uap case on delaney motors

7/15/2019 UAP Case on Delaney Motors

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Leo Almazora, Miriniza Cerrero , Cecilia Grulla, Alria Ventanilla

11/20/2012

DELANEY MOTORS

CASEABEP, UA&P



CASE 17 – 1 DELANEY MOTORS

Frank Delaney owned and operated Delaney Motors, a General Motors automobile dealership in Ohio.

Its operations consisted of new-car sales, used car sales, parts sales, vehicle lease and rentals, vehicle

service, and automobile body repairing and repainting. The dealership was profitable, earning almost 5

percent on sales, but the reported profit on the body shop operation seemed low to Mr Delaney.Consequently, he engaged a consultant to study the body shop operation and make recommendations.

As background for his study, the consultant took Mr Delaney’s data for the most recent year and made

certain adjustments.

Most semivariable costs contain a significant portion of common

costs. For example, the accountant performs many common services in

order to maintain the corporate structure (e.g. preparing and filing the

dealer’s tax returns). The attorneys and the owner also spend much of

their time providing general services.

Although many of the expenses would not be significantly

reduced if the owner sold certain departments, each department

benefits from these expenses, and thus should be allocated a portion of

these costs. The body shop, for example, should pay its proportionate

share of accountant’s fees relating to the preparation and filing of the

dealership’s income tax returns.

Telephone expenses and the fixed costs could properly be

allocated to the departments if the necessary documentation were

available. Since it is not, other cost allocation methods must beconsidered. A potentially controversial issue involves the owner’s salary.

The body shop manager could claim that because he exercises no

control over the owner’s salary, this cost should not be charged to his

department. The owner puts his time and name in all aspects of the

business, however, and his salary should be allocated accordingly.

Furthermore, industry data show that owner’s salaries tend to vary with

sales volume.

Semivariable costs can be allocated to operating departments

in several ways, thereby better appraising departmental and

managerial performance. These bases include units of production,

machine-hours, material costs, sales dollars, direct labor costs, and

direct labor-hours. Valid cost allocation bases reliably relate

semivariable costs to the basis used for the allocation. Because the

operating departments produce heterogeneous products that require

dissimilar materials and machines (the new-car and used-car

departments probably use no machines), the first three allocation bases



– units of production, machine-hours, and material costs – clearly are

inappropriate.

Sales dollars also are an invalid cost allocation basis. For

example, the cost of sales ratio on a $9,000 new automobile usually

exceeds the cost of sales ratio for a $1,000 body shop repair, therebyimplying an unequal allocation basis.

Direct labor hours constitute a valid cost allocation basis in

companies in which semivariable costs are labor related (i.e. the

operations are predominantly manual) and hourly rates are fairly

uniform. But because the dealership’s semivariable costs are not

labor related and the hourly rates are usually not uniform, direct

labor costs do not constitute a competent activity basis for your

company.

Direct labor hours will provide an acceptable cost allocation

base. Although some semivariable costs do not vary directly with

direct labor-hours, such as legal and audit fees, in the interest of

practicality and because the other methods clearly are not

acceptable, allocating semivariable costs based on direct labor-

hours appeared to be the most viable alternative.

Your financial statements list the number of direct and

indirect employees in each department but fail to disclose the

number of departmental hours worked. It is assumed that all direct

employees work approximately the same number of hours per week.The number of direct laborers consequently becomes the cost

allocation base for semivariable costs. As discussed later, fixed costs

are allocated based on the ratio of departmental square footage to

total dealer square footage, adjusted by a weighting factor.

