1. If Wilkerson were to cut prices, based on contribution margin, to just cover short-term variable costs, what consequences could it experience? (5 marks)
Several break-even-point assumptions are made in calculation:
1) Total fixed costs do not change with volume, and will exist regardless if the products are sold or not.
2) Sales mix will be constant.

The contribution-margin percentage is 66.1%, which means 66.1 percent of each sales dollar is available for covering fixed costs and making income: $1,365,650/66.1%=$2,065,387 sales are needed to break even.

Based on the existing sales mix and production units given (Valves 7,500, Pumps 12,500 and Flow Controllers 4,000), the break-even prices in dollars (BEP$) are shown as …show more content…
Meanwhile, flow controllers are the most profitable product, with a 41% actual gross margin, ranking the top among the three products of Wilkerson.

Exhibit #2. Product Profitability Analysis Based on ABC

After examining the production costs through ABC, we found that flow controllers are actually the least profitable product of the company. Specifically, under ABC accounting, flow controllers (which have the least production volume), consume the most receiving & production control, engineering, and packaging & shipping resources. This means the actual per unit production cost of flow controllers is $83.38, not $30, as previously thought (making flow controller unprofitable). On the contrary, pumps appear to be profitable under ABC.

Theoretically, the reason why the cost has shifted is due to the difference between ABC and traditional costing. Under a traditional costing system, a single allocation based can be used for all overheads. In this case, Wilkerson simply allocated the overhead costs to products according to 300% of production – run direct labor cost. Based on this, the manufacturing overhead per unit of pumps was $12.5 × 300% = $37.5, while that of the flow controllers was $10 × 300% = $30. However, under the ABC model, there are different cost drivers due to different relationships between overheads and production activities, and overhead costs are allocated based on resources