Question:
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 $124,000, what were the profits of the commercial and the residential services using labor-hours as the allocation base?
b. Overhead consists of costs of traveling, using equipment, and using supplies, which can be traced as follows:
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Cost Driver Volume
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Activity
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Cost Driver
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Cost
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Commercial
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Residential
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Traveling
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Number of clients served
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$ 16,000
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17
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47
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Using equipment
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Equipment hours
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36,000
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3,750
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2,250
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Using supplies
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Area serviced in square yards
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72,000
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130,000
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70,000
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Total overhead
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$124,000
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Recalculate profits for commercial and residential services based on these activity bases.
c. What recommendations do you have for management regarding the profitability of these two types of services?