Managerial Accounting Report: Pref Homes Profitability Analysis

This report analyzes the managerial accounting case of Preferential Homes (PH), a residential home builder with three divisions: prefabrication, transportation, and construction. The analysis addresses the potential discontinuation of the prefabrication and transportation divisions, concluding that neither should be discontinued due to the potential cost implications of outsourcing components. The report includes calculations of operating income for each division, demonstrating profitability across all three in 2008. Furthermore, the report explores the impact of allowing divisions to negotiate their own prices, highlighting the risk of decisions being driven by divisional rather than organizational interests, and the consequences of a forced lower transfer price, which would adversely affect the transportation division's profits and potentially reduce construction output. References to relevant accounting literature are provided to support the analysis.

MANAGERIAL ACCOUNTING
STUDENT ID:
[Pick the date]

a) The company (PH) should not discontinue either of the units as the high profit witnessed in
Construction is owing to the low profitability and losses that the prefabrication and
construction division are witnessing. By discontinuing one or both of the divisions, the
sourcing of the prefabricated components and relevant transportation would be from an
outside vendor which may charge a higher price since it would not run the operations in loss
(Heisinger, 2014). This premise is being made on the assumption that the operations of
prefabrication and construction are efficient. It seems that the current crisis may be attributed
to the transfer not being at arm’s length thereby lowering the revenue realisation. On the
other hand, if there are efficiency issues with the prefabrication and construction, then the
same should be fixed and only in the event of these issues not being fixed should an outside
vendor be explored (Bhimani et. al., 2017).
b) The operating income for the various divisions is highlighted in the table below.
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.
c) 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).
d) 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.