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

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 $ 862,000
Revenues—West 1,036,000
Revenues—Central 1,890,000
Operating Expenses—East 563,600
Operating Expenses—West 621,840
Operating Expenses—Central 1,167,900
Corporate Expenses—Shareholder Relations 150,000
Corporate Expenses—Customer Support 360,000
Corporate Expenses—Legal 252,000
General Corporate Officers’ Salaries 274,500

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 5,000 6,000 9,000
Number of hours billed 1,400 2,000 2,200
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?

Quarterly Income Statements

1. Prepare quarterly income statements showing income from operations for the three divisions. Use three column headings: East, West, and Central.

Red Line Railroad Inc.

Divisional Income Statements

For the Quarter Ended December 31

1

East

West

Central

2

Revenues

3

Operating expenses

4

Income from operations before service department charges

5

Service department charges:

6

Customer Support

7

Legal

8

Total service department charges

9

Income from operations

2. Compute the profit margin for each division. Enter percentage rounded two decimal places (e.g. .22547 is 22.55%).

Division

Profit Margin

East Division %
West Division %
Central Division %

Solutions

Expert Solution

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Part 1
East West Central
Revenues $                     862,000 $        1,036,000 $     1,890,000
Operating expenses $                    -563,600 $          -621,840 $   -1,167,900
Income from operations before service department charges $                     298,400 $            414,160 $        722,100
Service department charges:
Customer Support $                        90,000 $            108,000 $        162,000
Legal $                        63,000 $              90,000 $           99,000
Total service department charges $                     153,000 $            198,000 $        261,000
Income from operations $                     145,400 $            216,160 $        461,100
Working:
East West Central Total
Number of customer contacts 5,000 6,000 9,000 20,000
Weight 25.00% 30.00% 45.00%
Allocation of $360,000 $         90,000 $                     108,000 $            162,000
Number of hours billed 1,400 2,000 2,200 5,600
weight 25.00% 35.71% 39.29%
Allocation of $252,000 $         63,000 $                        90,000 $              99,000
Part 2 a b b/a
Revenue Operating Income Profit Margin
East $       862,000 $                     145,400 16.87%
West $   1,036,000 $                     216,160 20.86%
Central $   1,890,000 $                     461,100 24.40%
Part 3
Major weakness is that this method does not consider amount of investment being done by company which
have impact on earning.
Hence, better divisional performance measure would be:
1. Return on Investment (ROI)
2. Residual Income (RI)

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