Case 6.1 Eastside Medical Testing (LO2) Eastside Medical Testing performs five different tests (T1-T5) to detect drug use. Most clients are referred to the company by potential employers who pay for the tests. Revenue and costs related to the tests, for the most recent fiscal year, are detailed in the table below. Setting up equipment to conduct a test is the responsibility of three highly skilled technicians, one of whom is Emmet Wilson, founder and owner of the company. Tests T2 to T5 are high-volume tests that are conducted in batches of 100 tests per batch. Thus, for example, T5 is run approximately three times a day to annually process 92,000 tests in 920 batches. T1 is a test with relatively low demand. However, it is run almost every day (350 runs per year), so that results can be quickly communicated to employers. This fast turnaround represents a significant competitive advantage for the company. Nuclear Systems, Inc., is one of the few companies that requires T1. Indeed, it accounted for almost half of the 3,500 T1 tests conducted in the past year. Recently, Ron Worth, vice president of operations at Nuclear Systems, questioned the relatively high price being charged for T1. In a letter to Emmet Wilson he noted: We pay $35 for each T1 test, which is about 40% higher than your next most expensive test. Is this charge warranted? Frankly, this isn't just a matter of dollars and cents. We believe that we are being taken advantage of because we are one of the few companies that requires the test, and you are one of the few companies that provide it. If we believed that the high price was justified in terms of significantly higher costs, we would not be writing this letter. Before responding to Worth's letter, Emmet reviewed the revenue and cost data presented in the table below. As indicated, T1 produced a profit of $5.90 per test, which was much higher than the profit per test of any of the other procedures. However, since taking a day-long continuing education course at City College (titled ABC and Managing by the Right Numbers!), Emmet has wondered whether the profitability of tests is being distorted by the company's simple approach to allocating overhead- overhead allocation is based on direct labor cost. Direct labor consists of wages and benefits paid to relatively unskilled technicians who prepare samples for testing. This cost, $325,650, is only 9.6 percent of total overhead. With help from his bookkeeper, Emmet began to analyze overhead costs in an attempt to calculate the ABC cost of the five tests. In the past year, overhead amounted to $3,386,760, as follows: