wilkerson company (1)
TRANSCRIPT
Overview
Case Study Information
Costing Analysis
Traditional costing and Activity based costing
Implication of Wilkerson case
Conclusion
Information
• Business Structure of Wilkerson Company
• Information about Prices and Costs
• Current Issues from Operation
Business structure and Information
Actual Data
Target
Valves Pumps Flow Controller
Actual selling price $86.00 $87.00 $105.00
Standard unit costs $56.00 $70.00 $62.00
Actual gross margin (%) 34.9% 19.5% 41.0%
Valves Pumps Flow Controller
Target selling price $86.15 $107.69 $95.38
Standard unit costs $56.00 $70.00 $62.00
Target gross margin(%) 35.00% 35.00% 35.00%
Standard unit costs
Valves Pumps Flow ControllerDirect Labour cost $10.00 $12.50 $10.00
Direct material cost $16.00 $20.00 $22.00
Manufacturing overhead (@300%) $30.00 $37.50 $30.00
Standard unit costs $56.00 $70.00 $62.00
Production
Valves Pumps Flow Controller
Production process
• 4 component• Produced and shipped in large lots
• 5 components• Identical to valve process
• 10 components• More labour• More production run• More shipments
Business structure and Information
Competitive Position• Mature Market.
• Limited opportunities for innovation & declining profitability.
• Wilkerson baffled by pricing situation.
• One product line – intense competition and discounting.
• However able to raise prices in other products.
Competitive Position• 2 standard, high volume products (Valves & Pumps).
• Flow controllers – Lower volume, higher customised & specialised.
• Increased indirect overhead costs (O/H rate is 300% DL).
What Should We Do?
Cost Analysis• Traditional Absorption Costing
• Cost Allocation (ABC)
• Product Profitability Analysis
• Operating Results
• ABC versus Absorption Costing
• Distribution of Overhead Costs
What Do We Expect To See?
Traditional Absorption Costing
Product
7,500 Units 12,500 Units 4,000 Units
Valves ($) Pumps ($) Flow Controllers ($)
Direct Labour 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 (300% of DL) 225,000 54% 468,750 54% 120,000 48%
Total Cost Allocation 420,000 100% 875,000 100% 248,000 100%
Cost allocation (ABC)
Cost Pools
Cost Drivers
Activity-Based Rates
Cost allocation (ABC)
Manufacturing Overhead
Cost Pool (Exhibit 1) Amount ($)Exhibit 1 Cost Driver Amount (Exhibit 4) Activity-Based Cost Rate
Machine Related Expenses 336,000 Machine hours 11,200 machine hours $30 per machine hour
Setup labour 40,000 Production runs 160 production runs $250 per production run
Receiving and production control 180,000 Production runs 160 production runs $1,125 per production run
Engineering 100,000 Hours of engineering work 1,250 engineering hours $80 per engineering hour
Packaging and shipping 150,000 Number of shipments 300 shipments $500 per shipment
Direct Labour
Valves $10 per unit
Pumps $12.50 per unit
Flow Controllers $10 per unit
Direct Materials
Valves $16 per unit
Pumps $20 per unit
Flow Controllers $22 per unit
Cost allocation (ABC)
Product
Valves ($) Pumps ($) Flow Controllers ($)
Direct Labour 75,000 22% 156,250 21% 40,000 9%
Direct Material 120,000 35% 250,000 34% 88,000 19%
Total Direct Costs 195,000 56% 406,250 56% 128,000 28%
Manufacturing Overheads
- Machine Related Expenses 112,500 32% 187,500 26% 36,000 8%
- Setup labour 2,500 1% 12,500 2% 25,000 5%
- Receiving and production control 11,250 3% 56,250 8% 112,500 24%
- Engineering 20,000 6% 30,000 4% 50,000 11%
- Packaging and shipping 5,000 1% 35,000 5% 110,000 24%
Total Manufacturing Overheads 151,250 44% 321,250 44% 333,500 72%
Total Cost Allocation 346,250 100% 727,500 100% 461,500 100%
Product Profitability Analysis
TAC
Valves Pumps Flow Controllers
ABC
Valves Pumps Flow Controllers
Unit Produced 7500 12500 4000 7500 12500 4000
Standard Unit Cost $56.00 $70.00 $62.00 $46.17 $58.20 $115.38
Planned Gross Margin 35% 35% 35% 35% 35% 35%
Target Selling Price $86.15 $107.69 $95.38 $71.03 $89.54 $177.50
Actual Selling Price $86.00 $87.00 $105.00 $86.00 $87.00 $105.00
Actual Gross Margin 34.9% 19.5% 41.0% 46.3% 33.1% -9.9%
Operating Results
TAC ABC
($) ($)
