Question

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?

Answer 1

	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.