Indoor Pursuits (IP), a division of Network Diversions Limited (NDL), produces two computers: the Ruby, which IP has produced since 2015 and sells for $990; and the Diamond, a newer model introduced in late 2017 that sells for $1 254. The income statement of the Indoor Pursuits (IP) for the year ended 30 November 2018 is as follows:

	Ruby	Diamond	Total
Revenue	21,780,000	5,016,000	26,796,000
Cost of goods sold	13,794,000	3,511,200	17,305,200
Gross margin	7,986,000	1,504,800	9,490,800
Selling and admin expense	6,413,000	1,075,800	7,488,800

Operating income

1,573,000

429,000

2,002,000

Units produced and sold

22,000

4,000

$26,000

Operating income per unit sold

$71.50

$107.25

Details for cost of goods sold for Ruby and Diamond are:

Ruby Diamond
Costs	Total	Per unit	Total	Per unit
Direct materials	$5,033,600	$228.80	$2,569,600	$642.40
Direct production labour	$435,600	$19.80	$184,800	$46.20
Machine	$3,484,800	$158.40	$316,800	$79.20
Total direct	$8,954,000	$407.00	$3,071,200	$767.80
Production overhead	$4,840,000	$220.00	$440,000	$110.00
Total cost of goods sold	$13,794,000	$627.00	$3,511,200	$877.80

Ruby requires 1.5 hours per unit, and Diamond requires 3.5 hours per unit. The direct production labour rate is $13.20 per hour

Machine costs include lease costs of the machine, repairs and maintenance. Ruby requires 8 machine hours per unit, and Diamond requires 4 machine hours per unit. The machine-hour rate is $19.80 per hour.

Production overhead costs are allocated to products based on machine hours at the rate of $27.50 per hour.

Mike Johnson, the CEO of NDL, is very concerned about the declining profitability of the Ruby model. He had implemented a major restricting program called NRP-NDL Restructuring Program to address the falling profitability of this model on the recommendations provided by the companys External consultant Anil Perera of Anderson Management consultants. He also hired Ann Wood, an external management accounting consultant, to get advice on the companys cost accounting system and to get her assistance to train its management accountant, Claire Adams. Ann is a strong advocate of Activity Based Costing (ABC) and has helped a large number of companies around the globe to re-design their cost accounting systems. Ann had written several articles in practitioner journals on the subject, is interested in developing better accounting information systems for NDL as she has found significant issues with the companys data repositories and standardised protocols. In order to address the current production and accounting issues, Jonson is considering buying an enterprise resource planning system (ERP).

Since the profitability of Ruby has not improved significantly with the implementation of NRP, Senior management at NDL now decided to concentrate NDLs marketing resources on the Diamond model and begin to phase out the Ruby model because the Diamond generates a much bigger operating profit per unit. However, after having attended a series of ABC/ABM seminars and gaining substantial knowledge about ABC and discussing the relevant issues with Ann, Adams is advocating the use of ABC and activity-based management (ABM) at NDL. She has gathered the following information about the companys production overhead costs for the year ended 30 November 2018.

Activity-cost driver (driver quantity)	Activity-cost-driver quantities Ruby Diamond Total			Total Activity Costs
Soldering (number of solder points)	1,185,000	385,000	1,570,000	$1,036,200
Shipments (number of shipments)	16,200	3,800	20,000	$946,000
Quality control (number of inspections)	56,200	21,300	77,500	$1,364,000
Purchase orders (number of orders)	80,100	109,980	190,080	$1,045,400
Machine power (machine-hours)	176,000	16,000	192,000	$63,400
Machine set-ups (number of set-ups)	16,000	14,000	30,000	$825,000
Total production overhead				$5,280,000

After completing her analysis, Adams shows the results to Johnson. He does not like what he sees. If you show headquarters this analysis, they are going to ask us to phase out the Diamond line, which we have just introduced. This whole costing stuff has been a major problem for us. First, Ruby was not profitable and now Diamond.

Looking at the ABC analysis, I see two problems. First, we do many more activities than the ones you have listed. If you had included all activities, maybe your conclusions would be different. Second, you used number of set-ups and number of inspections as activity-cost drivers. The numbers would have been different had you used set-up hours and inspection hours instead. I know that measurement problems precluded you from using these other cost drivers, but I believe you ought to make some adjustments to our current numbers to compensate for these issues. I know you can do better. We cant afford to phase out either product.

Adams knows that her numbers are reasonably accurate. As a quick check, she calculates the profitability of Ruby and Diamond using more and different activity drivers. The set of activities and activity rates she had used results in numbers that closely approximate those based on more detailed analyses. She is confident that headquarters, knowing that Diamond was introduced only recently, will not ask NDL to phase it out. She is also aware that a sizeable portion of Johnsons bonus is based on division revenues. Phasing out either product would adversely affect his bonus. Still, she feels some pressure from Johnson to do something. She asks for your advice.

Required

1. Advise Claire Adams on how she should respond to Johnsons suggestions that she alter the costs produced by the costing system.