Case Scenario:
Alex Walker, manager of the new car sales department, sold a new car for $14,150. This purchase was financed by a cash down payment of $2,000, a trade-in allowance of $4,800, and a bank loan of $7,350. The dealer's cost was $11,420, which included factory price plus sales commission.
The manager of the used car sales department, Any Robbins, examined the trade-in vehicle. The trade-in had a wholesale guidebook value of $3,500. The guidebook, published monthly, was, at best, a near estimate of liquidation value. Actual values varied daily with the supply-demand balance at auto auctions. These variances could be as much as 25 percent of the book value.
Ms. Robbins believed that she could sell the trade-in quickly at $5,000 and earn a good margin, so she chose to carry it in inventory instead of wholesaling it for a value estimated to be $3,500. Mr. Walker, in turn, used the $3,500 value in calculating his actual profit on the new car sale.
In performing the routine maintenance check on the trade-in, the service department reported that the front wheels would need new brake pads and rotors and that the rear door lock assembly was jammed. The retail estimates for repair would be $300 for the brakes ($125 in parts, $15 in labor) and $75 to fix the lock assembly ($30 in parts, $45 in labor). Cleaning and touch-up (performed by service department as part of the service order for lock and brake) would cost $75. The service department also recommended that a full time tune-up be performed for a retail price of $255 ($80 in parts, $175 in labor).
The repair and tune-up work was completed and capitalized at retail cost into used inventory at $705. These mechanical repairs would not necessarily increase wholesale value if the car subsequently were sold at the auction. The transfer price for internal work recently had changed from cost to full retail equivalent. The retail markup for labor was 3.5 times the direct hourly rate and about 1.4 times for parts.
Problem 1. How should the transfer pricing system operate for each department (market price, full retail, full cost, variable cost)?
Problem 2. If it were found one week later that the trade-in could be wholesaled for only $3,000, which manager should take the loss?
Problem 3. North Country incurred a year-to-date loss of about $59,000 before allocation of the fixed costs on the wholesaling of used cars. Wholesaling of used cars is theoretically supposed to be a break-even operation. Where do you think the problem lies?
Problem 4. Should profit centers be evaluated on gross profit or "full cost" profit?
Problem 5. What advice do you have for the owners?