Wilkerson Company Activity Based Costing

1. Wilkerson CompanyActivity Based Costing Professor Doug Cerf Donald Bren Graduate School of Environmental Science and Management Corporate Environmental Management (ESM 281) Spring 2008

2. Printed on recycled paper-actually better, not printed at all

3. Printed on recycled paper-actually better, not printed at all 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

4. Printed on recycled paper-actually better, not printed at all 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

5. Printed on recycled paper-actually better, not printed at all 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?

6. Printed on recycled paper-actually better, not printed at all 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

7. Printed on recycled paper-actually better, not printed at all 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

8. Printed on recycled paper-actually better, not printed at all Questions What is the competitive situation faced by Wilkerson? Given some of the apparent problems with Wilkerson’s 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?

9. Printed on recycled paper-actually better, not printed at all Questions How does Wilkerson’s 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 Wilkerson’s 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 Wilkerson’s management team consider to improve the company’s profitability?

10. Printed on recycled paper-actually better, not printed at all 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.