1395295 Maaz Gabbur

ACCTG 523: Wilkerson Case1. 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 Wilkerson’s cost system, should executives abandon overhead assignments to individual products entirely, as some of Wilkerson’s 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 Wilkerson’s 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 Wilkerson’s 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 M/C related Exp Setup Labour Rec & Prod Ctrl Enggg Costs Shipping

Manufacturing OHs 3,36,000 40,000 1,80,000 1,00,000 1,50,000

Cost drivers Machine hrs (Point 1)

Production Run (Point 2)

Production Run (Point 3)

Eng Hrs # of shipments (Point 4)

Value 11,200 160 160 1,250 300Rate per hour 30 250 1,125 80 500

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 poolsActivity Cost Pool Valves Pumps Flow Ctrlors Total Cost DriversMachine Related 112500 187500 36000 336000 Machine HrsSetup Labor 2500 12500 25000 40000 Prod RunsReceiving & Production Ctrl 11250 56250 112500 180000 Prod RunsEngineering 20000 30000 50000 100000 Engg Work HrsPackaging and Shipping 5000 35000 110000 150000 # ShipmentsTotal 151250 321250 333500 806000

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3. Calculate activity rates (Costs & Profitablity)Per unit Activity Based Costing Valves Pumps Flow Controllers

Production Units 7,500.0 12,500.0 4,000.0Direct Labor Cost 10.0 12.5 10.0Direct Material Cost 16.0 20.0 22.0

Machine Related Expenses 15.0 15.0 9.0Setup Labor Expenses 0.33 1.00 6.25Receiving and production 1.5 4.5 28.1Engineering Expenses 2.67 2.40 12.50Shipping Expenses 0.67 2.80 27.50Total 46.17 58.20 115.38

4. Assign overhead costs to cost objects using the activity rates and activity measuresMargin Calculation Valves Pumps Flow Controllers

Planned Selling Price 86.15 107.69 95.38Actual Selling Price 86 87 105Per unit Activity Based Costing 46.17 58.20 115.38Margin (based on Planned SP) 46.41% 45.96% -20.96%Margin (based on Actual SP) 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.

5. Based on your analysis for Question 4, what actions might Wilkerson’s management team consider to improve the company’s 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.