MASTERS IN GENERAL MANAGEMENT

2023 - 2024

WILKERSON COMPANY
CASE STUDY

Strategic Management Accounting

Prof Dr Aleksandra Klein

Group Number: 2

Yentel Cassiman
Willem De Brandt
Elise Proost
Laure Roosen
Matthias Salembier

Engaging in irregularities is severely sanctioned in correspondence with article 64 of the Examination

rules. We hereby declare that we have not engaged in any such irregularities.
Question 1

Give a schematical overview of the costing systems (current and ABC).

Engaging in irregularities is severely sanctioned in correspondence with article 64 of the Examination

rules. We hereby declare that we have not engaged in any such irregularities.
Question 2

Estimate the unit product costs for valves, pumps and flow controllers, using ABC.

Calculation of cost driver rates

▪ Machine-related expense rate

= $336,000/11,200 h = $30/machine hour (Mh)
▪ Setup Labor rate
= $40,000/160 runs = $250/run
▪ Receiving & Production control rate
= $180,000/160 runs = $1,125/run
▪ Engineering rate
= $100,000/1,250 h = $80/engineering hour (Eh)
▪ Packaging & shipping rate
= $150,000/300 shipments = $500/shipment

E.g., overhead costs for valves

▪ Machine-related
0.5 machine hours/unit x $30/machine hour x 7,500 units = $112,500

▪ Setup labour
10 runs x $250/run = $2,500

▪ Receiving & Production Control

10 runs x $1,125/run = $11,250

▪ Engineering
250 engineering hours x $80/hour = $20,000

▪ Packaging & shipping

10 shipments x $500/shipment = $5,000

 Total = $112,500 + $2,500 + $11,250 + $20,000 + $5,000 = $151,250

Unit overhead cost = $151,250/7,500 units = $20,17/unit

 Total unit product cost = $16 for material + $10 for labour + $20,17 overhead
= $46,17/unit with a margin of (1 – (46.17/86)) x 100% = 46.30%

Repeating this for pumps and flow controllers gives us the table on the next page …

Engaging in irregularities is severely sanctioned in correspondence with article 64 of the Examination

rules. We hereby declare that we have not engaged in any such irregularities.
 Total Driver Cost Valves Pumps Flow
driver controllers
rate
Number of units 7,500 12,500 4,000
Overhead costs $ 806,000 $ 151,250 $ 321,250 $ 333,500
▪ Machine-related
expenses 336,000 11,200 Mh 30/Mh 112,500 187,500 36,000
▪ Setup labour 40,000 160 runs 250/run 2,500 12,500 25,000
▪ Receiving &
production control 180,000 160 runs 1,125/run 11,250 56,250 112,500
▪ Engineering 100,000 1,250 Eh 80/Eh 20,000 30,000 50,000
▪ Packaging & 300 500
shipping 150,000 shipments /shipment 5,000 35,000 110,000
Overhead units cost $ 20.17 $ 25.70 $ 83.38
+ Direct material costs 16.00 20.00 22.00
+ Direct labour costs 10.00 12.50 10.00
Total cost per unit $ 46.17 $ 58.20 $ 115.38
Actual selling price $ 86.00 $ 87.00 $ 105.00
Actual margin 46.3% 33.1% - 9.9%

Question 3

Compare the estimated costs you calculated with ABC to the existing standard
unit costs. What causes the different product costing methods to produce such
different results?

Current system

Valve Pump Flow Controller

Direct cost/unit $26.00 $32.50 $32.00
Overhead cost/unit $30.00 $37.50 $30.00
Total cost/unit $56.00 $70.00 $62.00
Profit margin 34.9% 19.5% 41.0%

ABC system

Valve Pump Flow Controller

Direct cost/unit $26.00 $32.50 $32.00
Overhead cost/unit $20.17 $25.70 $83.38
Total cost/unit $46.17 $58.20 $115.38
Profit margin 46.3% 33.1% - 9.9%

Engaging in irregularities is severely sanctioned in correspondence with article 64 of the Examination

rules. We hereby declare that we have not engaged in any such irregularities.
The two methods are used to allocate the overhead costs. As you can see, the
direct costs are the same for each product for the two methods. In the standard
unit cost method, it was assumed that the overhead costs are 300% of the direct
labour costs. In contrary, in the ABC-method, these overhead costs are allocated
to the five different activities and are divided based on the number of cost driver
units needed per product. Each activity has a different cost driver, and the cost
per driver was calculated.

Thus, by comparing the two methods, we can conclude that the end result is only
different due to the value of the overhead costs per product. When using the
traditional method, the flow controller seems to be the best product (with highest
profit margin). However, when using the ABC-method and allocating the costs in
a more correct way, by means of cost drivers, this product has a negative profit
margin. Moreover, using the ABC-method, it is shown that the valves and pumps
are performing much better than expected, because the traditional system
over-costed high volume products and under-costed low volume
products.

Question 4

What are the strategic implications of your analysis? What actions would you
recommend to the managers?

We would first of all recommend to switch to activity-based costing method.

Secondly, Wilkerson Company can for now continue to decrease the prices of
valves and pumps since the margins are quite high. However, they need to react
to the negative profitability of flow controllers. Hereby we recommend to review
its policy in respect to these flow controllers.

