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 – 6,400 on residential jobs and 3,600 on commercial 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, prepare 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 17 43

Equipment Deprec.

and maintenance Equipment Hours 18,000 3,500 2,500

Garden Supplies Area Covered

(square yards) 36,000 68,000 32,000

Total Overhead $62,000

Prepare 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?