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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 Country Auto has departments/profit centre : (i) New & (ii) Used Car
Sales, (iii) Parts, (iv) Service & (v) Body.

(b)

New & Used cars dept.: Headed by managers. They dealt in cars of Ford,
Saab & Volkswagen.

(c)

Parts dept.: Manager was responsible for tracking parts inventory for the
three lines & minimizing both carrying cost & obsolescence.

(d)

Service dept.: The service dept. Occupied over half the building space &
was most labour intensive.

(e)

Body Shop: They consisted of a manager, three technicians & a clerk.

Questions to be answered:
(1)

Using the data in the transaction, compute the profitability of 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.

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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. couldnt 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