AB Limited which buys and sells machinery has three departments:
New machines (manager, Newman)
Second-hand machines (manager, Handley)
Repair workshops (manager, Walker)
In selling new machines Newman is often asked to accept an old machine in part exchange. In such cases the old machine is disposed of by Handley.
The workshops do work both for outside customers and also for the other two departments. Walker charges his outside customers for materials at cost and for labour time at £8 per hour. This £8 is made up as follows:
Per hour (£)
Fixed costs 2.00 (10 000 budgeted hours per annum)
Variable costs 4.50
Profit 1.50
£8.00
AB Limited wishes to go over to a profit centre basis of calculations so as to be able to reward its three managers according to their results. It wishes to assess the situation in the context of the following transaction:
Newman sold to PQ Limited a new machine at list price of £16 000, the cost of which to AB Limited was £12 000. To make the sale, however, Newman had to allow PQ Limited £5000 for its old machine in part exchange.
PQ Limited's old machine was in need of repair before it could be re-sold and Newman and Handley were agreed in their estimate of those repairs as £50 in materials and 100 hours of workshop's labour time. That estimate was proved to be correct when the workshops undertook the repair.
At the time of taking PQ Limited's machine in part exchange Handley would have been able to buy a similar machine from other dealers for £3700 without the need for any repair. When the machine had been repaired he sold it to ST Limited for £4200.
(a) Show how you would calculate the profit contribution for each of the three departments from the above transaction.
(b) Re-calculate the profit contribution for each department if there were the following alternative changes of circumstances:
(i) When the workshops came to repair the old machine they found that they required an extra 50 hours of labour time because of a fault not previously noticed.
(ii) Before deciding on the figure he would allow PQ Limited for their old machine, Newman asks Walker to estimate the cost of repairs. This estimate is £50 in materials and 100 hours of workshops labour time. When, however, workshops came to repair the old machine, it took them 50 per cent longer than estimated.
(c) Recommend briefly how to deal with the following situations in the context of profit centre calculation:
(i) The manufacturer of the new machines allows AB Limited £200 per machine for which AB Limited undertakes to do all warranty repairs. Over the year the total cost of repairs under warranty exceeds the amount allowed by the supplier.
(ii) Although 4000 hours of workshop time were budgeted to be reserved for the other two departments, their load increases over the year by 20 per cent (at standard efficiency). The load from outside customers, however, stays as budgeted.