Classic Pen Case

By using the volume based costing system, Classic Pen appears to be profitable and making a good return on sales of blue, black, red, and purple pens. The percentage of return on sales of all four colors of pens seems to be no less than 17%. Once the traditional income statement is analyzed, the indirect costs are lumped together in the general cost pool titled “overhead”; these costs should be broken down into specific cost pools. See below. Indirect Labor & Benefits $15,016 $11,551 $2,310

Cost Pools Breakdown Scheduling & Production Set Up Record Keeping Machine Cost

Computer Systems $8,052 $2,141

Machinery

Maint.

Energy

$7,396
Blue 29,298 5,451 7,116 2,318 16,839 7,866 68,888 1.34
Black 21,318 4,217 5,505 1,686 12,253 4,683 49,662 1.33

$4,437
Red 5,040 4,217 5,505 406 7,056 1,377 23,601 2.62

$2,218
Purple 468 1,131 1,477 41 655 125 3,897 4.33

Totals $15,016 $19,603 $4,451 $14,051

Costs Materials Scheduling & Production Set Up Record Keeping Direct Labor Machine Cost Total Cost Total Cost Per Unit

With this information, a new Income statement can be generated for the Classic Pen Company, this once clearly shows the return on sales for all color pens sold is no longer 17% The blue and black pens sold have a return of 22% and 23% respectively, while the newly introduced colors of red and purple have a negative return of -48% and -133% respectively. ABC Income Statement Black Red $64,328 $15,930 21,318 5,040 12,253 7,056 4,217 5,505 1,686 4,683 $14,666 23% 4,217 5,505 406 1,377 -$7,671 -48%

Sales Material costs Direct labor Overhead Costs Scheduling & Production Set Up Record Keeping Machine Cost Total operating income Return on sales

Blue $88,408 29,298 16,839 5,451 7,116 2,318 7,866 $19,520 22%

Purple $1,674 468 655 1,131 1,477 41 125 -$2,223 -133%

Total $170,340 $56,124 $36,803 $15,016 $19,603 $4,451 $14,051 $24,292 14%

Based on the ABC system it would be in the best interest of management not to move forward with introducing additional colors for production, and not to raise prices on potential new colors. The costs for production of the red and purple pens are artificially low due to a lack in sales of these pens, and an increase in the production of these two pens will lead to a larger negative return.