Sales 2,152,500 100% 2,361,975 100%
Direct Labour Expense 271,250 271,250
Direct Materials Expense 458,000 458,000
Manufacturing Overhead 806,000 806,000
Gross Margin 617,250 29% 826,725 35%
General, Selling and Administration Expense 559,650 559,650
Operating Income (pre-tax) 57,600 3% 267,075 11%
Distribution of Overhead Costs
Valves ($) Pumps ($) Flow Controllers ($) Total ($)
Direct Labour 75,000 28% 156,250 58% 40,000 15% 271,251 100%
Direct Material 120,000 26% 250,000 55% 88,000 19% 458,001 100%
Manufacturing Overheads
- Machine Related Expenses 112,500 33% 187,500 56% 36,000 11% 336,001 100%
- Setup labour 2,500 6% 12,500 31% 25,000 62% 40,000 100%
- Receiving and production control 11,250 6% 56,250 31% 112,500 62% 180,000 100%
- Engineering 20,000 20% 30,000 30% 50,000 50% 100,001 100%
- Packaging and shipping 5,000 3% 35,000 23% 110,000 73% 150,000 100%
Total Manufacturing Overheads 151,250 19% 321,250 40% 333,500 41% 806,002 100%
Total Cost Allocation 346,250 23% 727,500 47% 461,500 30% 1,535,251 100%
What Does This Mean?
Traditional costing and Activity Based Costing
• Traditional Costing System - Advantages and disadvantages
• Activity Based Costing System - Assessment of information usefulness and cost-benefit
Traditional costing System
Advantage Easy to understand and applyLess subjective
• Inaccurate cost structure (only volume related)BUT
Advantage Cheaper
• Mislead managers in decision-makingBUT
Advantage Ideal for the mass-produced products
• Not suitable for large companiesBUT
Activity Based Costing System
Respond the limitations for absorption costing
• More fashionable than effective i.e. subjective and costly
Advantage
BUT
Advantage Ideal for the large companies, especially the services sector
• Cost drivers may not fully explain the cost behaviourBUT
Implication of Wilkerson Case
Switching to ABC
Recommendations
Other strategic plans
Summarized solutions
The current cost system does not reflect market behaviour that fit with product profitability
Wilkerson’s product lines are different in nature and delivery processE.g. Pumps: High-volume
Flow Controller: Customized
Overhead to total cost ratio (52.50%) is much greater than the DL to total cost ratio(17.67%)
Target pre-tax margin is achieved under ABC
Switching to ABC…Why?
Recommendation
Cost spread to other lines
Less motivation of manager
Risk of finding new opportunities
Demand decrease
Time consuming
Extra cost incurred
Company Target Overall performance and individual production line
Options
No change for Valves and Pumps
Flow controllers
Close down Continue operating
Enhance other lines New opportunities
Quality controlReduce Cost
Retaining all production lines
Recommendation
Product AttributeChange of Cost under
ABCSuggestion
Competitive
status
Valves
High quality;
Loyal customer base;
Competitors do not intend to cut price
17.55%
($56-46.17)
Maintain the same price at $86
(34.9% - 46.3%; greater profit margin)
Lower price
High quality
PumpsMajor product line;
Competitors’ reduced prices
16.86%
($70-58.2)
Maintain the same (recently lowered) price at $87
(19.5%-33.1%)
Average price
Maintain sales volume
Flow
Controllers
Generate 41% of total overhead;
Customized;
Underpriced
86.10%
($62-115.38)
-Increase price to a range of $128 - $177 with target margin of 10% - 35%
-Cost reduction, quality control and better OH management (long-term)
Price at an acceptable gross
margin
Operational ABM
What Can Be Done
Operational Improvements
•Perform batch and sustaining activities more efficiently – e.g decrease setup times, lower cost of receiving and handling materials, lower cost of packaging & engineering support required for flow controllers.
•Product Design Improvements•Redesign flow controllers – less components, reduce demand for set-up/engineering activities. Share components used in other products.
•Modify Customer Relationships:•Be more aggressive on pricing for flow controllers. •No reason to discount sales further if no complaints from customers.
•Minimum Order size – reduce o/h cost associated with small production runs/shipments.