Question

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	$1,172,500
Revenues—S Region	1,333,100
Revenues—W Region	2,504,200
Operating Expenses—N Region	743,000
Operating Expenses—S Region	793,400
Operating Expenses—W Region	1,514,400
Corporate Expenses—Dispatching	673,200
Corporate Expenses—Equipment Management	184,000
Corporate Expenses—Treasurer’s	178,300
General Corporate Officers’ Salaries	393,800

The company operates three service departments: the Dispatching Department, the Equipment Management Department, and the Treasurer’s Department. The Treasurer’s Department and general corporate officers’ salaries are not controllable by division management. The Dispatching Department manages the scheduling and releasing of completed trains. The Equipment Management Department manages the inventories of railroad cars. 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	5,000		5,900		8,900
Number of railroad cars in inventory	1,200		1,800		1,600

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
Less service department charges:
Dispatching
Equipment Management
Total service department charges
Income from operations

Feedback

1. Determine the dispatching rate per train by dividing service cost by output. For each division's dispatching cost, multiply the dispatching rate by the number of scheduled trains. Repeat this process for the other service department charges. Subtract the service department charges for a division from that division's income from operations before such charges.

2. What is the 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.
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.

Answer 1

1.

Divisional Income Statement
	North	South	West
Revenues	$1,172,500	$1,333,100	$2,504,200
Operating expenses	$743,000	$793,400	$1,514,400
Income from operations before service department charges	$429,500	$539,700	$989,800
Less : service department charges:
Dispatching (673200/(5000+5900+8900)	$170,000	$200,600	$302,600
	(34X 5000)	(34X 5900)	(34X 8900)
Equipment Management (184000/(1200 + 1800 + 1600)	$48,000	$72,000	$64,000
	(40X1200)	(40X1800)	(40X1600)
Total service department charges	$218,000	$272,600	$366,600
Income from operations	$211,500	$267,100	$623,200

2.

Profit Margin
	North	South	West
Income from Operations (A)	$            211,500	$            267,100	$            623,200
Revenues (B)	$        1,172,500	$        1,333,100	$        2,504,200
Profit Margin (A/B)	18.04%	20.04%	24.89%

3. e. All of these choices (a, b & c) would be included.