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OC Garden is a garden care service. The company originally specialized
in serving residential clients, but recently has started contracting for work with larger commercial clients. Wally Dyer, the owner, is considering reducing residential services and increasing commercial lawn care.
The company has five field employees who worked a total of 10,000 hours last year – 3,100 on commercial jobs and 6,900 on residential jobs. Wages paid to employees were $9 per hour for all work done. Direct materials were minimal and were included in overhead. All overhead is allocated on the basis of labor hours worked. Customer charges (billings) are based on labors hours worked. Because of greater competition for commercial accounts, Mr. Dyer can charge $23 per hour for residential work but only $18 per hour for commercial work.
Required:
(a)           If overhead for the year was $62,000, use an income statement to calculate the profits of each of the two services, commercial and residential, using labor hours as the allocation base for overhead. The income statement should have three columns, one for commercial services, one for residential services, and one for the totals. Please show all calculations.
(b)          A more detailed analysis of overhead revealed that it consists of three components: office supplies, garden supplies, and depreciation and maintenance of equipment. These costs can be traced to the following activities:
Activity Level
Activity                                 Cost Driver             Cost        Commercial Residential
Office Supplies        Number of clients served  $8,000              22               38
Equipment Deprec.
and maintenance     Equipment Hours              18,000            3,500            2,500
Garden Supplies       Area Covered
(square yards)                   36,000            65,000          35,000
Total Overhead                                                  $62,000
Use an income statement to recalculate the profits of each of the two services, commercial and residential, using Activity Based Costing to allocate overhead costs. The income statement should have three columns, one for commercial services, one for residential services, and one for the totals. Please show all calculations.
(C) As noted above, the owner is considering a strategy of reducing residential services and increasing commercial lawn care. Based on your ABC analysis in part (b), what recommendations do you as to this strategy?
 
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