Questions:

1. How does Wilkersons existing cost system operate? Develop a diagram to show how costs flow from factory expense accounts to products.

2. Develop and diagram an activity-based cost model using the information in the case. Provide your best estimates about the cost and profitability of Wilkersons three product lines. What difference does your cost assignment have on reported product cost and profitability? What causes any shifts in cost and profitability?

Wilkerson Company The decline in our profits has become intolerable. The severe price cutting in pumps has dropped our pre-tax margin to less than 3%, far below our historical 10% margins. Fortunately, our competitors are overlooking the opportunities for profit in flow controllers. Our recent 10% price increase in that line has been implemented without losing any business. Robert Parker, president of the Wilkerson Company, was discussing operating results in the latest month with Peggy Knight, his controller, and John Scott, his manufacturing manager. The meeting among the three was taking place in an atmosphere tinged with apprehension because competitors had been reducing prices on pumps, Wilkerson's major product line. Since pumps were a commodity product, Parker had seen no alternative but to match the reduced prices to maintain volume. But the price cuts had led to declining company profits, especially in the pump line (summary operating results for the previous month, March 2000, are shown in Exhibits 1 and 2). Wilkerson supplied products to manufacturers of water purification equipment. The company had started with a unique design for valves that it could produce to tolerances that were better than any in the industry. Parker quickly established a loyal customer base because of the high quality of its manufactured valves. He and Scott realized that Wilkerson's existing labor skills and machining equipment could also be used to produce pumps and flow controllers, products that were also purchased by its customers. They soon established a major presence in the high-volume pump product line and the more customized flow controller line. Wilkerson's production process started 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 facility. The same equipment and labor were used 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, and products were packed and shipped as completed. Valves were produced by assembling four different machined components. Scott had designed machines that held components in fixtures so that they could be machined automatically. The valves were standard products and could be produced and shipped in large lots. Although Scott felt several competitors could now match Parker's quality in valves, none had tried to gain market share by cutting price, and gross margins had been maintained at a standard 35%. Knight's team had collected the data shown in Exhibit 4 based on operations in March 2000. The team felt that this month was typical of ongoing operations. Some people recalled, however, that when demand was really heavy last year, the machines had worked 12,000 hours in a month and the factory handled up to 180 production runs and 400 shipments without experiencing any production delays or use of overtime. Exhibit 1 Wilkerson Company: Operating Results (March 2000) 100% $2,152,500 271,250 458,000 Sales Direct Labor Expense Direct Materials Expense Manufacturing overhead Machine-related expenses Setup labor Receiving and production control Engineering Packaging and shipping Total Manufacturing Overhead Gross Margin General, Selling & Admin. Expense Operating Income (pre-tax) $336,000 40,000 180,000 100,000 150,000 29% 806,000 $617,250 559,650 $ 57,600 3% Exhibit 2 Product Profitability Analysis (March 2000) Direct labor cost Direct material cost Manufacturing overhead (@300%) Standard unit costs Valves $10.00 16.00 30.00 $56.00 Pumps $12.50 20.00 37.50 $ 70.00 Flow Controllers $10.00 22.00 30.00 $62.00 Target selling price Planned gross margin (%) $86.15 35% $107.69 35% $95.38 35% Actual selling price Actual gross margin (%) $86.00 34.9% $87.00 19.5% $105.00 41.0% Exhibit 3 Product Data Product Lines Materials per unit Valves 4 components 2 @ $2 = $ 4 2 @ 6 = 12 Pumps 5 components 3 @ $2 = $6 2 @ 7 = 14 Flow Controllers 10 components 4 @ $1 = $ 4 5 @ 2 = 10 1 @ 8 = 8 $22 $16 .40 DL hours Materials cost per unit Direct labor per unit Direct labor $/unit @ $25/DL hour (including employee benefits) Machine hours per unit $20 .50 DL hours $12.50 $10 40 DL hours $10.00 0.5 0.5 0.3 Exhibit 4 Monthly Production and Operating Statistics (March 2000) Production (units) Machine hours Production runs Number of shipments Hours of engineering work Valves 7,500 3,750 10 Pumps 12,500 6,250 50 70 375 Flow Controllers 4,000 1,200 100 220 625 Total 24,000 11,200 160 10 300 250 1,250 Wilkerson Company The decline in our profits has become intolerable. The severe price cutting in pumps has dropped our pre-tax margin to less than 3%, far below our historical 10% margins. Fortunately, our competitors are overlooking the opportunities for profit in flow controllers. Our recent 10% price increase in that line has been implemented without losing any business. Robert Parker, president of the Wilkerson Company, was discussing operating results in the latest month with Peggy Knight, his controller, and John Scott, his manufacturing manager. The meeting among the three was taking place in an atmosphere tinged with apprehension because competitors had been reducing prices on pumps, Wilkerson's major product line. Since pumps were a commodity product, Parker had seen no alternative but to match the reduced prices to maintain volume. But the price cuts had led to declining company profits, especially in the pump line (summary operating results for the previous month, March 2000, are shown in Exhibits 1 and 2). Wilkerson supplied products to manufacturers of water purification equipment. The company had started with a unique design for valves that it could produce to tolerances that were better than any in the industry. Parker quickly established a loyal customer base because of the high quality of its manufactured valves. He and Scott realized that Wilkerson's existing labor skills and machining equipment could also be used to produce pumps and flow controllers, products that were also purchased by its customers. They soon established a major presence in the high-volume pump product line and the more customized flow controller line. Wilkerson's production process started 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 facility. The same equipment and labor were used 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, and products were packed and shipped as completed. Valves were produced by assembling four different machined components. Scott had designed machines that held components in fixtures so that they could be machined automatically. The valves were standard products and could be produced and shipped in large lots. Although Scott felt several competitors could now match Parker's quality in valves, none had tried to gain market share by cutting price, and gross margins had been maintained at a standard 35%. Knight's team had collected the data shown in Exhibit 4 based on operations in March 2000. The team felt that this month was typical of ongoing operations. Some people recalled, however, that when demand was really heavy last year, the machines had worked 12,000 hours in a month and the factory handled up to 180 production runs and 400 shipments without experiencing any production delays or use of overtime. Exhibit 1 Wilkerson Company: Operating Results (March 2000) 100% $2,152,500 271,250 458,000 Sales Direct Labor Expense Direct Materials Expense Manufacturing overhead Machine-related expenses Setup labor Receiving and production control Engineering Packaging and shipping Total Manufacturing Overhead Gross Margin General, Selling & Admin. Expense Operating Income (pre-tax) $336,000 40,000 180,000 100,000 150,000 29% 806,000 $617,250 559,650 $ 57,600 3% Exhibit 2 Product Profitability Analysis (March 2000) Direct labor cost Direct material cost Manufacturing overhead (@300%) Standard unit costs Valves $10.00 16.00 30.00 $56.00 Pumps $12.50 20.00 37.50 $ 70.00 Flow Controllers $10.00 22.00 30.00 $62.00 Target selling price Planned gross margin (%) $86.15 35% $107.69 35% $95.38 35% Actual selling price Actual gross margin (%) $86.00 34.9% $87.00 19.5% $105.00 41.0% Exhibit 3 Product Data Product Lines Materials per unit Valves 4 components 2 @ $2 = $ 4 2 @ 6 = 12 Pumps 5 components 3 @ $2 = $6 2 @ 7 = 14 Flow Controllers 10 components 4 @ $1 = $ 4 5 @ 2 = 10 1 @ 8 = 8 $22 $16 .40 DL hours Materials cost per unit Direct labor per unit Direct labor $/unit @ $25/DL hour (including employee benefits) Machine hours per unit $20 .50 DL hours $12.50 $10 40 DL hours $10.00 0.5 0.5 0.3 Exhibit 4 Monthly Production and Operating Statistics (March 2000) Production (units) Machine hours Production runs Number of shipments Hours of engineering work Valves 7,500 3,750 10 Pumps 12,500 6,250 50 70 375 Flow Controllers 4,000 1,200 100 220 625 Total 24,000 11,200 160 10 300 250 1,250