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ructions Red Line Railroad Inc. has three regional divisions organized as profit centers. The chief executive...

ructions

Red Line Railroad Inc. has three regional divisions organized as profit centers. The chief executive officer (CEO) evaluates divisional performance, using income from operations as a percent of revenues. The following quarterly income and expense accounts were provided from the trial balance as of December 31:

Revenues—East $ 878,000
Revenues—West 1,042,000
Revenues—Central 1,880,000
Operating Expenses—East 563,600
Operating Expenses—West 619,680
Operating Expenses—Central 1,172,940
Corporate Expenses—Shareholder Relations 155,000
Corporate Expenses—Customer Support 333,000
Corporate Expenses—Legal 233,100
General Corporate Officers’ Salaries 278,500

The company operates three service departments: Shareholder Relations, Customer Support, and Legal. The Shareholder Relations Department conducts a variety of services for shareholders of the company. The Customer Support Department is the company’s point of contact for new service, complaints, and requests for repair. The department believes that the number of customer contacts is an activity base for this work. The Legal Department provides legal services for division management. The department believes that the number of hours billed is an activity base for this work. The following additional information has been gathered:

East

West

Central

Number of customer contacts 4,500 5,500 8,500
Number of hours billed 1,350 2,100 2,100
Required:
1. Prepare quarterly income statements showing income from operations for the three divisions. Use three column headings: East, West, and Central.
2. Identify the most successful division according to the profit margin. Enter percentage rounded two decimal places (e.g. 0.22547 is 22.55%).
3. What would you include in a recommendation to the CEO for a better method for evaluating the performance of the divisions? What is a major weakness of the present method?

Solutions

Expert Solution

Computation of ABC rate
Activity OH Costs(Col 1) No. of activity base(Col 2) Activity Rate(Col 1 / Col 2)
Customer Support $                  3,33,000                                        18,500 $                                  18.00 per customer contact
Legal $                  2,33,100                                          5,550 $                                  42.00 per hour billed
Total Cost $                  5,66,100
Part 1
Income Statement
East West Central Total
Revenues $                  8,78,000 $                               10,42,000 $                           18,80,000 $                              38,00,000
Opearting expenses $                  5,63,600 $                                 6,19,680 $                           11,72,940 $                              23,56,220
Income from operations before allocating service department costs $                  3,14,400 $                                 4,22,320 $                             7,07,060 $                              14,43,780
Service department costs:
Customer Support(Activity base units*$18.00) $                     81,000 $                                    99,000 $                             1,53,000 $                                3,33,000
Legal(Activity base units*$42.00) $                     56,700 $                                    88,200 $                                88,200 $                                2,33,100
Income from Operations $                     24,300 $                                    10,800 $                                64,800 $                                   99,900
Part 2 Profit Margin(Income from Operations/Revenues) 2.77% 1.04% 3.45%
Central Division is the most successful division
Part 3 In the present method the company is ignoring Corporate expenses-Shareholders Returns and General Corp. officer's salaries. Both these conditions should be considered foor decision making
Both the cost should be allocated on the basis of a particular activiy base or Revenue.

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