SUMMIT ENTERPRISES

Journal of the International Academy for Case Studies, 2008 by Schneider, Arnold

CASE DESCRIPTION

The primary subject matter of this case concerns cost/managerial accounting - more specifically, transfer pricing and divisional performance evaluation. Secondary issues examined include cost estimation and cost-volume-profit analysis. The case has a difficulty level appropriate for junior level courses. The case is designed to be taught in a one hour class period and is expected to require three hours of outside preparation by students.

CASE SYNOPSIS

The case involves the application of transfer pricing, divisional performance analysis, cost estimation, and cost-volume-profit analysis. The setting is a diversified corporation with one division requesting services from another division. The objective of the case is for students to think about appropriate transfer prices and the use of ROI for service-oriented divisions, as well as to have students provide solutions for break-even points, operating leverage, and high-low cost estimates. Students often have trouble seeing how seemingly disparate topics in cost/managerial accounting relate to one another and this case offers an illustration of how a variety of topics are woven into one scenario.

INTRODUCTION

In 1970, Summit Enterprises was formed as a home remodeling company by Stan Stein in Columbus, Ohio, and has grown to a diversified corporation operating in over ten industries and in 35 states. The company has six separate divisions which are managed as independent investment centers. Over the years, the different divisions have done a very limited amount of business with each other, so corporate headquarters has seen no compelling reason to implement any transfer pricing policies. Recently, however, transfer pricing has evolved as a contentious issue as one of Summit's divisions (Chittenden Division) tries to launch a new business opportunity which requires the services of another division (Norwich Division).

NORWICH DIVISION

The Norwich Division, which was created in 1980, installs and services heating and air conditioning systems in commercial as well as residential buildings. Division revenues have grown rapidly over the past few years largely due to its reputation of high quality expertise and customer service. In 2006, Norwich Division expects to operate at full capacity and thereby increase its revenues over 2005 by 13 percent.

The Norwich Division is evaluated yearly on the basis of return on investment (ROI), measured as its pretax direct profit divided by its total direct assets. Indirect costs are not allocated from corporate headquarters. Dan White, the division's general manager, achieved a 33 percent ROI in 2005 and was rewarded by Summit Enterprises with a 12 percent salary bonus for his performance. Norwich's 2005 ROI far exceeded Summit's minimum required return of 25 percent. White hopes to improve even more, expecting to achieve a 35 percent ROI in 2006 and earn a promotion to one of the two corporate vice-presidencies that are expected to be vacant upon pending retirements.

The Norwich Division charges a rate of $60 per hour for the work it does. Its variable expenses are $40 per hour, direct fixed expenses are $860,000, and the division currently has $900,000 invested in directly traceable assets (vehicles, tools, and other equipment).

CHITTENDEN DIVISION

In contrast to the outstanding performance of the Norwich Division, the Chittenden Division has seen a downturn in its installation of swimming pools. From 1983 to 2001, the Chittenden Division was the market leader in installing outdoor swimming pools for health clubs, community centers, hotels, apartment complexes, and municipalities. In recent years, however, competitors' prices have come down while quality has improved, so that Chittenden's market share has eroded. As a consequence, Chittenden Division operated at only 75 percent of its practical capacity in 2005. Summit's controller has informed Shelley Greenberg, Chittenden's general manager, that unless capacity utilization improves to at least 80 percent by the end of the year, sizable staff cuts and other budget reductions will be made at Chittenden Division.

NEW BUSINESS OPPORTUNITY

To recapture its lost market share, the Chittenden Division has spent the past 18 months on a concerted effort to improve its product. A special project team formed for this purpose has developed a new swimming pool design that is supposed to significantly reduce maintenance costs over the pool's lifetime. Further, the project team estimates that this pool will last at least 10 more years than existing pools before major overhauls need to be made. The pool also includes a small waterslide. Prototypes have been constructed, tested, and demonstrated to a sample of prospective purchasers and the reception thus far has been very encouraging. In fact, one hotel chain has already agreed to purchase these new pools for six of its locations with the intention of possibly acquiring pools for 40 to 50 additional locations within the next two years. Greenberg views this order of six pools as key to significantly increasing Chittenden's capacity utilization in the near term, as Greenberg believes it will stimulate demand not only from this hotel chain but also from other prospective customers who have already shown some degree of interest.