Wilkerson Company Case Summary

Wilkerson Company is facing fierce competition in the water purification equipment business that could potentially cannibalize their sales. In matching the lower prices set by the competition, Wilkerson’s profits and pre-tax margins have declined as a result. Despite lowering the prices of pumps, which are Wilkerson’s major product line, the product’s gross margin has fallen under 20% - which is 15% below the company’s expectations. In light of these challenges, Wilkerson Company decided to examine their overhead costs.

II. Standard Unit Costs vs. Activity Based Costing Analysis

Wilkerson uses a simple cost accounting system in which each unit is charged for direct labor and material costs in addition to overhead costs, which are allocated depending on the percentage of production-run direct labor usage. Under this system, the overhead percentage set by Wilkerson was 300%. This standardized system, however, did not reflect the specific complexities of each

individual product; valves and pumps are made up of four and five components, respectively, while flow controllers are made up of 10 components.
Unlike the standard method, the Activity Based Costing system assigns costs depending on the intensity of activities performed to manufacture a product. Hence, given how each component "required a separate production run” and how laborers “ordered, processed, inspected, and moved” each batch of components, flow controllers ultimately had a cost that was almost twice as higher ($115.40) under the ABC system than they did under the standard method ($62), which disregarded the labor-intensive nature of the product. On the other hand, valves and pumps had a lower cost under the ABC than they did under the standard method; under the standard method they shared the burden of the activity-intensive flow controllers, which drove their production/unit cost up.
When comparing the gross margins under the standard method with their ABC system counterparts, we notice wide variations. Under the standard method and as aforementioned in the introduction paragraph, pumps were reported to have an “actual gross margin” of 19.5%. Under ABC method, however, pumps had a gross margin of 33% due to the lower production cost reported. Flow controllers, on the other side, were reported to have an “actual gross margin” of 41.0%; however, flow controllers were actually suffering from a 10% loss under the ABC method. Finally, valves reported the highest margin under the ABC method at a 46% compared to the standard method’s figure of 35%.
II.

Strategic Implications and Recommendations

The first implication that would arise from adopting the ABC system is that flow controllers will become an unprofitable product. In order to meet the “planned gross margin” of 35%, the company will have to charge $155 for flow controllers, which would be about a 48% increase from its current selling price. This could mean that flow controllers either will drop sharply in sales or will be eliminated altogether from the business, causing the company to lose a source of revenue.

The accuracy of ABC results are also up to debate since set-up costs were calculated using production-runs as a cost driver while the case does not explicitly mention the dynamics or mechanisms of each product’s set-up.

My recommendation for Wilkerson would be to keep their standard accounting system and to capitalize upon the relative inelasticity of flow controller’s demand by increasing their prices by about 10% in order to match the inherent labor-intensive nature of the

product.