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previous run if we just dumped in enough black ink to cover it up. But for the REDpens, even small traces of the blue or black ink created quality problems. And the inkfor the new PURPLE pens also has demanding specifications, but not quite asdemanding as for RED pens.We seem to be spending a lot more time on purchasing and scheduling activities andjust keeping track of where we stand on existing, backlogged and future orders. Thenew computer system we got last year helped a lot to reduce the confusion. But I amconcerned about rumours I keep hearing that even more new colours may beintroduced in the near future. I don’t think we have any more capability to handleadditional confusion and complexity in our operations.OperationsModern produced pens in a single factory. The major task was preparing and mixing the inkfor the different-coloured pens. The ink was inserted into the pens in a semiautomatedprocess. A final packing and shipping stage was performed manually.Each product had a bill of materials that identified the quantity and cost of direct materialsrequired for the product. A routing sheet identified the sequence of operations required foreach operating step. This information was used to calculate the labour expense for each ofthe four products. All of the plant’s indirect expenses were aggregated at the plant level andallocated to products on the basis of their direct labour content. Currently, this overheadburden rate was 520% of direct labour cost. Most people in the plant recalled that not toomany years ago the overhead rate was only 200%.Activity-Based CostingJane Hayvice had recently attended a seminar of her professional organisations in which aprofessor had talked about a new concept, called activity-based costing (ABC). This conceptseemed to address many of the problems she had been seeing at Modern. The speaker hadeven used an example that seemed to capture Modern’s situation exactly.The professor had argued that overhead should not be viewed as a cost or a burden to beallocated on top of direct labour. Rather, the organisation should focus on activitiesperformed by the indirect and support resource of the organisation and try to link the cost of2
performing these activities directly to the products for which they were performed. Hayviceobtained several books and articles on the subject and soon tried to put into practice themessage she had heard and read about.Activity-Based Cost AnalysisHayvice first identified six categories of support expenses that were currently being allocatedto pen production:EXPENSE CATEGORYEXPENSEIndirect labour$25,000Fringe Benefits15,000Computer systems10,000Machinery9,000Maintenance3,000Energy3,000Total