Comprehensive ABC implementation (Learning Objectives 2, 3)

Xnet develops software for Internet applications. The market is very competitive, and Xnet’s competitors continue to introduce new products at low prices. Xnet offers a wide variety of software—from simple programs that enable new users to create per¬ sonal Web pages to complex commercial search engines. Like most software compa¬ nies, Xnet’s raw material costs are insignificant.

Xnet has just hired Tom Merrell, a recent graduate of State University’s account¬ ing program. Merrell asks Software Department Manager Jeff Gire to join him in a pilot activity-based costing study. Merrell and Gire identify the following activities, related costs, and cost-allocation bases:

Xnet is planning to develop the following new applications:
• X-Page—software for developing personal Web pages • X-Secure—commercial security and firewall software X-Page requires 500,000 lines of code and 100 hours of testing, while X-Secure requires 7.5 million lines of code and 600 hours of testing. Xnet expects to produce and sell 30,000 units of X-Page and 10 units of X-Secure.
Requirements 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. (Hint: Compute the total activity costs allocated to each product line and then compute the cost per unit.)
3. Xnet’s original single-allocation-based cost system allocated indirect costs to prod¬ ucts at $100 per programmer hour. X-Page requires 10,000 programmer hours, while X-Secure requires 15,000 programmer hours. Compute the total indirect costs allocated to X-Page and X-Secure under the original system. Then, compute the indirect cost per unit for each product.
4. Compare the activity-based costs per unit to the costs from the simpler original system. How have the unit costs changed? Explain why the costs changed as they did.
5. What are the clues that Xnet’s ABC system is likely to pass the cost-benefit test?

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Activity Estimated Indirect Activity Costs Allocation Base Estimated Quantity of Allocation Base Applications development....... $1,600,000 New applications 4 new applications Content production.................. Testing Total indirect costs................... 2,400,000 Lines of code 12 million lines 288,000 Testing hours 1,800 testing hours $4,288,000