Question

Wendy Chen established Windy City Coaching (WCC) to provide teen counseling and executive coaching services to its clients. WCC charges a $300 fee per hour for each service. The revenues and costs for the year are shown in the following income statement: WINDY CITY COACHING Income Statement Teen Counseling Executive Coaching Total Revenue $66,000 $135,000 $201,000 Expenses: Administrative support 40,000 Transportation, etc. 36,000 Equipment 20,000 Profit $105,000 Page 360 WCC has kept good records of the following data for cost allocation purposes: Activity Level Activity Cost Driver Teen Counseling Executive Coaching Providing administrative support Number of clients 6 4 Traveling Number of visits 100 150 Using equipment Computer hours 900 700 Required

Complete the income statement using activity-based costing and WCC’s three cost drivers.

Recompute the income statement using direct labor-hours as the only allocation base (220 hours for teen counseling; 450 hours for executive coaching).

How might WCC’s decisions regarding pricing or dropping a service be altered if Wendy were to allocate all overhead costs using direct labor-hours?

Under what circumstances would the labor-based allocation and activity-based costing (using Wendy’s three cost drivers) result in similar profit results?

A local nonprofit charity is looking for worthy causes to support through financial grants. A primary criterion for support is financial need. Wendy is thinking of applying for support for the teen counseling program. Which allocation method would give her the best chance of winning a grant? Would it be ethical for Wendy to report the income using this method in her application?

Answer 1

Wendy City Coaching

Income Statement ( Activity Based Costing)

For the period ended....

	Teen Counselling	Executive Coaching	Total
	$	$	$
Revenue	66,000	135,000	201,000
Expenses
Administrative Support	24,000	16,000	40,000
Transportation	14,400	21,600	36,000
Equipment	11,250	8,750	20,000
Total Expenses	49,650	46,350	96,000
Operating Income	16,350	88,650	105,000

Wendy City Coaching

Income Statement ( Direct Labor Hours)

For the year ended......

	Teen Counselling	Executive Coaching	Total
	$	$	$
Revenue	66,000	135,000	201,000
Less: Expenses	31,522	64,478	96,000
Operating Income	34,478	70,522	105,000

Both the products are profitable, but there is cost distortion clearly using direct labor hours to allocate costs results in undercosting and underpricing for Teen Counselling and overcosting and overpricing for Executive Coaching. The firm might be losing market share on its more profitable product, i.e, Executive Coaching. On the hand, it is probably underquoting for Teen Counselling, and reducing its profitability.

Using ABC, the firm may be advised to drop Teen Counselling ( as it is less profitable) and concentrate more on Executive Coaching ( as it is more profitable), so that overall profit is maximized.

The results under labor based allocation and ABC would be similar only if there exists no distortion of cost information, or all the three activities were primarily direct labor hour driven.

When applying for the nonprofit charity, Wendy should opt for the ABC method, as the quotation would be based on more precise cost information, and even if a very low quote is tendered, chances of making loss would be lower.

Yes, it would be ethical for Wendy to report the income using this method in her application, as she should be totally transparent.