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BKAL 3063 INTEGRATED CASE STUDY

GROUP E
(BRIEF CASE REPORT: WILKERSON COMPANY)
NAME:

Nur Fatihah Binti Zainal Lim

221536

LECTURERS NAME:
PN ROHANA @ NORLIZA BT YUSSUF

SUBMISSION DATE:
27 OCTOBER 2015
Executive Summary:

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Wilkerson is a company that supplied products to manufacturers of water purification


equipment. The products that supplied by the Wilkerson company are pumps, flow controllers
and valves. Pumps are commodity products, produced in high volume for a market with high
price competition. The price cutting by the competitors led to a drop of Wilkersons 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 inelastic demand
at the current price range. Valves are standard, produced and shipped in large lots and gross
margin has been maintained at 35%. Wilkersons existing cost system is a tradition value
based costing systems. Direct costs are based on the price. Overhead costs are figures
proportionately to the direct labor costs at the rate of 300%.

1.0 INTRODUCTION
Wilkerson Company is in the business of manufacturing valves, pumps and flow
controllers. Wilkerson is currently faces with declining profit margins relative to industry
competitors. The severe industry has price cutting in pumps business which is Wilkersons
major product line and has badly affected the companys margin. Gross margin on pumps
sales had fallen below 20% as against the companys planned gross margin of 35%. On the
other hand, the flow controllers division wan performing above the expected profits. Thus,
Wilkerson needs to identify the proper mix of its product line to regain its profitability. This
is to be done based on information provided in the case, regarding pricing decisions,
decisions to discontinue or continue a product and product design.
Knights team had collected the data based on the operating results of March 2000,
show that the company has grouped its overhead into 5 cost items which is:

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Machine-related expenses
Receiving and production control
Setup labor cost
Engineering
Packaging and shipment

2.0 ANALYSIS OF PROBLEM


2.1 Statement of problems
The issue from this case is the current pricing method used by
Wilkerson is that the real manufacturing cost of each product is not
realistic. 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 amount of unit produced.
Wilkersons existing cost system is the traditional volume-based costing
which is direct materials and labor costs are based on standard prices of
materials and labor rates. In addition, the manufacturing overhead is also
considered as cost and it is allocated in proportion to direct labor cost at
the rate of 300%.
2.2 Cause of problem
There are a few factors show that volume-based costing may produce
inadequate estimate of the unit cost which is the first, overheads are quite high
(300% to direct labor cost). Second, products vary in terms of consumptions of
indirect resources. Pumps and valves are standard products, whereas flow
controllers are customized, so we should expect higher unit cost for the latter.
Existing volume-based costing with one-stage indirect cost allocation does not
allow differentiating indirect cost among products in accordance with their
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demand on indirect resources. Currently overheads are allocated to products in


proportion to direct labor costs, although they dont relate to direct labor
technologically.

2.0 ALTERNATIVE SOLUTIONS


Activity-based Costing
From the case study, we know that Wilkerson uses volume based costing system as
they record the direct material and labor costs based on standard prices. Other than that, the
overheads are charged as 300% of the direct labor cost. This implies overheads are applied
directly in relation to labor costs irrespective of relevance. As shown in the Table 1 below, we
can see that valves are performing within the planned margin while pumps are performing
below the planned gross margin (actual gross margin 19.50%) and flow controllers are
performing above the planned gross margin. (Actual gross margin 41%). This method,
volume based system, is not reliable since each product varies significantly in its overheads
costs association and the basic assumption.
Thus, from the situation that Wilkerson Company has faced, we suggest that the
company should use the appropriate cost drivers that reflect the relationship between the
volume of production of individual products and the level of overheads. Table 2 below shows
each of the cost driver match with the appropriate cost pool. For example, machine hours is
the appropriate cost driver foe the machine-related expenses cost pool.

Valves
$10.00
16.00
30.00

Pumps
$12.50
20.00
37.50

Flow Controllers
$10.00
22.00
30.00

$56.00

$70.00

$62.00

Planned gross margin (%)

$86.15
35%

$107.69
35%

$95.38
35%

Actual selling price


Actual gross margin (%)

$86.00
34.90%

$87.00
19.50%

$105.00
41.00%

Direct labor cost


Direct material cost
Manufacturing overhead
(@300%)
Standard unit costs
selling price
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e

Table 1: Product Profitability Analysis (Volume Based Costing)


Cost Driver
Machine Related Expenses
Setup Labor Costs
Receiving and Production control
Engineering Costs
Packaging and Shipping Costs

Cost Pool
Machine Hours
Production Run
Production Run
Engineering Hours
Number of Shipments

Rate
336,000/11,200 = 30
40,000/160 = 250
180,000/160 = 1,125
100,000/1,250 = 80
150,000/300 = 500

