Wilkerson Company INTRODUCTION Wilkerson supplied products to the manufactures of water purification equipment. It’s in the business of manufacturing valves, pumps p umps and flow controllers. Server industry wise price cuts in the pumps business which is Wilkerson’s main product line has badly affected the company’s margins. The pre-tax margins have dropped less to 3% far below the historical margins of 10%. On the other hand the flow controllers division was performing above the expected profits. The firm needs to identify the proper mix of its product line to regain its profitability. ANALYSIS The production process starts with the purchase of semi-finished components from several suppliers. It machined these parts to the required tolerances and assembled them in the company’s modern manufacturing manufacturing facility. The firm used same equipment and labor for all three product lines and production runs were scheduled to match customer shipping requirements. Suppliers and customers had agreed to just in time deliveries. The manufacturing process for pumps was identical of that of valves. Flow controllers were devices that controlled the rate and direction of the flow of chemicals. They required more components and more labor than the other two. The firm has recently hiked the prices by 10% with no apparent effect on demand. The firm always used simple costing accounting system. Each unit of the product was charged for direct labor and direct material cost. (See Table 1 in Appendix). Material cost was based on the prices paid for the components under annual purchasing agreements. The company had only one producing department, in which components were both machined and assembled into finished products. The overhead cost in this department were allocated to the products as a percentage of production run direct labor cost, with the rate of 300%. Several points came up while analyzing the case. First, workers operated on several machines simultaneously, for other operations they could operate only one machine. Thus machine related expenses might relate more to the machine hours of a product than to its production run labor hours. Second, a setup had to be performed each time batch components had to be machined in the production run. Each component required a separate production run to machine the raw materials. Third, people in the receiving and production control departments ordered, processed, inspected and moved each batch of components for production run. This work required about the same amount of time whether the components were a long or a short production run or whether the components were expensive and inexpensive.
Currently, the company uses simple Overhead Absorption Rate (OAR) in its accounting system. After OAR is obtained through dividing the total manufacturing overheads by the total activity level; it is then charged to different products' unit cost based on the respective direct labor hour spent. The OAR obtained in this case study is 300%. The fact that flow controllers have better selling price since this product line is protected from market competiveness, it appears to have the highest actual gross margin of 41.0%; followed by valves (34.9%) and pumps (19.5%). The OAR reflects the company's major product line - pumps, to hold direct responsibility on the overall poor income performance, mainly due to its continuous price reduction to compete against the market. Conversely comparing the operating statistics in March 2000, the flow controllers recorded the least units produced and yet required the highest production runs, shipments and engineering works. This product line also being charged at low manufacturing overheads comparing to pumps, by reason of its low direct labor cost. Considering another accounting system, Activity-Based Costing (ABC) identifies the company's activities level and allocate respective costs based on workload and expenditure; assigning indirect costs to the products' direct costs. Thus based on the company's study on Wilkerson's overheads, ABC would be fair as the selected accounting system to identify the products actual costs, where the manufacturing overheads and other expenses are charged based on the relevant activities level showed in Table 1. Referring to Exhibit 3, the ABC has indicated that valves (47.9%) have the highest actual gross margin, followed by pumps (35.7%) and flow controllers (0.88%). In fact, it is found that the flow controllers are having such low gross margin due to the extensive workload required to produce and deliver the products. The results for both systems have turned out to be totally different, whereby the flow controllers' product line in underperforming and should be increased in selling price. In Table 2 we can see that the firm’s pretax margin is only 3% which has fallen significantly from 10% due to huge price cuts. Table 1 shows the activities and the cost involved in those activities also. Based on the traditional costing method, for the firm manufacturing of the flow controllers would be more profitable. The margin contribution is 41%. But it is advisable for the firm to use ABC method of costing. According to the calculation of ABC analysis Valves is the product which has maximum margin contribution. (See table 3 in Appendix). CONCLUSION Thus based on the company's study on Wilkerson's overheads, ABC would be fair as the selected accounting system to identify the products actual costs, where the manufacturing overheads and other expenses are charged based on the relevant activities level showed.
APPENDIX Table 1 Activity wise cost analysis
Direct Labor cost Direct material cost Manufacturing overhead(@300%) Standard Unit costs Target selling price Planned gross margin Actual selling price Actual gross margin
Table 2 Operating Results of firm. Sales Direct labor Expense Direct Material Expense Manufacturing Overhead Machine related Setup labor Receiving and Production Control Engineering Packing and shipping Total Manufacturing overhead Gross margin General, selling and Admin Operating income(pre-tax)
Valves 10 16
Pumps 12.5 20
Flow controllers 10 22
30 56 86.15 35% 86 35%
37.5 70 107.69 35% 87 20%
30 62 95.38 35% 105 41%
2152500 271250 458000
100% 13% 21%
806000 617250 559650 57600
37% 29% 26% 3%
336000 40000 180000 100000 150000
Table 3:- ABC Analysis of cost vs Traditional Costing
Material Cost Direct Labor Machine components Setup machines Receive and schedule Provide engineering support Pack and Ship products Total Cost Selling price Margin Margin (Traditional method)
Valves 16 10 14 0.30 1.33 2.67 0.50 44.80 86 47.91% 35%
Pumps 20 12.5 14 0.89 4.00 2.40 2.10 55.89 87 35.76% 20%
Flow controllers 22 10 8.4 5.56 25.00 12.50 20.63 104.08 105 0.88% 41%
