We're having a hard time finding the blue pen to equal $1.34 for ABC

Timeless Pen Case Jane Dempsey, controller of the Timeless Pen Company, was concerned about the recent financial trends in operating results. low-cost producer of traditional BLUE pens and BLACK pens. Profit margins were over 22% of sales. Several years earlier Dennis Selmor, the sales manager, had seen opportunities to expand the business by extending the produ offered premium selling prices over traditional BLUE and BLACK pens. Five years earlier, RED pens had been introduced; they r production technology but could be sold at a 3% premium. And last year, PURPLE pens had been introduced because of the 8% they could command. But Dempsey had just seen the financial results (see Exhibit 1) for the most recent fiscal year and was keenly disappointed. The new RED and PURPLE pens do seem more profitable than our BLUE and BLACK pens, but overall profitability even the new products are not earning the margins we used to see from our traditional products. Perhaps this is th competition I have been reading about. At least the new line, particularly PURPLE pens, is showing much higher m we should follow Dennis's advice and introduce even more specialty colored pens. Dennis claims that consumers a higher prices for these specialty colors. Jeffrey Donald, the manufacturing manager, was also reflecting on the changed environment at Timeless Pen: Five years ago, life was a lot simpler. We produced just BLUE and BLACK pens in long production runs, and every smoothly, without much intervention. Difficulties started when the RED pens were introduced and we had to make m changeovers. This required us to stop production, empty the vats, clean out all remnants of the previous color, and production of the red ink. Making black ink was simple; we didn't even have to clean out the residual blue ink from if we just dumped in enough black ink to cover it up. But for the RED pens, even small traces of the blue or black in problems. And the ink for the new PURPLE pens also has demanding specifications, but not quite as demanding a We seem to be spending a lot more time on purchasing and scheduling activities and just keeping track of where w existing, backlogged, and future orders. The new computer system we got last year helped a lot to reduce the conf concerned about rumors I keep hearing that even more new colors may be introduced in the near future. I don't thi more capability to handle additional confusion and complexity in our operations. Sales Material costs Direct labor Overhead @ 270% Total operating income Return on sales Exhibit 1 Traditional Income Statement Blue Black Red $88,408 $64,328 $15,930 29,298 21,318 5,040 12,028 8,752 2,106 32,476 23,630 5,686 $14,606 $10,628 $3,098 17% 17% 19% Purple $1,674 468 211 570 $425 25% Operations Timeless produces pens in a single factory. The major task was preparing and mixing the ink for the different-colored pens. Th in a semiautomated process. A final packing and shipping stage is performed manually. Each product has a bill of materials that identifies the quantity and cost of direct materials required for the product. A routing sh operations required for each operating step. This information is used to calculate the labor expenses for each of the four produ expenses are aggregated at the plant level and allocated to products on the basis of their direct labor content. Currently, this ov of direct labor cost. Most people in the plant recalled that not too many years ago the overhead rate was only 200%. Activity-Based Costing Jane Dempsey recently attended a seminar of her professional organization in which a professor had talked about a new conce costing (ABC). This concept seemed to address many of the problems she had been seeing at Timeless. The speaker even us to capture Timeless's situation exactly. The professor argued that overhead should not be viewed as a cost or a burden to be allocated on top of direct labor. Rather, t on activities performed by the indirect and support resource of the organization and try to link the cost of performing these activ for which they were performed. Dempsey obtained several books and articles on the subject and soon tried to put into practice and read about. Activity-Based Cost Analysis Dempsey first identified six categories of support expenses that were currently being allocated to pen production: Expense Category Indirect labor Fringe benefits Computer systems Machinery Maintenance Energy Total Expense $20,626 17,489 10,193 7,396 4,437 2,221 $62,362 She determined that the fringe benefits were 40% of labor expenses (both direct and indirect) and would thus represent just a p 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 was involved in scheduling or handling production runs. This proportion included scheduling production orders; purchasing, pre