Wilkerson Company Activity Based Costing

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Wilkerson CompanyActivity Based Costing

• Professor Doug Cerf
• Donald Bren Graduate School of Environmental
  Science and Management
• Corporate Environmental Management (ESM 281)
• Spring 2008

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Purpose of Wilkerson Case

• System of appropriate allocation of overhead
  costs to products for proper product
  profitability determination
• Decisions
• Product pricing
• Product introduction
• Production retention/elimination

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Activity Based Costing

• A method of allocating support (overhead) costs
  to products or services based on drivers of those
  costs
• Activity-based costing was first clearly defined
  in 1987 by Robert Kaplan and William Burns as a
  chapter in their book Accounting and Management
  A Field Study Perspective (Harvard Business
  School Press 1987)
• Kaplan is author of this case

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Applicability to Bren students

• Allocation of environmental costs from overhead
• If allocation of environmental costs are not
  properly assigned to products, the products that
  do not cause environmental damage are subsidizing
  the products that cause the damage

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Environmental Examples

• Were the cost of products produced during the
  creation of the superfund sites understated?
• If so, then the profit was overstated.
• This leads to production of unprofitable
  products.
• Is it inappropriate to include the cost of
  cleanup related to past damage in the cost of
  current products?

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Costs to consider in pricing a product

• Current environmental costs
• Costs related to cleanup of environmental damage
  from past operations
• Costs related to cleanup of environmental damage
  from current operations
• Companies may become responsible in the future
  for operations that meet current minimum
  environmental standards, but do not meet
  requirements of future regulation
• If you price products based on competition then
  how will knowing the true cost help?
• The true cost will help a firm make appropriate
  product retention/elimination decisions

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Activity Based Costing System

• Conditions under which ABC system is beneficial
• Large and growing indirect and support costs
• Diversity among products overhead needs
• Example
• Company produces two types of paint, one that
  generates hazardous waste and one that does not
• Issue Cost of hazardous waste disposal is part
  of overhead and overhead is allocated base on
  direct labor hours

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Questions

• What is the competitive situation faced by
  Wilkerson?
• Given some of the apparent problems with
  Wilkersons cost system, should executives
  abandon overhead allocation to products entirely
  by adopting a contribution margin approach in
  which manufacturing overhead is treated as a
  period expense? Contribution margin is price
  less direct costs (labor, materials). Why or why
  not?

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Questions

• How does Wilkersons existing cost system
  operate? Develop a diagram to show how costs
  flow from factory expense accounts to products.
• Develop and diagram an activity based costing
  model using the information in the case. Provide
  your best estimates about the cost and
  profitability of Wilkersons three product lines.
  What difference does your cost assignment have
  on reported product costs and profitability? What
  causes shifts in cost and profitability?
• Based on your analysis for Question 4, what
  actions might Wilkersons management team
  consider to improve the companys profitability?

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Questions

• What concerns, if any, do you have with the cost
  estimates you prepared in the answer to Question
  4? What other information or analysis would you
  want for better cost and profitability estimates?
• Wilkerson has been compensating salespersons with
  commissions on their gross sales volumes (less
  returns). Parker wonders whether the company
  should change the incentive system.