Table 2: Cost driver and cost pool

Product Costing
Machine Hrs
Machine Related Expenses (x30)

Valves
3,750
112,500

Pumps
6,250
187,500

Flow Controllers
1,200
36,000

336,000

Production Runs
Setup Labor Expenses (x250)
Receiving and production costs
(x1,125)

10
2,500
11,250

50
12,500
56,250

100
25,000
112,500

40,000
180,000

Engineering Hrs
Engineering Expenses (x80)

250
20,000

375
30,000

625
50,000

100,000

No of shipments
Packaging & Shipping Costs (x500)

10
5,000

70
35,000

220
110,000

150,000

Total Overhead Expenses


Table 3: Product Data Activity Based Costing

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Total

806,000

Per unit Activity Based Costing

Valves

Pumps

Flow Controllers

Production Units

7,500.0

12,500.0

4,000.0

Direct Labor Cost

10.0

12.5

10.0

Direct Material Cost

16.0

20.0

22.0

Machine Related Expenses

11,250/7,500 = 15.0

36,000/4000 = 9.0

Setup Labor Expenses

2,500/7,500 = 0.33

187,500/12,500 =
15.0
12,500/12,500 = 1.00

25,000/4,000 = 6.25

Receiving and production

11,250/7,500 = 1.5

56,250/12,500 = 4.5

112,500/4,000 = 28.1

Engineering Expenses

20,000/7,500 = 2.67

30,000/12,500 = 2.40

50,000/4,000 = 12.50

Shipping Expenses

5,000/7,500 = 0.67

35,000/12,500 = 2.80

110,000/4,000 = 27.50

46.17

58.20

115.35

Total

Table 4: Per Unit Activity Based Costing

Valves

Pumps

Flow
Controllers

86.15

107.69

95.38

Per unit Volume Based Costing


Margin (based on Planned SP)

56
35.00%

70
35.00%

62
35.00%

Per unit Activity Based Costing


Margin (based on Planned SP)

46.17
46.41%

58.20
45.96%

115.38
-20.96%

86

87

105

56
34.9%

70
19.5%

62
41%

46.17
46.32%

58.20
33.10%

115.38
-9.88%

Margin Calculation
Planned Selling Price

Actual Selling Price


Per unit Volume Based Costing
Margin (based on Actual SP)
Per unit Activity Based Costing
Margin (based on Actual SP)

Table 5: Margin Calculation

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Table 2 presents with the information about various activities on which we have based the
costing basically the cost pools, drivers of the relevant cost pools and the rate of the costing
which should be taken into account. In order to carry out an activity based costing so that we
can find the relevant costs associated with each product we do the product wise activity based
costing for the individual cost pools shown in Table 3. Exhibit 4 provides us with the data
relating to the monthly production and operating statistics which can be combined with the
costs for each cost pool derived in table 2 to give us the individual product wise activity
based costing. The data obtained from table 3 enables us to arrive at table 4 which calculates
the per unit ABC taking into account the total cost for each activity and the number of units
produced of each product to get the individual product wise per unit costs. The total costs will
be the sum of the direct costs and the ABC. This total cost of each product will enable us to
calculate the margins that each product provides based on the planned as well as the actual
selling prices. The information is provided in table 5 as shown below.

Direct costing and Contribution analysis


Direct costing and contribution analysis are adequate for short-term decision making
(e.g. accept or reject an additional order when only those costs that would change if a
particular option is taken are relevant). In the long-run under price competition, however, the
company needs to be sure that each product is at a minimum break even. Besides, direct
costing would provide highly unreliable information for decision-making when overheads are
so significant and there is variability among products.

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3.0 RECOMMENDATIONS
Based on the analysis given above, we recommended that Wilkerson Company move
from Volume-based Costing to Activity-based Costing to better analyze the cost figure and
health of the company. It will be enable the overheads to be attached to the products and
activities where they are being consumed and not directly be related to the products on the
basis of production run direct labor hours. Also can be seen from the analysis of the 2
methods the gross margin returns vary in both cases. The clear indicator of that is the flow
controller that the company manufactures. Volume based costing indicates that the product is
highly profitable providing a gross margin of 40.95% whereas the activity based costing
shows us that flow controllers are not providing any returns and on the contrary it is a loss
making product since we are unable to recover even the costs involved. We recommend the

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company to review its policy in respect to flow controllers. Wilkerson can work on changing
the prices of individual flow controllers in order to secure a healthy profit margin. One way
to do this is setting prices in accordance with the amount of resources consumed (activitybased pricing) by individual product or customer.

5.0 EXTERNAL SOURCING


https://www.business-case-analysis.com/activity-based-costing.html

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