Prime Electronics, a division of Batton Corporation, manufactures two large-screen television models: the Mammoth, which has been produced since 2013 and sells for $967, and the Maximum, a newer model introduced in early 2015 that sells for $1,315.

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Based on the following income statement for the year ended November 30, 2017, senior management at Batton have decided to concentrate Prime's marketing resources on the Maximum model and to begin to phase out the Mammoth model because Maximum generates a much bigger operating income per unit.

Prime Electronics
Income Statement for the
Fiscal Year Ended November 30, 2017
	Mammoth	Maximum	Total
Revenues	$22,241,000	$5,260,000	$27,501,000
Cost of goods sold	14,462,400	3,523,600	17,986,000
Gross margin	7,778,600	1,736,400	9,515,000
Selling and administrative expense	5,560,250	1,052,000	6,612,250
Operating income	$2,218,350	$684,400	$2,902,750
Units produced and sold	23,000	4,000
Operating income per unit sold	$96.45	$171.10

Details for cost of goods sold for Mammoth and Maximum are as follows:

		Mammoth		Maximum
		Total	Per Unit	Total	Per Unit
Direct materials		$5,257,800	$228.60	$2,569,200	$642.30
Direct manufacturing labor	(a)	483,000	21.00	196,000	49.00
Machine costs	(b)	3,661,600	159.20	318,400	79.60
Total direct costs		$9,402,400	$408.80	$3,083,600	$770.90
Manufacturing overhead costs	(c)	5,060,000	220.00	440,000	110.00
Total cost of goods sold		$14,462,400	$628.80	$3,523,600	$880.90

(a)Mammoth requires 1.5 hours per unit and Maximum requires 3.5 hours per unit. The direct manufacturing labor cost is $14.00 per hour.

(b) Machine costs include lease costs of the machine, repairs, and maintenance. Mammoth requires 8 machine-hours per unit and Maximum requires 4 machine-hours per unit. The machine-hour rate is $19.90 per hour.

(c) Manufacturing overhead costs are allocated to products based on machine-hours at the rate of $27.50 per hour.

Prime's controller, Sonny Jacobi, is advocating the use of activity-based costing and activity-based management and has gathered information about the company's manufacturing overhead costs for the year ended November 30, 2017. After completing his analysis, Jacobi shows the results to Charlie Campo, the Prime division president.

		Units of the Cost-Allocation Base
Activity Center (Cost-Allocation Base)	Total Activity Costs	Mammoth	Maximum	Total
Soldering (number of solder points)	$1,113,000	1,140,000	450,000	1,590,000
Shipments (number of shipments)	1,001,000	16,300	5,700	22,000
Quality control (number of inspections)	1,348,500	51,300	26,200	77,500
Purchase orders (number of orders)	951,000	80,500	109,700	190,200
Machine power (machine-hours)	48,000	175,600	16,400	192,000
Machine setups (number of setups)	1,038,500	16,600	14,400	31,000
Total manufacturing overhead	$5,500,000

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Campo does not like what he sees. "If you show headquarters this analysis, they are going to ask us to phase out the Maximum line, which we have just introduced. This whole costing stuff has been a major problem for us. First Mammoth was not profitable and now Maximum.

"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 setups and number of inspections as allocation bases. The numbers would be different had you used setup-hours and inspection-hours instead. I know that measurement problems precluded you from using these other cost-allocation bases, 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 can't afford to phase out either product." Jacobi knows that his numbers are fairly accurate. As a quick check, he calculates the profitability of Maximum and Mammoth using more and different allocation bases. The set of activities and activity rates he had used results in numbers that closely approximate those based on more detailed analyses. He is confident that headquarters, knowing that Maximum was introduced only recently, will not ask Prime to phase it out. He is also aware that a sizable portion of Campo's bonus is based on division revenues. Phasing out either product would adversely affect his bonus. Still, he feels some pressure from Campo to do something.

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Requirements

1.Using activity-based costing, calculate the gross margin per unit of the Maximum and Mammoth models.

2.Explain briefly why these numbers differ from the gross margin per unit of the Maximum and Mammoth models calculated using Prime's existing simple costing system.

3.Comment on Campo's concerns about the accuracy and limitations of ABC.

4.How might Prime find the ABC information helpful in managing its business?

5.What should Sonny Jacobi do in response to Campo's comments?