Case classic pen company with extension
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Case classic pen company with extension Case classic pen company with extension Presentation Transcript

  • Activity Based Costing Case Based on Classic Pen Company* with extensions Classic Pen Company: Developing an ABC Model, Harvard Business School, September 17, 1998 Walnut+ Herluf Trolles Vej 243 DK-5220 Odense Denmark (+45) 70 23 05 80Walnut+ info@walnutplus.com 1
  • Case background• Classic Pen was a low-cost producer of traditional Blue and Black ink pens• Classic Pen had a profit margin of at least 20% of sales• 5 years earlier- introduced Red Pens using same technology at 3% premium• Recently, introduced Purple Pens using same technology at 10% premium. Walnut+
  • Case backgroundIssues facing the Management• Issue 1 - Profitability – While Red and Purple pens seem to be more profitable, overall profitability of the company is falling• Issue 2 - Pricing – “Tough Global Competition” – – “Can the products be priced better?”• Issue 3 – Product Mix – Process for Red and Purple pens require more resources (set-up time etc.)• Issue 4 – Internal Processes – A lot of time spent on scheduling and purchasing activities Walnut+
  • Case backgroundThe costing system of Classic Pen was simple• All indirect costs were aggregated at factory level and allocated to products based upon the direct labor cost• At this time the overhead rate was 300% of direct labor cost• Before new types of pens were introduced the overhead rate was only 200% of direct labor cost• Sales cost is allocated in proportion with sales Walnut+
  • Case backgroundProduct costing calculated with traditional full costing method 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 Markup @ 300% of Direct Labor 30.000 24.000 5.400 600 60.000 Sales cost 4.980 3.984 926 110 10.000 Total Cost 69.980 55.984 12.806 1.460 140.230 Total Operating income 5.020 4.016 1.144 190 10.370 Return on sales 6,69% 6,69% 8,20% 11,54% 6,89% Walnut+
  • Activity Based Costing• Before: – Production primarily manual – Total indirect cost were less that the direct labor cost – Classic Pen’s two products were identical with respect to volume and batch size• Direct labor cost and indirect cost has decreased due to automation• As low volume products were introduced the result was increased demand for: – Increased planning – More setups of machines – More quality control – Computers to keep track of jobs and product specifications Walnut+
  • Activity Based Costing• Same physical output, same cost of material• The firm has approximately – Property taxes, security cost and heating cost which are unchanged – Much higher indirect and support costs due to the larger and more diversified product mix and more complex production• One unit of the high volume standard product (blue or black) uses approximately the same amount of direct labor as one unit of red or purple• The traditional costing system would fundamentally report identical costs for the standard and special products, independent of production volume• The use of indirect and support activities by the special products are higher that the use by the standard products Walnut+
  • Activity Based CostingABC at Classic Pen - Analysis of the cost structure:• Indirect labor – 50% of the indirect labor costs are caused by what the controller called handling of production batches – 40% of the indirect labor cost were caused by the physical change from one color to another and were called setup costs – 10% of the time was used to an activity which the controller labeled support activities (Parts admin.)• Computer Expenses – 20% allocated to support activities (Parts admin.) • This is an activity which is already found in the catalogue of activities as it was used to account for the 4 products – 80% of computer resources were used to produce batches and are closely related to handling of production batches Walnut+
  • Activity Based CostingABC at Classic Pen - Analysis of the cost structure:• Three categories of indirect cost remained: – Machine depreciation – Machine maintenance – Energy for running the machines• These costs were incurred to maintain the production capacity for the production of pens.• The Controller calls the production activities Running the machines Walnut+
  • Activity Based Costing Indirect labor/Fringe benefits/computer Expenses systems/machinery/maintenance/Energy Indirect Labor/Fringe benefits for DL/Computer Cost Pools Expenses/Machine Expenses Machine Setting/Handling Production Activities Batches/Part Administration/Machine Support/Sales Order handling/Key Account Management Products Walnut+
  • Activity Based CostingDefine Activities and Activity Drivers Activities Drivers • Handle Production Batches • Production Batches • Set up Time • Setup Hours • Parts Administration • No. of Parts • Machine Support • Machine Hours • Direct Labor Fringe • Direct Labor • Sales Order handling • Sales Orders • Key Account Management • KAM Hours Walnut+
