North Country Auto Inc Case Solution

1. In order to calculate the net profit for each department, it is important to accurately determine the costs associated to them and their revenues. Since departmental transactions are interrelated, especially in this case, one department’s revenue will be another’s cost. Costs will also be divided into two categories; direct costs that can be directly traced to a particular department, and overhead costs that are shared between departments and have to be allocated accordingly.

In this case, the process was initiated by the New Car Sales department. The department sold a brand new vehicle for $14,150. This sale value constituted of a down payment of $2,000, a trade-in of an old car valued at $4,800, and a bank loan of $7,350. Upon closer inspection, however, it was discovered that the old car was worth $3,500. As a result, the total sales value for the New Car Sales department was $12,850. The total cost of the vehicle, including sales commission, was $ 11,420, resulting in a gross profit, for the department, of $ 1,430.

Similarly, the Used Car Sales Department sold the trade-in car for $5,000, which will become their revenue for the transaction. Since the trade-in was valued at $3,500, this will become part of the cost of sales for the department. The cost of sales will also include all costs incurred to bring the vehicle to its selling condition. These will include costs of both labour as well as parts from their relevant departments. This puts the total of the cost of sales to $ 4,455, resulting in a gross profit of $545. The Used Car Sales department’s proportion of the overhead allocation amounts to $ 665, giving a net loss for the department of $120.

Revenue of the services department will be the number of hours billed for the work done on the trade-in vehicle. This includes $175 for the brakes, $45 for the locks and doors, $75 for cleaning and touch up, and $175 for the tune-up, bringing the total revenue to $470. According to the inter-departmental pricing policy, the labor hours were billed at retail price, which is 3.5 times the actual. This means that the cost incurred in producing the revenue was $ 134.29, resulting in a gross profit of $ 335.71. The service department’s share of the overheads rounds to $114, which gives an ending profit of $ 221.71 for the department.

In the same manner, the parts department’s revenue will also depend on the amount of work done on the trade-in vehicle. It will include $125 for brakes, $30 for locks, and $80 for tune-up, which brings to a total of $235. Just as in the revenue department, the inter-departmental pricing policy dictates the transfer of parts at retail value, which is 1.4 times the cost. This results in a cost of sales of $ 167.86 giving a gross profit of $ 67.14. The parts department contributes $32 to the overheads, which gives a net profit of $35.14.

2. The transfer pricing policy is an extremely important element of the profit center model adopted by North Auto’s management. The basic issue is that the department on the receiving end of the services and/ or items will want the lowest possible price since it increases their costs; whereas, the department giving the services and/or items will want the highest possible price since it increases their revenue. On paper, the profit center model will require the transfer pricing to be at full retail value because it most accurately depicts the notion of independent businesses.

However, since the departments are highly interlinked, the business requires a more hybrid model. Given the nature of the relationship between the departments, the service and parts departments can be considered to be service departments. As a result, these two departments can be turned into cost centers instead to profit centers; thereby, charging any transfers from them at cost. New and Used car sales departments can remain profit centers with any transfers made at full retail.

3. The value of any item bought or traded should be the responsibility of the manager who bought or traded it. In this case, since the New Car Sales department manager was the one who traded in the vehicle, he should be the one to bear the reduction in value. This can be done by making an adjustment entry against the sales for that department, expensing the loss.