1. The Wilkerson Company is in the business of manufacturing valves, pumps and flow controllers. The company has been experiencing profit losses due to price reductions as a result of heavy competition in the pump category, which is considered a commodity product. In the valves category, Wilkerson seems to be a market leader with a loyal customer base. The valve business is less competitive, with no price reductions, and therefore the company has maintained its gross margin target while not compromising market share. Similarly to the valve business, the flow controller category is not as competitive as the pump industry, hence Wilkerson's ability to increase price by 10% without sacrificing volume. In addition, the company needs to take into consideration its increase in indirect expenses relatively to the direct labor expenses. All in all, the company has seen its pre-tax margin decrease from 10% to 3%.
2. Adopting a periodic expense approach will severe the already current problems with Wilkerson's cost system by distorting even more the actual cost picture. The reason is that the periodic method would ignore the company's product mix as each of the 3 categories has a differentiated direct cost structure. This would therefore create an even more incorrect analysis of the company's profit structure. Although the current cost allocating system is not optimal (as will be discussed later), it is still preferable over the periodic system, which does not take into account any overhead costs when analyzing product margins and the margins' effect on the overall profit.
3. Today, Wilkerson uses a simple cost accounting system which charges each unit of product for direct material and labor cost. Material cost is based on the component price, while labor rates are charged to products based on the production run times of each product. Then, the overhead costs are allocated to each of the 3 products as a percentage of production run direct labor costs...
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