We can therefore look at several options:

1. We can leave the flow controllers policy as it is
2. We can drop the flow controllers
3. We can adjust flow controllers policy

1. We can leave the flow controllers policy as it is

• Gross margin of -10%, this comes down to -$41500
 flow controllers will continue to drag down the profit

2. We can drop the flow controllers

• After recalculating without flow controllers, it would lead to an increased
gross margin and operating income for Wilkerson Company

(+) of this strategy

• Eliminates part of negative gross margin
• Leads to increase in operating income
(-) of this strategy

Engaging in irregularities is severely sanctioned in correspondence with article 64 of the Examination

rules. We hereby declare that we have not engaged in any such irregularities.
 • Loss on potential sales
• Just diminishes the negativeness but does not achieve the company’s goal
for regaining profit
• Opportunity cost (= the potential profit the company could have generated
if it had used that capacity to produce goods or services instead of leaving
it unused)

3. We can adjust flow controllers policy

The goal of this strategy would be to regain the net profit of around +-10%
Possible actions:
• Reduce the cost of non-value adding activities
• Solely price adjustment: increase the price due to current high demand
• Reduce the cost of flow controllers and then increase the price: calculate
the breakeven point
• Due to absence of price competition and the customized flow controllers
line, they could change prices of individual flow controllers to secure a
better profit margin. They could for example set prices in accordance with
the amount of resources consumed.
o Change the design: decreases complexity by decreasing
components
o Switch to batch production and delivery: reduces the number of
shipments to customers and number of production runs
(+) of this strategy
• Eliminates negative gross margin
• Meets the company goal for regaining profit
• Increases efficiency
(-) of this strategy
• Question remains if they can handle demand and supply?
• Would this strategy create a competitive market for this product?

Question 5

How much higher or lower would the ‘net income’ reported under the ABC system
be than the ‘net income’ that will be reported under the present system? Why?

ABC
▪ Valves
Net Income = (86−46.17) × 7,500 =$298,725

▪ Pumps
Net Income = (87−58.20) × 12,500 = $360,000

▪ Flow Controllers
Net Income = (105−115.38) × 4,000 = -$41,520

Total Net Income (ABC) = $298,725 + $360,000 − $41,520 = $617,205

Engaging in irregularities is severely sanctioned in correspondence with article 64 of the Examination

rules. We hereby declare that we have not engaged in any such irregularities.
Existing
▪ Valves
Net income = (86-56) x 7,500 =$225,000

▪ Pumps
Net income = (87-70) x 12,500 = $212,500

▪ Flow Controllers
Net income = (105-62) x 4,000 = $172,000

Total Net Income (Existing) = $225,000 +$212,500 +$17,200 = $609,500

Net income difference = +$7705 (or 7750, when taking into account rounding)

The costing system does not directly affect net income. However, the use of
different costing systems leads to varying interpretations of net income. For
instance, ABC systems allocate costs more accurately by tracing them to specific
activities and processes. This precision helps in attributing costs to products more
fairly based on their actual resource consumption. In contrast, traditional costing
methods often rely on broad cost allocation bases like direct labour hours or
machine hours, which can lead to over- or under-costing of products and services
which here explains the difference of $7705 in net income. Because of the broad
allocation of overhead costs in the current system (300% of direct labour), the
overhead costs are over-costed, hence the difference with the actual
observed manufacturing overhead used in the ABC system. These differences
have major impact on businesses as these outcomes are taking into consideration
when crucial decisions such as production adjustments for specific products,
pricing strategies, etc. are made. Therefore, the use of a certain costing system
can have an impact on the change in total income.

Extra

Estimate the unit product costs for valves, pumps and flow controllers, using
capacity cost rate in the ABC analysis.

If e.g., the machines are able to work up to 12,000 hours a month without
experiencing any production delays or use of overtime, but typical operations
indicate only 11,200 machine hours, then there is still quite some unused
capacity that should not be included in the unit product cost, since the cost driver
rate will be $28/Mh instead of $30/Mh. The unused capacity costs for machines
will then amount to

(12,000 Mh – 11,200 Mh) x $28/Mh = $22,400

When taking this unused capacity cost object into account, one also notices that
both valves and pumps now have better margins than predicted, but also that
flow controllers no longer have negative contribution margins.

Engaging in irregularities is severely sanctioned in correspondence with article 64 of the Examination

rules. We hereby declare that we have not engaged in any such irregularities.
 Total Driver Cost Unused Valves Pumps Flow
driver capacity controllers
rate
Number of units 7,500 12,500 4,000
Overhead costs $ 806,000 $ 84,344 $ 140,972 $ 292,361 $ 288,322
▪ Machine-related
expenses
336,000 12,000 Mh 28/Mh 22,400 105,000 175,000 33,600
▪ Setup labour 40,000 180 runs 222/run 4,444 2,222 11,111 22,222
▪ Receiving &
production control 180,000 180 runs 1,100/run 20,000 10,000 50,000 100,000
▪ Engineering 100,000 1,250 Eh 80/Eh - 20,000 30,000 50,000

▪ Packaging & 400 375

shipping 150,000 shipments /shipment 37,500 3,750 26,250 82,500
Overhead units cost $ 18.80 $ 23.39 $ 72.08
+ Direct material costs 16.00 20.00 22.00
+ Direct labour costs 10.00 12.50 10.00
Total cost per unit $ 44.80 $ 55.89 $ 104.08
Actual selling price $ 86.00 $ 87.00 $ 105.00
Actual margin 47.9% 35.8% 0.9%

Engaging in irregularities is severely sanctioned in correspondence with article 64 of the Examination

rules. We hereby declare that we have not engaged in any such irregularities.