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

Exercise 27

Activity-Based Costing in a Service Environment

We-Clean, Inc., is a home-cleaning service. It originally specialized in serving small residential clients but recently started contracting for work in large apartment and office buildings. Julie Lodge, the owner, believes that the commercial sector has more growth opportunities and is considering dropping the residential service.

Twenty cleaning employees worked a total of 40,000 hours last year, 26,000 on residential jobs and 14,000 on commercial jobs. Wages were $15 per hour for all work done. Any materials used are included in overhead as supplies. All overhead is allocated on the basis of labor-hours worked, which is also the basis for customer charges. Because of increased competition for commercial accounts, Julie can charge $35 per hour for residential work, but only $27 per hour for commercial work.

Required

a.If overhead for the year was $124,000, what were the profits of the commercial and the residential services using labor-hours as the allocation base?

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b.Overhead consists of costs of traveling, using equipment, and using supplies, which can be traced as follows:

			Cost Driver Volume
Activity	Cost Driver	Cost	Commercial	Residential
Traveling	Number of clients served	$ 16,000	17	47
Using equipment	Equipment hours	36,000	3,750	2,250
Using supplies	Area serviced in square yards	72,000	130,000	70,000
Total overhead		$124,000

Recalculate profits for commercial and residential services based on these activity bases.

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c. What recommendations do you have for management regarding the profitability of these two types of services?

Step 1 of 28

Activity-based Costing:

Activity-based Costing which is more popularly known as ABC method is an accounting method in which the firms identify the various activities and then assigns indirect costs incurred to carry out those activities.