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Wilkerson Company
INTRODUCTION
It uses a simple cost accounting system based on Volume Based Costing approach. In
this approach, the overhead costs are allocated to products as a percentage of
production-run labor cost at a rate of 300%. The reason for following this approach is
because it is an inexpensive way of allocating overhead costs to products.
valves 112500 2500 11250 20000 5000 151250 225000 -73750 -32.78%
pumps 187500 12500 56250 30000 35000 321250 468750 -147500 -31.47%
Valves Pumps FC
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Earlier ABC Earlier ABC Earlier ABC
Direct labour cost 10 10 12.5 12.5 10 10
DMC 16 16 20 20 22 22
MOH 30 20.17 37.5 25.7 30 83.38
Standard unit cost 56 46.17 70 58.2 62 115.38
SP 86 86 87 87 105 105
Gross margin 34.9% 46.3% 19.5% 33.1% 41.0% -9.9%
Now, comparing the product profitability analysis between the two approached –
Volume-Based and Activity-Based as shown below:
It can be easily seen that gross margin of high-volume product – Pumps - is actually
near the planned gross margin whereas the gross margin of low-volume products –
Flow Controllers is in negative, i.e., it is making loss for the company.
As mentioned before, the reason for this is that the production process for Flow
Controllers is complex in comparison to Pumps. The number of production runs for Flow
Controllers is 100 whereas the number of production runs for Pumps is nearly half that
is 50.
CONCLUSION
From the above shown analysis, it can be concluded that the falling margin is a result of
negative gross margin of Flow Controllers. To improve its profitability, the company
needs to better price the flow controllers. Given that the recent price increase of Flow
Controllers by 10% had not impact on it demand, its demand can be said to
inelastic. They can continue increasing their margin in intervals by 7-10% until the
planned gross margin is reached. If it starts to affect its demand at a low margin, then the
company can consider to discontinue its production.
For rest of the two-product lines, based on industry conditions, the company can either
try to build competitive advantage by investing or becoming a cost leader by optimizing
its various production activities.
The major disadvantage for using ABC based accounting method is that it does not
measure the incremental costs needed to produce an item. Therefore, to assume the
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full-cost information as incremental cost information can negatively impact decision
making of the company.