Case Study Wilkerson Company

Assessment 2 – Individual
By – Andrew Chan

WILKERSON COMPANY

Overview

Wilkerson Company is facing a decline in profits and has attributed this to a severe price cutting exercise in their Pumps line of products, dropping the company’s pre-tax margin to less than 3%, far below the historically healthy 10% margins.

It appears that gross margins on pump sales in the latest month had fallen below 20%, well below the budgeted gross margin of 35%. Although a recent increase to Flow Controllers by 10% seems to have been overlooked by competitors and have not caused an apparent effect on demand.

Wilkerson had always practiced using a simple cost accounting system in their business.

Cost Drivers
| |Valves
|Pumps |Flow Controllers |TOTAL |
|Production |7500 |12,500 |4,000 |24,000 |
|Direct Labor |10 |12.50 |10 | |
|Material Costs |16 |20 |22 | |
| | | | | |
|Machine Hours |3,750 |6,250 |1,200 | |
|Production Run |10 |50 |100 | |
|No.
of Shipments |10 |70 |220 | |
|Hrs Engineering |250 |375 |625 | |
| | | | | |
|Direct Labor Expenses |75,000 |156,250 |40,000 |$271,250 |
|Direct Material Expenses |120,000 |250,000 |88,000 |$458,000 |

Action

Whilst a simple cost accounting system gives us the overall picture of the company, it doesn’t truly reflect an accurate picture of the performance of each product. In order to get a clearer picture of the situation, we need to examine the true relation of costs on each product based on their
activities.

For this to happen, we need to use the ABC system to examine and identify the overhead costs of each product based on their activities.
[pic]

|Machine |Set Up |Receiving |Engineering |Shipping |
|$336,000/ |$40,000/ |$180,000/ |$100,000/ |$150,000/ |
|11,200 |160 |160 |1250 |300 |
|=$30 p/h |=$250 |=$1,125 p/run |=$80 p/h |=$500 p/ship |

Manufacturing Overhead Using ABC

| |Valves |Pumps |Flow Control |TOTAL |
| |30x3750 |30x6250 |30x1200 | |
|Machine |112,500 |187,500 |36,000 |$336,000 |
| |1125x10 |1125x50 |1125x100 | |
|Receiving |11,250 |56,250 |112,500 |$180,000 |
| |80x250 |80x375 |80x625 | |
|Engineering |20,000 |30,000 |50,000 |$100,000 |
| |500x10 |500x70 |500x220 | |
|Shipping |5,000 |35,000 |110,000 |$150,000 |
| |250x10 |250x50 |250x100 | |
|Set Up |2,500 |12,500 |25,000 |$40,000 |
| |$151,250/ |$321,250/ |$333,500/ |$806,000
|
| |7500 |12,500 |4000 | |
| | | | | |
|Overhead Costs p/unit using ABC |$20.17 |$25.70 |$83.38 | |

Comparison between Simple Cost Accounting System and ABC System

Simple Cost Accounting
| |Valves |Pumps |Flow Controller |
|Costs p/unit |$56 |$70 |$62 |
|Actual Selling Price |$86 |$87 |$105 |
|Actual Profit |$30 |$17 |$43 |

ABC System
| |Valves |Pumps |Flow Controller |
|Costs p/unit |$46.17 |$58.20 |$115.38 |
|Actual Selling Price |$86 |$87 |$105 |
|Actual Profit |$39.83 |$28.80 |$(10.38) |

| |Valves |Pumps |Flow Controller |
|Simple Accounting Gross Margin | | | |
| |34.9% |19.5% |41% |
| | | | |
|ABC Gross Margin |46.3% |33.1% |-9.9% |

Key Findings

• The previously thought “star” product, the Flow Controller when using the ABC system is identified to be actually performing poorly. The cost of producing the Flow Controller is higher then the actual selling price and producing a negative gross margin of nearly 10%. • The Pumps product line which was causing the concern of management and blamed for dragging Wilkerson’s operating income to a 3% margin is in fact not doing badly. This may explain why competitors dropped their pricing. • Being a simple 4 machined component product to produce and can be shipped in large lots, Wilkerson’s Valves are doing extremely well and performing well above the targeted 35% gross margin.

Recommendations

• Increase the selling price of Flow Controllers by 10% to $116, making the sale price and costs per unit to be of negligible difference. Monitor the results, review and suggestion is to continue the gradual price increase into profit territory over a 6-12 month period. • Cut price to Valves by 10% in order to capture market share as no competitors have tried. Based on March 2000 data, operations still have room to run at a higher capacity which in turn lowers per unit costs. • Hold pricing on Pumps as the process of manufacturing is practically identical to Valves and the increase in production of Valves can be rolled over to Pumps and thus reduce costs per unit.

| |Valves |Pumps |Flow Controller |
|Costs p/unit |$46.17 |$58.20 |$115.38 |
|New Selling Price |$77 |Hold |$116 |
|Target Profit |$30.83 |Hold |- |
|Target gross margin |40% |Hold |0% |

At Capacity

|Machine |Set Up |Receiving |Engineering |Shipping |
|$336,000/ |$40,000/ |$180,000/ |$100,000/ |$150,000/ |
|12,000 |180 |180 |1250 |400 |
|=$28 p/h |=$222.22 |=$1,000 p/run |=$80 p/h |=$375 p/ship |

-----------------------

$336,000 $40,000 $180,000 $100,000 $150,000

Products

Machine Set Up Receiving Engineering Shipping

Overhead
$806,000