Wilkerson Company academic essay help English essay help

Wilkerson should consider action targeted atcost reduction (changes in flow controllers design or in their production and delivery process) orraising the price of flow controllers for customers. Since flow controllers are customized, thecompany can set different prices for different customers (groups of customers) based on the actualamount of resources spent (e. g. implement activity-based pricing). Problem Wilkerson has to estimate the profitability of its products in order to make long-term product mixdecisions.

These decisions should be based on estimation of product costs and might includedecisions to continue / stop production of a particular product, pricing decisions, and decisionsconcerning product and process design, including customer relations. Information Information about direct labor and material costs as well as overhead costs is available. Overheadsare recorded by five cost pools (machining, setup labor, receiving and production control,engineering, and packaging and shipment). We assume that the current month is typical in terms of (a) capacity utilization, and (b) cost of resources. Analysis Competitive situation

The competitive situation varies for Wilkerson’s products. Pump and flow controllers are on theopposite sides of the spectrum. Pumps are commodity products, produced in high volumes for amarket with severe price competition. Flow controllers, on the contrary, are customized products,sold in a less competitive market with inelastic demand at the current price range. The third product,valves, is standard, produced and shipped in large lots. Wilkerson is a quality leader, but thisleadership may soon be contested by several competitors. Although they are able to match Wilkerson’s quality, there are no signs of price competition yet.

Nevertheless, in the long-runWilkerson should be prepared to compete on price. Existing (pumps) and potential (valves) pricecompetition pushes Wilkerson to analyze its overhead costs, since no reserves of cost cutting are leftin its supply chain (both customer and suppliers agreed to just-in-time delivery). Existing cost system Currently Wilkerson implements volume-based full costing. Direct materials and labor costs arebased on standard prices of materials and labor rates. Indirect cost (overhead) is allocated to costobjects (products) in proportion to direct labor cost at the rate of 300%.

Two factors demonstrate that volume-based costing may produce inadequate estimates of the unitcost: * Overheads are quite high (300% to direct labor cost). * Products vary in terms of consumption of indirect resources. Pumps and valves are standardproducts, whereas flow controllers are customized, so we should expect higher unit cost for thelatter. Existing volume-based costing with one-stage indirect cost allocation (from aggregated cost pool to products) doesn’t allow differentiating indirect cost among products in accordance with their demand on indirect resources.

Currently overheads are allocated to products inproportion to direct labor costs, although they don’t relate to direct labor technologically. Option I: Direct costing and Contribution analysis Direct costing and contribution analysis are adequate for short-term decision making (e. g. accept orreject an additional order when only those costs that would change if a particular option is taken arerelevant). In the long-run under price competition, however, the company needs to be sure thateach product is at a minimum break even.

Besides, direct costing would provide highly unreliable information for decision-making whenoverheads are so significant and there is variability among products. Option II: Activity-based costing Activity-based costing allows tracing indirect costs to product with a high degree of accuracy. Whilevolume-based costing is implicitly based on an assumption that there’s a direct relationship between volume of production of individual products and level of overhead, activity-based costing allowsfinding individual relationships between volume of production and different overheads.

It becomespossible due to combining overheads into cost pools and allocating these cost pools to products inproportion to selected cost drivers that reflect these individual relationships between volume of production and level of overheads. Wilkerson should pool overheads into five groups (cost pools): machine-related expenses, setuplabor cost, receiving and production control, engineering, packaging and shipment. The next step ischoosing most appropriate cost drivers that reflect the relationship between volume of productionof individual products and level of overheads.

Machine hours are the most natural cost driver formachine-related expenses. Both setup and receiving, and production control activities are changedin proportion to number of production runs. Engineering cost can be allocated in proportion tohours of engineering work, whereas packaging and shipment activity is driven by the number of shipments The selected cost pools, cost drivers and calculated cost driver rates are presented below: Per unit cost of products can be found as a sum of direct labor and material costs and allocatedoverheads.

Each cost driver rate is multiplied by the volume of cost driver for an individual productand then divided by volume of production of this product (see Table 1). Activity-based costing provides more accurate information about product cost and, therefore, theirgross margins. Customized product (flow controllers) appeared to be much less attractive for thecompany that standardized valves and pumps. Actually, flow controllers generate negative grossmargin (under assumption made), while valves and pumps are much more profitable than thecompany initially believed (see Table 2).

Wilkerson can continue to decrease prices of commodity products (valves and pumps) since theirmargins are quite high, but need to react to negative profitability of flow controllers. Correction for unused capacity Variations in capacity utilization may have significant impact on unit costs of individual products and,therefore, on decision made on the basis of full cost analysis. If the demand can be higher in somemonths, and Wilkerson can still meet it, we should acknowledge the fact of having unused capacity in the “typical month” that we consider.

Higher capacity utilization will increase products’ gross margins. Preliminary analysis indicates that flow controllers might have low, but positive margin, if capacity utilization goes up as stated. If we can reasonable believe that the company can actually increase the level of capacity utilizationin the long-run, cost analysis for individual products should be done on the basis of cost of usedcapacity only, leaving aside cost of unused capacity. The latter, if temporary, can be subtracted from the company’s profit along with general and administrative expenses. Limitations of analysis

Our calculation of cost drivers and product cost doesn’t allow revealing t he difference betweenindividual flow controllers, although we know that they are customized. So, their unit costs areaverage and might vary significantly for a specific configuration (cost of production) or a specificcustomer (cost of delivery). Regular analysis of product profitability based on activity-based costing is an expensive exercise, sowe are not able to accommodate the impact of variability of volume of product on unit costs. Weassume here, that calculations are done for a representative (typical) month in terms of capacityutilization.

We also assume that costs of resources (including cost driver rates for overheads) areconstant for a given time horizon of decisions made on the basis of calculations. General and administrative expenses, al though significant, weren’t allocated among products. Recommendations Taking into account variability among products in demand for indirect resources, high level of overheads and absence of linear relationship between the volume of activity and volume of production of individual products, we recommend to move from traditional volume-based costing toactivity-based costing.

Based on the information about unit cost obtained by ABC we can recommend the company toreview its policy in respect to flow controllers. Having in mind the absence of price competition,customized nature of a product, and price inelastic demand, Wilkerson can change prices of individual flow controllers in order to secure healthy profit margin.

One of the ways of doing this issetting prices in accordance with the amount of resources consumed (activity-based pricing) byindividual product or customer. The company can also consider a set of action that might reduce the cost of flow controllers: changetheir design, adjust the production process to eliminate waste of resources, switch to batchproduction and delivery to decrease the cost per unit associated with production runs and numberof shipments.