Classic Pen Company

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THE CLASSIC PEN COMPANY
Activity Based Costing case study

Topics
• About The Classic Pen Company
• Issues
• ABC introduction at TCPC

• Managerial implications
• Recommendations
School of Business and Economics - Opleiding tot Registercontroller (EMFC)

About
• Classic Pen Company is a low cost provider of
traditional BLUE and BLACK pens
• High profit margins (over 20% of sales)
• Cost allocated on basis of traditional cost price
method
• Introduction of new colors (RED and PURPLE could
be sold at 3% premium)
• Expectations: higher profit margins
• Realization: Lower profitability

School of Business and Economics - Opleiding tot Registercontroller (EMFC)

Issues
• By expanding the assortment, with premium
models, higher results on sales were realized, but
overall profitability was declining
• Allocation of 300% overhead via direct labour 
hard to maintain
EXHIBIT 1

Traditional Income Statement

Sales
Material costs
Direct labor
Overhead @ 300%
Total operating income
Return on sales

BLUE
BLACK
RED
PURPLE
TOTAL
$ 75.000 $ 60.000 $ 13.950 $ 1.650 $ 150.600
25.000
20.000
4.680
550
50.230
10.000
8.000
1.800
200
20.000
30.000
24.000
5.400
600
60.000
$ 10.000 $ 8.000 $ 2.070 $
300 $ 20.370
13,3%
13,3%
14,8%
18,2%
13,5%

School of Business and Economics - Opleiding tot Registercontroller (EMFC)

Activity based costing analysis
EXPENSE CATEGORY

Overhead

EXHIBIT 2

Indirect labor
Fringe benefits
Computer systems
Machinery
Maintenance
Energy
Total

EXPENSE
20.000
16.000
10.000
8.000
4.000
2.000
60.000

Direct Costs and Activity Cost Drivers

Production sales
volumes (no. of units)
Unit selling price
Material/unit cost
Direct labor hr/unit
Machine hour/unit
No. of production runs
Setup time/run (hours)
Total setup time (hours)
Number of products

BLUE
BLACK
RED
PURPLE TOTAL
50.000
40.000
9.000
1.000
100.000
$1,50
$0,50
0,02
0,1
50
4
200
1

$1,50
$0,50
0,02
0,1
50
1
50
1

$1,55
$0,52
0,02
0,1
38
6
228
1

$1,65
$0,55
0,02
0,1
12
4
48
1

2.000
10.000
150

School of Business and Economics - Opleiding tot Registercontroller (EMFC)

526
4

Allocations based on ABC

School of Business and Economics - Opleiding tot Registercontroller (EMFC)

Costs per unit

School of Business and Economics - Opleiding tot Registercontroller (EMFC)

Managerial implications

The revised cost clearly shows that black and blue pens have profit margin > 20% of sales. Additionally, both red and purple has negative profit margin. Hence, the recommendation is that Classic Pen Company should keep producing black and blue pen and stop producing red, purple and other specialty colored pens.

To produce a new color, ABC needs to invest in huge overhead in computer systems and machinery (fixed overhead cost). Hence, it is not advisable to produce a new color unless the sales will exceed the breakeven point. School of Business and Economics - Opleiding tot Registercontroller (EMFC)

Recommendation as a result of activity
based costing
BLUE
BLACK

RED

PURPLE

School of Business and Economics - Opleiding tot Registercontroller (EMFC)

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