Wilkerson

Submitted to:
Dr. Archana Patro
Company
Group 8
Divya Sharma
Aradhana Patwa
Asmita Singh
Deepali Gupta
Ashima Goel
Shabhnam Kerketta
Sumeet Tigga
 Operating Results (March 2000)

Sales 2152500
Direct Labor Expense 271250
Direct Material Expense 458000
Manufacturing Overhead
Machine related Expenses 336000
Setup Labor 40000
Receiving and production Control 180000
Engineering 100000
Packaging and Shipping 50000
Total manufacturing Overhead 806000
Gross Margin 617250
General, Selling and Admin Expenses 559650
Operating Income 57600
Product Profitability Analysis (March 2000)

Valves Pumps Flow Controllers

Direct Labor Costs 10 12.5 10
Direct Material Cost 16 20 22
Manufacturing Overhead (@300%) 30 37.5 30
Standard Unit Costs 56 70 62

Target Selling Price 86.15 107.69 95.38

Planned Gross Margin(%) 35% 35% 35%

Actual Selling Price 86 87 105

Actual gross margin(%) 34.90% 19.50% 41%
 Product data

Product Valves Valves Pumps Flow Controllers

materials per unit 4 components 5 components 10 components
2@$2=$4 3@$2=$6 4 @ $ 1= $ 4
2 @ 6 = 12 2 @ 7 = 14 5 @ 2 = 10
1@8=8
Materials cost per unit $16 $20 $22
Direct Labour per unit 0.4 DL hrs 0.5 DL hrs 0.4 DL hrs
Direct Labour $/ unit @ $25/DL hour $10 $ 12.50 $ 10

Machine hours per unit 0.5 0.5 0.3

monthly Production and operating Statistics

Valves Pumps Flow Controllers Total

Pruductuion Units 7500 12500 4000 24000
Machine hourd 3750 6250 1200 11200
Production Runs 10 50 100 160
Number of shipments 10 70 220 300
Hours of engineeing 250 375 625 1250
  1.      What is the competitive situation faced by Wilkerson?

The competitive situation is different between the products.

Pumps are commodity products, produced in high volumes for a market with high pricecompetition -
price cutting by competitors led to a drop of Wilkerson’s pre-tax margin to under 3%, gross margin on
sales for pump sales has fallen below 20%.

Flow controllers are customized products, sold in a less competitive market with inelasticdemand at the
current price range.
Valves are standard, produced and shipped in large lots - gross margins have been maintained at 35%.
Wilkerson is a quality leader, but this leadership may soon be contested by severalcompetitors.
Although they are able to match Wilkerson's quality, there are no signs of price-competition as of now.

Nevertheless, in the long-run Wilkerson should be prepared to compete on price.

The price competition pushes Wilkerson to analyze its overhead costs, since no reserves of cost cutting
are left in its supply chain.
2.      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?

The problem in the current pricing method used by Wilkerson is that the real manufacturingcost of each product is not realistic
because of the high proportion of overhead costs whichare 806,000 of 1,535,250 (52.5%).

The current method assumes the overhead costs are correlated to the labor costs at 300% rate,while many of the overhead activities
are performed per product line regardless of the amountof units produced.

The approach of treating the overhead expenses as a period expense, suggests that the product cost and profitability will be
measured without overhead costs (by increasing the profitabilitymargins). This means there is a correlation between the variable
costs (labors and materials)to the product price.

The method doesn't consider the different activities performed for each product line.Although in a lucky way better reflects the real
cost of the products, giving more weight of the overhead costs to the Flow Controllers, just because their material price is higher, but
not
from the real reason (higher activity costs), this solution is not good from similar reasons likethe current method.
3. How does Wilkerson‘s existing cost system operate? Develop a diagram to show how costs flow from factory expens

Wilkerson's existing cost system of is the traditional volume-based costing: Direct materialsand labor costs are based on standard prices of
rates.
In addition, themanufacturing overhead is also considered as cost and it is allocated in proportion to directlabor cost at the rate of 300% (B
that there’s a direct relationship between volume of production of individual products and level of overhead).

