Classic Pen Company

INTRODUCTION

The Classic Pen Company; originally producing Black and Blue Pens, decided to enlarge it’s product portfolio by introducing new products in the market. The sales prices are determined as %3 more for Red nd 10% more for Purple with an expecance of higher margins.

With the coming products production started to cry out on the difficulties of producing the new red and purples stating that they need extra workload for production, planning and keeping track of the information.

On the financial data it was clearly seen that the overhead cost increased drammatically compared to previous years from 200% to 300% (when only blu and black was produced) and the profit margin is eroded from 20% to 13,5%.

Since the beginning the cost structure was determinded by allocation of overhead cost according to the sales. And the data pushed management question the cost structure.

COMPANY DATA

Company is producing the following unit of products with correcponding Sales Revenues.

Currently Overhead Cost structure is allocated on the basis of sales revenues. Where Overhead of Blacks is around 50% with a value of $30,000, Blue 40% with a value of $24,000, Red 9% with a value of $5,400 and Purple 1% with a value of $600.

Based on the above data the Return on Sales is caculated as follows;

When the management decided to reallocate the costs according to ABC Costing; they found out the following data;

1) The costs are Material Cost, Direct labour and Overhead Costs.

2) Material and direct labour are variable costs which are directly proportional to the production units therefore can be kept as is.

3) The Overhead cost on the otherhand is Fixed Cost which consists of 6 different categories such as; Indirect labour, Fringe Benefits, Computer Systems, Machinery, Maintenance and Energy. Yet; these items should actually be allocated accoring to their weighted input of their cost drivers on the item to be produced.

A basic total overhead cost structure is as follows;

When examined carefully the following data is achieved;

Indirect Labour: 50% of indirect labour is distributed by # of production runs. 40% is distributed by setup time. 10% is distributed by production volume.

Fringe Benefits: Equals to 40% of direct labour+indirect labour

Computer Systems: 80% of computer systems is distributed by # of production runs. 20% is distributed by # of production volume.

Machinery: Distributed by machine hours.

Maintenance: Distributed by machine hours.

Energy: Distributed by machne hours.

When we spread the costs on each item based on the information above; we get the following cost allocation compared