Wilkerson Company a supplier of products to manufacturers of water purification equipment is facing an apprehension because competitors had been reducing prices on one of the company’s main product line pumps. The president of Wilkerson Company Robert Parker was discussing operating results of the previous month with controller and manufacturing manager. The product lines for the Wilkerson are pumps, valves and flow controllers. Pump is the major product line for Wilkerson. The company is forced to reduce its price of pumps as its competitors are lowering the price. Since they wanted to maintain the sales volume they are reducing their price which then lowers its gross margin. Wilkerson believes that its’ competitors are using overhead expenses as period expenses while Wilkerson uses it as product expenses. A study had also been organized to calculate the overhead cost as they are larger than that of the direct labor expense. The raw materials are purchased as semi-finished products which are later assembled in a manufacturing facility. PUMPS: Five components are assembled to produce a pump. The gross margin in its latest month had fallen below 20%. Recently the price of the pump was increased by 10% without affecting its sales volume. VALVES: The valves are designed uniquely. They have loyal customer base because of its high quality. Four machine components are assembled to produce a valve. It has a gross margin of 35%. FLOW CONTROLLER: These are customized products. They require more labor and components for each unit of product produced. They were able to increase the price of the product by 10% without affecting the demand for the product.
QUESTIONS AND SOLUTIONS:
1. What is the competitive situation faced by Wilkerson?
The competitive situation varies for Wilkerson’s products. Pump and flow controllers are on the opposite sides of the spectrum. Pumps are commodity products, produced in high volumes for a market 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 this leadership 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-run Wilkerson should be prepared to compete on price. Existing (pumps) and potential (valves) price competition pushes Wilkerson to analyze its overhead costs, since no reserves of cost cutting are left in its supply chain (both customer and suppliers agreed to just-in-time delivery).
2. Given some of the apparent problems with Wilkerson’s cost system, should executives abandon overhead assignment to products entirely by adopting a contribution margin approach in which manufacturing overhead is treated as a period expense? Why or why not?
Problems of Traditional Costing Method:
Overhead cost allocation was considered as 300 % of direct labor which was adopted as an inexpensive method of cost allocation. Wrong cost drivers for overhead expenses lead to inappropriate volume based cost analysis
Contribution Margin Approach:
Sales Per Unit
Direct labor cost
Direct material cost
Total Variable Costs per unit
Overhead activities are performed per product line regardless of the amount of units produced. The product cost and the profitability will be calculated without overhead costs. The product cost will be directly correlated to variable costs. The method does not consider the various activities...
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