Use the Case above to answer the folllowing question:

1) Using the manufacturing overhead costs provided in Exhibit 1 and the production and operating statistics provided in Exhibit 4, calculate new overhead application rates using an activity-based costing approach.

ROBERT KAPLAN 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 354. The manufactuning process for pumps was practically identical to that for valves. Five components were machined and then assembled into the final product. The pumps were shipped to industrial product distributors after assembly. Recently, it seemed as if each month brought new reports of reduced prices for pumps. Wilkerson had matched the lower prices so that it would not give up its place as a major pump supplier. Gross margins on pump sales in the latest month had fallen below 2017 well below the company's planned gros margin of 35. flow controllers were devices that controlled the rate and dirxtion of flow of chemicals. They required more components and more labor, than pumps valves, for each finished unit. Also, there was much more variety in the types of flow controllers used in industry, so many more production runs and shipments were performed for this product line than for valves. Wilkerson had recently raised flow controller prices by more than 10% with no apparent effect on demand. Wilkerson had always used a simple cost accounting system. Each unit of product was charged for dired material and labor cost. Material cost was based on the prices paid for components under annual purchasing agreements. Labor rates, including fringe hendfits, were $25 per hour, and were charged to products based on the standard run times for ach product (see Exhibit 3). The company had only one producing department in which components were both machined and az embled into finished products. The overhead cents in this department were allocated to products as a percentage of production-run direct labor cost. Currently, the rate was 300%. Since direct labor cost had to be randa anyway to prepare factory payroll, this was sin inexpensive way to allocate overhead costs to products TE Knight nated that some companics didn't allocate any osterhead costs to products, treating them isme as period, net product, expenses. For these companies, product profitability was measured at the time contribution margin level prices all variable costs. Wilkerion variable costs were only its direct Links miaterial and direct labor cuts On that hasis: all products, including pumps, would be generating hstantial contribution to overhead and profils she thought that perhaps me Wilson GREA Semneliters were talesung this procedure and pricing to cover variable costs. Kaught had recenti le amaitask force fostenly Vilket sikur te the had became much larger than the direct labore expense Theisstudy had terealed the following internation: LES Workers often aperated several of the machine simultaruusle Drice they were set up or atlerin, DWNE Workers could operate only one machines that madhins related espense might elle mure to the machine hour ata palikt than its production-Funer hours *plad In le parlemed each time a batch of components had to be machined in a Productiom run. Each component in a product required a separate production man te machine the mandals tranhed part to the sperifications for the palat People in the receiving and production control departments ordered pet inspected and moved each batch of components for a production ruin. This work required about the same amount of time whether the components were for a long or a short production run, or whether the components were expensive or inexpensive The work in the packaging and shipping area had increased during the past couple of years as Wilkerson increased the number of customers it served. lach time products were packaged and shipped, about the same amount of work was required. regardless of the number of items in the shipment 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 Wilkerson Company: Operating Results (March 2000) $2,152,500 21250 458,000 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 150000 29 S16000 $617 250 559 650 $57.600 39 Exhibit 2 Product Profitability Analysis (March 2010) Pumps Valves $10.00 16.00 Flow Controllers $10.00 120.00 Dire i labor cost Direct material cost Manufacturing overheid (@300%) Standard unit costs 30,00 $ 6200 $56.00 $70.00 $107.69 $95.38 Target selling price Planned gross margin (1) $86.15 35%. Actual selling price Actual gross margin (4) $97.00 19.5% $105.00 410 34.99 Product Data Product Lines Materials per unit Valves mannen nach Pumps components How Controllers 10 comenPRS @STS 510 Materials cost per unit Direct labor per unat Direct labor sanit S25 DI hour including employee benehts) Machine hours per unit Al hous $10 10 hour 2. 