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 companys 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 companys 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 models 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.
2. Comment on the differences in the unit cost for each model.
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.
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.