Question

Corbett Company develops software. The market is very competitive and Corbett's competitors continue to introduce new products at low prices. Corbett offers a wide variety of software - from simple programs to extremely complex programs. Like most software companies Corbett's raw materials costs are insignificant. You have recently been hired by Corbett as a business analyst and attended a seminar on Activity-Based Costing (ABC) and are considering using it at Corbett. Working with the Software Department Manager you identigy the following activities, related costs, and cost-allocation bases.

Activity Estimated indirect acitivity costs Allocation base estimated quantity of allocation base

Applications development $1,800,000 New applications 6 new applications

Content production 2,800,000 Lines of code 14 million lines

Testing 248,000 Testing hours 1,600 testing hours

Total indirect costs 4,848,000   

Corbett is planning to develop the following new applications

1) X-Page

2) X-Secure

X-page requires 680,000 lines of code and 90 hours of testing, while x-secure requires 10.2 million lines of code and 540 hours of testing. Corbett expects to produce and sell 20,000 units of x-page and 8 units of x-secure.

1) Write a memo to the General Manager of Corbett Company comparing the ABC costs per unit to the costs from the simpler original system. Explain why the unit costs changed and whether you think the new ABC system is likely to pass the cost-benefit test.

Answer 1

Calculation of Activity Cost Allocation Rates
Particulars	Application Development	Content Production	Testing
Estimated Cost	1800000	2800000	248000
Estd. Cost Allocation Base	6 applications	14000000 lines	1600 testing
Overhead Rate	300000	0.2	155
Calculation of Activity Cost
Particulars	Calculation	X Page	Calculation	X Secure
Application Development	1 x $ 300000	$3,00,000.00	1 x $ 300000	$3,00,000.00
Content Production	680000 x 0.20	$1,36,000.00	10200000x0.20	$20,40,000.00
Testing	90 x 155	$13,950.00	540 x 155	$83,700.00
Total Cost		$4,49,950.00		$24,23,700.00
Number of units		20000.00		8.00
Per unit cost		22.4975		302962.5

The original system alloted excess overhead to X secure than to X page. But X secure required 15times as many line of codes and 6 times as much testing as x page. The activity based cost system identifies this difference and allots X secure with more content production and testing costs.

The company is likely to pass ABC because

- it used differrent amount of resources

- they have high rate of indirect costs

- needs accurate costing as it is in competetive market