Traditional Costing Systems: The Cooper Pen Company

Cooper Pen is a low-cost producer of blue pens and black pens. Recently, Cooper Pen introduced red and purple pens, using same basic production technology, combined with more complex processes, selling at prices respectively 3% and 10% higher than black and blue. According to cost estimates based on traditional costing, overall profitability for all pens decreased, but red and purple pens recorded higher profit margins than black and blue. Decision: Should Cooper Pen change its product mix so as to de-emphasize blue and black and increase production of new specialty-colored pens?

Coopers Traditional Cost Accounting System

• Cooper uses its plant as a single cost center for cost accumulation.
  • All indirect support costs of the plant were aggregated at the plant level into one cost pool and allocated to products based on each products direct labor cost.
  • Currently, the cost systems overhead (indirect costs) allocation (burden) rate was 300% of direct labor cost (i.e., indirect support costs were allocated at a rate of $3 per $1 of direct labor costs).
  • Before the new pens were introduced, the overhead burden rate was only 200% of direct labor cost.

Coopers Change to a More Complex Production Environment

Cooper observes the following major changes to a more complex production environment:

• Direct labor costs have decreased, and indirect costs have increased as a result of automation.
• As specialty low-volume products, such as red and purple pens, were added. Coopers production system required more scheduling, more setups, more quality control, and a computerized system, to track orders and product specifications
• Making black ink is simpler; Cleaning residual blue ink from the previous run is not required if enough black ink was dumped in to cover it up
• Switching to red requires Cooper to stop production, and clean out all remnants of previous colors.
• Production of purple pens is more complex than black and blue, but less than red.

Reason for Cost Distortions in Coopers Traditional Costing Systems

Cooper identifies the following main reasons for growing cost distortion:

• Coopers traditional costing system uses the same burden rate for all pens in allocating indirect costs. This practice is based on the implicit assumption that the production systems for all pens are of about the same complexity.
• As a result, Coopers traditional costing system would report essentially identical indirect costs per direct labor dollar unit for all pens, standard and specialty.
• In reality, considerably more indirect and support resources are required per dollar of direct labor for the low-volume, newly designed red and purple pens than for the high-volume, standard blue and black pens.
• Hence, Coopers traditional costing system over-allocates indirect costs to Blue and black pens, and under-allocates indirect costs to red and purple pens.

Activities and Activity Cost Drivers at Coopers ABC

Analysis of the activities identified the following major pen production and support activities performed at Coopers. This was followed by the selection of the most appropriate cost drivers that drive the costs of these activities. The activities and the activity cost drivers used by Cooper for its ABC were:

CASE REQUIREMENTS:

1. Compute the ACDRs in Table 4:

2. Compute the activity Costs Assigned from Activity Cost Pools to the Cost Objects

3. Compute ABC Profitability by product.

4. Compare Coopers ABC Profitability Report to Coopers Traditional Profitability Report. Discuss which Profitability Report is likely to be more accurate.

5. How can Cooper use its ABC Results to plan for improve performance in production, cost management, marketing, and profitability?

6. If ABC results bring to changes in Coopers strategies, please design a procedure for estimating the value added of the ABC information to Cooper relative to the additional cost of ABC implementation? Please describe the major cost and value-added components.

Table 1: Profitability by Product (Traditional Costing) Blue Black Red Purple Total Units 50,000 40,000 9,000 1,000 100,000 Price $ 4.50 $ 4.50 $ 4.65 $ 4.95 Sales $225,000 $180,000 $41,850 $4,950 $451,800 Direct Materials 75,000 60,000 14,040 1,650 150,690 Direct Labor 30,000 24,000 5,400 600 60,000 Indirect Costs 90,000 72,000 16,200 1.800 180,000 Tot. Mfg. Cost 195,000 156,000 35,640 4,050 390,690 Gross Margin GM $ 30,000 $ 24,000 $ 6,210 $ 900 $61,110 13.3% 13.3% 14.8% 18.2% 13.5% G.M. % of Sales Table 2: Activities, Activity Cost Pools and Activity Cost Drivers ACTIVITY ACTIVITY COST DRIVER PRODUCTION RUNS HANDLE PRODUCTION RUNS SET UP MACHINES SETUP HOURS SUPPORT PRODUCTS NUMBER OF PRODUCTS RUN MACHINES MACHINE HOURS PROVIDE FRINGE BENEFITS LABOR DOLLARS Table 3: Activity Cost Drivers Requirements per Product Unit & Total Cost Driver Levels for Each Activity Activity Cost Driver/unit Blue Black Red Purple Total ** DL hr/unit 0.02 10.02 10.02 10.02 2,000 Mach.hr/unit 0.1 10.1 0.1 10.1 |10,000 Prod. runs 70 165 50 15 200 Setup time hr/run 4 12.4 5.6 5.6 Total setup hr 280 156 280 84 800 # of products 1 # of Pens 50,000 40,000 19,000 1,000 Table 4: Activity Cost Pools and Activity Cost Driver Rates (ACDRs) Activities Activity Cost Activity Cost Driver Driver Quantity ACDR Handle Production Runs $66,000 Number of production runs Set up machines $33,600 Number of setup hours Support Products $14,400 Number of products Run Machines $42,000 Number of machine hours $156,000 Table 5: Activity Costs Assigned from Activity Cost Pools to Cost Objects Blue Black Red Purple Total Handle Production Runs Set up machines Support Products Run Machines Total Costs Assigned Table 6: Cooper's ABC Profitability by Product Red Sales Material Labor 40% fringe on DL Blue $225,000 75,000 30,000 12,000 Black $180,000 60,000 24,000 9,600 $41,850 14,040 5,400 2,160 Purple $4,950 1,650 600 240 Total $451,800 150,690 60,000 24,000 Support Total Mfg. Expenses Gross Margin G.M. % Of Sales