National Pen Company

National Pen Company is the worldwide leader in providing high value promotional products for businesses and professionals in every industry at low factory pricing. National Pen Company develops two specialized products (Yu-Lee, 2001). The first product is the specialized fountain pen. The second product is the official bag. National Pen Company has a good market share and its products sell as fast as they are produced; so there is virtually no inventory. The company sold 900,000 units of bags and 1,100,000 units of fountain pens (Grant, 2009). Based on traditional cost methodology, the table below shows the division of company’s costs.

Bag Fountain Pen
Direct Material 30,000,000 44,000,000
Direct Labor 7,000,000 2,000,000
Applied Factory Overhead (300% Overhead) 21,000,000 6,000,000
Product Cost 58,000,000 52,000,000
Cost Per Unit In $ 64.4 47.27

Each item was sold for $60 which resulted in $120,000,000 of revenue. At the same time, administrative costs totaled to $6,000,000. In the result, profit that was generated from sales was $ 4,000,000. Despite the overall profit, National Pen Company is actually experiencing a loss by selling bags as the cost per unit of bag, which is $64.44 as it is more than its sales price of $60

Revenue $ 120,000,000
Bag $ 58,000,000
Fountain Pen $ 52,000,000
Selling Costs (General and Administrative) $ 6,000,000
Profit $ 4,000,000

Each item was sold for $60 which resulted in $120,000,000 of revenue. At the same time, administrative costs totaled to $6,000,000. In the result, profit that was generated from sales was $ 4,000,000. Despite the overall profit, National Pen Company is actually experiencing a loss by selling bags as the cost per unit of bag, which is $64.44 as it is more than its sales price of $60

By using the ABC cost analysis method, some additional information was gathered regarding company’s costs allocation. National Pen Company has accompanying costs analysis of $ 116,000,000 in total costs. The company’s technology and core components are basically the same for each device. The extra cost in material for the production of fountain pen is due to use of ink chemicals. Meanwhile, the extra cost of producing bags is directly related to the use of manual labor for sewing. It was also discovered that both items are produced on practically the same automated assembly line (Bragg, 2010).

In the analysis, bags were produced in batches of 9,000 and fountain pens in batches of 1,000 units. This, therefore, indicates that bags require 100 set ups (900,000units/9,000 units per set up) while fountain pen require 1,100 set ups (1,100,000 units/1,000 units per set up). The automated machinery is leased, and its rental charges are based on the units processed. National Pen Company also hired Cannon Advertising to provide them with comprehensive marketing campaign. This campaign was conducted in the three major markets. This was done at a cost of $ 1,000,000 per campaign. Moreover, a technical department was created in the company in order to provide help and assistance to customers. Bags were sold in America and Europe while fountain pens were sold in Asia, Europe and America. Based on the ABC cost analysis method, the table below shows comprehensive cost allocation in the company.

Cost Analysis
Direct Materials $ 74,000,000
Direct Labor 9,000,000
Indirect Labor 2,000,000
Indirect Materials 1,000,000
Factory Maintenance 1,500,000
Lease of Equipment 20,000,000
Insurance 700,000
Other Costs 1,800,000
Total Production Cost $110,000,000
Selling costs (General and Administrative)
Management Salaries 800,000
Selling Expenses 500,000
Design and Engineering 900,000
Advertisement 3,000,000
Business Offices Rent 200,000
Accounting 600,000
Total Period Costs 6,000,000
Total Cost $ 116,000,000

A careful study at National Pen Company identifies five unique activities. It can be seen that the cost of each activity was a significant consumer of company’s resources. In the automated section of the company, the robotic function is related to the operation of assembly line. Large part of the cost of robotics is tied directly to the number of units produced. It also observed that production set up is a batch level activity. National Pen Company requires setting up the assembly process for each batch. Furthermore, activity for product design is driven by a number of products. Lastly advertising activity is driven by the number of markets served (Grant, 2009).

In conclusion, activity based costing attempts were used to overcome the perceived deficiencies in traditional costing methods by more closely aligning activities with products. Like in our case; National Pen Company, abandoning the traditional division between product and period costs, instead of seeking for a more direct linkage between activities, costs and products. In ABC costing products are charged with the cost of manufacturing and nonmanufacturing activities (Bragg, 2010). Also, a product is only charged with the cost of capacity utilized. The only drawback to this cost method is that external reporting must be based on traditional absorption cost methods.

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