Question

EZ-Seat, Inc., manufactures two types of reclining chairs, Standard and Ergo. Ergo provides support for the body through a complex set of sensors and requires great care in manufacturing to avoid damage to the material and frame. Standard is a conventional recliner, uses standard materials, and is simpler to manufacture. EZ-Seat’s results for the last fiscal year are shown in the following statement.

EZ-SEAT, INC. Income Statement
	Ergo			Standard			Total
Sales revenue	$	3,000,000		$	4,000,000		$	7,000,000
Direct materials		900,000			1,200,000			2,100,000
Direct labor		600,000			400,000			1,000,000
Overhead costs
Administration								600,000
Production setup								496,000
Quality control								330,000
Distribution								711,000
Operating profit							$	1,763,000

EZ-Seat currently uses labor costs to allocate all overhead, but management is considering implementing an activity-based costing system. After interviewing the sales and production staff, management decides to allocate administrative costs on the basis of direct labor costs but to use the following bases to allocate the remaining costs.

		Activity Level
Activity Base	Cost Driver	Ergo	Standard
Setting up	Number of production runs	60	100
Performing quality control	Number of inspections	220	220
Distribution	Number of units shipped	1,500	6,400

Required:

a. Complete the income statement using the preceding activity bases.

c. Restate the income statement for EZ-Seat using direct labor costs as the only overhead allocation base.

Answer 1

Solution :

(a) Income Statement Using Activity Bases :

Account	Ergo	Standard	Total
(a) Sales Revenue	$ 3,000,000	$ 4,000,000	$ 7,000,000
(b) Direct Material	$ 900,000	$ 1,200,000	$ 2,100,000
(c) Direct Labor	$ 600,000	$ 400,000	$ 1,000,000
Overhead Costs :
Administration	$ 360,000	$ 240,000	$ 600,000
Production Setups	$ 186,000	$ 310,000	$ 496,000
Quality Control	$ 165,000	$ 165,000	$ 330,000
Distribution	$ 135,000	$ 576,000	$ 711,000
(d) Total Overhead Costs	$ 846,000	$ 1,291,000	$ 2,137,000
(e) Operating Profit (Loss) (a - b - c -d )	$ 654,000	$ 1,109,000	$ 1,763,000

(2) Income Statement Using Direct Labor Bases :

Account	Ergo	Standard	Total
(a) Sales Revenue	$ 3,000,000	$ 4,000,000	$ 7,000,000
(b) Direct Material	$ 900,000	$ 1,200,000	$ 2,100,000
(c) Direct Labor	$ 600,000	$ 400,000	$ 1,000,000
(d) Total Overhead Costs (c * 213.70%)	$ 1,282,200	$ 854,800	$ 2,137,000
(e Operating Profit (Loss) (a - b - c - d)	$ 217,800	$ 1,545,200	$ 1,763,000

Working :

(1) Activity Rate :

Activity	Total OH	Total Cost Drivers	Activity Rate
Administration	$ 600,000	$ 1,000,000	60% of DL Cost
Production Setups	$ 496,000	160 Production Runs	$ 3,100 per Production Run
Quality Control	$ 330,000	440 Inspection	$ 750 per Inspection
Distribution	$ 711,000	7,900 Units Shipped	$ 90 per Unit Shipped

(2) Allocation of OH basis on Activity :

Activity	Activity Rate (a)	Ergo Activity (b)	Standard Activity (c)	OH Ergo (a * b)	OH Standard (a * c)
Administration	60% of DL Cost	$ 600,000	$ 400,000	$ 360,000	$ 240,000
Production Setups	$ 3,100 per Production Run	60	100	$ 186,000	$ 310,000
Quality Control	$ 750 per Inspection	220	220	$ 165,000	$ 165,000
Distribution	$ 90 per Unit Shipped	1,500	6,400	$ 135,000	$ 576,000

(3) OH Cost as per Direct Labor Cost :

Total OH	Total Direct Labor Cost	% of DL Cost
$ 2,137,000	$ 1,000,000	213.70% of DL Cost

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