1. Calculate the revised product costs for the four pens, based on the activity information collected by Dempsey 2. What actions are stimulated by the ABC product costs?

Expense Category Expense Indirect Labor Fringe Benefits Computer Systems Machinery Maintenance Energy Total $20,000 16,000 10,000 8,000 4,000 2.000 $60,000 She determined that the fringe benefits were 40% of labor expenses (both direct and indirect) and would thus represent just a percentage markup to be applied on top of direct and indirect labor charges. Dempsey interviewed department heads in charge of indirect labor and found that three main activities accounted for their work. About half of indirect labor was involved in scheduling or handling production runs. This included scheduling production orders, purchasing, preparing, and releasing materials for the production run, first-item inspection performed every time the process was changed over, and some scrap loss at the beginning of each run until the process settled down. Another 40% of indirect labor was required just for the physical changeover from one color pen to another. The time to change over to BLACK pens was relatively short (about 1 hour) since the previous color did not have to be completely eliminated from the machinery. Other colors required longer changeover times; RED pens required the most extensive changeover to meet the demanding quality specification for this color. The remaining 10% of the time was spent maintaining records on the four products, including the bill of materials and routing information, monitoring and maintaining a minimum supply of raw materials and finished goods inventory for each product, improving the production processes, and performing engineering changes for the products. Dempsey also collected information on potential activity cost drivers for Classic's activities (see Exhibit 2) and the distribution of the cost drivers for each of the four products. Dempsey next turned her attention to the $10,000 of expenses to operate the company's computer system. She interviewed the managers of the Data Center and the Management Information System departments and found that most of the computer's time (and software expense) was used to schedule production runs in the factory and to order and pay for the materials required in each production run. Since each production run was made for a particular customer, the computer time required to prepare shipping documents and to invoice and collect from a customer was also included in this activity. In total, about 80% of the computer resource was involved in the production run activity. Almost all of the remaining computer expense (20%) was used to keep records on the four products, including production process and associated engineering change notice information. The remaining three categories of overhead expense (machine depreciation, machine maintenance, and the energy to operate the machines) were incurred to supply machine capacity to produce the pens. The machines had a practical capability of 10,000 hours of productive time that could be supplied to pen production. Exhibit 1 Traditional Income Statement Blue Black Red Total Sales Purple $1,650 550 $75,000 25,000 10,000 30,000 $10,000 $60,000 20,000 8,000 24,000 $8,000 Material Costs Direct Labor Overhead @300% Total Operating Income Return on Sales $13,950 4,680 1,800 5,400 $2,070 200 $150,600 50,230 20,000 60,000 $20,370 600 $300 13.6% 13.3% 14.8% 18.2% 13.5% Exhibit 2 Direct Costs and Activity Cost Drivers Blue Black Red Total Purple 1,000 50,000 40,000 9,000 100,000 Production Sales Volume Unit Selling Price Materials-unit cost Direct labor brs/unit $1.65 $1.50 $0.50 0.02 $1.50 $0.50 $1.55 $0.52 $0.55 0.02 0.02 0.02 2,000 Machine hours/unit 0.1 0.1 0.1 0.1 10,000 50 50 38 12 150 4 1 6 4 Production runs Setup time/run Total setup time (hours) Parts administration 200 50 228 48 526 1 1 1 1 4