CLASSIC PEN CO. ABSORPTION COSTING METHOD Harvard Case Solution & Analysis

CLASSIC PEN CO. ABSORPTION COSTING METHOD Case Study Solution

ACTIVITY BASED COSTING METHOD
BLUE BLACK RED PURPLE TOTAL
Production/Sales Volume          50,000          40,000            9,000          1,000          100,000
Sales Price              1.50              1.50              1.55            1.65
SALES REVENUE          75,000          60,000          13,950          1,650          150,600
Direct Material          25,000          20,000            4,680             550            50,230
Direct Labor          10,000            8,000            1,800             200            20,000
Indirect Labor            6,875            4,594            6,501          2,030            20,000
Fringe Benefits            6,750            5,038            3,320             892            16,000
Computer systems            3,167            3,167            2,527          1,140            10,000
Machinery            4,000            3,200                720                80              8,000
Maintenance            2,000            1,600                360                40              4,000
Energy            1,000                800                180                20              2,000
TOTAL COSTS          58,792          46,398          20,088          4,952          130,230
PROFIT / (LOSS)          16,208          13,602          (6,138)       (3,302)            20,370

 

According to the Activity based Costing method, two entire color classes show a negative profit of $ 6,138 for RED COLOR and $ 3,302 for the PURPLE COLOR.

This is directly against the organization’s strategic perspective which was trying to incorporate more new colors in their production cycle.

Further, if we separately take the profit making colors, then the BLUE COLOR PENS is providing a return of 21.6% and the BLACK PEN is providing a return of 22.67%; providing that the expected margins by the organization of 20% is being achieved. The new production colors of RED and PURPLE are the loss makers which is reducing the overall profitability of the organization.

Recommendations

The main recommendations for the CLASSIC PEN COMPANY, is to immediately stop producing the RED and the PURPLE COLOR PENS as this is making losses for the organization.

The organization should utilize all its machine capacity of producing 100,000 units for the BLUE and the BLACK pens only, as this will increase their profits more.

New colors introduction, for which the organization was considering was a plan with very high variable over heads which needs to be sought out using the activity based costing method before acceptance.......

 

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