Product Valves Pumps Flow Controllers Total

Pruductuion Units 7500 12500 4000 24000
Direct Labor Costs 75000 156250 40000 271250
Direct msterial 120000 250000 88000 458000
Total direct Costs 195000 406250 128000 729250
Overhead Costs @300% 225000 468750 120000 813750
Total costs 420000 875000 248000 1543000
w from factory expense accounts to products.

sed on standard prices of materials and labor

ost at the rate of 300% (Based on the assumption

4. Develop and diagram an Activity Based cost model using the information in the case Provide your best estimates about the cost and profitability of Wilkerson’s t
does your cost assignment have on operated product costs and profitability? What causes any shifts in cost and profitability?

As overhead costs are not in proportion with the volume of production output the cost systemWilkerson is using at the moment is an in
wrong assumptionswhen analyzing profitability and therefore leads to wrong pricing decisions and ineffectivecost management.

Activity based costing helps to find the real relationship between thevolume of production of a product and the overhead. In a first step
and find the drivers of those costs. In Wilkerson’s case the different pools would be machine related expenses, set up labor, receiving an
andshipping and engineering.

The related cost drivers are machine hours, production runs, hoursof engineering work and number of shipments.

Cost Activity Amount Cost Driver Quamtity Cost driver rate

Machine Related Exp. 336000 Machine hrs 11200 30
Setup Labor 40000 Production runs 160 250
R&P Control 180000 Production runs 160 1125
Enfineering 100000 Hrs of Engineering work 1250 80
Packaging 150000 No of Shipments 300 500

Product Valves Pumps Flow Controllers Total

Pruductuion Units 7500 12500 4000 24000
Direct Labor Costs 75000 156250 40000 271250
Direct msterial 120000 250000 88000 458000
Machine Related Exp. 112500 187500 36000 336000
Setup Labor 2500 12500 25000 40000
R&P Control 11250 56250 112500 180000
Enfineering 20000 30000 50000 100000
Packaging 5000 35000 110000 150000
Total cost 13750 68750 0 1535250
Cost per unit 1.8333333333 5.5 0 63.96875
Actual Selling Price 86 87 105
Actual margin 98% 94% 100%
nd profitability of Wilkerson’s three product lines. What difference
ifts in cost and profitability?

is using at the moment is an inappropriate method that leads to

ctivecost management.

nd the overhead. In a first step it is necessary to definecost pools

nses, set up labor, receiving and production control, packaging

ipments.
5. Based on your analysis for Question 4, what actions might Wilkerson’s management team consider improving the
company’s profitability?

5.The first thing to take care of is the Flow Controllers, as the Wilkerson's management teamcan take advantage of the
favorable competitive situation in this market which is the inelastic in demand and the lack of competition, and
therefore raise their price up to the range between116-177.5, depends on the market reaction (even if the previous
10% price raise didn'tdamaged the sales, a 50% raise may damage them).

Also the management team can compete in the price competition on the valves and pumps tomaintain and maybe
increase their market share , although an exam should be made in order to check if the price decrease will harm
the profit.
6. What concerns, if any, do you have with the cost estimates you prepared in the answer to Question4? What other information or analysis would you want for bett
profitability estimates?

The cost calculations in question 4 are sensitive to the utilization of the product line.

We based our numbers on the information of March 2000, which is mentioned as a typical month, but it is also mentioned that on months of high demand
machines worked 12,000 hours,factory handled 180 production runs and 400 shipments.

The cost calculations would be best achieved if we based it on past years demands charts which include seasonal shifts in demands.The cost of the resources
and labor can also change during time and should be updated for accurate cost calculation
nalysis would you want for better cost and

months of high demand

s.The cost of the resources

7. Wilkerson has been compensating salespersons with commissions on their gross sales volumes(less returns).Parker wonders whether the company
should change this incentive system.

The current salespersons incentive system, based on volumes only, drives the salespersons tomaximize their sales
regardless Wilkerson's profit.
There are 2 main problems-1. The salespersons will want to sell for the lowest price they can, in order to increase
their sales volume.2. If the Company has several product lines, the salespersons do not necessarily have theincentive to
sell the most profitable products, but only the products generating maximalvolumes.I

recommend on changing the incentive system to compensation on the profit generated fromeach sale, based on the
known values of cost of each product using Activity-Based Costs.

In this way the interests are similar and the salespersons will gain more when the company will profit mor
nders whether the company