North country Auto

IntroductionFranchised dealer and authorized service

center for Ford, Saab and VolkswagenNew cars, used cars (front end) parts, service

and body shop (back end) were the departments in the company

Aim was to keep the back end operations profitable as the front end sales were under pressure

The challenge was to change the structure from a centralized to a decentralized profit center

Transfer price of various sales within the organization was required to be determined

Question 1Using the data in the transaction , compute the profitability of this one transaction to the new, used, parts and service departments. Assume a sales commission of $250 for the trade in on a selling price of $5000

New Car

Used Car Parts Service

Revenue 14150 5000 135+30+80=245

175+45+75+175=470

Costs (11420) (750) (167.86) (134.29)

Commission

- (250)

Overheads (835) (665) (32) (114)

Gross Profit

1895 3380 35.14 221.79

Question 2How should the transfer pricing system operate for each department?(market price, full retail. Full cost , variable cost)

The transfer pricing system should be operated at market price system because the department could cut off the non value added costs for other department and still refer to the market situation

The aim should be to maximize profits for each of the departments but not at the cost of other department

Question 3If it were found that the trade in could be wholesaled for only $ 3000 which manager should take the loss?

If the used car is sold at auction for $3,000 after the trade-in value was set at $4,800, the company should note a loss of $1,800. However, if the new car salesman only gives $3,500 of value to the new customer based on the Blue Book value, then the loss reflected on the income statement and balance sheet should only be $500.

The wholesale guidebook value for used cars is $3500

Hence the trade in is lower than the guidebookThis makes the Used car sales department manager

(Amy Robins) responsible for the loss.

Question 4North Country incurred a year-to-date loss of about $59,000, before allocation of fixed costs, on the wholesaling of used cars, which is theoretically supposed to be a break-even operation. Where do you think the problem lies?

New car owners were giving customers looking to trade-in existing cars above market valuations on their used cars

If new owners were providing credit for $4,800 for a used car that is worth $3,500, the used car group would have a difficult time making a profit

While there would be times (like the example above) where they could sell the car for $5,200 and still make a profit despite the inflated prices, most of the time they will have difficulty selling the used car above its Blue Book value of $3,500

Therefore, the used car division may be operating at a loss because the cost they are using for the used cars is too high.

Question 5Should profit centres be evaluated on gross profit or full cost profit?

Profit center should be evaluted at full cost because:

Full cost not only includes COGS but will also account for the traceable fixed cost related to that profit center

This method could encourage the manager responsible to control the cost precisely

Question 6What advice do you have for the owners?

All NCAI managers should be gathered to decide the fair transfer pricing.

By doing that, the decision making will be accepted by all the managers and thereby decrease any competition between them.

Each department should be evaluated by full cost pricing system to control costs in a better way

Proper incentives should be given to each manager based not only on the department performance but all the overall company performance.

Thank You