Assignment # 2

Classic Pen Company: Developing an ABC Model

Submitted by:Abdullah Inayatullah12123025Ahsan Iqbal12123019

MBA3.5 Years (Finance)

Submitted to:Sir Naveed Mughal

Introduction:The classic pen company shift its product mix from high volume standard products to include low volume speciality products. Its overhead cost will rise to accommodate the more complex demands being made on the factory but a conventional cost system will allocate much of the increased overhead costs to the high volume standard products.AnalysisRun machine is a unit related activity. The quantity of the activity was proportional to the total number of pens produced. Production runs and setup machines are batch related. The quantity demand is proportional to the number of batches runs. The demand for the activity expands with the number of different products produced in the factory but is independent of the production volumes. The Fringe benefits activity is best viewed as a support activity for the four new activities plus direct labour. Its expense can be spread back to these five activities as a percentage mark-up over direct and indirect labour expense within each activity.Classis Direct Labour FringeOutputsPurple PensRed PensBlack PensBlue PensDirect Labour $Machine HoursNumber of PartsSet Up HoursProduction RunsDriversMachine SupportParts AdminSet Up TimeHandle Prod, RunsActivatesPen Company Model:

Activity Based Product Profitability:The activity based cost and profitability of the four products shown below. The profitability of Classic Pen was decreasing in recent years.The two speciality products which the previous cost system had reported as the most profitable are in fact highly unprofitable.To produce these new products the company has added large quantity of overhead resources, a large computer system and many more indirect and support employee to enable these products to be designed and produced. The high expense of these additional resources has not been compensated by the revenue from the sale of Red and Purple pens.The activity based analysis shows that contrary to the perspective of the traditional system. The blue and Black pens are the only profitable products made by Classic Pen. These products retain 20% profit margin that the company had enjoyed before the new speciality products had been introduced.Activites:Handle Production runsSet Up MachineAdmin PartsRun MachineTotal Expense

Indirect labour & 1/2 fringe50%40%10%$28000

Computer expense80%20%10000

Machine depreciation100%8000

Maintenance100%4000

Energy100%2000

Activity expense$22000$11200$4800$14000$52000

Cost driver activity150526410000%

units of measurementsProduction runssetup hoursNo of partsMachine hours

Activity cost driver rate$147$21$1200$1.40

ABC Income Statement:BlueBlackRed PurpleTotal

Sales7500060000139501650150600

Material cost2500020000468055050230

Direct labour100008000180020020000

40% fringe of D.L40003200720808000

Machine time expense70005600126014014000

Production run expense733373335573176021999

setup time expense425910654855102211201

Admin parts expense12001200120012004800

Total expense5879246398200884952130230

Operating income1620813602-6138-330220370

Return on sales21.60%22.70%-44%-200%13.50%

Recommendations: Jeffrey Donald and his manufacturing people should try to run their production equipment faster. They should improve the performance of unit level activities. Donald should reduce the setup time by improving the performance of batch level activities. So that small batch of the speciality products would be less expensive to produce.Alternatives:Pricing, process improvement and engineering and design improvement would significantly increase Classic Pens profitability without compromising its ability to compete in both the high volume Blue and Black pen markets.