522 10 hours SIDO DS Exhibit Monthly Production and Operating Statistics (March 2000) Valves 7500 3.750 10 Pumps 12 500 1.350 Flow Contfalter 000 200 denon (units) Machine hours Production runs Number of shipments Hours of engineering work Total 00012 11.00 10 300 1250 ROBERT KAPLAN 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 354. The manufactuning process for pumps was practically identical to that for valves. Five components were machined and then assembled into the final product. The pumps were shipped to industrial product distributors after assembly. Recently, it seemed as if each month brought new reports of reduced prices for pumps. Wilkerson had matched the lower prices so that it would not give up its place as a major pump supplier. Gross margins on pump sales in the latest month had fallen below 2017 well below the company's planned gros margin of 35. flow controllers were devices that controlled the rate and dirxtion of flow of chemicals. They required more components and more labor, than pumps valves, for each finished unit. Also, there was much more variety in the types of flow controllers used in industry, so many more production runs and shipments were performed for this product line than for valves. Wilkerson had recently raised flow controller prices by more than 10% with no apparent effect on demand. Wilkerson had always used a simple cost accounting system. Each unit of product was charged for dired material and labor cost. Material cost was based on the prices paid for components under annual purchasing agreements. Labor rates, including fringe hendfits, were $25 per hour, and were charged to products based on the standard run times for ach product (see Exhibit 3). The company had only one producing department in which components were both machined and az embled into finished products. The overhead cents in this department were allocated to products as a percentage of production-run direct labor cost. Currently, the rate was 300%. Since direct labor cost had to be randa anyway to prepare factory payroll, this was sin inexpensive way to allocate overhead costs to products TE Knight nated that some companics didn't allocate any osterhead costs to products, treating them isme as period, net product, expenses. For these companies, product profitability was measured at the time contribution margin level prices all variable costs. Wilkerion variable costs were only its direct Links miaterial and direct labor cuts On that hasis: all products, including pumps, would be generating hstantial contribution to overhead and profils she thought that perhaps me Wilson GREA Semneliters were talesung this procedure and pricing to cover variable costs. Kaught had recenti le amaitask force fostenly Vilket sikur te the had became much larger than the direct labore expense Theisstudy had terealed the following internation: LES Workers often aperated several of the machine simultaruusle Drice they were set up or atlerin, DWNE Workers could operate only one machines that madhins related espense might elle mure to the machine hour ata palikt than its production-Funer hours *plad In le parlemed each time a batch of components had to be machined in a Productiom run. Each component in a product required a separate production man te machine the mandals tranhed part to the sperifications for the palat People in the receiving and production control departments ordered pet inspected and moved each batch of components for a production ruin. This work required about the same amount of time whether the components were for a long or a short production run, or whether the components were expensive or inexpensive The work in the packaging and shipping area had increased during the past couple of years as Wilkerson increased the number of customers it served. lach time products were packaged and shipped, about the same amount of work was required. regardless of the number of items in the shipment 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 Wilkerson Company: Operating Results (March 2000) $2,152,500 21250 458,000 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 150000 29 S16000 $617 250 559 650 $57.600 39 Exhibit 2 Product Profitability Analysis (March 2010) Pumps Valves $10.00 16.00 Flow Controllers $10.00 120.00 Dire i labor cost Direct material cost Manufacturing overheid (@300%) Standard unit costs 30,00 $ 6200 $56.00 $70.00 $107.69 $95.38 Target selling price Planned gross margin (1) $86.15 35%. Actual selling price Actual gross margin (4) $97.00 19.5% $105.00 410 34.99 Product Data Product Lines Materials per unit Valves mannen nach Pumps components How Controllers 10 comenPRS @STS 510 Materials cost per unit Direct labor per unat Direct labor sanit S25 DI hour including employee benehts) Machine hours per unit Al hous $10 10 hour 2. 522 10 hours SIDO DS Exhibit Monthly Production and Operating Statistics (March 2000) Valves 7500 3.750 10 Pumps 12 500 1.350 Flow Contfalter 000 200 denon (units) Machine hours Production runs Number of shipments Hours of engineering work Total 00012 11.00 10 300 1250