Wilkerson Company Case
1. If Wilkerson were to cut prices, based on contribution margin, to just cover short-term variable costs, what consequences could it experience? (5 marks)
Several break-even-point assumptions are made in calculation:
1) Total fixed costs do not change with volume, and will exist regardless if the products are sold or not.
2) Sales mix will be constant.
The contribution-margin percentage is 66.1%, which means 66.1 percent of each sales dollar is available for covering fixed costs and making income: $1,365,650/66.1%=$2,065,387 sales are needed to break even.
Based on the existing sales mix and production units given (Valves 7,500, Pumps 12,500 and Flow Controllers 4,000), the break-even prices in dollars (BEP$) are shown as below: Therefore, based on the data above, if the company cut its prices to just cover short-term variable costs, the company’s total sales would fall by 4.05%, from $2,152,500 to $2,065,387, which would also result in 4.05% drop in the selling price of each unit of products, total variable costs at $699,737, and zero operating income before tax.
2. (a) How does Wilkerson's existing cost system operate? (5 marks)
Wilkerson's current cost system is based on a simple cost accounting system. Material cost is recorded as prices paid to the suppliers for components. Labour rates and fringe benefits were appropriated to products by using the standard run times for each of their three products at a rate of $25 per hour. Finally, the company allocated the overhead costs for its sole producing department to products as a percentage (300%) of production-run direct labour cost.
However, due to the growth of the company, the 300% estimate may lead to inaccuracies in future projections. Potential problems of the existing cost system are listed as below:
1) It failed to reflect the specialized costs of multiple products
2) It is inaccurate when estimating manufacturing overhead only based on direct labor cost
3) It roughly applied
Several break-even-point assumptions are made in calculation:
1) Total fixed costs do not change with volume, and will exist regardless if the products are sold or not.
2) Sales mix will be constant.
The contribution-margin percentage is 66.1%, which means 66.1 percent of each sales dollar is available for covering fixed costs and making income: $1,365,650/66.1%=$2,065,387 sales are needed to break even.
Based on the existing sales mix and production units given (Valves 7,500, Pumps 12,500 and Flow Controllers 4,000), the break-even prices in dollars (BEP$) are shown as below: Therefore, based on the data above, if the company cut its prices to just cover short-term variable costs, the company’s total sales would fall by 4.05%, from $2,152,500 to $2,065,387, which would also result in 4.05% drop in the selling price of each unit of products, total variable costs at $699,737, and zero operating income before tax.
2. (a) How does Wilkerson's existing cost system operate? (5 marks)
Wilkerson's current cost system is based on a simple cost accounting system. Material cost is recorded as prices paid to the suppliers for components. Labour rates and fringe benefits were appropriated to products by using the standard run times for each of their three products at a rate of $25 per hour. Finally, the company allocated the overhead costs for its sole producing department to products as a percentage (300%) of production-run direct labour cost.
However, due to the growth of the company, the 300% estimate may lead to inaccuracies in future projections. Potential problems of the existing cost system are listed as below:
1) It failed to reflect the specialized costs of multiple products
2) It is inaccurate when estimating manufacturing overhead only based on direct labor cost
3) It roughly applied