Question

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 $ 870,000
Revenues—West 1,034,000
Revenues—Central 1,880,000
Operating Expenses—East 565,700
Operating Expenses—West 621,360
Operating Expenses—Central 1,174,660
Corporate Expenses—Shareholder Relations 150,000
Corporate Expenses—Customer Support 350,000
Corporate Expenses—Legal 264,000
General Corporate Officers’ Salaries 281,000

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 3,000 4,000 7,000
Number of hours billed 1,300 2,160 2,040

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

a)	Quarterly Statements:
			Division 1	Division 2	Division 3
			East	West	Central
	Revenues		$ 870,000.00	$ 1,034,000.00	$ 1,880,000.00
	Expenses		$ 565,700.00	$    621,360.00	$ 1,174,660.00
	Customer Contract		$   75,000.00	$    100,000.00	$    175,000.00
	Legal Expenses		$   62,400.00	$    103,680.00	$      97,920.00
	Shareholder Relation		$   50,000.00	$      50,000.00	$      50,000.00
	Gross Profits		$ 116,900.00	$    158,960.00	$    382,420.00
	Total Profits		$ 658,280.00
	Less: Corp Exp		$ 281,000.00
	Net Profit		$ 377,280.00
b)	Profit Margin		13.44%	15.37%	20.34%
	Most Profitable				Most Profitable
c)	For better performance the CEO should focus his manufacture more on
	the central division as it has more pofit margins. The existing costing method
	is also faulty as the customer expenses relations should be on the basis of
	actual customers catered and not contracts. There might be one customer
	having multiple contracts with the company so that customer will not be
	using that many customer desk hours as other companies.