1. Sales: body shop $ 306, 652

2. Gross profit: body shop 91,107

3. Gross profit percentage (line 2 / line 1) 29.7%

Analysis of Semivariable Costs4. Legal and auditing (body shop) 0

5. Owner’s salary 0

6. Telephone and telegraph (body shop) 839

7. Total body shop semivariable costs 839

8. Legal and auditing (company) 2,113

9. Owner’s salary (company) 21,600

10. Telephone and telegraph (company) 21,676



11. Total company semivariable costs 45,389

12. Body shop percentage (line 7/line 11) 1.85%

13. Body shop employees as percent of total (5/23) 21.7%

14. Revised body shop semivariable costs (line 11*line 13) 9,867

15. Increase in body shop semivariable costs (line 14 – line 7) 9,028

Analysis of Fixed Costs

Body shop fixed costs, as now allocated 6,106

Total company fixed costs 28,815

Body shop percentage (line 16/line 17) 21.19%

Revised body shop fixed costs (20% of line 17) 5,763

Decrease in body shop fixed costs (line 19 – line 16) -343

Summary Findings

Net increase in costs (line 15 – line 20) 8,685

Unrevised body shop profit 9,009

Revised body shop profit (line 22 – line 21) -324

Unrevised profit to sales (line 22 / line 1) 2.94%

Revised profit to sales (line 23 / line 1) 0.1%

Table 1: Partial financial report on the Delaney Motors body shop performance. This includes costs as

originally reported by Mr. Delaney and as adjusted by the consultant.

CALCULATIONS

A summary of selected data from your financial statements is shown in Exhibit 1.

The body shop’s and dealership’s semivariable costs are shown in

lines 7 and 11, respectively. Semivariable cost allocations are based

upon direct labor-hours, assuming that each employee works the

same number of hours per week. In line 13 the number of body shop

employees performing the direct labor work is divided by the total

number of employees for the entire dealership. Based on this

method, the increase in semivariable costs, as seen in line 15, shows

that you have underallocated overhead to the body shop manager,

whose bonus includes a portion of his department’s profits. The cost

accounting system therefore should be changed to more accuratelyreflect each department’s use of dealership’s resources.

Fixed costs for the body shop and the dealership are summarized in

lines 16 and 17. The quotient of these two amounts appears in line

18. In line 19 the revised allocation of fixed costs is shown. Many

GM dealers allocate fixed costs to the body shop based on the ratio



of body shop square footage to dealer’s total square footage. This

allocation base accurately allocates fixed building costs but fails to

account for the various machinery, equipment, furniture and fixtures

located throughout the dealership.

To allocate these fixed costs more properly, “weights.” Similar tothose developed by Volkswagen, should be used. Volkswagen

dealers multiply the square footage of each dealership segment by

a value factor to weight the proper distribution of fixed costs. For

example, used vehicles and body shop weights are 2.4 and 1.0,

respectively. Assuming that these weights also apply to you, you

should reduce your allocation to the body shop to 20 percent. Line

19 thus represents this 20 percent balance of the dealership’s fixed

costs.

Lines 21 through 25 summarize the findings. The revised costallocations decrease the body shop’s profits from 2.94 percent of

sales to 0.30 percent of sales.

The consultant had collected data similar to that shown in Exhibit 1

for 11 other dealerships. Summary data for three of these are

shown at the bottom of Exhibit 1. They are arranged in order of the

body shop profit percentage (line 25): Dealer No. 3 had the third

highest percentage, Dealer No. 6 was in the middle, and Dealer No.

9 was third from the bottom.

DEALERSLINE No. 9 Delaney No. 6 No.3

1 Sales: body shop $ 363, 662 306,652 505,025 681,201

3 Gross profit percentage (line 2 / line 1) 32.9% 29.7% 30% 30.6%

14 Revised body shop semivariable costs (line 11*line 13) 9,545 4,791 13,913 18,177

19 Revised body shop fixed costs (20% of line 17) 12,767 5,763 11,134 12,233

22 Unrevised body shop profit 4,453 9,009 26,338 56,401

23 Revised body shop profit (line 22 – line 21) -8,190 5,400 19,386 36,650

24 Unrevised profit to sales (line 22 / line 1) 1.22% 2.94% 5.22% 8.28%

25 Revised profit to sales ( line 23 / line 1) -2.25% 1.76% 3.84% 5.38%Table 2: Comparison of Delaney Motors’ body shop performance with that of three other body shops. The

statistics were provided by the financial consultant.

