Gibson Networking develops software for internet applications. It offers a wide

Question

Gibson Networking develops software for internet applications. It offers a wide variety of different software from simple programs that enable new users to create personal Web pages to complex commercial search engines. Currently Gibson is planning to develop the following new applications:
1) X-PAGE software for developing personal Web pages
2) X-SECURE commercial security and firewall software.
Gibson has just hired you to pilot a study which compares development cost for these two products using two different methods: the traditional allocation method and the activity-based costing method. At present, a single-allocation base costing system allocates indirect costs to products at $104 per programmer hour.
The proposed ABC allocation system will be based on the following information:

1)
ACTIVITY: Applications Development
ESTIMATED COST: $1,5000,000
ALLOCATION BASE: New Applications
ESTIMATED USE OF ALLOCATION BASE: 3 New Applications

2)
ACTIVITY: Content Production
ESTIMATED COST: $ 2,700,000
ALLOCATION BASE: Lines of code
ESTIMATED USE OF ALLOCATION BASE: 9 million lines

3)
ACTIVITY: Testing
ESTIMATED COST: $270,000
ALLOCATION BASE: Testing hours
ESTIMATED USE OF ALLOCATION BASE: 1,500 testing hours

XPAGE requires 480,000 lines of code and 70 hours of testing. X-SECURE requires 7,200,000 lines of code and 420 hours of testing. Gibson expects to produce and sell 25,000 units of X-PAGE and 9 units of X-SECURE.

REQUIRED:

1) Compute the cost allocation rate for each activity.

2) Use the activity-based cost allocation rates to compute the indirect cost of each unit of X-PAGE and X-SECURE.

3) X-PAGE requires 14,000 programmer hours, while X-SECURE requires 21,000 programmer hours. Compute the indirect costs allocated to X-PAGE and X-SECURE under the original system.

4) Compare the activity-based costs per unit to the unit costs from the simpler original system. Explain the differences in the costs using the two different methods.

5) List three disadvantages that Gibson might find in using the activity-based system rather than the traditional costing system.

Explanation / Answer

1) ACTIVITY: Applications Development ESTIMATED COST: $1,5000,000 ALLOCATION BASE: New Applications ESTIMATED USE OF ALLOCATION BASE: 3 New Applications Activity Driver : No of Apps Activity Cost = Est Cost/No of Apps = 15000,000/3 = $5,000,000 per App 2) ACTIVITY: Content Production ESTIMATED COST: $ 2,700,000 ALLOCATION BASE: Lines of code ESTIMATED USE OF ALLOCATION BASE: 9 million lines Activity Driver : Lines of code Activity Cost = Est Cost/No of lines of code = 2700,000/9000,000 = $0.30 per Line 3) ACTIVITY: Testing ESTIMATED COST: $270,000 ALLOCATION BASE: Testing hours ESTIMATED USE OF ALLOCATION BASE: 1,500 testing hours Activity Driver : Testing Hrs Activity Cost = Est Cost/Testing Hrs = 270,000/1500 = $180 per Test hrs Ans 1) Compute the cost allocation rate for each activity. Activity Cost : Apps = $5,000,000 per App Activity Cost :No of lines of code = $0.30 per Line Activity Cost: Testing Hrs = $180 per Test hrs Ans 2) Use the activity-based cost allocation rates to compute the indirect cost of each unit of X-PAGE and X-SECURE. XPAGE requires 480,000 lines of code and 70 hours of testing. So Indirct COst = 480000*$0.30 + 70*$180 + $5,000,000 = $5,156,600 X-SECURE requires 7,200,000 lines of code and 420 hours of testing. So Indirct COst = 7,200,000*$0.30 + 420*$180 + $5,000,000 =$7,235,600 3) X-PAGE requires 14,000 programmer hours, while X-SECURE requires 21,000 programmer hours. Compute the indirect costs allocated to X-PAGE and X-SECURE under the original system. X-PAGE requires 14,000 programmer hour So Indircet Cost = 14000*$104 = $1,456,000 X-SECURE requires 21,000 programmer hours. So Indircet Cost = 21000*$104 = $2,184,000 4) Compare the activity-based costs per unit to the unit costs from the simpler original system. Explain the differences in the costs using the two different methods. We find that ABC system is assigning cost more objectively & is based on Lines of Code, Testing hrs reqd & New Appl dev cost. Traditional System uses only no of Prog Hrs to assign cost. This results in Less cost allocation than ABC system. 5) List three disadvantages that Gibson might find in using the activity-based system rather than the traditional costing system. A intelligent Prog may write more lines of code than avge programmer. This will result in all programers being paid same salary. However if teh intelligent programer leaves, cost will shootup as more prog hrs may then be reqd. a. Thus Implementing an ABC system is a major project that requires substantial resources. Once implemented an activity based costing system is costly to maintain. Data concerning numerous activity measures must be collected , checked, and entered into the system. b. ABC produces numbers such as product margins, that are odds with the numbers produced by traditional costing systems. But managers are accustomed to using traditional costing systems to run theirs operations and traditional costing systems are often used in performance evaluations. c. Activity based costing data can be easily misinterpreted and must be used with care when used in making decisions. Costs assigned to products, customers and other cost objects are only potentially relevant. Before making any significant decision using activity based costing data, managers must identify which costs are really relevant for the decisions at hand.

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