Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 34

Comparative Income Statements and Management Analysis

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
Revenue	$1,950,000	$1,840,000	$3,790,000
Direct materials	550,000	500,000	1,050,000
Direct labor	400,000	200,000	600,000
Overhead costs Administration			234,000
Production setup			540,000
Quality control			360,000
Distribution			720,000
Operating profit			$ 286,000

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.

---

b. Write a brief report indicating how management could use activity-based costing to reduce costs.

---

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

---

d. Write a report to management stating why product line profits differ using activity-based costing compared to the traditional approach. Indicate whether activity-based costing provides more accurate information and why (if you believe it does provide more accurate information). Indicate in your report how the use of labor-based overhead allocation could cause EZ-Seat management to make suboptimal decisions.

Step 1 of 4

a.?EZ-Seat, Inc. Income Statement

Account	Rate		Ergo		Standard		Total
Revenue			$1,950,000		$1,840,000		$3,790,000
Direct materials			$   550,000		$   500,000		$1,050,000
Direct labor			400,000		200,000		600,000
Overhead costs:
Administration	39%	a	156,000	e	78,000		234,000
Production setup	$3,600	b	180,000	f	360,000		540,000
Quality control	$900	c	180,000	g	180,000		360,000
Distribution	$96	d	144,000	h	576,000		720,000
Total overhead costs			660,000		1,194,000		1,854,000
Operating profit			$?340,000		$ (54,000)		$?286,000

a39% = $234,000 of Administrative costs ÷ $600,000 of direct labor costs

b$3,600 = $540,000 of Production setup costs ÷ 150 production runs

c$900 = $360,000 of Quality control costs ÷ 400 inspections

d$96 = $720,000 of Distribution costs ÷ 7,500 units shipped

e$156,000 = $0.39 x $400,000 direct labor costs

f$180,000 = $3,600 per setup x 50 production runs

g$180,000 = $900 per inspection x 200 inspections

h$144,000 = $96 per unit x 1,500 units shipped