Case submission 4

Wilkerson Company
 INTRODUCTION

Wilkerson Company supplies products to manufacturers of water purification

equipment. It has three types of product lines Valve, Pump, and Flow Controller.
Production department for all products is a common one. Also, semi-finished
components are purchased from several suppliers, then machined and assembled.
Because of severe price cutting in pumps, Wilkerson’s major product line, their pre-tax
margin has fallen from 10% to 3%.

It uses a simple cost accounting system based on Volume Based Costing approach. In
this approach, the overhead costs are allocated to products as a percentage of
production-run labor cost at a rate of 300%. The reason for following this approach is
because it is an inexpensive way of allocating overhead costs to products.

PROBLEM WITH VOLUME-BASED COSTING

➢ The problem with the traditional Volume-Based Costing Approach is that many
overhead costs are not in proportion to the output volume. Many overhead costs
are affected by production complexity rather than volume. This may lead to
irregular costing for different products.
➢ The reason for this discrepancy is that setup costs are allocated on the basis of
production volume leading to large allocation of setup cost. This leads to the high-
volume product being over costed.
➢ This leads to misleading profitability analysis which causes inappropriate pricing
decision and ineffective cost management.
➢ Using Activity-Based Costing approach, the variation between cost of the high-
volume product and low-volume product can be easily identified and analyzed.
➢ In Activity-Based Costing Approach, first, major activities and related cost
drivers are identified.
Manufacturing MR set up R&P engineering packaging total Earlier change %change
overhead expense control and shipping

valves 112500 2500 11250 20000 5000 151250 225000 -73750 -32.78%

pumps 187500 12500 56250 30000 35000 321250 468750 -147500 -31.47%

FC 36000 25000 112500 50000 110000 333500 120000 213500 177.92%

Valves Pumps FC

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 Earlier ABC Earlier ABC Earlier ABC
Direct labour cost 10 10 12.5 12.5 10 10
DMC 16 16 20 20 22 22
MOH 30 20.17 37.5 25.7 30 83.38
Standard unit cost 56 46.17 70 58.2 62 115.38

SP 86 86 87 87 105 105
Gross margin 34.9% 46.3% 19.5% 33.1% 41.0% -9.9%
Now, comparing the product profitability analysis between the two approached –
Volume-Based and Activity-Based as shown below:

It can be easily seen that gross margin of high-volume product – Pumps - is actually
near the planned gross margin whereas the gross margin of low-volume products –
Flow Controllers is in negative, i.e., it is making loss for the company.

As mentioned before, the reason for this is that the production process for Flow
Controllers is complex in comparison to Pumps. The number of production runs for Flow
Controllers is 100 whereas the number of production runs for Pumps is nearly half that
is 50.

CONCLUSION

From the above shown analysis, it can be concluded that the falling margin is a result of
negative gross margin of Flow Controllers. To improve its profitability, the company
needs to better price the flow controllers. Given that the recent price increase of Flow
Controllers by 10% had not impact on it demand, its demand can be said to
inelastic. They can continue increasing their margin in intervals by 7-10% until the
planned gross margin is reached. If it starts to affect its demand at a low margin, then the
company can consider to discontinue its production.

For rest of the two-product lines, based on industry conditions, the company can either
try to build competitive advantage by investing or becoming a cost leader by optimizing
its various production activities.

The major disadvantage for using ABC based accounting method is that it does not
measure the incremental costs needed to produce an item. Therefore, to assume the

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full-cost information as incremental cost information can negatively impact decision
making of the company.