ACTG 5210 X Group Assignment: Wilkerson Company

Executive summary
Wilkerson Company follows an ancient method to allocated overhead costs. Total overhead costs are allocated to products as a percentage of production-run direct labor cost. Due to increased competition, which has forced Wilkerson to reduce prices and since all Wilkerson products are generating substantial contribution to overhead, a more efficient - activity based cost accounting method is needed to accurately allocate overhead costs to different departments. Additionally this method will help us understand the individual profitability of different products and help us with the decision-making. Based on "activity based cost allocation" it is clear that the previous overhead cost analysis (multiple 300% of direct labor cost) does not produce an accurate overhead cost analysis. The actual gross margin for valves, pumps and flow controllers were 46.3%, 33.1%, -9.9% respectively, and Wilkerson is currently loosing money on flow controllers. We have 3 recommendations for flow controllers: Increase selling price, stop production, or reduce cost by improving operations. The first option is to keep producing flow controllers with a 35% profit margin. In order to achieve this Wilkerson has to raise selling price of flow controllers from $105 to $156 in 10% increments while monitoring the price elasticity of demand. The second recommendation is to look for ways of make the flow controllers profitable by reducing operation costs and improving the manufacturing process. Based on our analysis Wilkerson will have to reduce production complexity by eliminating certain unprofitable flow controllers and reducing the production runs,

shipment and engineering overhead by 50% in order to achieve it's target 35% profit. Lastly, if the above two recommendations do not make the flow controllers profitable it is best to eliminate the production of flow controllers and redistribute company resources for towards making the pump and valve productions more profitable.

Cost analysis
Key assumptions for overhead costs analysis
1. Machine-related expenses were 100% related to Machine hours, not related to Production runs. 2. Each Production run has one Set-up labor process. 3. Each Production run has one Receiving and production control process. 4. Each Shipment required same Packaging and shipping work. 5. Maximum capacity for a month was above 12,000 hours Machine hours, 180 Production runs and 400 Shipments.

Overhead cost analysis

Manufacturing overhead cost can be divided by the variable cost Activity cost=Cost of manufacturing overhead/Related operating activity Table 1. Activity cost
Manufacturing overhead Machine-related expenses Setup labor Receiving and production control Engineering Packaging and shipping Cost 336,000 40,000 180,000 100,000 150,000 Related operating activity Machine hours Production runs Production runs Hours of engineering work Number of shipments Total 11,200 160 160 1,250 300 Activity cost $30 $250 $1,125 $80 $500

The receiving and production control per production run ($1,125) and shipping cost per shipment ($500) were significantly higher than other overhead costs. Table 2. Actual overhead cost for each type of products
Valves Machine hours Production runs Number of shipments 112,500 13,750 5,000 Pumps 187,500 68,750 35,000 Flow Controllers 36,000 137,500 110,000

Hours of engineering work Total overhead cost Production (units) Unit overhead cost

20,000 151,250 7,500 20.2

30,000 321,250 12,500 25.7

50,000 333,500 4,000 83.4

Flow controllers required many more production runs and shipments than valves and pumps. More production runs resulted higher receiving control and shipping cost and higher total overhead cost for flow controllers.

Product profitability analysis

Table 3. Product Profitability Analysis
Valves Manufacturing overhead Direct labor cost Direct material cost Actual standard unit cost Actual selling price Actual gross margin Actual gross margin (%) 20.2 10.0 16.0 46.2 86.0 39.8 46.3% Pumps 25.7 12.5 20.0 58.2 87.0 28.8 33.1% Flow Controllers 83.4 10.0 22.0 115.4 105.0 (10.4) (9.9%)

Wilkerson was losing $10.4 for each flow controller sold by current selling price.

Recommendations
1. Increase selling price. To keep 35% profit margin, Wilkerson need to raise selling price of flow controllers to 115.4*1.35=$156. Given that the recent 10% price increase did not affect the demand it is recommended to increase the price in 10% increments and monitor the effect it has on demand until equilibrium has reached. 2. Stop producing flow controllers. Wilkerson may lose previous investments of fixed assets. 3. Reduce cost. Improve the manufacturing overhead of flow controllers by reducing number of production runs and shipments. If Wilkerson keeps the current selling price and 35% profit margin, the target cost for flow controllers was 105/1.35=$78. To achieve this goal, Wilkerson need to reduce production runs, shipments and engineering by 50% while keeping current productivity. One of the ways this can be achieved is to conduct an analysis of various types of flow controllers and identify profitable flow controllers, and eliminate the production of flow controllers that are not profitable. This will reduce the operational complexity including production runs and shipments.

If it possible to reduce production runs and, shipments and engineering for flow controllers then it is recommended to reduce the same by 50%. If its not possible to reduce production runs and, shipments and engineering then it is highly recommended to increase the price of flow controllers. If none of the two suggested are possible then Wilkerson should stop production of flow controllers to be sustainable.