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ACCTG 523: Wilkerson Case
1. What is the competitive situation faced by Wilkerson?
Wilkerson is facing a severe decline in profits and has been forced to severely cut prices
of its products, which has been a result of it facing a stiff price war with its competitors in
its pumps product line. This has resulted in the pretax margin shrinking from 10% to less
than 3%.
2. Given some of the apparent problems with Wilkersons cost system, should
executives abandon overhead assignments to individual products entirely, as
some of Wilkersons competitors appear to be doing? Would setting prices
based on product-line contribution margins be advisable for Wilkerson? Why or
why not?
In the present approach, direct material and labor costs decide standard prices.
Overheads are charged as 300% of the direct labor cost. This indicates that the
overheads are applied directly in relation to labor costs irrespective of relevance. Hence,
the cost drivers used to calculate the overhead costs vary greatly with each product line.
Workers working on different machines at the same time also result in over calculation of
the overhead costs with this approach. The gross margin thus calculated does not depict
its true value. Considering these problems it seems to be a wise approach to change the
cost accounting and set prices based on product line contribution margins.
3. How does Wilkersons existing cost system operate?
Wilkerson uses a simple job-based costing method as explained above. In the present
approach, direct material and labor costs decide standard prices. Overheads are charged
as 300% of the direct labor cost.
4. Develop an activity-based cost model using the information in the case.
Provide your best estimates about the cost and profitability of Wilkersons
three product lines. What difference does your cost assignment have on
reported product costs and profitability? What causes any shifts in cost and
profitability?
The following steps have been followed to develop an activity based costing method:
1. Identify and define activities, activity cost pools, and activity measures.
Cost Drivers &
Rates
Manufacturing
OHs
M/C related
Exp
Setup
Labour
3,36,000
40,000
Production
Run (Point
2)
160
250
Cost drivers
Machine hrs
(Point 1)
Value
Rate per hour
11,200
30
Rec & Prod Ctrl
Enggg
Costs
1,80,000
1,00,000
Production Run
(Point 3)
Eng Hrs
160
1,125
1,250
80
Shipping
1,50,000
# of
shipments
(Point 4)
300
500
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This table tells us about the various activities on which we have based the costing
basically the cost pools, drivers of the relevant cost pools and the rate of the costing
which should be taken into account.
2. Assign overhead costs to activity cost pools
Flow
Activity Cost Pool
Valves
Pumps
Ctrlors
Total
Machine Related
112500
187500
36000 336000
Setup Labor
2500
12500
25000
40000
Receiving & Production
Ctrl
11250
56250
112500 180000
Engineering
20000
30000
50000 100000
Packaging and Shipping
5000
35000
110000 150000
Total
151250 321250
333500 806000
3.
Cost Drivers
Machine Hrs
Prod Runs
Prod Runs
Engg Work Hrs
# Shipments
Calculate activity rates (Costs & Profitablity)
Per unit Activity Based
Costing
Production Units
Direct Labor Cost
Direct Material Cost
Machine Related Expenses
Setup Labor Expenses
Receiving and production
Engineering Expenses
Shipping Expenses
Total
Valves
7,500.0
10.0
16.0
Pumps
12,500.0
12.5
20.0
Flow Controllers
4,000.0
10.0
22.0
15.0
0.33
1.5
2.67
0.67
46.17
15.0
1.00
4.5
2.40
2.80
58.20
9.0
6.25
28.1
12.50
27.50
115.38
4. Assign overhead costs to cost objects using the activity rates and activity
measures
Margin Calculation
Valves
Pumps
Flow Controllers
Planned Selling Price
Actual Selling Price
Per unit Activity Based Costing
Margin (based on Planned
SP)
Margin (based on Actual
SP)
86.15
86
46.17
107.69
87
58.20
95.38
105
115.38
46.41%
45.96%
-20.96%
46.32%
33.10%
-9.88%
Based on the activity based costing model, the overheads are allocated on the basis of
the activity associated with it. Due to this the overhead costs per unit of flow controllers
increases as compared to the earlier being used and also decreases the overhead unit
costs of other products.
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5. Based on your analysis for Question 4, what actions might Wilkersons
management team consider to improve the companys profitability?
Based on my analysis I would recommend that Wilkerson Company to adopt the activity
based costing to better analyze the cost figures and financial status of the company. It
will enable the overheads to be attached to the products and activities where they are
being consumed and not directly be related to the products on the basis of production
run direct labor hours. The gross returns calculated from these two methods vary wildly
in both the cases. The flow controller statistics support this proposition. Volume based
costing indicates that the product is highly profitable providing a gross margin of 40.95%
whereas the activity based costing shows us that flow controllers are not providing any
returns and on the contrary it is a loss making product since we are unable to recover
even the costs involved.
6. What concerns, if any, do you have with the cost estimates you prepared in
the answer to Question 4? What other information or analysis would you want
for better cost and profitability estimates?
Several assumptions have been made while carrying out this analysis such as average
costs for a unit of flow controller. Administrative expenses are not taken into
consideration while performing the calculations. We are assuming that all the goods are
sold holding no inventory. The profitability may thus be incorrect. Moreover additional
information on cost drivers will help strengthen or rebut the hypothesis proposed above.
