Wilkerson Case Study

Q. What is the competitive situation faced by Wilkerson?

A.

  1. Competitors are reducing the price on pumps that in turn forcing Wilkerson to cut its prices too.  This took the pre-tax margin below 3% and gross margin to 19.5% which is way below the planned gross margin of 35%.  Production of Pumps is most costly but it gets the lowest margin in the Wilkerson product line as it is selling at $20 below the targeted price.
  2. The flow controller is the most resource-intensive product as it requires more components and resources but it is not getting the appropriate revenue because of the inappropriate current volume-based costing method. Therefore even when Wilkerson increased the price of the flow controller, the demand remains the same.
  3. Demand for valves are less elastic as compare to pumps in the commoditized market and can be produced and shipped in large quantity so it can benefit from economies of scale. Thus Wilkerson can increase the price and its profit margin on the valves.

Q. Given some of the apparent problems with Wilkerson’s cost system, should executives abandon overhead assignment to products entirely by adopting a contribution margin approach in which manufacturing overhead is treated as a period expense? Why or why not?

A.

Yes, Wilkerson should use the contribution margin approach as it recognizes the variable and fixed cost and can be attributed to each product i.e. valve, pump and flow control based on the machine-related expense, setup labor, receiving and production control, engineering and packaging, and shipping.

In the present costing method, the manufacturing overhead is estimated by multiplying direct labor cost with 300%. This estimation is not accurate and allocates the wrong cost to the product which results in mispricing which costs the company with losses.

Q.

How does Wilkerson’s existing cost system operate? Develop a diagram to show how costs flow from factory expense accounts to products. In other words, how do machine expense, set-up labor, receiving/production control, engineering, and packaging/shipping costs get allocated to valves, pumps, and flow controllers?

A.

In the current system, the manufacturing overhead is allocated based on the direct labor cost. The labor cost is multiplied by 300% to reach the total cost.

Q.

Diagram an activity-based cost model using the information in the case.

A.

Q.

What difference does your ABC cost assignment have on reported product costs and profitability, as compared to the standard costing profitability reported in the Case Exhibit 2 for valves, pumps, and flow controllers?

A.

In the case of standard costing, there is no recognition of activities that are part of the production and manufacturing overhead is allocated based on labor cost multiplied to 300%. According to standard costing the company is earning a profit of 34.9% on Valves, 19.5% on pumps and 41% on Flow controller.

In case of ABC costing the different activity has been recognized namely machine-related expense, setup cost, receiving and production control, engineering and packaging, and shipping. The overhead cost allocation under ABC and Standard costing are as follow:

In ABC we can see that the actual profit margin in the valve is 46.3% against reported of 34.9%. In the case of the pump, the gross profit is 33.1% as against reported profit margin of 19.5% and inflow controller, the company is actually incurring loss instead of profit of 41%.

Q.

What actions might Wilkerson’s management team consider to improve the company’s profitability?

A.

The Wilkerson’s management should adopt ABC costing as it reveals the real costing of the product. Under this, the management can understand that it can reduce the price of the valve to compete better and it can comfortably increase the price of the flow controller as it is in the loss as even in price increment of flow controller the demand does not go down. It will help the management to understand the cost behavior and making a proper pricing strategy.

Q.

Wilkerson has been compensating salespersons with commissions on their gross sales volumes (fewer returns). Parker wonders whether the company should change this incentive system. What is your advice on this matter?

A.

Currently, the commission is totally dependent on gross sales value. In this case, the high price product will be pitched by the salesperson. The highest-priced product, in this case, is Flow controller but in actual by selling this the salesperson is giving loss to the company as ABC costing showing it at a loss when sold for that price.

Thus the sales commission should be based on the gross profit rather than sales value. In this case, the salesperson will try to sell those products that carry maximum profit.