Classic Pen Company is analyzing its cost accounting system using activity-based costing to better understand profitability. Previously, all overhead costs were allocated based on direct labor, but ABC analysis identified drivers like setup time and production runs. This showed that red and purple pens have higher costs than indicated previously due to more setups. ABC cost per unit for red and purple exceeds their selling price, suggesting price increases are needed to improve profitability for those products.

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

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. 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