Accounting Case 22-2Shuman 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

• Manager’s remuneration is based on a straight percentage of their department’s 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 $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

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 department’s opportunity for profit is decreased

• It would be more profitable for the service department to only repair outside cars

• The service department charged an outside customer $2,042 for similar repairs

• The used car department should also be charged this price

The Appropriate Repair Charge

Incremental Gross Profits

• Service Department

Sale of Repairs $2 042

(Cost of Repairs) (1 594)

Incremental Gross Profit $448

• 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

Incremental Gross Profits

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

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)

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

If Car Is Repaired and Sold…

New Car List Price $ 14 400.00

Cost of Goods Sold – New Car (12 240.00)

Cost of Trade-In (6 500.00)

Cost of Repairs (1 594.00)

Retail Price for Used Car 7 100.00

Gross Profit 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 $14 400.00

Cost of Goods Sold – New Car (12 240.00)

Cost of Trade-In (6 500.00)

Used-Car Price obtained at Auction 5 000.00

Repairs Charged to Other Customer 2 042.00

Cost of Repairs for Other Customer (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 doesn’t fit the criteria

(Departments not responsible for selling expenses).

• Operate the departments as expense centers.– Not viable, doesn’t 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