Classic Pen Company.docx

Executive Summary Classic Pen Company used to get a profit margin of over 20% of sales when they used to produce traditional low-cost Blue and Black ink pens. They decided to expand to Red and Purple ink pens. In spite of these selling at a premium, the profit percentage fell to 13.5%. It is only when an activity-based cost model is adopted does the underlying problem of margins comes to the forefront. Issues at Classic Pen Company 

Profitability Red and Purple pens seem more profitable using the traditional method of allocating Indirect Cost but the overall profitability of the company is falling.

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Pricing Due to tough global competition, the company needs to decide the pricing of the products accordingly.

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Product Mix Red and Purple pens require more resources in terms of indirect cost.

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Internal Processes Operational inefficiency in scheduling and purchasing activities are contributing to higher costs as per calculations.

Observations  

The excessive indirect costs are due to the high overhead costs introduced for the new products Activity-based costing reveals the actual indirect cost distribution for the new products Activities

Drivers

Handle Production Runs Setup Time Parts Administration Machine Support Direct Labour Fringe

Production Runs Setup hours No of parts Machine Hours Direct Labour

Expenses Machine Expenses Production Runs Expenses Setup Expenses Administration Expenses Fringe Expenses

Activity Unit Level Activity Batch Level Activity Batch Level Activity Production Level Activity Facility Level Activity

Recommendation   

Increase prices of the Red and Purple pens to 2.43 and 4.95 respectively to achieve break-even. Thus, overall profit margin increases to 18.63 Increase prices of the Red and Purple pens to 2.79 and 6.19 respectively to achieve 20% profit margin. Thus, overall profit margin increases to 21.68 Operational efficiency can be increase by more production of red and purple pens per Production Run. It is currently low due to order-drive production method which could be changed to produce-and-sell method. However, inventory holding cost needs to be accounted for. Eg: For Purple pens, the production run could be brought down from 12 to 1 run to produce 1000 pens bringing down production costs for these pens.