materials for the production run; performing a first-item inspection every time the process was changed over, and some scrap lo run until the process settled down. Another 40% of indirect labor was required just for the physical changeover from one color p The time to change over to BLACK pens was relatively short (about 1.1 hour) since the previous color did not have to be compl machinery. Other colors required longer changeover times; RED pens required the most extensive changeover to meet the dem for this color. The remaining 8% of the time was spent maintaining records on the four products, including the bill of materials and routing info maintaining a minimum supply of raw materials and finished goods inventory for each product, improving the production proces engineering changes for the products. Dempsey also collected information on potential activity cost drivers for Timeless's activ distribution of the cost drivers for each of the four products. Dempsey next turned her attention to the $10,193 of expenses to o computer system. She interviewed the managers of the Data Center and the Management Information System departments an computer's time (and software expense) was used to schedule production runs in the factory and to order and pay for the mate production run. Because each production run was made for a particular customer, the computer time required to prepare shipping documents a a customer was also included in this activity. In total, about 79% of the computer resource was involved in the production run a remaining computer expense (21%) was used to keep records on the four products, including production process and associate information. The remaining three categories of overhead expense (machine depreciation, machine maintenance, and the energy to operate to supply machine capacity to produce the pens. The machines had a practical capacity of 10,100 hours of productive time tha production. Dempsey believed that she now had the information she needed to estimate an activity-based cost model for Timeless Pen. Production sales volume (no. of units) Unit selling price Materials/unit cost Exhibit 2 Direct Costs and Activity Cost Drivers Blue Black Red 51,400 $1.72 $0.57 37,400 $1.72 $0.57 9,000 $1.77 $0.56 Purple 900 $1.86 $0.52 Direct labor hr/unit Machine hour/unit No. of production runs Setup time/run (hours) Total setup time (hours) Number of products 0.02 0.11 53 4.60 244 1 0.02 0.09 41 1.10 45 1 0.02 0.11 41 6.40 262 1 0.02 0.10 11 3.80 42 1 5654 3366 990 90 Required: 1. Design an Excel model to estimate the costs for the four pen products using an activity-based costing approach. 2. Write a report to Jane Dempsey and Dennis Selmor explaining the managerial implications from the revised cost estimates. 3. Bonus Question: Why is it acceptable for the fringe benefits associated with direct to be in the overhead cost pool when using direct labor as the allocation base and it is not acceptable for the fringe benefits associated with direct labor to be in the overhead cost pool when using ABC? Hints: 1.) The cost of the blue pen using ABC is: $1.34 (rounded). 2.) The overhead cost pool for the ABC method totals $53,123.40. 3.) When switching from the plant wide allocation of overhead using direct labor as the allocation base to the ABC method, you must assign to direct labor the fringe benefits associated with direct labor and not maintain this portion of the fringe benefits in the overhead cost pool. e ancial trends in operating results. Timeless Pen had been the of sales. business by extending the product line into new products that pens had been introduced; they required the same basic een introduced because of the 8% premium in selling price and was keenly disappointed. LACK pens, but overall profitability is down, and ional products. Perhaps this is the tougher global E pens, is showing much higher margins. Perhaps . Dennis claims that consumers are willing to pay at Timeless Pen: n long production runs, and everything ran introduced and we had to make more mnants of the previous color, and then start the ean out the residual blue ink from the previous run small traces of the blue or black ink created quality ons, but not quite as demanding as for RED pens. and just keeping track of where we stand on ar helped a lot to reduce the confusion. But I am uced in the near future. I don't think we have any Total $170,340 $56,124 $23,097 $62,362 $28,757 17% for the different-colored pens. The ink is inserted into the pens uired for the product. A routing sheet identifies the sequence of penses for each of the four products. All of the plant's indirect ct labor content. Currently, this overhead burden rate is 270% ad rate was only 200%. sor had talked about a new concept, called activity-based at Timeless. The speaker even used an example that seemed ed on top of direct labor. Rather, the