The consultant pointed out that the body shop was even less profitable than Mr Delaney had thought,

and he suggested that Mr Delaney consider selling it, leasing it to another party, increasing prices, or, if

the body shop demand was thought to be elastic, lowering prices. He pointed out that selling or leasing

the body shop would permit Mr Delaney to devote more time to other areas of dealership.



Mr Delaney considered this recommendation, but he was by no means sure that profitability should be

a major consideration. He felt that the dealership had an obligation to provide high-quality body shop

work to its customers, and that a lessee might provide below-standard service. He was not sure that

prices could be raised, but asked the consultant to find out more about the prices charged by

competitive dealers before making a judgment on this.

BACKGROUND ON THE AUTOMOTIVE DEALERSHIP INDUSTRY

A car dealership or vehicle local distribution is a business that sells new or used cars at the retail level,

based on a dealership contract with an automaker or its sales subsidiary. It employs automobile

salespeople to do the selling. It may also provide maintenance services for cars, thus employing

automotive technicians, stock and sell spare automobile parts, and process warranty claims.

(Wikipedia.com)

A body shop is a facility for the repair and restoration of automobiles. The staff is trained to dealspecifically with damage to the body and frame of a car, such as that which might be incurred in a

collision. Repairing damages to the body of a car or the frame can get quite complicated, and as a result

a trip to the body shop is rarely cheap. (wisegeek.com)

QUESTIONS

1. Comment on the consultant’s adjustments made in Exhibit 1. Do you agree with each of them?

If not, can you suggest better methods of making the adjustments for the stated purpose?

With respect to the adjustments/recommendations made by the consultant with respect to cost

allocation, we have the following comments:

- Body shop should pay its proportionate share of legal and accounting fees: We agree since the

body shop, like all the other departments, benefits from the legal and auditing services

rendered for the dealership as a whole. The consultant’s proposed method of allocation is

based upon direct labor hours, but further assumes that each direct employee renders the same

number of hours of service each week. Given that the operating hours of a dealership are fixed,

and all the segments of a dealership are open for the same number of hours, this is a reasonable

assumption.

- The body shop should pay for its proportionate share of telephone and telegraph costs: Yes,

since those utilities are enjoyed by each segment, each should contribute towards those costs.

Since proper documentation to determine each department’s actual usage of said utilities is

unavailable, an alternative rational cost allocation system should be used. In the interest of

practicality, the consultant suggests using direct labor hours (and further assuming that each

http://en.wikipedia.org/wiki/Used_car

http://en.wikipedia.org/wiki/Retail

http://en.wikipedia.org/wiki/Automaker

http://en.wikipedia.org/wiki/Subsidiary

http://en.wikipedia.org/wiki/Automobile_salesman


http://en.wikipedia.org/wiki/Service_(motor_vehicle)

http://en.wikipedia.org/wiki/Automobile_parts

http://en.wikipedia.org/wiki/Warranty

http://en.wikipedia.org/wiki/Warranty

http://en.wikipedia.org/wiki/Automobile_parts

http://en.wikipedia.org/wiki/Service_(motor_vehicle)



http://en.wikipedia.org/wiki/Subsidiary

http://en.wikipedia.org/wiki/Automaker

http://en.wikipedia.org/wiki/Retail

http://en.wikipedia.org/wiki/Used_car



department works equal number of hours per week); to us, the cost allocation basis is

acceptable.

- Owner's salary should not be charged to the body shop's operations department but should be

proportionately allocated accordingly just as the legal and accounting fees were: The owner’s

salary should not be charged solely to the body shop. However, since the owner’s salary isrelated to the sales performance of the dealership, and the owner’s name and work benefits the

dealership as a whole, it follows that the each segment of the dealership should contribute to

the owner’s salary.

- Mr. Delaney has under-allocated overhead to the body shop manager, so the cost accounting

system for this department has to be changed: We agree that the overhead should be

allocated. Since the body shop manager receives a bonus based on a portion of his

department’s profit, the unit overhead cost should be higher than it is now.

