Question

1. Profit Center Responsibility Reporting for a Service Company

   Thomas Railroad Company organizes its three divisions, the North (N), South (S), and West (W) regions, 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—N Region	$1,095,000
   Revenues—S Region	1,306,900
   Revenues—W Region	2,356,700
   Operating Expenses—N Region	693,900
   Operating Expenses—S Region	777,800
   Operating Expenses—W Region	1,425,200
   Corporate Expenses—Dispatching	561,600
   Corporate Expenses—Equipment Management	254,200
   Corporate Expenses—Treasurer’s	166,500
   General Corporate Officers’ Salaries	367,800

   The company operates three service departments: the Dispatching Department, the Equipment Management Department, and the Treasurer’s Department. The Dispatching Department manages the scheduling and releasing of completed trains. The Equipment Management Department manages the railroad cars inventories. It makes sure the right freight cars are at the right place at the right time. The Treasurer’s Department conducts a variety of services for the company as a whole. The following additional information has been gathered:

   	North		South		West
   Number of scheduled trains	5,900		7,000		10,500
   Number of railroad cars in inventory	1,000		1,600		1,500

   Required:

   1. Prepare quarterly income statements showing income from operations for the three regions. Use three column headings: North, South, and West. Do not round your interim calculations.

   Thomas Railroad Company
   Divisional Income Statements
   For the Quarter Ended December 31
   	North	South	West
   Revenues	$	$	$
   Operating expenses
   Income from operations before service department charges	$	$	$
   Service department charges:
   Dispatching	$	$	$
   Equipment Management
   Total service department charges	$	$	$
   Income from operations	$	$	$

   Feedback

   2. What is the A component of the rate of return on investment, computed as the ratio of income from operations to sales.profit margin of each division? Round to one decimal place.

   Region	Profit Margin
   North Region	%
   South Region	%
   West Region	%

   Identify the most successful region according to the profit margin.
   

   • North
   • South
   • West

   3. What would you include in a recommendation to the CEO for a better method for evaluating the performance of the divisions?

   1. The method used to evaluate the performance of the divisions should be reevaluated.
   2. A better divisional performance measure would be the rate of return on investment (income from operations divided by divisional assets).
   3. A better divisional performance measure would be the residual income (income from operations less a minimal return on divisional assets).
   4. None of these choices would be included.
   5. All of these choices (a, b & c) would be included.
   • a
   • b
   • c
   • d
   • e

Answer 1

Solution:

1) Income statement

Thomas Railroad Inc
Divisional Income statement
For the Quarter Ended December 31
	North	South	West
Revenues	$1,095,000	1,306,900	2,356,700
Operating expenses	693,900	777,800	1,425,200
Income from operations before service department charges	401,100	529,100	931,500
Less: Service department charges
Dispatching	141,600	168,000	252,000
Equipment management	62,000	99,200	93,000
Total service department charges	230,600	267,200	345,000
Income from operations	170,500	261,900	586,500

2)

North	15%
South	20%
West	25%

3. What would you include in a recommendation to the CEO for a better method for evaluating the performance of the divisions?

All of these choices (a, b ) would be included

Working

Allocation of service department charges:

Dispatching:

North division = 561,600/23,400*5900 = 141,600

South division = 561,600/23,400*7000   = 168,000

West division = 561,600/23,400*10,500  = 252,000

Equipment management:

North division = 254,200/4,100*1000 = 62,000  

South division = 254,200/4,100*1600 = 99,200

West division = 254,200/4,100*1500 = 93,000

  

Profit Margin

North division = 170,500/1,095,000*100 = 15%

South division = 261,900/1,306,900*100 = 20%

West division = 586,500/2,356,700*100 = 25%