Montreal Electronics Company manufactures two large-screen television models: the Nova, which has been produced for 10 years and sells for $900, and the Royal, a new model introduced in early 20x0, which sells for $1,140. Based on the following income statement for 20x1, a decision has been made to concentrate Montreal’s marketing resources on the Royal model and to begin to phase out the Nova model.

The standard unit costs for the Royal and Nova models are as follows:

Manufacturing overhead was applied on the basis of machine hours at a predetermined rate of $25 hour.

Montreal Electronics Company’s controller is advocating the use of activity-based costing and activity-based management and has gathered the following information about the company’s manufacturing- overhead costs for 20x1.

Required:

1. Briefly explain how an activity-based costing system operates.

2. Using activity-based costing, determine if Montreal Electronics should continue to emphasize the Royal model and phase out the Nova model.

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MONTREAL ELECTRONICS COMPANY Income Statement For the Year Ended December 31, 20x1 Royal Nova Total Sales $4,560,000 $19,800,000 $24,360,000 Cost of goods sold 3,192,000 12,540,000 15,732,000 Gross margin $ 7,260,000 5,830,000 $ 1,430,000 $1,368,000 $ 8,628,000 Selling and administrative expense 978,000 6,808,000 Net income . $ 390,000 $ 1,820,000 Units produced and sold 4,000 22,000 Net income per unit sold 97.50 65.00