HI5017 Managerial Accounting: Transportation Divisions Of PH
Preferential Homes (PH) is a residential home builder that does things a little differently than the competition. PH builds homes to completion in a factory rather than outdoors and on site. PH has three divisions, prefabrication, transportation, and construction. The Prefabrication division builds whole sections of floors, walls and roof trusses that are shipped to the Construction division, who uses these sections to build the shell of the house before adding all other interior and exterior components (e.g. insulation, wiring, outer walls, doors, etc.). The Prefabrication division “sells” its sections to the Transportation division who ships and “sells” the sections to Construction. Construction then sells finished products to the public.
At present, PH is the only home builder that makes pre-engineered homes and as such has been using its own internal transfer prices, which were set by head office. See appendix 1 for the past two year’s summary segmented income statements.
Required
- PH is happy with the profitability of its Construction division but is concerned that the other two divisions are struggling. PH is considering discontinuing one or both of these divisions. They have asked you, an outside consultant, for advice. Advise PH as to whether it should discontinue one of, both, or neither of its Prefabrication or Transportation divisions.
- Now consider for 2008 that there are other competitors in the pre-engineered home business. Prefabrication can sell, Transportation can buy and sell, and Construction can buy from external parties and all divisions are operating at capacity. Market prices for 1 prefabricated housing unit, pre and post shipping, are $60,000 and $90,000, respectively. Further assume that at these prices, the optimal capacity remains at 200 units per division. Calculate operating income for each division using market prices as the transfer prices – does your answer to part a change at all given these results?
- Still considering that the market prices from part b exist, what would happen if PH allowed the divisions to negotiate their own transfer prices? Qualitatively discuss whether or not there would be changes to the transfer price or quantity exchanged.
- Still considering that the market prices from part b exist, what would happen if PH forced the old transfer price of $75,000/unit between Transportation and Construction? Qualitatively discuss whether or not there would be changes to the quantity exchanged between the two divisions.
Answer:
In the above computation, the revenues for prefabrication and transportation have been computed with the price of $ 60,000 and $ 90,000 per house respectively. The cost of goods sold has been adjusted for the transportation and construction based on the revenue of the respective previous divisions. It is apparent from the above computation that for 2008, all the three divisions are making profits.
3.If PH allowed the divisions to negotiate their own prices, then it may so happen that the optimum quantity may not be produced and also the transfer price may not be equal to the market price and may be above or lower the market price. This is because each of the division would be concerned with showing profits so as to highlight the need for the division to be continued. Hence, decision making may be driven by interests of the respective division rather than the organisation as a whole. This may have adverse impact on the business profitability in the long run (Drury, 2016).
4.If the transfer price forced is lower at $ 75,000 instead of $ 90,000, then there would be an adverse impact on the profits of the transportation division whereas the profitability of the construction division would increase. This is because there is underreporting of revenues for the transportation division along with lower cost of goods sold for the construction division. Under such a scenario, it is likely that the production quantity by construction would be lower than the optimum quantity so as minimise the losses (Emmauel & Otley, 2015).
References
Bhimani, A., Horngren, C.T., Datar, S.M. and Foster, G. (2017), Management and Cost Accounting 4th ed. Harlow: Prentice Hall/Financial Times
Drury, C. (2016) Cost and Management Accounting: An Introduction. 6th ed. New York: Cengage Learning
Emmauel, R.C. & Otley, T.D. (2015) Accounting for Management Control. 8th ed. London: Cengage Learning.
Heisinger, K.(2014) Essentials of Managerial Accounting 4th ed. London: Cengage Learning.
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