Accounting Case 22-2

1. Accounting Case 22-2 Shuman Automobiles, Inc.

2. Group Members • Shannon Barbour • Jillian Kavanagh • Jean Manning • Steven Penney

3. 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

4. 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)

5. 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

6. 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

7. 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 Car2 160 Trade-in Retail Price7 100 (Cost of Trade-in) (6 500) (Cost of Repairs) (1 594) Total Incremental Gross Profit$1 166

8. 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

9. 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

10. 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

11. 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

12. The Appropriate Repair Charge • Itshould 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

13. 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

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

15. 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

16. 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

17. 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 Price3 758 Incremental Gross Profits($582)

18. 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

19. If Car Is Repaired and Sold…

20. 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.

21. If Used Car Is Auctioned “As Is”

22. The Result

23. 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?

24. 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.

25. 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

26. 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.

27. 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.

28. 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.

29. Questions