Accounting Case 222

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Accounting Case 22-2

• Shuman Automobiles, Inc.

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Group Members

• Shannon Barbour
• Jillian Kavanagh
• Jean Manning
• Steven Penney

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Case Facts

• Shuman Automobiles, Inc
• Clark Shuman
• Owner and GM of an automobile dealership
• Nearing retirement
• In process of withdrawing from day-to-day
  activities

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Case Facts

• Shuman Automobiles, Inc
• Dealership is divided into 3 departments
• Each department has its own manager
• New Car department
• Used Car department
• Service department
• Each department is to be run as an independent
  business (a profit center)

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Case Facts

• Managers remuneration is based on a straight
  percentage of their departments gross profits
• Each department is concerned with maximizing its
  own profits
• This has caused disputes between the three profit
  centers

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New Car Purchase Transaction

• Customer traded in his old car (which required
  repairs) in return for a reduced price on the new
  car
• The transaction involves all 3 departments
• The departments disagree over the appropriate
  trade-in price

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Sample Transaction

• Buying a new car with a trade-in
• New Car List Price 14 400
• (Cost of Goods Sold New Car) (12 240)
• Profit on Sale of Car 2 160
•   
• Trade-in Retail Price 7 100
• (Cost of Trade-in) (6 500)
• (Cost of Repairs) (1 594)
• Total Incremental Gross Profit 1 166

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Profit Center Transactions

• Assumptions
• Each department is operating as a profit center
• It is known with certainty beforehand that the
  repairs to the trade-in will cost 1 594

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The Correct Transfer Value

• The new car department will have to transfer the
  trade-in to the used car department at a cost of
  5 800 less the cost of repairs
• The new car department paid 6,500 on the
  trade-in, resulting in a loss for the department

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The Correct Transfer Value

• It states in the case that the used car
  department is not obligated to take over the car
• The car will have to be transferred at a cost
  that the used car manager is willing to pay
• The Blue Book gave a cash buying range of the
  trade-in model of 5,200 - 5,800

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The Correct Transfer Value

• Since the customer was a difficult one, and the
  new car sales manager had to allow an increased
  amount to complete the sale, the car should be
  transferred at 5800
• The trade-in has not been repaired therefore,
  this cost should be deducted from the transfer
  cost

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The Appropriate Repair Charge

• It should be able to charge the used car
  department the price it charges outside customers
  
• If service is required to repair the trade-in
  other inside repair work at cost this
  departments opportunity for profit is decreased
• It would be more profitable for the service
  department to only repair outside cars

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The Appropriate Repair Charge

• The service department charged an outside
  customer 2,042 for similar repairs
• The used car department should also be charged
  this price

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Incremental Gross Profits

• Service Department
• Sale of Repairs 2 042
• (Cost of Repairs) (1 594)
• Incremental Gross Profit 448

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Incremental Gross Profits

• Used Car Department
• Transfer Price of Trade-In
• Blue Book Price 5 800
• (Price of Repairs) (2 042)
• Transfer Price of Trade-In 3 758

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Incremental Gross Profits

• Used Car Department
• Incremental Gross Profit
• Trade-in Retail Price 7 100
• (Transfer Price) (3 758)
• (Price of Repairs) (2 042)
• Incremental Gross Profits 1 300

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Incremental Gross Profits

• New Car Department
• New Car List Price 14 400
• (Cost of Goods Sold New Car) (12 240)
• (Cost of Trade-in) (6 500)
• Transfer Price 3 758
• Incremental Gross Profits (582)

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Total Gross Profit for Shuman

• Total of 3 Departments
• New Car Dept. (582)
• Used Car Dept. 1 300
• Service Dept. 448
• Incremental Gross Profits 1 166

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If Car Is Repaired and Sold
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A Higher-profit Alternative?

• Possibility Sell the used car, as is, at the
  regional used car auction.
• Assumption The service department is operating
  at full capacity.
• Repair time for the used car would reduce the
  profit realized from dealing with other
  customers.

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If Used Car Is Auctioned As Is
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The Result
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Results

• More profit will be realized if used car is
  repaired and sold.
• Points to consider
• minimal trade-off will not always exist in such
  situations (with service department at capacity).
  
• a more reasonable amount for the trade-in would
  cause results to differ.
• will Shuman Automobiles, Inc. be able to move
  the car as quickly? What are the costs of having
  the used car on the lot?

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Profit-centers at Shuman

• Is a three-profit-center approach appropriate?
• No, we do not feel that the three-profit-center
  approach is appropriate for Shuman to be using.
• This approach is not appropriate because
• All three departments are highly interconnected.
• Department managers do not influence both
  revenues and costs.

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Alternatives to Profit Centers

• Operate the new car department and the used car
  department as profit centers, but not the service
  department
• This alternative is not viable because of
  interconnectivity of all three departments

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Alternatives to Profit Centers

• Operate the departments as revenue centers.
• Not viable because doesnt fit the criteria
  (Departments not responsible for selling
  expenses).
• Operate the departments as expense centers.
• Not viable, doesnt fit criteria.

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Alternatives to Profit Centers

• Operate the departments as investment centers.
• Not viable because the departments not
  responsible for the use of both assets and
  profits.
• Operate in the same manner as before the
  introduction of profit centers.

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Our Recommendation

• We recommend that the company return to operating
  the way they were before the introduction of
  profit centers.
• This is the best alternative because of the
  interconnectivity of the departments and the
  company was operating profitable before the
  changes were made.

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Questions