In front of his lay the latest income statement for Jacob's Gardens, the landscaping business he had run since purchasing The Fabulous Garden from Lucia Gray more than four years ago. In general, Jacob did not spend too much time reviewing his company's financial data. As long as profits continued to rise, Jacob considered finances to be the responsibility of his accountant, Katie Sue. Recently, however, she had become more focused on the financial results of Jacob's Gardens. Jacob wanted to grow his business but did not know which of the company's services provided most beneficial results.
SERVICES PROVIDED
Jacob's Gardens offered three main landscaping services to clients in and around the local area. Jacob and one other full-time designer provided land-scape design services, which brought in revenue of $180,000 during the past year. In addition, 10 part-time employees installed plant and irrigation systems for Jacob's design clients and other customers, generating $820,000 in revenue for the company over the past year.
Jacob's services:
- Lawn mowing
- Mulching
- Pruning
During the past year, revenue from this segment totaled $280,000, and Jacob employed eight part-time workers to handle the existing clientele. The company's one-time design and installation clients often became long-term-maintenance customers.
ANALYSIS
Jacob looked again at the company's most recent statement of earnings (Exhibit 1).Although the firm was clearly making a profit margin of approximately 11.5% overall, Jacob was unsure if all three services were equally profitable, information he needed in order to decide which service(s) he should try to expand. He concluded it was about time he paid attention to the company's accounting data, and decided to call Katie Sue with some additional questions. Based on their discussion, Jacob learned the following information:
1. In addition to Jacob's $85,000 annual salary, the other garden designer earned $62,000 a year. During the past year, an average of 80% of the designers' time was spent on design, the rest on general supervision and administration.
2. Plant and sod costs were 45% of installation revenues for the year and 15% of maintenance revenues.
3. Each installation employee worked an average of 1,500 hours a year at a rate of $15 an hour. Each maintenance employee worked an average of 1,200 hours a year at a rate of $12 an hour.
4. Miscellaneous materials and other supplies averaged 3% of revenues for all three service lines.
Following his discussion with Katie Sue, Jacob sat down and prepared a statement of earnings for each of the company's service lines (Exhibit 2).
Jacob knew that an accurate allocation of the shared costs of depreciation, rent, and support personnel was critical to determining the service-line profits for her company, but he did not know how to go about allocating those expenses. Therefore, he put those costs in a column labeled "Administration,'' and called Sue for help.
"I've seen it done several ways,'' Katie Sue told Morrow in response to his questions about overhead allocation.
"Sometimes, shared costs for service businesses are allocated based on the number of full-time equivalent employees (FTEs) in each service line. Other times, overhead costs are allocated based on direct-labor dollars, direct-labor dollars plus direct-materials cost, or another metric of your choosing."
"In addition, you might want to consider which of your three service lines actually use each of the overhead departments."
Together, Jacob and Sue determined the number of FTEs for each service line, and how each line used the shared resources of the company during the past year (Exhibit3). He also considered the effects on the shared resources if she decided to grow revenues by approximately 10% for each of the service lines.
He knew that he was currently at full capacity with his existing trucks, and would need to purchase a new truck to expand any of the service lines. A new truck would cost approximately $25,000, and would be used for at least five years.
In addition, if he expanded either the installation or maintenance line, he would have to rent additional nursery space at a cost of $10,000 a year. He thought that most of the other costs would remain approximately the same regardless of the service line he chose to expand.
Jacob looked forward to completing her analysis as soon as possible, and hoped she would not have to concentrate on the financial data for Morrow's Gardens too much longer.
REQUIREMENTS:
- Discuss the various reasons why Jacob might allocate the company's shared costs to it's various service lines. What are the pros and cons of allocating these costs?
- Using the information given in the case, allocate the company's shared costs to each service line in FOUR different ways (using FOUR different bases): based on FTE's, direct-labor costs, direct labor plus direct materials, and using specific usage information given to Jacob by Katie.
- Calculate the profit percentage for each service line under each overhead allocation methods described in #2 above.
- Which service line is most financially attractive? Fully discuss and defend your answer. Would the fact that design and installation clients often use Jacob's Gardens for maintenance services have any impact on your conclusion?
- ASSUME that the volume AND revenues for each service line could grow by 10%. Which service line should Jacob expand? Is this answer consistent with your conclusion in #4? Why or why not? Explain fully and show all computations in support of your recommendation.