- Fixed costs for the body shop and dealership: The body shop should bear its fair share of the

dealership’s fixed costs. Based on the convention adopted by GM dealerships, square footage

should be used as a basis for determining the equitable allocation of fixed costs to be

shouldered by the body shop and all other departments. However, if the consultant’s

recommended approach for allocating fixed costs among the departments (i.e., using a

weighting factor for each department aside from square footage in order to account for

furniture, equipment, and fixtures) can be applied to Delaney Motors, then it should be used

instead. The applicability of the Volkswagen approach to Delaney Motors must be ascertained

beforehand.

2. Assuming Mr Delaney decides to keep the body shop, and the consultant reports that it is

feasible to raise prices, should Mr Delaney do so? If he does, what general guide can you

suggest as to how much prices should be increased?

Assuming that the body shop is kept and the financial consultant says it is feasible to raise

prices, the decision to increase prices and by how much would depend on several factors.

The first factor to consider is how the competitors’ prices for body shop services compare to his.

If the market prices for body shop services are generally higher than the prices he is currently

charging, and in spite of that, his body shop is less profitable than competing body shops, then

it suggests that lower prices do not give the Delaney Motors body shop a competitive

advantage over others. A comparison of the Delaney Motors body shop with three other body

shops, as provided in Exhibit 1, shows it has the lowest gross profit percentage. We also know

that Mr. Delaney feels that the body shop’s unadjusted return on sales of 2.94% is low

compared to the dealership’s overall return on sales of almost 5%, and based on the

comparison of unadjusted return on sales with other body shops, a return on sales of 5% on

body shop operations should be possible. Therefore, in this case, it will be more beneficial for

Mr. Delaney to increase the prices of the body shop services to increase his profit margin.



Another consideration that Mr. Delaney has to make is with regards to the price elasticity of

demand for body shop services. Common sense would indicate that demand for body shop

services is elastic with respect to price since it would presumably take a significant portion of a

consumer’s income, and it’s presumably not as critical as repairs to parts that are vital for the

operation of a car (e.g., brake, clutch, transmission, etc). In this case, Mr. Delaney would gain

more revenue by decreasing the prices of body shop services. However, he also would have to

consider that the resulting increased quantity demanded for body shop services would also

result in increased variable costs; if the increase in revenue is not enough to offset the increase

in variable costs, then a price decrease will ultimately not be beneficial. If the additional variable

costs incurred by the increased business are minimal, then the decrease in price will be a good

strategy.

Assuming that raising prices is the right thing to do, the price of body shop services set by

competitors should serve as a guideline in raising prices. The final price for repairs charged in

the Delaney Motors body shop should be comparable to the prices offered by competitors.

Setting prices too high would drive business away, as customers would go to the competing

body shops with lower prices instead.

If there is still a concern that potential customers may get turned off by increased prices, Mr.

Delaney can explore the possibility of offering more flexible payment terms for high-cost repair

jobs. If it is possible to offer an installment plan, it is likely that more customers will choose to

avail of their services. The demand for the body shop’s services could also be somewhat raised

by offering cross-promotions with other departments. For example, some vehicle owners may

not want to put their vehicle in the shop because they do not want to be carless, so the vehicle

rental department could offer body shop customers discounts on their regular car rental rates.

If they offer body shop customers the opportunity to drive slightly better vehicles (e.g., cars

with better gas mileage than the ones they’re having the shop fix), it may also offer additional

incentive for people to take have their body shop repairs done at Delaney Motors.

Since the body shop still posts a profit in terms of return on sales, the current prices at which

the Delaney Motors body shop services are offered are enough to recover the direct and

indirect costs of its operation. However, there is one more thing that businesses want to

accomplish with the revenue from sales: to get a satisfactory return on investment. The

financial statement that was provided in the case study shows only a partial picture of the

income earned and costs incurred by the body shop. Other figures, such as return on assets,

should also be considered in measuring profitability. Assuming he hasn’t thought about this

yet, Mr. Delaney may want to work with the consultant in order to determine how much

additional return he wants on investments in the dealership, and how much he can increase

prices for body shop services in order to reach that goal. If possible, they could also work

together to determine the proper assignment of assets employed in body shop operations so



they can get a value for return on assets for that specific department only, and set desired goals

based on that value.