  • Activity Based CostingUnderstanding Activities: Levels Machine expenses: Unit Level Activity Handle Production Runs: Batch Level Activity Set up Expenses: Batch Level Activity Parts admin. Expenses: Product Level Activity Fringe Expenses: Facility Level Sales Order handling: Customer level Key Account Management: Customer level Walnut+
  • Activity Based CostingResources and resource cost pools Resources (Indirect cost) Resources (direct cost) Expense Expense Indirect labor 30.000 Material costs 50.230 Fringe benefits 16.000 Direct Labor 20.000 Computer systems 10.000 Total 70.230 Machinery 8.000 Maintenance 4.000 Energy 2.000 Total 70.000 Total cost 140.230 Resources Cost Pools Fringe Indirect benefits for Computer Machine Sales Labor DL Expenses Expenses support Total 20.000 10.000 30.000 8.000 8.000 16.000 10.000 10.000 8.000 8.000 4.000 4.000 2.000 2.000 28.000 8.000 10.000 14.000 10.000 70.000 Walnut+
  • Activity Based Costing Resources to activities Machine Computer Fringe benefitsIndirect labor Expenses for DL Sales support Expenses 50% 40% 10% 50% 50% 80% 20% Machine Direct Labor Sales Order Key AccountHandling Setup Parts Admin. Support Fringe handling Management Walnut+
  • Activity Based CostingData and Cost Drivers Direct costs and cost drivers Blue Black Red Purple Total Production quantities 50.000 40.000 9.000 1.000 100.000 Sales price per unit 1,50 1,50 1,55 1,65 Cost of material per unit 0,50 0,50 0,52 0,55 Direct Labor Hours per unit 0,02 0,02 0,02 0,02 2.000 Machine Hours per unit 0,1 0,1 0,1 0,1 10.000 Number of Production batches 50 50 38 12 150 Setup Hours per batch 4 1 6 4 Total setup time (Hours) 200 50 228 48 526 Number of products 1 1 1 1 4 Sales quantities and Cost Drivers for customers Department Department Department Book Store Book Store Store A Store B Store C 1 2 Total Sales quantities Blue 30.000 9.000 9.000 1.000 1.000 50.000 Sales quantities Black 25.000 10.000 4.900 92 8 40.000 Sales quantities Red 7.000 700 900 300 100 9.000 Sales quantities Purple 300 200 200 100 200 1.000 Sales quantities total 62.300 19.900 15.000 1.492 1.308 100.000 Sales 93.845 29.915 22.575 2.268 1.997 150.600 Sales orders 36 12 12 6 50 116 KAM Hours 600 200 200 50 200 1.250 Walnut+
  • ResultsActivity cost Activit Activity Cost Cost driver Cost Driver Activities cost Driver quantity rate Per Handle Production Batches 22.000 Production Batches 150 146,67 Batch Set up Time 11.200 Setup Hours 526 21,29 Hour Parts Administration 4.800 No. of Parts 4 1.200,00 Product Machine Support 14.000 Machine Hours 10.000 1,40 Hour Direct Labor Fringe 8.000 Direct Labor cost 20.000 0,40 DLcost Sales Order handling 5.000 Sales Orders 116 43,10 Order Key Account Management 5.000 KAM Hours 1.250 4,00 Hour Total 70.000 Walnut+
  • ResultsActivity cost per cost object Activities Blue Black Red Purple Total Handle Production Batches 7.333,33 7.333,33 5.573,33 1.760,00 22.000,00 Set up Time 4.258,56 1.064,64 4.854,75 1.022,05 11.200,00 Parts Administration 1.200,00 1.200,00 1.200,00 1.200,00 4.800,00 Machine Support 7.000,00 5.600,00 1.260,00 140,00 14.000,00 Direct Labor Fringe 4.000,00 3.200,00 720,00 80,00 8.000,00 23.791,89 18.397,97 13.608,09 4.202,05 60.000,00 Department Department Department Book Store Book Store Activities Store A Store B Store C 1 2 Total Sales Order handling 1.551,72 517,24 517,24 258,62 2.155,17 5.000,00 Key Account Management 2.400,00 800,00 800,00 200,00 800,00 5.000,00 3.951,72 1.317,24 1.317,24 458,62 2.955,17 10.000,00 Walnut+
  • ResultsIncome Statement Activity Based Costing 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 Handle Production Batches 7.333 7.333 5.573 1.760 22.000 Set up Time 4.259 1.065 4.855 1.022 11.200 Parts Administration 1.200 1.200 1.200 1.200 4.800 Machine Support 7.000 5.600 1.260 140 14.000 Direct Labor Fringe 4.000 3.200 720 80 8.000 Total Production Cost 58.792 46.398 20.088 4.952 130.230 Total Operating income 16.208 13.602 -6.138 -3.302 20.370 Return on sales 21,61% 22,67% -44,00% -200,12% 13,53% Sales Cost 10.000 Net income 10.370 Return on sales 6,89% Walnut+
  • Results Income StatementCustomer income Department Department Department Store A Store B Store C Book Store 1 Book Store 2 TotalSales 93.845 29.915 22.575 2.268 1.997 150.600Cost goods sold 81.384 24.735 19.266 2.447 2.399 130.230Sales Order handling 1.552 517 517 259 2.155 5.000Key Account Management 2.400 800 800 200 800 5.000Customer income 8.510 3.863 1.992 -638 -3.357 10.370Return on sales 9,07% 12,91% 8,83% -28,13% -168,10% 6,89% Walnut+
  • Observations• To produce the new products the company has added large quantity of overheads: Computer systems and support expenses• So the overheads to the new products are high under ABC. Which, is the correct reflection of the cost determination• Customer income shows profitable customers and non-profitable cusotmers Walnut+