Classic Pen Company Analysis

Case Analysis: Classic Pen Company

ABSTRACT

Classic Pen Co. is a pen producing company traditionally specializing in blue and black pens. Recently, the company has decided to add the colors red and purple into their product line. Although the new colors seem profitable, the company’s overall profitability is declining. Due to this decline, the company has begun exploring an Activity-based Costing method rather than the traditional approach in order to help determine whether or not it is beneficial to keep the four colors they currently produce, add more colors, or just simply produce the two original colors. After revising the original Income Statement using activity-based costing we concluded that producing the red and purple pens are not profitable. In addition to the extra time it takes to switch ink and clean out the machines, Classic Pens is also incurring additional costs maintaining and selling more products.

ANALYSIS

Classic Pen Company had originally started with just two colors, blue and black, but after seeking to become even more profitable, the company introduced two additional colors, red and purple. These two colors seemed to exhibit similar manufacturing processes and costs, but returned premiums of 3-10% in price compared to the blue and black pens. But although the reports showed such a great premium when looking at the pens individually, this was not so in the overall reports which displayed a company-wide decline in profitability.

Once analyzing the new processes involved in producing the new pens, Classic Pen found that they incurred more changeover time which was primarily due to the extensive cleaning of machines required to ensure quality control when switching from lighter colors to darker ones. In retrospect of seeing the costs and time associated with this changeover, the Company has realized that the traditional cost accounting approach has not sufficiently accounted for all of the costs associated with the two new colors.

So in order to better determine the true profitability and costs of adding additional colors to the product line, a switch from the traditional cost accounting method to the activity based accounting approach has been made. This new approach will help to identify each color’s profitability and tell us whether or not it is truly the best decision in including the new colors to the mix, or simply sticking the originals.

RESULTS

First, we specified the core activities in the process, which include the following production runs: scheduling and handling, changeover, machine operations and support, records maintenance and fringe benefits. Next, we determined the cost drivers associated with these, which are: number of production runs, total setup time, machine hours, part administration number, and direct labor hours. Next,