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	$	2,925,000		$	2,760,000		$	5,685,000
Direct materials		550,000			500,000			1,050,000
Direct labor		400,000			200,000			600,000
Overhead costs
Administration								468,000
Production setup								1,080,000
Quality control								720,000
Distribution								1,440,000
Operating profit							$	327,000

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	200	200
Distribution	Number of units shipped	1,500	6,000

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

a) Firstly we need to allocate overhead to each product using activity based costing which is shown as follows:-

Calculation of Activity Rate (Amounts in $)

Activity Base	Cost Driver	Total Overhead Cost (A)	Total Activity (B)	Activity Rate (A/B)
Administration	Direct Labor Cost	468,000	$600,000	$0.78
Production Setup	No. of production runs	1,080,000	150 runs	$7,200 per run
Quality Control	No. of inspections	720,000	400 inspections	$1,800 per inspection
Distribution	No. of units shipped	1,440,000	7,500 units	$192 per unit

Allocation of overhead to each product (Amounts in $)

	Ergo	Standard	Total
Administration	312,000 (400,000*$0.78)	156,000 (200,000*$0.78)	468,000
Production Setup	360,000 (50*$7,200)	720,000 (100*$7,200)	1,080,000
Quality Control	360,000 (200*$1,800)	360,000 (200*$1,800)	720,000
Distribution	288,000 (1,500*$192)	1,152,000 (6,000*$192)	1,440,000
Total Overhead	1,320,000	2,388,000	3,708,000

Income statement is shown as follows (Amounts in $)

EZ-SEAT, INC. Income Statement
	Ergo			Standard			Total
Sales revenue (A)		2,925,000			2,760,000			5,685,000
Direct materials		550,000			500,000			1,050,000
Direct labor		400,000			200,000			600,000
Overhead costs
Administration		312,000			156,000			468,000
Production setup		360,000			720,000			1,080,000
Quality control		360,000			360,000			720,000
Distribution		288,000			1,152,000			1,440,000
Total cost (B)		2,270,000			3,088,000			5,358,000
Operating profit/(Loss) (A-B)		655,000			(328,000)			327,000

b) Total Overheads = $468,000+$1,080,000+$720,000+$1,440,000

= $3,708,000

Total Direct labor costs = $600,000

Total overheads per direct labor cost = $3,708,000/$600,000 = $6.18 per direct labor

Income statement using direct labor costs as the allocation base is shown as follows (Amounts in $)

EZ-SEAT, INC. Income Statement
	Ergo			Standard			Total
Sales revenue (A)		2,925,000			2,760,000			5,685,000
Direct materials		550,000			500,000			1,050,000
Direct labor		400,000			200,000			600,000
Overhead costs		2,472,000 (400,000*$6.18)			1,236,000 (200,000*$6.18)			3,708,000
Total cost (B)		3,422,000			1,936,000			5,358,000
Operating profit/(Loss) (A-B)		(497,000)			824,000			327,000