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UPLOAD 3
UPLOAD 3
$ $
Target selling price 86 $ 108 95
Planned gross margin (%) 35% 35% 35%
$ $
Actual selling price 86 $ 87 105
Actual gross margin (%) 34.90% 19.50% 41%
General Financial Information 2
Wilkerson Case Study
Product Data
Product lines Valves Pumps flow Controllers
Materials per Unit $ 4 $ 6 $ 4
$ 12 $ 14 $ 10
$ 8
materia cost per uniT $ 16 $ 20 $ 22
direct labor per unit dl hour 0.4 0.5 0.4
direct labor $/unit@25$/dl hour $ 10 $ 13 $ 10
machine hours per unit 0.5 0.5 0.3
Tasks
•Wilkerson was forced to match the reduced prices on market to maintain the volume, but severe price cutting on pumps has
dropped has dropped pre tax margin less than 3 %
•Valves were standardized products and could be produced and shipped in large lots. Most important is that competitors could
have competed in context of quality of product but no one tried to gain market share by reducing prices , and actual gross
margin was almost the same as it was planned.
•Product is less sensitive compared to others that’s why company can maintain high price and at the same time have high
volume.
Q2 - Overhead assignment to products 6
Wilkerson Case Study
Should executives abandon overhead assignment to products entirely by adopting a contribution margin
approach in which manufacturing overhead is treated as a period expense?
• The contribution margin approach separates fixed and variable costs which cannot be normally seen on a traditional
income statement.
• Wilkerson should adopt a contribution approach because they are a company with three products and it is useful to
understand the variable expenses that can be attributed to each product. Thus the company can understand which costs
increases if production increases.
• In a traditional income statement approach, it is difficult to determine which costs belong to increasing productivity
whereas this is much easier in a contribution margin approach.
• A contribution margin statement would be required if Wilkerson wanted to conduct further analysis such as target profit
analysis, break-even and margin of safety.
• Also for internal calculations the contribution approach would help determine:
• cost-volume analysis (including CM ratio and variable expense ratio for example)
Diagram for existing cost system 8
Wilkerson Case Study
300%
*
based on labour cost based on labour cost based on labour cost
Finishes product
Selling, General
and Administrative
costs
Q3 - Activity-based costing 9
Wilkerson Case Study
• Activity-based costing allows tracing indirect costs to product with a high degree of accuracy. While volume-based
costing is implicitly based on an assumption that there’s a direct relationship between volume of production of individual
products and level of overhead, activity-based costing allows finding individual relationships between volume of
production and different overheads.
• It becomes possible due to combining overheads into cost pools and allocating these cost pools to products in proportion
to selected cost drivers that reflect these individual relationships between volume of production and level of overheads.
• Wilkerson should pool overheads into five groups (cost pools):
• Machine-related expenses
• Setup labor cost
• Receiving and production control
• Engineering
• Packaging and Shipment
• The next step is choosing most appropriate cost drivers that reflect the relationship between volume of production
of individual products and level of overheads.
• Machine hours are the most natural cost driver for machine-related expenses
• Both setup and receiving, and production control activities are changed in proportion to number of production
runs
• Engineering cost can be allocated in proportion to hours of engineering work
• Packaging and shipment activity is driven by the number of shipments
Diagram for Activity-based costing 10
Wilkerson Case Study
Production
Department • Machine-related expenses
• Setup labor cost
• Receiving and production control
ABC • Engineering
Find Activity
• Packaging and Shipment
Calculate
manufacturing
overhead
Finished products
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.
Existing Activity-Based
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%.
Q5 12
Wilkerson Case Study
What actions might Wilkerson’s management team consider to improve the company’s
profitability?
• 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
• General recommendation is that the company should revaluate the industry average margins and redesign its own
targets based on the results, given that they are selling different product types (commodities vs. customized).
Otherwise, management may misallocate company resources or misjudge results.
Q6 13
Wilkerson Case Study
• Customer information:
It would be very useful to have information about key accounts. The company could manage key accounts in more
detail and gain loyalty and, therefore profitability in the medium term. Also, customer requirements in advance could
be very helpful as the production department could plan and schedule productions in advance and gain efficiency.
• Order breakdown:
Each order should detail the number of units of each product. With this information, the company should be able to
determine a minimum quantity order to be more efficient and reduce packaging and shipping costs.
• Shipping information:
It would be very useful to have information about how the company is managing its shipments i.e. whether the
company outsources the shipping service to third parties, or whether the company carries out its own logistics. With
this information, certain decisions could be made in order to become even more efficient in cost reduction.
Q7 14
Wilkerson Case Study
Wilkerson has been compensating sales persons with commissions on their gross sales volumes
(less returns). Parker wonders whether the company should change the incentive system.
• Wilkerson currently pays commissions on gross sales. This means that regardless of a product's gross margin
(GM), a sales person is motivated to sell as many units of the product with the highest price, as they will be
receiving the highest commission.
• This is problematic because flow controllers yield a negative GM but its high pricing motivates salespeople to
sell these to the company's detriment.
• One solution is to pay salespeople on GM. By weighting each product according to its GM (e.gp pumps have
the highest gross margin, therefore, they have the highest commission rate of 7.25%), salespeople will earn
most when they sell more of the most profitable products.
• We suggest weighting the flow controller lowest until management can increase its margins.
• For now, direct sales efforts to valves and especially pumps where Wilkerson need to maintain their edge
against industry competitors.