We seem to be spending a lot more time on purchasing

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 we got last year
helped a lot to reduce the confusion. But, I am concerned about rumors I keep hearing that even more new
colors may be introduced in the near future. I don’t think we have any more capability to handle additional
confusion and complexity in our operations.
Operations
Classic produced pens in a single factory. The major task was preparing and mixing the ink for
the different-colored pens. The ink was inserted into the pens in a semiautomated process. A final
packing and shipping stage was performed manually.
Each product had a bill of materials that identified the quantity and cost of direct
materials required for the product. A routing sheet identified the sequence of operations required
for each operating step. This information was used to calculate the labor expenses for each of the
four products. All of the plant’s indirect expenses were aggregated at the plant level and allocated
to products on the basis of their direct labor content. Currently, this overhead burden rate was
300% of direct labor cost. Most people in the plant recalled that not too many years ago the
overhead rate was only 200%.

Activity-Based Costing
Jane Dempsey had recently attended a seminar of her professional organization in which a
professor had talked about a new concept, called activity-based costing (ABC). This concept
seemed to address many of the problems she had been seeing at Classic. The speaker had even
used an example that seemed to capture Classic’s situation exactly.
The professor had argued that overhead should not be viewed as a cost or a burden to be
allocated on top of direct labor. Rather, the organization should focus on activities performed by
the indirect and support resource of the organization and try to link the cost of performing these
activities directly to the products for which they were performed. Dempsey obtained several
books and articles on the subject and soon tried to put into practice the message she had heard
and read about.
Activity-Based Cost Analysis
Dempsey first identified six categories of support expenses that were currently being allocated to
pen production:
Expense Category Expense
Indirect Labor $20,000
Fringe Benefits 16,000
Computer Systems 10,000
Machinery 8,000
Maintenance 4,000
Energy 2,000
TOTAL $60,000
She determined that the fringe benefits were 40% of labor expenses (both direct and
indirect) and would thus represent just a percentage markup to be applied on top of direct and
indirect labor charges.