organization should focus the cost of performing these activities directly to the products and soon tried to put into practice the message she had heard d to pen production: and would thus represent just a percentage markup to be activities accounted for their work. About 52% of indirect labor production orders; purchasing, preparing, and releasing changed over, and some scrap loss at the beginning of each sical changeover from one color pen to another. us color did not have to be completely eliminated from the nsive changeover to meet the demanding quality specification he bill of materials and routing information, monitoring and , improving the production processes, and performing y cost drivers for Timeless's activities (see Exhibit 2) and the on to the $10,193 of expenses to operate the company's formation System departments and found that most of the and to order and pay for the materials required in each to prepare shipping documents and to invoice and collect from s involved in the production run activity. Almost all of the production process and associated engineering change notice nance, and the energy to operate the machines) were incurred 0,100 hours of productive time that could be supplied to pen d cost model for Timeless Pen. Total 98,700 1,974 10,100 146 593 4 based costing approach. ons from the revised cost in the overhead cost enefits associated with cation base to the ABC not maintain this Activity Based Costing - Class Example Blue Black Red Purple Step 1 - Identify each activity that is performed during the manufacturing process. Estimate Overhead Activity Production Set-up Color Changeover Record Keeping Production Total Step 2 - Estimate the total amount of each activity that will be utilized during the year. Overhead Activity Production Set-up Color Changeover Record Keeping Production Step 3 - Calculate the predetermined overhead rate for each activity. Overhead Activity Formula Production Set-up Color Changeover Record Keeping Production Total Step 4 Allocate some MOH cost to each job worked on during the year by multiplying the activity Overhead Activity - Blue Formula Production Set-up Color Changeover Record Keeping Production Total Overhead Activity - Black Formula Production Set-up Color Changeover Record Keeping Production Total Overhead Activity - Red Formula Production Set-up Color Changeover Record Keeping Production Total Overhead Activity - Purple Formula Production Set-up Color Changeover Record Keeping Production Total s Example Units Produced 51,400 37,400 9,000 900 98,700 ty that is performed during the manufacturing process. Estimate the total manufacturing cost overhe Activity Cost Driver Total set-up time # of changeovers # of records Production runs amount of each activity that will be utilized during the year. Activity Cost Driver machine hours total set-up time dl hr # of production runs ermined overhead rate for each activity. Total Activity Cost Column A $ 22,304 $ 8,250 $ 3,791 $ 18,778 $ 53,123 cost to each job worked on during the year by multiplying the activity cost allocation rate by the actual amou Unit Activity Rate Column A $ 2.21 $ 13.92 $ 1.92 $ 128.62 $ 146.66 Unit Activity Rate Column A $ 2.21 $ 13.92 $ 1.92 $ 128.62 $ 146.66 Unit Activity Rate Column A $ 2.21 $ 13.92 $ 1.92 $ 128.62 $ 146.66 Unit Activity Rate Column A $ 2.21 $ 13.92 $ 1.92 $ 128.62 $ 146.66 ocess. Estimate the total manufacturing cost overhead (MOH) for the coming year for each activity. Total Activity Cost 22,304.40 8,250.40 3,790.61 18777.99 53,123.40 the year. Total Quantity of Activity 10,100 593 1,974 146 Total Quantity of Activity Column B Unit Activity Rates Column C = A/B 10,100 $ 2.21 $ 593 $ 13.92 1,974 $ 1.92 146 $ 128.62 12,813 $ 147 plying the activity cost allocation rate by the actual amount of each activity used by the job. Quantity of Activity - Blue Overhead Cost of Activity Column B Column C = A * B $ 1,111.00 2,453.48 243.80 3,393.13 1,028.00 1,974.04 53 6,816.67 2,435.80 $ 14,637.32 Quantity of Activity - Black Overhead Cost of Activity Column B Column C = A * B $ 909 2,007.40 45 626.30 39 75.81 41 5,273.27 1,034.48 $ Quantity of Activity - Red 7,982.77 Overhead Cost of Activity Column B $ $ Column C = A * B 1,111 2,453.48 262 3,646.43 39 75.81 41 5,273.27 1,453.48 $ 11,449.00 Quantity of Activity - Purple Overhead Cost of Activity Column B Column C = A * B 1,010 2,230.44 42 584.54 39 75.81 11 1,414.78 1,102.48 $ 4,305.57 ming year for each activity. d by the job. Overhead Cost per unit Column D = C/total # of units produced $ 0.05 $ 0.07 $ 0.04 $ 0.13 $ 0.28 Overhead Cost per unit Column D = C/total # of units produced $ 0.05 $ 0.02 $ 0.00 $ 0.14 $ 0.21 Overhead Cost per unit Column D = C/total # of units produced $ 0.27 $ 0.41 $ 0.01 $ 0.59 $ 1.27 Overhead Cost per unit Column D = C/total # of units produced $ 2.48 $ 0.65 $ 0.08 $ 1.57 $ 4.78