Tora Automotive Inc: Case Study

Read the case: Tora Automotive Inc. (attached below)

Required:

Assuming you are Mr. Kane Hiroshi (Financial Controller) who has been employed by the management of Tora Automotive to present solutions of the issues facing the company. You are required to write a report to Mr. Yukio Huwang (President of the company) addressing the issues shown below. 

Your report should contain:

• Group assessment cover sheet.

•  To be signed by all members of the group.

• A separate title page (not included in page limit): The title page must include your team members’ full names and student ID numbers.

• A maximum of 7 pages of text covering all of the requirements set out in the assignment parts (1 to 3 below), excluding the title page, reference list, and appendices:

• Please use Times New Roman, 12 font in double spaced,and minimum of 2cm on each margin for the body of the report.
  • The excel file that shows all the calculations including the formula used for these calculations.

• Appendices which report all your calculations and reference list. Please use external references instead of the book.

Tora automotive Inc.

Tora Inc. is a new multinational automotive manufacturer headquartered in Aichi, Japan. The company manufacturers its own car seats while gets the remaining component parts from suppliers at the local level. The company uses a hybrid costing system that combines traditional absorption costing system as well as process costing system. A process costing system is used for assigning costs to identical units of car seats in batches employing a consistent process. A traditional absorption costing system is used to account for the manufacturing costs of the company’s main car models; CLR, CLO, CLV and CLM. The company allocates total manufacturing overhead of $1,680,000 to individual models using a manufacturing overhead rate based on total direct labor cost. That is, the manufacturing overhead cost for each car model is determined by multiplying the direct labor cost of each car model by the manufacturing overhead rate.

Part 1: The manufacturing cost of cars

The president of the company Mr. Yukio Huwang has been showing concerns lately with respect to the profitability of CLM model. Mr. Yukio is thinking to drop CLM model from the company’s product line due to its high manufacturing overhead costs exceeding $25,000 per car. He believes that pricing CLM above its full cost of nearly $51,000 would lead to a drop in the market share as competitive cars in the market with similar specifications are priced within the range of $42,000-$45,000. Mr. Yukio has hired a new financial controller Mr. Kane Hiroshi – who holds a Certified Management Accountant (C.M.A.) qualification – to assess the profitability of each car model before eliminating CLM model. 

On the first week of work, Mr. Kane was provided with the following table summarizing manufacturing overhead categories and their associated costs:

Purchasing	$          72,000
Machine Setups for productions runs	$          92,500
Material Movements	$          36,000
Machinery	$        840,000
Design	$        480,000
Inspection	$        159,500
Total	$     1,680,000

Mr. Kane also requested the Management and Cost Accounting Department to provide him with additional data related to the four models. Additional data summarizes the direct costs, cost drivers of the overhead categories and the number of units produced of each model:

	CLR	CLO	CLV	CLM
Units Produced	20	20	40	40
Direct Material Cost	$90,000	$90,000	$180,000	$540,000
Direct Labor Cost	$84,000	$84,000	$168,000	$504,000
Overhead Categories
Purchase orders written	180	18	126	36
No. of production run setups	148	37	74	111
Material movements	600	120	360	120
Machine hours	10,500	3,500	28,000	28,000
Design hours	6,400	3,200	16,000	6,400
Inspection hours	10,500	3,500	28,000	28,000

After reviewing the information in the above tables, Mr. Kane was surprised to know that the company has been implementing the traditional costing system even though manufacturing overhead has been driven by several activities. Mr. Kane tried to talk Mr. Yukio out of dropping CLM by explaining that the current costing system of the company is inadequate. Mr. Kane further explained that CLM could be more profitable than what it seems under the traditional costing system. Mr. Kane advised the president to use a more accurate costing system that assigns overhead costs to activities and then assigns the costs to the car models based on each car model’s usage of the activities. Mr. Yukio showed interest in the suggested method by Mr. Kane and subsequently asked him to prepare a report summarizing the cost per unit for each car model accordingly.

Required:

Assuming you are Mr. Kane:

1. Prepare a report to Mr. Yukio that shows the calculations of the cost per unit for each car model under both the traditional absorption costing system and the suggested costing system. (20%)
2. Comment on the differences in the unit cost for each model. (5%)
3. Write your recommendations to Mr. Yukio on whether to discontinue CLM model based on the cost per unit determined by the suggested costing system. (5%)
4. Lastly, explain how the new costing system suggested by Mr. Kane improves the accuracy of reported cost of individual models compared to the absorption costing system. (5%)

Part 2: The manufacturing cost of car seats

As the company manufactures its own car seats, each car seat passes through the assembly department. The process-costing system at Tora Inc. has direct materials and conversion costs. Direct materials are added at the beginning of the process. Conversion costs are added evenly during the process. The company is currently using the weighted-average method of process costing. However, Mr. Yukio has also expressed concerns with the new financial controller Mr. Kane about the possibility of incurring high income taxes in the current period due to using the weighted-average method which results in lower cost of goods sold. Mr. Kane asked Mr. Yukio to consider the use of another method which leads to higher cost of goods sold and subsequently lower income taxes. Mr. Kane further explained that, unlike the weighted-average method, the new method separates the work done on beginning inventory from the work done in the current period. That is, only costs incurred and units produced in the current period are used to calculate cost per equivalent unit of work done in the current period. This method, as a result, yields a higher cost of units completed, higher cost of goods sold and therefore lower income taxes than the weighted-average method.

Mr. Yukio looked a bit confused and so requested Mr. Kane to prepare a comparative report showing the calculations of the costs assigned to units completed of car seats under the weighted-average method and the suggested method, given the following data for the assembly department for November 2020:

	Physical Units (Car Seats)	Direct Materials	Conversion Costs
Work in process, November 1a	5,000	$        1,250,000	$             402,750
Started during November	20,000
Completed during November	22,500
Work in process, November 31b	????
Total costs added during November		$        $4,500,000	$          2,337,500
aDegree of completion: direct materials,?%; conversion costs, 60%.  bDegree of completion: direct materials,?%; conversion costs, 70%.

Required:

Assuming you are Mr. Kane:

1. Prepare a comparative report to Mr. Yukio that shows the calculations of the costs assigned to units completed of car seats under the weighted-average method and the suggested method. (20%)
2. Explain the differences in both methods and why the suggested method leads to lower income taxes than the weighted-average method. (5%)
3. Based on your analysis, should Mr. Yukio choose the weighted-average method or the suggested method? Explain briefly. (5%)

Part 3: Car Pricing

Two weeks later, Mr. Yukio met Mr. Kane to discuss new prices for each car model based on the report submitted by Mr. Kane concerning the cost per unit of each car model under the new costing system (See Part 1). Mr. Yukio shared his plan with Mr. Kane about pricing the cars at full cost plus a markup on full cost to earn the target return on investment. He informed Mr. Kane that the capital invested in CLR, CLO, CLV and CLM is $1,000,000, $1,000,000, $2,000,000 and $2,000,000 respectively and the target return on investment is 20% for all models. He further told Mr. Kane that the company has no fixed costs and expects no inventories. That is, it is expected that all units produced will be sold by the end of the current year. Given this, Mr. Yukio asked Mr. Kane to help him determine the prices that should be charged for each car model.

Required:

Assuming you are Mr. Kane:

1. Help Mr. Yukio determine the target prices that should be charged for each car model according to his pricing plan. (20%)
2. Calculate the markup as a percentage of the full cost of each car model. (5%)
3. Calculate the operating income of each car model based on the target prices. (5%)
4. Lastly, determine which car model is most profitable based on the profit margin.  Explain your answer. (5%)