Kingston Fountain Pens (KFP) was founded in Kingston, New York, in 2010 by Richard Chen. Richard, who had a mechanical engineering degree in material sciences from Cornell University, had long been a dedicated user and collector of fountain pens. Chen had observed a renewed interest in fountains occurring internationally and felt the time was right to launch KFP. The business model of KFP was to combine the century-old traditions and features of fountain pens with modern manufacturing and design. KFP initially focused on manufacturing and selling a model of fountain pen that used replaceable ink cartridges. In 2017 it added higher-end models that used more sophisticated internal filling mechanisms. KFPs business model was to sell to retailers that specialized in high-end fountain pens. KFP competed with long-established pen brands like Mont Blanc, Parker, Waterman, and Cross as well as other small specialty fountain pen producers such as Visconti, Omas, and Namiki. KFP's products were expensive, but Richard was proud that his company's products were highly regarded in the fountain pen market after just a decade following their launch. Fountain pens consisted of several key components. The barrel of the pen, the part held in ones hand while using the pen, also contained the liquid ink reservoir. For pens that used ink cartridges (cartridge filling = CF), the barrel would unscrew from the section and the cartridge could be inserted. In contrast, the models of KFP pens that utilized an internal filling mechanism used the barrel itself as the ink reservoir and a piston was placed inside the barrel (piston filling = PF). To fill these models with ink, the nib of the pen was submerged in a bottle of ink and the piston mechanism was operated to draw the ink from the bottle into the barrel. The PF pens thus had a greater ink capacity and, because of their complicated design, were considered a higher-end pen then the CF models. Both models of pen used a 14-karat gold nib with an iridium tip. Gold was utilized for this portion of the pen because of the luxurious feel created when writing with the pen. KFP purchased the nibs in a semi-finished from Germany and completed the nib processing by adding engraving and grinding to nib to various sizes (e.g., fine point, medium point, italic). The final key component of a fountain pen is the cap. Caps are critical in protecting the nib when the pen is not in use. Caps normally slide over the pens nib and connect with the barrel, by either screwing the two together or some other locking mechanism. Caps normally include a clip which can be used to help store a fountain pen in a shirt of jacket pocket when not in use. Pen models within each of the CF and PF lines were differentiated in several ways, including: size; barrel and cap material (e.g., metal, resin), and nib shape. EXHIBIT 1: 2020 Budgeted Production and Activity Levels CF Fountain Pens PF Fountain Pens Production volume (units) 25,000 12,500 Production runs (batches) 24 96 Materials purchase orders 90 210 Product shipments 80 320 Different parts numbers 18 32 Direct labor hours per unit 4 4 Machine hours per unit 3 5 Note: Budget assumes no change in inventory levels, therefore budgeted production volume is equal to budgeted sales volume. EXHIBIT 2: Standard Direct Material and Labor Cost per Unit CF Fountain Pens PF Fountain Pens Direct material cost $88.00 $111.00 Direct labor cost 64.00 64.00 Total direct costs $152.00 $175.00 KFP had experienced a steady increase in demand for its CF fountain pens in almost every year of its existence. In 2015, with a production and sales volume of approximately 25,000 CF fountain pens, KFP reached manufacturing capacity and outgrew its facilities. In 2016 it built and moved into a new state-of-the-art production facility about a mile away from the original facility, which was subsequently closed and sold. The state of-the-art machinery in the new facility was built to a capacity of two times the 2015 demand for two reasons. First, KFP expected demand for CF fountain pens to continue to grow. Second, KFP had begun the development of its PF fountain pens. The first of four models of PF fountain pens went into production in January 2018, followed by a staggered introduction of the three more models. By early 2019, all four models were available for sale. KFP's sales philosophy was to earn consistently solid margins. "We do not want to compete based on lowest price, so we rarely discount," said Sandra Charles, VP Marketing & Sales. Prices were set to yield, roughly, a markup of 30 percent on a full cost basis. To estimate full product costs, Michael Kristoff, the company controller, spread the totality of all overhead costs to products based on the products' usage of direct labor hours in the production process. All four types of PF fountain pens incurred roughly the same direct material and labor costs so, for reporting purposes, cost data were grouped into the two product lines only: CF and PF. Budgeted production data, unit standard direct material and labor