Accounting Case 22-2

Shuman Automobiles, Inc.

Group Members

Shannon Barbour Jillian Kavanagh Jean Manning Steven Penney

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

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)

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

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

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

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

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

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

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

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

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

Incremental Gross Profits

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

Incremental Gross Profits

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

Incremental Gross Profits

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

Incremental Gross Profits

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

Total Gross Profit for Shuman

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

If Car Is Repaired and Sold

New Car List Price Cost of Goods Sold New Car

$ 14 400.00 (12 240.00)

Cost of Trade-In
Cost of Repairs Retail Price for Used Car Gross Profit

(6 500.00)
(1 594.00) 7 100.00 1 166.00

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.

If Used Car Is Auctioned As Is

New Car List Price Cost of Goods Sold New Car Cost of Trade-In

$14 400.00 (12 240.00) (6 500.00)

Used-Car Price obtained at Auction

Repairs Charged to Other Customer Cost of Repairs for Other Customer

5 000.00
2 042.00 (1 594.00)

Gross Profit

1 108.00

The Result

Gross Profit realized when used car is repaired and sold retail.

$ 1 166.00

Gross Profit realized when used car is sold at the auction.

1 108.00

Difference

58.00

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?

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.

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

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.

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.

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.

Questions