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    Classic Pen

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    Ankur Mittal
    Classic Pen Company is seeing declining profits despite introducing new red and purple pen products at a premium. [1] Their traditional costing system allocates overhead as a percentage of direct labor, hiding differences in resource usage between products. [2] Implementing an activity-based costing (ABC) system would identify key activities, cost drivers, and allocate overhead more accurately. [3] ABC shows red and purple pens are less profitable than indicated previously, highlighting the need to reconsider product mix or pricing.

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    Classic Pen

    Uploaded by

    Ankur Mittal
    236 views15 pages
    Classic Pen Company is seeing declining profits despite introducing new red and purple pen products at a premium. [1] Their traditional costing system allocates overhead as a percentage of direct labor, hiding differences in resource usage between products. [2] Implementing an activity-based costing (ABC) system would identify key activities, cost drivers, and allocate overhead more accurately. [3] ABC shows red and purple pens are less profitable than indicated previously, highlighting the need to reconsider product mix or pricing.

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    Classic pen

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    Classic Pen Company is seeing declining profits despite introducing new red and purple pen products at a premium. [1] Their traditional costing system allocates overhead as a percentage of direct labor, hiding differences in resource usage between products. [2] Implementing an activity-based costing (ABC) system would identify key activities, cost drivers, and allocate overhead more accurately. [3] ABC shows red and purple pens are less profitable than indicated previously, highlighting the need to reconsider product mix or pricing.

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    236 views15 pages

    Classic Pen

    Uploaded by

    Ankur Mittal
    Classic Pen Company is seeing declining profits despite introducing new red and purple pen products at a premium. [1] Their traditional costing system allocates overhead as a percentage of direct labor, hiding differences in resource usage between products. [2] Implementing an activity-based costing (ABC) system would identify key activities, cost drivers, and allocate overhead more accurately. [3] ABC shows red and purple pens are less profitable than indicated previously, highlighting the need to reconsider product mix or pricing.

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    of 15

    Activity-based cost systems

    Case:

    The classic pen company


    Classic pen company
    Facts:
    Low-cost producer of traditional BLUE and
    BLACK pens
    Profit margin: over 20% of sales
    Declining trend in operating results
    Opportunity for adding new products:
    1. Red pen introduced five years before with same
    technology at 3% premium
    2. Purple pen introduced with 10% premium last
    year
    Issues before management
    Premium products (Red & Purple) more
    profitable, but overall profitability is down
    Even new products margin declining in face of
    competition
    Introduction of new pens requires: more
    activities (more resources?)
    More set-up time (max. for red pen)
    More purchasing and scheduling time
    Present cost system
    Features:
    Single overhead absorption rate
    Direct labour cost is the base
    Rate is 300% of DLC
    Previously it was 200% (indicates increase
    in indirect expenses)
    Traditional cost sheet
    Blue Black Red Purple Total

    DM 25000 20000 4680 550 50230

    DL 10000 8000 1800 200 20000

    OH (300% 30000 24000 5400 600 60000


    of DL)

    Total cost 65000 52000 11880 1350 130230

    Sales 75000 60000 13950 1650 150600

    Operating 10000 8000 2070 300 20370


    income

    Margin 13.3 13.3 14.8 18.2 13.5


    (%)
    ABC
    Overhead is not a burden to be allocated on top of
    direct labour
    Identify activities of indirect and support resource
    of the entity
    Relate the cost of these activities to the products
    for which they are performed
    Condition:
    large overhead (46% of TC) and multiple products
    may be ABC would help
    ABC Analysis
    Expenses identified: Rs.
    Indirect labour 20,000
    Fringe benefits 16,000
    Computer Systems 10,000
    Machinery 8,000
    Maintenance 4,000
    Energy 2,000
    Total 60,000
    Forming cost pools
    Indirect labour Rs. 20,000 + 40% of fringe
    benefit, i.e., Rs.8,000 =
    Rs.28,000

    Computer expenses Rs.10,000

    Machine expenses Rs.8,000+Rs.4,000+Rs.2,000


    =Rs.14,000
    Activities identified
    Scheduling or handling production runs
    Production set up
    Record keeping
    Machine support
    Relating activities to activity drivers
    Activities Activity drivers
    Handling production runs Production runs (150
    nos.)
    Production set up Setup time (526 hours)

    Record keeping No. of products (4)

    Machine support Machine hours


    (10,000hr)
    Allocation of cost to activities
    Indirect % share Comp. % share Machine % share Total
    labour expenses expenses

    Handling 14,000 50% 8,000 80% 22,000


    Productio
    n run
    Prod. set 11,200 40% 11,200
    up

    Record 2,800 10% 2,000 20% 4,800


    keeping

    Machine 14,000 100% 14,000


    support
    Total 28,000 10,000 14,000 52,000
    New cost system-ABC
    Blue Black Red Purple Total
    DM+DL 35,000 28,000 6,480 750 70,230
    Fringe benefit 4,000 3,200 720 80 8,000
    Overheads
    Handling prod. Run 7,333 7,333 5,573 1,760 22,000
    Prod. Set up 4,259 1,065 4,855 1,022 11,200
    Record keeping 1,200 1,200 1,200 1,200 4,800
    Machine support 7,000 5,600 1,260 140 14,000
    Total overhead 19,792 15,198 12,888 4,122 52,000
    Total cost 58,792 46,398 20,088 4,952 130,230
    Sales 75,000 60,000 13,950 1,650 150,600
    Profit 16,208 13,602 -6,138 -3,302 20,370
    Profit margin(%) 21.6 22.7 -44 -200.1 13.5
    Comparison of OH share
    Traditional cost system ABC system

    Blue - 30,000 Blue - 19,792


    Black -24,000 Black 15,198
    Red - 5,400 Red -12,888
    Purple - 600 Purple 4,122
    Comparison of Margin
    Traditional cost system ABC system

    Blue - 13.3% Blue - 21.6%


    Black 13.3% Black 22.7%
    Red - 14.8% Red - (-44%)
    Purple - 18.2% Purple (-200.1%)
    Conclusion
    Addition of new products has resulted in
    increase of overheads
    New product mix means disproportionate
    demand on resources of the organisation
    due to unequal activity content that goes
    into different products
    ABC can result in more accurate costing in
    such cases

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