Question:
Comparative Income Statements and Management Analysis
EZ-Seat, Inc., manufactures two types of reclining chairs, Standard and Ergo. Ergo provides support for the body through a complex set of sensors and requires great care in manufacturing to avoid damage to the material and frame. Standard is a conventional recliner, uses standard materials, and is simpler to manufacture. EZ-Seat's results for the last fiscal year are shown in the following statement.
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EZ-SEAT, INC.
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Income Statement
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Ergo
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Standard
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Total
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Revenue
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$1,950,000
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$1,840,000
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$3,790,000
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Direct materials
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550,000
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500,000
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1,050,000
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Direct labor
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400,000
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200,000
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600,000
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Overhead costs
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Administration
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234,000
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Production setup
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540,000
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Quality control
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360,000
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Distribution
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720,000
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Operating profit
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$ 286,000
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EZ-Seat currently uses labor costs to allocate all overhead, but management is considering implementing an activity-based costing system. After interviewing the sales and production staff, management decides to allocate administrative costs on the basis of direct labor costs but to use the following bases to allocate the remaining costs:
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Activity Level
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Activity Base
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Cost Driver
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Ergo
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Standard
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Setting up
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Number of production runs
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50
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100
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Performing quality control
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Number of inspections
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200
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200
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Distribution
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Number of units shipped
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1,500
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6,000
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Required
a. Complete the income statement using the preceding activity bases.
b. Write a brief report indicating how management could use activity-based costing to reduce costs.
c. Restate the income statement for EZ-Seat using direct labor costs as the only overhead allocation base.
d. Write a report to management stating why product line profits differ using activity-based costing compared to the traditional approach. Indicate whether activity-based costing provides more accurate information and why (if you believe it does provide more accurate information). Indicate in your report how the use of labor-based overhead allocation could cause EZ-Seat management to make suboptimal decisions.