Classic Pen Co.: Developing an ABC Model - Case Solution

Classic Pen Co. has moved into the business of producing new specialized colors besides its core blue and black pen. However, it experienced a decreasing margin on the blue and black pens and a rising cost. Seeking an explanation for such problems, the company studied its activity-based costing (ABC).

Robert S. Kaplan
Harvard Business Review ( 198117-PDF-ENG )
April 10, 1998

Case questions answered:

Case study questions answered in the first solution:

Case Overview
Inspection
ABC System Diagram
Key Findings & Analyses

Case study questions answered in the second solution:

Compute the profitability of each of the pens using Traditional Absorption Based Costing, then Activity-Based Costing.
Identify the main causes of the difference in profitability emerging from the ABC analysis (compared to traditional costing).
What are the likely implications of this finding for managerial decision-making?
What strategic options does the company Classic Pen Co. have to address the problems revealed through the ABC analysis?

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Classic Pen Co.: Developing an ABC Model Case Answers

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Case Overview - Classic Pen Co.: Developing an ABC Model

Classic Pen Co. is a low-cost pen-producing company that traditionally produces blue and black pens with a profit margin of over 20%. About 7 years ago, the sales manager saw growth opportunities in colored pens and thus introduced red and purple into their product line, which was sold at a premium.

Unfortunately, this strategy, which otherwise should be driving profitability, is now exhibiting an overall decline in profits as per the financial results. The flagship products’ margins also seem to be dipping, which compelled us to review the income statement from an activity-based lens.

Inspection:

As a starting point of the investigation, we derived the cost price per pen in the traditional income statement format, which was currently used by Classic Pen Co.

*Traditional Income Statement*
	Blue	Black	Red	Purple	Total
Revenue	$75,000	$60,000	$13,950	$1,650	$1,50,600
Material costs	25,000	20,000	4,680	550	50,230
Direct Labour	10,000	8,000	1,800	200	20,000
Overhead @ 300%	30,000	24,000	5,400	600	60,000
Total Costs	65,000	52,000	11,880	1,350	1,30,230
Total operating income	$10,000	$8,000	$2,070	$300	$20,370
Volume	50,000	40000	9000	1000	100000
Selling Price / Unit	1.5	1.5	1.55	1.65	1.506
Cost Price / Unit	1.3	1.3	1.32	1.35	1.3023
Return on sales	13.3%	13.3%	14.8%	18.2%	13.5%

The traditional cost prices of the pens were as follows:

Blue - $1.3
Black - $1.3
Red - $1.32
Purple - $1.35

Using the activity-based costing method, we then calculated the revised product costs for each of the pens produced by Classic Pen Co. with the information collected by Dempsey.

Calculations for Total Indirect Costs
Fringe benefits	$16,000.00
Direct labor	$20,000.00
Indirect labor	$20,000.00
Total Indirect labor	$28,000.00
[Divided the fringe benefits as per the weightage between direct labor and indirect labor]