1. If Wilkerson were to cut prices, based on contribution margin, to just cover short-term variable costs, what consequences could it experience? (5 marks) Several break-even-point assumptions are made in calculation: 1) Total fixed costs do not change with volume, and will exist regardless if the products are sold or not. 2) Sales mix will be constant.
The contribution-margin percentage is 66.1%, which means 66.1 percent of each sales dollar is available for covering fixed costs and making income: $1,365,650/66.1%=$2,065,387 sales are needed to break even.
Based on the existing sales mix and production units given (Valves 7,500, Pumps 12,500 and Flow Controllers 4,000), the break-even prices in dollars (BEP$) are shown as below:
Therefore, based on the data above, if the company cut its prices to just cover short-term variable costs, the company’s total sales would fall by 4.05%, from $2,152,500 to $2,065,387, which would also result in 4.05% drop in the selling price of each unit of products, total variable costs at $699,737, and zero operating income before tax.
2. (a) How does Wilkerson's existing cost system operate? (5 marks) Wilkerson's current cost system is based on a simple cost accounting system. Material cost is recorded as prices paid to the suppliers for components. Labour rates and fringe benefits were appropriated to products by using the standard run times for each of their three products at a rate of $25 per hour. Finally, the company allocated the overhead costs for its sole producing department to products as a percentage (300%) of production-run direct labour cost. However, due to the growth of the company, the 300% estimate may lead to inaccuracies in future projections. Potential problems of the existing cost system are listed as below: 1) It failed to reflect the specialized costs of multiple products 2) It is inaccurate when estimating manufacturing overhead only based on direct labor cost 3) It roughly applied all overhead costs including unused or idle capacity costs to products
2. (b) Develop a diagram to show how costs flow from factory expense accounts to products. (5 marks)
3. (a) Develop an activity-based costing model based on actual production volumes. Show full calculations, including gross margin per unit. (8 marks) As below:
3. (b) Develop an activity-based costing model based on capacity. Show full calculations including gross margin per unit. (8 marks) As below:
3. (c) Which cost driver rates should be used? Actual, or capacity? Why? (7 marks)
Activity Based Costing models based on actual production volumes and capacity both provide significant data and advantages over each other. When combined, we are able to observe the costs/losses of our unused capacity. However, if we had to choose one method, based on the above data, we believe that the capacity driver rates should be used for Wilkerson Company. These (actual) figures indicate that we are losing money on our flow controllers, which are consuming a disproportionate amount of the resources – it actually consumes the highest amount of setup, receiving & production control, engineering, and packaging & shipping resources. By using our capacity numbers, we find that if we were to increase our production proportions to utilize our unused capacity and operate at full capacity, we could actually make money on this product line (despite it consuming the majority of our resources). In addition, our capacity numbers also give us significant data on our product line and our production capabilities, which allows us to make decisions on optimizing our production processes. For example, we look into our packaging and shipping costs for flow controllers to see if we could bundle deliveries to customers ordering additional products, or maybe even see if we are using 20 different vendors, instead of a preferred list (and thereby...
Please join StudyMode to read the full document