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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

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Accounting Case 22-2

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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

  • 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


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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 Car2 160

Trade-in Retail Price7 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

  • 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


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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 Price3 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 doesn’t fit the criteria (Departments not responsible for selling expenses).

  • Operate the departments as expense centers.

    • Not viable, doesn’t 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


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