Activity-based costing; product decisions: manufacturer Territory Electronics Company (TEC) manufactures two large-screen television models, the Novelle, which has been produced for 10 years and sells for $910, and the Zodiac, a new model which sells for $1 160. Based on the income statement for the year just ended, presented below, a decision has been made to concentrate TEC's marketing resources on the Zodiac model and to begin to phase out the Novelle model. Territory Electronics Company Income statement Zodiac Novelle Total Sales $4640 000 $20020000 $24 660 000 Cost of goods sold 3232 000 13024000 16256000 Gross margin $1 408 000 $ 6996000 $ 8404 000 Selling and administrative expenses 980 000 5700000 6 680 000 Net profit $ 428000 $ 1 296000 $ 1724 000 Units produced and sold 4000 22 000 Net profit per unit sold $ 107.00 $ 58.91* Rounded The unit costs for the Zodiac and Novelle models are as follows: Zodiac Novelle Direct material $655 $363 Direct labour: Zodiac (3.5 hr x $14) 49 Novelle (1.5 hr x $14) 21 Manufacturing overhead* 104 208 Cost per unit $808 $592 Manufacturing overhead was applied on the basis of machine hours at a predetermined rate of $26 per hour. Territory Electronics Company's financial controller is advocating the use of activity-based costing and has gathered the following information about the company's manufacturing overhead costs for the year just ended: Quantity of activity driver consumed Activity (activity driver) Activity costs Zodiac Novelle Total Soldering (number of solder joints) $ 880 000 400 000 1 200 000 1 600000 Shipments (number of shipments) 836 000 3800 15 200 19000 Quality control (number of inspections) 1 170 000 21 060 56940 78000 Purchase orders (number of orders) 1 1 10 000 105 450 79 550 185000 Machine power (machine hours) 47 500 15 200 174 800 190000 Machine setups (number of setups) 948 500 4 500 4985 9485 Total activity costs $4 992 000 Required: 1. Briefly explain how an activity-based costing system operates. 2. Using activity-based costing, determine whether TEC should continue to emphasise the Zodiac model and phase out the Novelle model