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    Abc - Classic Pen

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    Vinay Goyal
    The Classic Pen Company produces blue, black, red, and purple ink pens. While the red and purple pens seem more profitable, the company's overall profitability is falling. The company currently uses a traditional costing system but management wants to understand the true costs. An activity-based costing (ABC) system would better reflect how indirect costs like machine setup, production runs, and administration are consumed by each product. ABC analysis found much higher costs and lower or negative profits for the red and purple pens compared to the traditional system. This is because the new products require more resource-intensive activities like machine setup that were previously not fully allocated in costs. ABC provides management with more accurate product cost information to make better pricing and

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    Abc - Classic Pen

    Uploaded by

    Vinay Goyal
    86 views14 pages
    The Classic Pen Company produces blue, black, red, and purple ink pens. While the red and purple pens seem more profitable, the company's overall profitability is falling. The company currently uses a traditional costing system but management wants to understand the true costs. An activity-based costing (ABC) system would better reflect how indirect costs like machine setup, production runs, and administration are consumed by each product. ABC analysis found much higher costs and lower or negative profits for the red and purple pens compared to the traditional system. This is because the new products require more resource-intensive activities like machine setup that were previously not fully allocated in costs. ABC provides management with more accurate product cost information to make better pricing and

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    The Classic Pen Company produces blue, black, red, and purple ink pens. While the red and purple pens seem more profitable, the company's overall profitability is falling. The company currently uses a traditional costing system but management wants to understand the true costs. An activity-based costing (ABC) system would better reflect how indirect costs like machine setup, production runs, and administration are consumed by each product. ABC analysis found much higher costs and lower or negative profits for the red and purple pens compared to the traditional system. This is because the new products require more resource-intensive activities like machine setup that were previously not fully allocated in costs. ABC provides management with more accurate product cost information to make better pricing and

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    86 views14 pages

    Abc - Classic Pen

    Uploaded by

    Vinay Goyal
    The Classic Pen Company produces blue, black, red, and purple ink pens. While the red and purple pens seem more profitable, the company's overall profitability is falling. The company currently uses a traditional costing system but management wants to understand the true costs. An activity-based costing (ABC) system would better reflect how indirect costs like machine setup, production runs, and administration are consumed by each product. ABC analysis found much higher costs and lower or negative profits for the red and purple pens compared to the traditional system. This is because the new products require more resource-intensive activities like machine setup that were previously not fully allocated in costs. ABC provides management with more accurate product cost information to make better pricing and

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    Activity-Based Cost Systems

    The Classic Pen Company


    The Classic Pen Company – A Case for
    Activity Based Costing

    Introduction:
    • Low-cost producer of traditional Blue and Black ink
    pens
    • Profit margins of over 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.
    Classic Pen Company – Issues facing the
    Management
    ISSUE 1 - Profitability ISSUE 3 – Product Mix
    While Red & Purple pens seem Process for Red and Purple
    to be more profitable, overall pens require more resources
    profitability of the company is (set-up time etc.)
    falling cfgfhhjhbjkCV
    ISSUE 2 - Pricing ISSUE 4 – Internal Processes
    “Tough Global Competition” – A lot of time spent on
    scheduling and purchasing
    “Can the products be priced
    activities
    better?”
    Conventional Cost Sheet
    Blue Black Red Purple Total
    DM 25,000 20,000 4,680 550 50,230
    DL 10,000 8,000 1,800 200 20,000
    OV 30,000 24,000 5,400 600 60,000
    Total Cost 65,000 52,000 11,880 1,350 130,230

    Sales 75,000 60,000 13,950 1,650 150,600

    Profit 10,000 8,000 2,070 300 20,370

    Profit Marging 13% 13% 15% 18% 14%


    Shift in Costing: To ABC

    Expenses Indirect labour/Fringe benefits/computer


    systems/machinery/maintenance/Energy

    Cost Pools Indirect Labour/Computer Expenses/Machine


    Expenses

    Activities Machine Setting/Handling Production Runs/Part


    Administration/Machine Support

    Products
    Classic Pen: Define Activities and
    Activity Drivers
    Activities Drivers

    • Handle Production • Production Runs


    Runs • Setup hours
    • Set up Time • No. of Parts
    • Parts Administration • Machine Hours
    • Machine Support • Direct Labour
    • Direct Labour Fringe
    Understanding Activities: Levels

    • Machine expenses: Unit Level Activity


    • Handle Production Runs: Batch Level
    Activity
    • Set up Expenses: Batch Level Activity
    • Admin. Expenses: Product Level Activity
    • Fringe Expenses: Facility Level
    Forming Cost Pools: Under ABC

    Indirect Labour 28,000 20000 + 8000 (40% 0f direct labor)


    Computer Expenses 10,000
    Machine Expense 14,000 (8000+4000+2000)

    These expenses to be apportioned over the activities


    mentioned in the previous slides using the
    appropriate drivers.
    Cost Allocation: Under ABC
    Indirect labour Computer Exp. Machine Exp Total Activity Rate
    Handle Production Runs 50% 14,000 80% 8,000 22,000 150 146.7
    Set up Time 40% 11,200 11,200 526 21.29
    Parts Administration 10% 2,800 20% 2,000 4,800 4 1200
    Machine Support 100% 14000 14,000 10000 1.4

    Total 28,000 10,000 14000 52,000


    How can the Classic Pen Company discover
    what its true costs are?
    OLD WAY
    (What is spent?) Activity Based Costing

    Traditional accounting
    INDIRECT LABOUR $ 20,000

    FRINGE BENEFITS $ 8,000 SCHEDULE PRODUCTION RUNS $ 22,000

    COMPUTER SYSTEMS $ 10,000 SET UP $ 11,200

    DEPRECIATION $ 8,000 ADMINISTRATION


    NEW WAY $ 4, 800
    MAINTENANCE $ 4,000 (How is it
    MACHINE SUPPORT
    ENERGY
    spent?) $ 14,000
    $ 2,000
    TOTAL $ 52,000 TOTAL $ 52,000

    Step 1 – Map resource Costs


    to Activities
    ABC Cost Sheet
    Blue Black Red Purple Total
    50,000 40,000 9,000 1,000 100,000
    DM 25,000 20,000 4,680 550 50,230
    DL 10,000 8,000 1,800 200 20,000
    40% Fringe Benefits 4,000 3,200 720 80 8,000
    Overheads
    Machine Support 7,000 5,600 1,260 140 14,000
    Prod Run Exp. 7,333 7,333 5,573 1,760 22,000
    Set up Exp. 4,259 1,065 4,855 1,022 11,200
    Admin Exp 1,200 1,200 1,200 1,200 4,800
    TotalOverheads 19,792 15,198 12,888 4,122 52,000

    Total Cost 58,792 46,398 20,088 4,952 130,230


    CPU 1.18 1.16 2.23 4.95
    Sales 75,000 60,000 13,950 1,650 150,600
    1.50 1.50 1.55 1.65
    Profit 16,208 13,602 -6,138 -3,302 20,370
    Profit/unit 0.32 0.34 -0.68 -3.30
    Profit Margin 22% 23% -44% -200% 14%
    OVERHEADS

    Overhead Breakup - Traditional Costing Overhead Breakup - Activity Based Costing


    Purple
    Red Purple 7%
    9% 1% Red Blue
    23% 39%

    Black
    Blue Black
    40%
    50% 31%
    Traditional vs. ABC

    Return on Sales BLUE BLACK RED PURPLE TOTAL


    (ABC) 21.6% 22.7% -44.0% -200.1% 13.5%
    (Traditional) 13.3% 13.3% 14.8% 18.2% 13.5%
    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

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