Numerical: (1)
North Country Auto-Transfer Pricing problem, Page 181, Book: MCS by Vijay Govindarajan & Robert N Anthony
Solution: Facts of the case: (a)
North North Countr Country y Auto Auto has depart departmen ments/ ts/pro profit fit centre centre : (i) (i) New & (ii) (ii) Used Used Car Car Sales, (iii) Parts, (iv) Service & (v) Body.
(b) (b)
New New & Used Used car cars s dept dept.: .: Head Headed ed by by mana manage gers rs.. They They deal dealtt in car cars s of For Ford, d, Saab & Volkswagen.
(c)
Parts Parts dept.: dept.: Manage Managerr was was respon responsib sible le for tracki tracking ng parts parts invent inventory ory for the three lines & minimizing both carrying cost & “obsolescence.”
(d)
Servic Service e dept dept.: .: The servic service e dept. dept. Occupi Occupied ed over over half half the the build building ing space space & was most labour intensive.
(e) (e)
Body Body Sho Shop: p: The They y cons consis iste ted d of a man manag ager, er, three three tec techn hnic icia ians ns & a cle clerk. rk.
Questions to be answered: (1)
Using Using the data data in the transa transacti ction, on, comput compute e the the profit profitabil ability ity of this this one transaction to the new, used, parts, and service dept. Assume a sales commission of $250 for the trade-in on a selling price of $5000. (Note: use the following allocations, new: $835; Used: $665; parts: $32; service: $114, for overhead expenses while computing the profitability of this one transaction. These overhead allocations are also shown as Note 13 in Exhibit 3.)
Ans Page 1 of 3,
Professor Abhay Singh-MCS
O.H expenses has been converted into for the complete units. Thus for this one transaction the Net Profit will be $10,78,000/Assumption: Variable Cost for used cars is taken as 87.86% of Sales (as derived from the Financial statement-Exhibit 3). (2)
How should the transfer-pricing system operate for each dept (market price, full retail, full cost, variable cost)?
Ans
The transfer-pricing should be at Full-cost for all the departments, but at the same time they should act as profit centre & compete with the market for quality & price of service.
Page 2 of 3,
Professor Abhay Singh-MCS
(3)
If it were found one week later that the trade-in could be wholesaled for only $3000, which manager should take the loss?
Ans
The loss should be booked on the used-car sales only. But the management should be conscious that this will be discouraging for the team, hence the incentives has to be designed in such a way, so as to strike a balance between the price of used car & no. of used cars, sold.
(4)
North country incurred a year-to-date loss of about $59000, before allocation of fixed costs on the wholesaling of used cars (see Note 2 in Exhibit 3). Wholesaling of used cars is theoretically supposed to be a break-even operation. Where do you think the problem lies?
Ans
The problem lies with the used- car market. The external conditions were not favourable & hence the dept. couldn’t break even.
(5)
Should profit centres be evaluated on gross profit or “full cost” profit?
Ans
Profit centres has to be evaluated on Full-cost basis only, since financial viability of any profit centre is very important. They compete with the market and any subsidised evaluation, will lead to future accumulation of cost, leading to long-term losses.
(6) Ans
What advice do you have for the owners? My advise to owners to make all the transfer-pricing on the basis of totalcost and at the same time service departments like parts, service & body shop, should give their services to external customers at the market price.
Page 3 of 3,
Professor Abhay Singh-MCS
