Classic pen company activity based costing

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Classic pen company activity based costing

  1. 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. 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. 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. 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. 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. 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. 7. Activity Based Costing   Three categories of indirect cost remained:  Machine  Machine maintenance  Energy These costs were incurred for activities Support
  8. 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. 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
  10. 10. Resources and Cost Pooling Resources Cost Pools Indirect labour $20,000 $8,000 (50% Fringe benefit) DL Fringe benefit Computer System Machine Expenses Expenses $8,000 (50% Fringe Benefit) $10,000 $28,000 $8,000 $10,000 $8,000 $4,000 $2,000 $14,000
  11. 11. Activity Cost Drivers Rate Total Activities Activit Activity cost driver y cost ($) 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. 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. 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. 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. 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. 16. Recommendation based on ABC analysis  Increase the sales price of red and purple pens.  Minimize overhead cost

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