costs, and budgeted overhead costs for fiscal year 2020 are shown in Exhibits 1, 2, and 3 (Column A), respectively. Based on these budget data and margin requirements, the suggested unit sale prices were set at $300 for CFs and $330 for PFs. Since KFP moved into the new facility, Sandra found herself addressing increasingly frequent requests from sales reps to discount CF fountain pens. A few of the requests were made for large quantity orders, but more frequently the rationale was that KFP's price-quality proposition for CF fountain pens was out of line with the competition. A downward trend in CF sales, from 32,350 units in 2016 to an expected 25,000 units in 2020, had caused Sandra to become more prone to allow the discounts. Sandra had not noticed similar pressures to discount PF fountain pens and demand for PFs had not fallen. As shown in Exhibit 1, PF models were expected to grow to one-third of KFPs total sales in units in 2020 which was quite remarkable given the relatively recent introduction of the PF models. Sandra had developed several hypotheses about what might have caused the price pressure on the CF fountain pens. Product costing was one possible factor she had considered. Sandra had tried to raise this question with Michael in early 2019 when the final model in the PF line had been introduced. The rapid growth in product diversity at that time led Sandra to ask Michael if the existing cost system was providing the true cost of the various models. Michael replied, at that time, that a more elaborate costing system was not yet justifiable and suggested that even more product growth was necessary before the current system would be reviewed. Michael went on at some length about the complexity of revising the current corporate policy on costing and the additional work for him and his staff that any change would require. In the February 2020 executive meeting, David Reich, VP-Manufacturing, said that he thought the company should be working toward what he called an activity-based cost (ABC) system. As David described it, the essence of an ABC system is to identify the major activities that cause the company's overhead costs to be incurred and then to apply those costs to products based on the products' consumption of each of those activities. David's key point was that using a single, standard overhead rate and applying it to all the products did not make sense because, clearly, there are differences in volume and resource utilization across the CF and PF product lines. David pointed out that manufacturing cost control would benefit from a more detailed cost measurement system. Richard, however, deferred the issue because Michael was not present at this meeting. Richard speculated that in order to be able to convince Michael and himself, David needed to make strong case for change, backed by hard-and-fast numbers. Sandra was not entirely sure why David had raised this issue. Unlike her, David's bonus was not dependent on margins; it was based on his ability to meet his budget for total manufacturing costs . Anyhow, she called David after the meeting because she thought that the issue he had raised was related to the concern she had tried to discuss with Michael before. David agreed to meet with Sandra the next week. At that meeting, David showed her the information provided in Exhibit 3 (Column B).

Questions: 1. Why are Sandra and David each interested in having the company review and consider changing its cost system? 2. Calculate the full cost per unit of the CF and PF fountain pens: a. Using the existing costing method. b. Using David's proposed ABC method (thus using the suggested "driver" information shown in Exhibit 3, Column B). c. Using an "in-between" costing method that David and Charles intended to propose if they were unable to convince Richard and Michael that the ABC method should be adopted. The "in-between method" proposes to allocate overhead costs based on two drivers only: direct material cost and machine hours, as shown in Exhibit 3 (Column C). 3. What are the effects, if any, of changing the company's costing method? Specifically, are the differences between these three methods significant in terms of: a. Their effect on individual product costs? b. Their effect on total company profits (assuming that there are no changes in any operating decisions, such as regarding prices and production volumes)? Where the differences are significant, explain why they exist. If there are no differences, or if the differences are not significant, explain why this is the case. 4. Do you think the cost system was a cause of the requests that Kelly was receiving to discount CF fountain pens that started with the move to the new plant but before the production of the PF fountain pens fountain pens? Would it have made sense to start implementing ABC at that time? 5. What should KFP management do regarding its cost system? To the extent that they exist, discuss the advantages and disadvantages of each alternative. Why did you recommend the alternative that you chose? Explain.