1. Case 3 – Classic Pen Co.
17 May 2012
Groups 1 & 2
Executive Summary
Problem Statement
The Traditional Income Statement (TIS) method used at the Classic Pen Company was believed to be
providing an inaccurate representation of the operating costs and return on sales.
Accounting Analysis
The Activity Based Costing (ABC) method was used to reallocate variable costs and group them into
appropriate cost pools. This can be a valuable three step process for more accurate tracking of indirect
costs to be used in managerial decisions. Below is the process used:
Indirect Labor / Fringe Benefits Scheduling Blue Pen
Computer Systems Set-ups Black Pen
Machinery Record Keeping Red Pen
Maintenance Machine Costs Purple Pen
Energy
The following graph compares the return on sales percentages using TIS and the more accurate ABC
model. A 151% difference can be seen for the Purple Pen, for example.
100%
Return on Sales
75% 27% 25%
50% 17% 22% 17% 19%
Percentage
25%
0%
-25%
-50%
-75% -39%
-100%
-125% Products
-150% -126%
TIS ABC1 TIS ABC1 TIS ABC1 TIS ABC1
Recommendation
After reviewing the results from the ABC analysis, it was determined that the set-up and production
costs for the red and purple pens are excessively high. It was found that by instituting large production
runs at a minimum of 900 units, the Classic Pen Company can minimize indirect costs and operate much
more profitably. The following graph shows the increase in percent on return on sales for the red and
purple pens with this recommendation implemented.
100%
Return on Sales
75%
50% 22% 22% 27% 27% 21% 26%
Percentage
25%
0%
-25%
-50%
-75% -39%
-100%
-125% Products
-150% -126%
ABC1 ABC2 ABC1 ABC2 ABC1 ABC2 ABC1 ABC2