Chapter 9, Problem 39E

Activity-Based Costing in a Service Environment

Elite Lawn & Plowing (EL&P) is a lawn and snow plowing service with both residential and commercial clients. The owner believes that the commercial sector has more growth opportunities and is considering dropping the residential service.

Twenty employees worked a total of 20,000 hours last year, 13,000 on residential jobs and 7,000 on commercial jobs. Wages were $25 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, EL&P can charge $60 per hour for residential work, but only $45 per hour for commercial work.

Required

1. a.      If overhead for the year was $205,000, what were the profits of the residential and commercial services using labor-hours as the allocation base?
2. b.      Overhead consists of costs of traveling to the site, using equipment (including vehicle rental), and using supplies, which can be traced as follows:

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

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