total
Production run
$7333.33
$7333.33
$5573.33
$1760
$22,000
Set up
$4258.55
$1064.63
$4,854.70 $1,022.05 $11,200
Parts Administration
$1,200
$1,200
$1,200
$1,200
$4,800
Support
$7,000
$5,600
$1,260
$140
$14,000
Direct labour fringe
$4,000
$3,200
$720
$80
$8,000
13. ABC Income statement
Sales
ABC Income statement
Blue
Black
Red
$75,000 $60,000
$13,950
Purple
$1,650
Total
$150,600
Material costs
$25,000 $20,000
$4,680
$550
$50,230
Direct labour
$10,000 $8,000
$8,000
$200
$20,000
Overhead
Production run
Set up
$7333
$4259
$7333
$5573
$1760
$22,000
$1064.63 $4,854.70 $1,022.05 $11,200
Parts Administration
Support
Direct labour fringe
Total operating cost
$1,200
$7,000
$4,000
$58,792
$1,200
$5,600
$3,200
$46,398
$1,200
$1,260
$720
$20,088
$1,200
$140
$80
$4,952
$4,800
$14,000
$8,000
$130,230
Total operating income
$16,208 $13,602
-$6,138
-$3,302
$20,370
Return on sales
21.6%
22.6%
-44%
-200%
13.5%
14. ABC Cost per unit vs Selling Price per
unit
ABC
cost/unit
Selling
price/unit
Blue
$1.17
Black
$1.15
Red
$2.23
Purple
$4.95
$1.50
$1.50
$1.55
$1.65
15. 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
16. Recommendation based on ABC
analysis
Increase the sales price of red and purple pens.
Minimize overhead cost