3. What action should Mr Delaney take?

To decide on what to do next, it is advisable to evaluate the operations of the Delaney Motors’body shop according to profitability and other considerations such as safeguarding consumer

loyalty and ensuring providing quality service to customers.

Profitability

Currently, the body shop is only slightly profitable after the semi-variable and fixed costs have

been allocated to the different departments. Its gross profit percentage is comparable with the

other dealers. However, its revised profit to sales is one of the lowest. Therefore, costs are

eating up the profits. Profits decreased significantly after the semi-variable and fixed costs have

been allocated. The revised profit to sales figure gives us a better picture of the state of the

body shop’s profitability and can help us pinpoint what specific costs need to be minimized.

After comparing its performance with other dealers, the body shop is not yet at par with other

dealers such as Dealers 3 and 6 which have 3.84% and 5.38% revised profit to sales. It would be

advisable for Mr. Delaney and his consultant to review the semi-variable costs which is the

highest when viewed as a percentage to sales. Mr. Delaney can try to study how the other

dealers minimize their semi-variable costs. If he is successful in lowering his costs, he can

reduce his prices and become more competitive. Fortunately, reducing costs is within the

control of Mr. Delaney although it can be challenging. He can look into ways of reducing costs

such as bulk purchases of parts.

Delaney No. 9 No. 6 No. 3

Cost of sales

215,576.36 244,017.20 353,517.50 472,753.49

Cost of sales % 70.30% 67.10% 70.00% 69.40%

Semivariable cost to sales 3.22% 2.63% 2.75% 2.67%

Fixed cost to sales 1.99% 3.51% 2.20% 1.80%

Semivariable and fixed costs to sales 5.21% 6.14% 4.96% 4.46%

Table 3: Comparison of the costs incurred by the Delaney Motors body shop with that of other body

shops. Note: cost of sales = sales - (gross profit % * sales).

Improving the body shop’s profitability can also be achieved through:

Increasing prices – This can help increase profitability although quantity demanded will

likely decrease. This option is suitable for goods with inelastic demand. As seen in the study

by Anderson, Mclellan and Wolfram, demand for automotives is elastic in the short run. If



we extend this fact to body shop repair which is a complementary product to automotive

sales, it may not be advisable to increase prices—doing so can even decrease total profits.

Reducing prices – Since demand is elastic for automotives, lowering the price of body shop

repairs can lead to increased sales that can more than offset the price decrease. This can

result in higher overall profits.

Providing favourable financing terms - Since car repairs are usually expensive, he can

provide flexible payment terms to his customers. This can be another way of attracting

potential customers.

If the information is available, it would also be advisable for Mr. Delaney and his consultant to

review the return on investment on the body shop.

Other considerations

Although profitability is a main consideration for continuing with the body shop operations, it isalso advisable for Mr. Delaney to view his business as a whole before deciding. Car dealerships

normally offer end-to-end services which range from selling to financing to after-sales

servicing. Doing away with the body shop will limit him from providing end-to-end service to his

customers which is very important to car owners. Although outsourcing the body shop can also

be another option, he will not be able to ensure the quality of the service provided by the

outsourced body shop employees.

In addition, Delaney motors will continue to incur its fixed costs regardless of whether the body

shop is in operation or not. Should he decide to close the body shop, the other departments in

the car dealership will each end up bearing a larger portion of the allocated cost. Thesedepartments may, then, turn out to be unprofitable.

Recommendation

Given all the following, it advisable for Mr. Delaney to retain the body shop. Keeping it in

operation will allow Delaney motors to continue offering a complete range of services to

potential buyers while safeguarding the quality of service provided to his customers. Currently,

the body shop is still profitable, although minimally. Mr. Delaney can, instead, focus on how to

minimize costs in order to be more competitive. If he succeeds in doing this, the body shop can

become profitable either by retaining its current prices or by decreasing its price in order to

attract more potential Ocustomers.

uap case on delaney motors

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