CPA Services - Profitability Analysis

Hy and Lowe is a public accounting firm that offers two primary services, auditing and tax preparation. A disagreement has developed between the partners who head up the two services as to who is contributing the most to firm profitability. The area of contention is the assignment of overhead. The tax partner argues for assigning overhead on the basis of 40% of direct labor cost. The audit partner argues for implementing activitybased costing.

The partners agree to use next year's budget data for analysis and comparison. The following data are collected:

	Audit	Tax
Revenues	$2,300,000	$1,200,000
Employee labor	$1,000,000	$800,000

Activity	Cost Driver	Estimated Overhead
Employee training	Direct labor cost	$216,000
Typing and secretarial	Number of reports / forms	76,200
Computing	Number of minutes	204,000
Facility rental	Number of employees	142,500
Travel	Per expense reports	81,300
	Total	$720,000

	EXPECTED ACTIVITY
Activity	Cost Driver	Audit	Tax
Employee training	Direct labor cost	$1,000,000	$800,000
Typing and secretarial	Reports/forms	600	1,900
Computing	Minutes	25,000	35,000
Facility rental	Employees	22	18
Travel	(Direct)	$56,000	$25,300

Required:

Compare the traditional costing using the direct labor cost as an allocation base with activity based costing. Classify each of the activities as Value Added or NonValue Added. Make a recommendation on a costing system based on your analysis (use some type of return ratio or margin ratio to help support your decision).