Wilkerson Company
...duced. If these are allocated to products using unit-based measures (such as direct labor hours or units produced), the resulting product costs are not a true reflection of actual resource consumption. Thus this costing system is likely to under-cost low-volume products and over-cost high-volume products in terms of the overhead assigned to them. 3. Should Wilkerson abandon its overhead cost allocation system and make managerial decisions based on contribution margin (price less variable costs); thereby in effect using marginal costs rather than average costs? Note: only direct materials and direct labor costs are assumed to be variable here. No. The variable costing approach based on contribution margin shifts fixed manufacturing costs from the product cost category to the period cost group. In some ways, this understates the true cost of production. In this case, if Wilkerson plans to stop producing some products, variable costing could be quite useful in avoiding incorrect decisions about product discontinuation. But, Wilkerson is not considering product discontinuation. And the only direct materials and direct labor costs are variable in this case. Thus, variable manufacturing overhead costs are also shifted to the period cost with fixed manufacturing costs. This can result in some very wrong decision. Therefore, Wilkerson should stick to its overhead cost allocation system and improve the system to allocate its overhead costs. 4. What would an ABC (activity-based costing) system look like? What cost drivers should be selected for the various activities? What are the corresponding calculated cost driver rates? At Wilkerson, the following five activity costs pools and activity measures are selected: Machine-related Setup Receiving and Production Control Engineering Packaging and Shipping Cost Pools Costs Allocation Base Units of Allocation Base Allocation Rate Valves Pumps Cont. Total Direct Labor $ 271,250 Direct Materials $ 458,000 Machine-related $ 336,000 Machine hours 3,750 6,250 1,200 11,200 $30 / machine hour Setup Labor $ 40,000 Number of production runs 10 50 100 160 $250 / production run Receiving & Production Control $ 180,000 Number of production runs 10 50 100 160 $1125 / production run Engineering $ 100,000 Hours of engineering work 250 375 625 1,250 $80 / engineering hour Packaging & Shipping $ 150,000 Number of shipments 10 70 220 300 $500 / shipment 5. Compute revised product costs based on the ABC analysis. Interpret your findings regarding the profitability of the different products. Cost Drivers Valves Pumps Flow Controllers Total Units Amount Unit Amount Unit Amount Sales 7,500 $ 645,000 12,500 $ 1,087,500 4,000 $ 420,000 $ 2,152,500 Direct Labor 7,500 $ 75,000 12,500 $ 156,250 4,000 $ 40,000 $ 271,250 Direct Matetials 7,500 $ 120,000 12,500 $ 250,000 4,000 $ 88,000 $ 458,000 Machine-related 3,750 $ 112,500 6,250 $ 187,500 1,200 $ 36,000 $ 336,000 Setup 10 $ 2,500 50 $ 12,500 100 $ 25,000 $ 40,000 Receiving & Production Control 10 $ 11,250 50 $ 56,250 100 $ 112,500 $ 180,000 Engineering 250 $ 20,000 375 $ 30,000 625 $ 50,000 $ 100,000 Packaging & Shipping 10 $ 5,000 70 $ 35,000 220 $ 110,000 $ 150,000 ...