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BUSI 294Activity Based Costing Question 1Jane Dempsey, controller of the Classic Pen Company, was concerned about the recent financial trends in operating results. Classic Pen had been the low-cost producer of traditional BLUE pens and BLACK pens. Gross margin were over 20%of sales. Several years earlier Dennis Selmor, the sales manager, had seen opportunities to expand the business by extending the product line into new products that offered premium selling prices over traditional BLUE and BLACK pens. Five years earlier, RED pens had been introduced; they required the same basic production in technology but could be sold at a 3% premium. And last year, PURPLE pens had been introduced because of the 10% premium in selling price 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 is down, and even the new products are not earning the margins we used to see from our traditional products. Perhaps this is the tougher global competition I have been reading about. At least the new line, particularly PURPLE pens, is showing much higher margins. Perhaps we should follow Dennis’s advice and introduce even more specialty coloured pens. Dennis claims that consumers are willing to pay higher prices for thesespecialty colours.”Jeffrey Donald, the manufacturing manager, was also reflecting on the changed environment at Classic Pen:“Five years ago, life was a lot simpler. We produced just BLUE and BLACK pens in long production runs, and everything ran smoothly, without much intervention. Difficulties started when the RED pens were introduced, and we had to make more changeovers. This required us to stop production, empty the vats, clean out all remnants of the previous colour, and then start the production of the red ink. Making black ink was simple; we didn’t even have to clean out the residual blue ink from the previous run if we just dumped in enough black ink to cover it up. But for the RED pens, even small traces of theblue or black ink created quality problems. And the ink for the new PURPLE pens also has demanding specifications, but not quite as demanding as for RED pens.1
We seem to be spending a lot more time on purchasing and scheduling activities and just keeping track of where we stand on existing, backlogged, and future orders. The new computer system wegot last year helped a lot to reduce the confusion. But I am concerned about rumors. I keep hearing that even more new colours may be introduced in the near future. I don’t think we have any more capabilityto handle additional confusion and complexity in our operations.”OperationsClassic produced pens in a single factory. The major task was preparing and mixing the ink for the different-coloured pens. The ink was inserted into the pens in a semi-automated process. A final packing and shipping stage was performed manually.