Managerial Accounting

Wilkerson Company
Case Study
Group 10
Roadmap

Correction for unused Recommendation

Introduction Existing cost system capacity

1 3 5 5

2 4 6

Analysis New Costing method

Limitations of analysis

2
Introduction
Company Overview
▪ A mid sized manufacturing company for
water purification system
▪ It specializes in Producing of 3 products:
Valves
Pump
Flow Controller Issues to address

▪ Wilkerson Company has one producing

department, where all the components are ▪ Falls in Profit - A growing Concern
machined and assembled. ▪ Margins at an all - time low of 3%
▪ Uses Volume Based Costing because it's less
costly.

3
Analysis of competitive situation
Wilkinson company

Pump Flow controller Valves

Commodity product Customised product Standard

Produced in high volume Less competitive market Produced and shipped in
Severe price competition Inelastic product large quantity

Despite the fact that they can match Wilkerson's quality, there is no evidence of price competition at this time.
Wilkerson should, however, be prepared to compete on pricing in the long run.
Wilkerson is analysing its overhead expenses due to existing (pumps) and potential (valves) price competition, as
there are no cost-cutting reserves remaining in its supply chain as both customer and suppliers agreed to just-in-
time delivery
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 Existing Cost System
Wilkerson implements volume based full costing
Direct materials Standard price of material
labor costs Standard price of labour
Allocated to cost objects (products) in proportion to
Indirect cost (overhead)
direct labor cost at the rate of 300%.

Problems related to volume based costing

● Overheads are quite high (300% to direct labor cost)

● In terms of indirect resource usage, products differ.
○ Flow controllers are customised, whereas pumps and valves are common components, thus we
can expect a higher unit cost for the latter.
○ Volume-based costing, which uses a one-stage indirect cost allocation (from the aggregated cost
pool to the products), does not allow for distinguishing indirect costs across goods depending on
their demand for indirect resources.
○ Currently, overheads are assigned to goods in proportion to direct labour expenses, despite the
fact that they are not technologically related to direct labour.

5
New Costing Method

1. Direct costing and Contribution analysis

● Direct costing and contribution analysis are adequate for short-term decision making.
● In the long-run under price competition, however, the company needs to be sure that each product is at a minimum break
even.
● Direct costing would provide highly unreliable information for decision-making overheads are significant

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 Activity Cost Cost Driver Cost Driver
Activity
Pool
Cost Driver
Quantity 2. Activity Based Costing
Rate

Activity-based costing allow to tracing

Machine
Related
indirect costs
$336,000 to product 11,200
Machine
Hours
with a high degree
$30
of accuracy.
Activity-based costing finds individual
Production
Setup relationships Runs
$40,000 between volume
160 of $250

production and different overheads.

Receieving and Wilkerson can pool overheads into five

Production
Production groups (cost pools):
$180,000
Runs machine-related
160 $1,125
Control
expenses, setup labor cost, receiving and
production control, engineering, packaging
and shipment.

7
 Unit Costs Under Activity Based Costing
Cost Items/Products Valves Pumps Flow Controllers
Direct Cost
Direct Material $16.00 $20.00 $22.00
Direct Labor $10.00 $12.00 $10.00

Overheads
Machine-related expenses $15.00 $15.00 $9.00
Setup Labor $0.33 $1.00 $6.25
Receiving And Production Control $1.50 $4.50 $28.13
Engineering $2.66 $2.40 $12.50
Packaging And Shipping $0.67 $2.80 $27.50

Activity-based costing provides much accurate information about product cost and their
gross margins. Customized product (flow controllers) appear to be much less attractive for
the company that standardized valves and pumps. Actually, flow controllers generate
negative gross margin (under assumption made), while valves and pumps are much more
profitable than the company initially believed.

8
Product Profitability: Volume Based Costing VS Activity Based Costing

Valves Pumps Flow Controllers

Actual Price $86.00 $87.00 $105.00
Wilkerson can continue to
Volume-based costing reduce prices of products
Standard unit costs $56.00 $70.00 $62.00 (valves and pumps) as their
margins are high, but have to
Actual gross margin (%) 34.90% 19.50% 41.00%
react to negative profitability
of flow controllers.
Activity-based costing
Standard unit costs $46.17 $58.20 $115.38

Actual gross margin (%) 46.30% 33.10% -9.90%

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Correction for unused capacity

● Variations in capacity utilisation may have a considerable influence on

individual product unit costs.
● as a result, on decisions made based on a thorough cost analysis.
● If demand is higher in some months and Wilkerson is still able to satisfy it, we
should recognise the fact that we have unused capacity in the "average month"
we examine.
● Product gross margins will rise as capacity utilisation rises.
● According to preliminary study, flow controllers may have a low but positive
margin if capacity utilisation increases as predicted.
● If we have reason to assume that the firm will be able to boost capacity
utilisation in the long term,cost analysis for particular products should be
based only on the cost of used capacity, taking the cost of unused capacity out
of the equation.
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Limitations of analysis

● Our cost drivers and product cost calculations prevent us from exposing the
differences between unique flow controllers, despite the fact that we know they
are customised.
● As a result, their unit prices are averages that may vary greatly depending on
the configuration (cost of manufacture) or the client (cost of delivery).
● We are unable to handle the influence of product volume variations on unit
costs since regular study of product profitability based on activity-based
costing is a costly exercise.
● In this case, we'll suppose that capacity utilisation estimations are done for a
representative (typical) month.
● For a particular time horizon of decisions based on calculations, we also
assume that resource costs (including cost driver rates for overheads) are
constant.
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 Recommendations

To improve the company’s profitability, Wilkerson’s

management should implement the following steps:
(a)To determine the correct cost and profitability of its
product lines, selling expenses should be distributed to
various product lines based on relevant cost drivers.
(b)To achieve prompt customer payments, sales incentives
should be focused on fast customer service recovery
rather than gross sales.
(c)Efforts should be made to reduce the number of
shipments by dispatching multiple orders from the same
client at the same time to reduce packaging and shipping
costs.
(d)To minimise associated idle set-up time and set-up cost,
efforts should be taken to reduce production runs and
maximise production in a single stretch.
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13
Thank you
Group 10