Case study. In the Wilkerson Company case study of Harvard Business School, the main issue that the company is facing lower pre-tax operating margin (3%) comparing to historical pre-tax operating margin of 10%. Currently, the company uses simple Overhead

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Management Accounting

Course Assessment

In the Wilkerson Company case study of Harvard Business School, the main issue that the company is facing lower pre-tax operating margin (3%) comparing to historical pre-tax operating margin of 10%. Currently, the company uses simple Overhead Absorption Rate (OAR) in its accounting system. After OAR is obtained through dividing the total manufacturing overheads by the total activity level; it is then charged to different products’ unit cost based on the respective direct labor hour spent. The OAR obtained in this case study is 300%. Referring to Exhibit 1, with the fact that flow controllers have better selling price since this product line is protected from market competiveness, it appears to have the highest actual gross margin of 41.0%; followed by valves (34.9%) and pumps (19.5%). The OAR reflects the company’s major product line – pumps, to hold direct responsibility on the overall poor income performance, mainly due to its continuous price reduction to compete against the market. Conversely comparing the operating statistics in March 2000, the flow controllers recorded the least units produced and yet required the highest production runs, shipments and engineering works. This product line also being charged at low manufacturing overheads comparing to pumps, by reason of its low direct labor cost.

Exhibit 1

Considering another accounting system, Activity-Based Costing (ABC) identifies the company’s activities level and allocate respective costs based on workload and expenditure; assigning indirect costs to the products’ direct costs. Thus based on the company’s study on Wilkerson’s overheads, ABC would be fair as the selected accounting system to identify the products actual costs, where the manufacturing overheads and other expenses are charged based on the relevant activities level showed in Table 1. Referring to Exhibit 2, the ABC has indicated that valves (46.3%) have the highest actual gross margin, followed by pumps (33.1%) and flow controllers (-9.9%). In fact, it is found that the flow controllers are having negative gross margin due to the extensive workload required to produce and deliver the products. The results for both systems have turned out to be totally different, whereby the flow controllers’ product line in underperforming and should be increased in selling price. As for valves and pumps, the ABC actually proves that valves have achieved, while pumps almost achieve the targeted 35% gross margin.

Table 1

Exhibit 2

Recently, Wilkerson Company has raised the price for flow controllers for more than 10%, and it is found that the decision does not affect the sales. Referring to Exhibit 3, raising the price for exactly 10% (approximately $116 per unit) will allow the product’s gross margin to break even with its unit cost according to ABC. Therefore in order to obtain profit, the company needs to raise at least 10% in the selling price. However by taking account of the general, selling and admin expenses, again this product line has suffered great loss in pre-tax operating income. Referring to Exhibit 4, in order to resolve this problem effectively by breaking even the pre-tax operating income for flow controllers, the selling price has to be raised for 108% (approximately $218 per unit). Nevertheless, raising the price for 108% over a short period is an unreasonable yet risky approach; and will definitely affect the sales of the product as clients will look for alternative suppliers in the market. Moreover, Wilkerson could not terminate this product line because of its loss making, mainly to preserve its market reputation and branding as a leading company which provides wide range of products.

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Exhibit 3

Exhibit 4

Since raising selling price for 108% would not be possible as a short term solution, the price will remained as $116 per unit for the next analysis. Looking on flow controllers required high manufacturing overheads, Wilkerson should put effort in reducing these overheads. By reducing 15% on its machine hours, production runs, number of shipments and hours of engineering work without affecting the production, this will help to reduce the unit cost to drop to approximately $103 and raise the gross margin to 11.3%. Machine hours, production runs and engineering works can ...

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