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 statement below.

EZ-SEAT, INC. Income Statement
	Ergo			Standard			Total
Sales revenue	$	2,000,000		$	5,000,000		$	7,000,000
Direct materials		600,000			1,500,000			2,100,000
Direct labor		400,000			500,000			900,000
Overhead costs
Administration								540,000
Production setup								465,000
Quality control								270,000
Distribution								800,000
Operating profit							$	1,925,000

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	50	100
Performing quality control	Number of inspections	180	180
Distribution	Number of units shipped	1,700	6,300

Required:

a. Complete the income statement using the preceding activity bases. (Do not round intermediate calculations.)

c. Restate the income statement for EZ-Seat using direct labor costs as the only overhead allocation base. (Do not round intermediate calculations.)

Answer 1

Formula sheet

A	B	C	D	E	F	G	H	I	J
2
3
4		EZ-SEAT, INC.
5		Income Statement
6			Ergo	Standard	Total
7		Sales revenue	2000000	5000000	7000000
8		Direct materials	600000	1500000	2100000
9		Direct labor	400000	500000	900000
10		Overhead costs
11		Administration			540000
12		Production setup			465000
13		Quality control			270000
14		Distribution			800000
15		Operating profit			1925000
16
17				Activity Level
18		Activity Base	Cost Driver	Ergo	Standard	Total
19		Setting up	Number of production runs	50	100	=E19+F19
20		Performing quality control	Number of inspections	180	180	=E20+F20
21		Distribution	Number of units shipped	1700	6300	=E21+F21
22
23		Activity	Total Budgeted cost	÷	Total Expected Use of allocation base	=	Allocation Rate
24		Administration (Direct Labour as Base)	=F11	÷	=F9		=D24/F24
25		Setting up	=F12	÷	=G19	=	=D25/F25
26		Performing quality control	=F13	÷	=G20	=	=D26/F26
27		Distribution	=F14	÷	=G21	=	=D27/F27
28
29		Using the allocation rate calculated above the overhead cost can be allocated as follows:
30			Ergo	Standard	Total
31		Administration (Direct Labour as Base)	=D9*$H$24	=E9*$H$24	=SUM(D31:E31)
32		Setting up	=E19*$H25	=F19*$H25	=SUM(D32:E32)
33		Performing quality control	=E20*$H26	=F20*$H26	=SUM(D33:E33)
34		Distribution	=E21*$H27	=F21*$H27	=SUM(D34:E34)
35		Total	=SUM(D31:D34)	=SUM(E31:E34)	=SUM(F31:F34)
36
37		Income Statement using ABC system will be as follows:
38			Ergo	Standard
39		Sales revenue	2000000	5000000
40		Direct materials	600000	1500000
41		Direct labor	400000	500000
42		Overhead costs	=D35	=E35
43		Operating Income	=D39-SUM(D40:D42)	=E39-SUM(E40:E42)
44
45		c)
46
47		Using direct labor cost as the basis to assign overhead cost, first plantwide overhead rate need to be calculated using following formula:
48
49
50
51		Using the following data:
52		Total overhead cost	=SUM(F11:F14)
53		Total direct labor costs	=F9
54
55		Plantwide overhead rate can be calculated as follows:
56
57		Plantwide allocation rate	=Total overhead costs / Total allocation base used
58			=D52/D53
59
60		Using the allocation rate calculated above the overhead cost can be allocated as follows:
61			Ergo	Standard	Total
62		Manufacturing Overhead	=D9*$D$58	=E9*$D$58	=SUM(D62:E62)
63
64		Income Statement using direct labor as allocation base will be as follows:
65			Ergo	Standard
66		Sales revenue	2000000	5000000
67		Direct materials	600000	1500000
68		Direct labor	400000	500000
69		Overhead costs	=D62	=E62
70		Operating Income	=D66-SUM(D67:D69)	=E66-SUM(E67:E69)
71
72