Alexandria Ltd. manufactures high-quality pens. For many years the company manufactured only one type of pen (namely, ballpoint pens) but last year the company also began to manufacture fountain pens. The decision to begin manufacturing fountain pens was taken only after the company's marketing manager confirmed that there was a significant niche market for fountain pens and the company's cost accountant estimated that the cost of production for such pens would be much less than the selling price predicted by the marketing manager.

When the fountain pen was introduced, sales (in terms of both quantity and price) were higher than expected. Nevertheless the overall profits of Alexandria Ltd. have declined steadily. As a result, the cost accountant decided that he should re-examine his estimate of the cost of producing the fountain pen, with particular reference to overhead costs. In his original analysis, he allocated all manufacturing overhead costs to products in proportion to direct labour cost. However, in his re-examination he decided that activity based costing (ABC) should be used in order to gain a more thorough understanding of the situation. The following data is available for the most recent month:

• Direct cost of production, per unit of each product:

Ballpoint pen Fountain pen

Direct materials cost K11.25 K18.75

Direct labour cost K2.50 K5.00

• Number of units of each product produced and sold:

Ballpoint pen Fountain pen

Units produced and sold 32,000 4,000

• Manufacturing overhead costs for the month:

Activity cost pool Activity measure Cost

Machine running costs Machine hours K91,000

Stores requisitions Number of requisitions K189,500

Materials movements Number of movements K67,500

Production set-ups Number of batches K102,000

Total = K450,000

• Activity levels in relation to each product:

Activity Ballpoint pen Fountain pen Total

Machine hours 7,500 10,000 17,500

Number of requisitions 500 500 1,000

Number of movements 325 125 450

Number of batches 50 25 75

REQUIRED:

(a) Calculate the cost per unit for each of the two types of pen, if all manufacturing overheads are

allocated to products in proportion to direct labour cost.

(b) Calculate the cost per unit of each of the two types of pen, if all manufacturing overheads are

allocated to products using activity-based costing.

(c) Explain why the calculated cost per unit of the fountain pen is much higher in part (b) than in part (a), and suggest what additional factors (i.e., other than those reflected in the calculations here) may have contributed to the decline in the company's profitability since the fountain pen was introduced.