Auto Dealer Cost Accounting Comment

Auto Dealer Cost Accounting Comment on the consultant's adjustments made in Exhibit 1. Do you agree with each of them? If not, can you suggest better methods of making the adjustments for the stated purpose? The consultant's reallocation of semi-variable and fixed costs significantly decreases the profitability of the body shop from 2.94% of sales to 0.30% of sales. The consultant's analysis is an attempt to accurately determine the body shop's profit by more accurately aligning semi-variable and fixed costs between the dealership's different departments.

The table below outlines the assumption changes used to determine the allocation of semi-variable costs: Semi-variable cost Mr. Delaney assumptions The consultant assumptions Legal, auditing and owner's salary These costs would not be significantly reduced if the body shop was eliminated and should therefore not be attributed to the body shop Industry data show that owners' salaries tend to vary with sales volume. Each department benefits from these expenses and thus should be allocated a portion of these costs using a direct labor-hours allocation base Telephone and telegraph Mr.

Delaney's methodology is not stated Allocate costs based on direct labor-hours The consultant has chosen to use a cost allocation based on direct labor-hours. The financial statements lack information on the number of departmental hours worked and to use the direct labor-hours methodology the consultant must make the assumption that "all direct employees work approximately the same number of hours per week." The direct labor-hours allocation process treats all labor hours as the same in terms of costs and profit and may therefore overstate the costs and understate the profits.

I believe there is a flaw in using this methodology. Mr. Delaney's dealership has six departments: new-car sales, used-car sales, part sales, vehicle leases and rentals, vehicle service and automobile body repairing and repainting. The first four departments are focused on sales of tangible products -- cars and parts, while the vehicle service and automobile body repairing and repainting departments provide services.

It is fair to assume that the labor-hours and labor costs between sales and services are very different; additionally, the sale or leasing of a car is a one-time activity taking place on both weekdays and weekends, while the servicing and repair of a car can happen multiple times per customer and traditionally, dealership only offer services on weekdays. The consultant allocates fixed costs based on the ratio of departmental square footage to total dealer square footage, adjusted by a weighting factor.

The weighting factor takes into account various machinery, equipment, furniture, and fixtures located throughout the dealership. The consultant used a factor of 1, which is an industry standard. The consultant acknowledges that the departments have very different functions, costs and profits, however his attempt to allocate costs does not adequately take into consideration their differences. I believe that these results are questionable due to the lack of specificity in the financial statements.

Given that the revised profitability number will be used to determine if jobs will be eliminated and is also used to determine the body shop manager's bonus, I recommend that if it is available that, Mr. Delaney provides more detailed information on the labor-hours or creates a better measurement system for both fixed and semi-variable costs and then has the consultant repeat the analysis in.