MANAGEMENT ACCOUNTING

CLASSIC PEN COMPANY

CASE STUDY
INTRODUCTION
CLASSIC PEN COMPANY
CASE STUDY
CASE BACKGROUND
 Classic Pen was a low-cost producer of Blue and Black pens
 Profit margins were over 20% of sales
02years earlier Red pens were introduced at 3% premium
 Five
 Recently Purple pens were introduced at 10% premium.

03
All pens are same technology and production facility
 Overhead
04 burden rate increased from 200% to 300% with
introduction of
05
Issues faced by the 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
· Purple color are showing higher margins, so should we introduce more
colors.
Traditional costing income statement
Activity Blue Black Red Purple Total

Sales 75,000.00 60,000.00 13,950.00 1,650.00 150,600.00

Material Costs 25,000.00 20,000.00 4,680.00 550.00 50,230.00

Direct Labor 10,000.00 8,000.00 1,800.00 200.00 20,000.00

Overhead @300% 30000 24,000.00 5,400.00 600.00 60,000.00

Total Op. Income $10000 8,000.00 2,070.00 300.00 20,370.00

Return on Sales 13.6% 13% 14.8% 18.2% 14%

 Traditional costing system
· 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
· Traditional Costing charged the overheads on the labor hours only.
· The inaccurate absorption of overheads cost result in increase in the product
cost and reduce the profits.
· Production expansion under traditional method would not be a wise decision.
 Conclusion
· It is strongly recommended that Classic Pen Company should implement the ABC
to accurately charge the overhead cost to the products.
· It make an accurate and better decisions to expend the product line or shutdown
those who are making loss consistently or even below the breakeven point
 Activity base costing method
Activity-based costing (ABC) is a costing technique that identified activities and
allocates the cost of every action to all products and services based on the actual
activities performed by each
Identification
Calculate the
Identification of cost driver Allocate the
predetermine
of major for each resources
d overhead
activities and single activity (indirect
absorption
estimate their and estimate costs) to the
rate for each
indirect costs. the number of product.
activity.
driver’s.
 ABC Income statement
Income Statement - ABC
  Blue Black Red Purple Total

Production sales volume 50,000.00 40,000.00 9,000.00 1,000.00 100,000.00

Sales 75,000.00 60,000.00 13,950.00 1,650.00 150,600.00

Direct Material 25,000.00 20,000.00 4,680.00 550.00 50,230.00

Direct Labor 10,000.00 8,000.00 1,800.00 200.00 20,000.00

Overheads:

40% fringe benefits 4,000.00 3,200.00 720.00 80.00 8,000.00

Production Run 7,333.00 7,333.00 5,573.00 1,760.00 22,000.00

Setup Time 4,259.00 1,065.00 4,855.00 1,022.00 11,200.00

Administration 1,200.00 1,200.00 1,200.00 1,200.00 4,800.00

Machine 7,000.00 5,600.00 1,260.00 140.00 14,000.00

Total Cost 58,792.00 46,398.00 20,088.00 4,952.00 130,230.00

Profit 16,208.00 13,602.00 (6,138.00) (3,302.00) 20,370.00

 Activity cost pool
Indirect Computer Machine Fringe
Cost Pool Total
Labor Expenses Expenses Benefits

Handle Production Run 14,000.00 8,000.00 - - 22,000

Set Up Time 11,200.00 - - - 11,200

Parts Administration 2,800.00 2,000.00 - - 4,800

Machine Supply - - 14,000.00 - 14,000

Fringe Benefits - - - 8,000.00 8,000
Total 28,000.00 10,000.00 14,000.00 8,000.00 60,000
 Activity cost drivers
Cost Driver

Activities Activity Cost Cost Driver No. of Drivers Cost Per Driver

Production Runs 22,000.00 Production Runs 150.00 146.67

Setup Cost 11,200.00 Setup Time 526.00 21.29
Parts Administration 4,800.00 Parts Administration 4.00 1,200.00
Machine Support 14,000.00 Machine Hour 10,000.00 1.40
Direct Labor Fringe 8,000.00 Direct Labor Hour 2,000.00 4.00
ABC vs traditional costing system
ABC vs Traditional Costing System
  Blue Black Red Purple

Selling Price 1.50 1.50 1.55 1.65

Traditional (cost/unit) 1.30 1.30 1.32 1.35

Profit Margin 0.13 0.13 0.15 0.18

ABC (cost/ unit) 1.18 1.16 2.23 4.95

Profit Margin 0.22 0.23 (0.44) (2.00)

 ABC vs Traditional Method
Traditional costing
Due to the dynamic market, traditional
costing methods are obsolete and does not
give a clear picture of the cost.
traditional methods of costing does not aid
to make better decisions and unable to
maintain the product profitability
Activity base costing
ABC system is advance-costing method,
which based on the analysis of specific
costs related to every activity performed
the company has a more precise view of the
impact of each activity on the operational
costs of the business, and make more profit.
 ABC Recommendation
 Increase the sales price of red and purple pens.
 Minimize overhead cost by identifying the different activities
 Reduce the time consuming process
 Introduce the automation in the operation process
 Reduce the production runs or increase the size of batches for manufacturing
of RED and PURPLE pen that make these a profitable product line.
 Expansion of the future products line would be more lucrative using ABC
 Better allocation of resources help to manage the microeconomics factors of
the firm
Thank you