Case Summary • Classic pen is a producer of BLACK and BLUE ink pen• Previously, profit margin were over 20% of sales• Five year earlier, Classic pen introduced the Red ink pen at 3%

premium• Last year, PURPLE pen had been introduced at 10% premium

Issue faced by company management• Profitability

• Even though company introduced the new product with high return, the overall profit still falling

• Processing time• a lot of time to be used in scheduling and purchasing activities• The production of new products need longer time to produce and process

• Product mix • Required more resources for process the new product

• Operation• The overhead rate increased from 200% to 300 % after the new product launched

Cost Structure Expenses Indirect labor, fringe benefits, computer system, machinery,

maintenance and energy Cost Pool Indirect labor, fringe benefits for direct labor, computer system

expenses, and machinery expenses Activities Machines Setting, handling production activities, Part

Administrative, machine support, sales order handling, key account management

Product Black, Blue, Red, and Purple

Analysis Cost Pool Structure• Direct labor

• Fringe Benefits were 50% of labor expenses

• Indirect Labor• 50% of indirect labor involved in scheduling and handling production • 40% of indirect labor were due to the physical changeover from one color to another• 10% of indirect labor was used to maintaining records activities

• Computer expenses • 80% was involved in the production run activity• 20% was used to keep record on the four products

• Machinery expenses • Machinery, maintenance, energy used to support the daily activity

Resource (Indirect Cost ) Resources (Direct Cost Category Expenses ($) Expenses ($)Indirect Labor 20,000 Material Cost 50,230Fringe Benefits 16,000 Direct Labour 20,000Computer System 10,000Machinery 8,000Maintenance 4,000Energy 2,000Total 60000

Indirect labor $ 20000

Computer system expenses

$ 10000

Machinery $14000

Fringe Benefit$16000

Indirect labor+fringe benefit (IDL)

$28000

Computer SystemExpenses$10000

Machinery $14000

Fringe Benefit (DL)

$8000

Activity setup

Expenses

Part administrative

Machine Support DL (Fringe Benefit)Production run

50%

40%10% 80%

20%

Indirect labor =$14000 Computer expenses=$8000 = $ 22000

Indirect labor = $11200 Indirect labor = $2800Computer Expenses= $2000 = $ 4800

Machinery = $14000 Fringe Benefit = $8000

Cost Pool

Calculation for cost per unit (ABC model)

Calculation for cost per unit (ABC model)

Calculation for cost per unit (ABC model) cont.

Compare Traditional VS ABC modelTranditional Method calculating manufacturing overhead per unit

Blue Black Red PurpleDirect material 0.50 0.50 0.52 0.55 Direct labour 0.02 0.02 0.02 0.02 Manufacturing overhead 0.60 0.60 0.60 0.60Total cost per unit 1.12 1.12 1.14 1.17Budgeted manufacturing overhead 60,000.00

Compare Traditional VS ABC model cont.

ABC model calculating Manufacturing Overhead per unit

Blue Black Red PurpleDirect material 0.50 0.50 0.52 0.55 Direct labour 0.02 0.02 0.02 0.02 Total direct cost per unit 0.52 0.52 0.54 0.57

Manufacturing overhead (ABC)Production run 0.15 0.18 0.62 1.76Setup 0.09 0.03 0.54 1.02Record 0.02 0.03 0.13 1.20Machine 0.14 0.14 0.14 0.14Direct labour 0.08 0.08 0.08 0.08Total ABC overhead cost per unit 0.48 0.46 1.51 4.20

Total product cos per unit 1.00 0.98 2.05 4.77

Compare Traditional VS ABC model cont.

Compare Traditional VS ABC model cont.ABC model Income Statement

Blue Black Red Purple TotalSales 75000 60000 13950 1650 150600LessMaterial Cost 25000 20000 4680 550 50230Direct labour 10,000 8000 1800 20 19820Manufacturing Overhead Production run 7333.3333 7333.3333 5573.3333 1760.000 22000Setup 4541.23 4541.23 3451.34 1089.90 13623.7Record 1200.00 1200.00 1200.00 1200.00 4800Machine 7000.00 5600.00 1,260.00 140.00 14000Direct labour fringe 4000 3200 720.00 80.00 8000Total Operating cost 59074.568 49874.568 18684.672 4839.896 132473.7

Total Operating income 15925.432 10125.432 -4734.672 -3189.9 18126.3

Return on sales 0.21 0.17 (0.34) (1.93) 0.12

ABC Model per unit VS Traditional Cost per unit

Total ABC product cost per unit 1.00 0.98 2.05 4.77Total cost per unit (Tranditional) 1.12 1.12 1.14 1.17

Recommendation based on ABC model• Increase the sale price of RED and PURPLE pens• Reduced Overhead cost • Outsource the RED and PURPLE pen production to other company • Company should add a new production line for these two product to

reduce physical changeover of color in the machinery