Management Accounting-- Wilkerson Company Case
The purpose of this report is discussing the case of Wilkerson Company that confronting tough competition in price cutting in pumps which caused to a big drop of pre-tax operating income from 10% to 3%. After observing the existing costing allocation, we found out there is an issue on the existing costing report that the manager could not be able to see the real situation. In light of this, there will be brought to the discussion on the feasibility of using an alternative costing method – Activity based costing (ABC) in the latter paragraphs.
The issue of misallocation cost
With the use of Traditional Absorption Costing (TAC) which means Wilkerson Company is now only put the costing of direct labor and material in place. As we can see the table 1 below, the percentage of total direct cost allocation in Valves, Pumps and Flow Controllers are 46%, 46% and 52% respectively, and so for the manufacturing overhead are 54%, 54% and 48%.
Table 1: Traditional Absorption Costing Product Valves ($) Pumps ($) Flow Controllers ($)
Direct Labor 75,000 18% 156,250 18% 40,000 16%
Direct Material 120,000 29% 250,000 29% 88,000 35%
Total Direct Costs 195,000 46% 406,250 46% 128,000 52%
Manufacturing Overheads 225,000 54% 468,750 54% 120,000 48%
Total Cost Allocation 420,000 100% 875,000 100% 248,000 100%
Now if we go for ABC method, the company then requires the following six basic steps according to Ray H. Garrison and Eric W. Noreen to implement an ABC system as below:
1. Identify and define cost pools and cost drivers
2. Directly trace costs to activities (to the extent feasible)
3. Assign costs to activity cost pools
4. Calculate activity rates
5. Assign costs to cost objects using the activity rates and activity measures previously determined
6. Prepare and distribute management reports
With refer to the monthly production and operating statistics in March 2000, we can identify the cost pools and cost drivers which
The issue of misallocation cost
With the use of Traditional Absorption Costing (TAC) which means Wilkerson Company is now only put the costing of direct labor and material in place. As we can see the table 1 below, the percentage of total direct cost allocation in Valves, Pumps and Flow Controllers are 46%, 46% and 52% respectively, and so for the manufacturing overhead are 54%, 54% and 48%.
Table 1: Traditional Absorption Costing Product Valves ($) Pumps ($) Flow Controllers ($)
Direct Labor 75,000 18% 156,250 18% 40,000 16%
Direct Material 120,000 29% 250,000 29% 88,000 35%
Total Direct Costs 195,000 46% 406,250 46% 128,000 52%
Manufacturing Overheads 225,000 54% 468,750 54% 120,000 48%
Total Cost Allocation 420,000 100% 875,000 100% 248,000 100%
Now if we go for ABC method, the company then requires the following six basic steps according to Ray H. Garrison and Eric W. Noreen to implement an ABC system as below:
1. Identify and define cost pools and cost drivers
2. Directly trace costs to activities (to the extent feasible)
3. Assign costs to activity cost pools
4. Calculate activity rates
5. Assign costs to cost objects using the activity rates and activity measures previously determined
6. Prepare and distribute management reports
With refer to the monthly production and operating statistics in March 2000, we can identify the cost pools and cost drivers which