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	$ 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?

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	%

Now identify the most successful division according to the profit margin:

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?

A major weakness of the present method is that

the assets invested in each division are not considered.

nonfinancial drivers are not identified.

the service department charges are incorrectly allocated.

a full year’s income is needed for assessment.

there is no weakness. The present method works well.

Which of the following methods would better evaluate divisional performance? Check all that apply.

Considering residual income (income from operations less a minimal return on divisional assets).

None of these. The present method works well.

Completing a balanced scorecard for each service department.

Computing the rate of return on investment (income from operations divided by divisional assets).

Utilizing transfer pricing between divisions.

Including direct and indirect operating expenses for each division.

Focusing on revenues and expenses.

Answer 1

1 Red Line Railroad Inc.
Divisional Income Statements
For the Quarter Ended December 31
East ($) West ($) Central ($)
Revenues 878,000 1,042,000 1,880,000 a
Operating Expenses 563,600 619,680 1,172,940 b
Income from operations before service department charges 314,400 422,320 707,060 c= a-b
Service Department Charges:
Customer Support (Working Note - 1) 81,000 99,000 153,000 d
Legal (Working Note - 2) 56,700 88,200 88,200 e
Total Service Department Charges 137,700 187,200 241,200 f=d+e
Income from Operations 176,700 235,120 465,860 g=c-f
Working Note - 1
Customer contacts is the base for seggregating corporate expenses - customer support
East West Central
Number of Customer Contacts 4,500 5,500 8,500
Total number of customer contacts = 4500+5500+8500 = 18500
Corporate expenses - customer support = $ 333,000
Expenses Seggregation:
East = 333,000*4500/18500 = $ 81,000
West = 333,000*5500/18500 = $ 99,000
Central = 333,000*8500/18500 = $ 153,000
Working Note - 2
Number of hourse billed is the base for seggregating corporate expenses - Legal
East West Central
Number of hours billed 1,350 2,100 2,100
Total number of hours billed = 1350+2100+2100 = 5550
Corporate expenses - Legal = $ 233,100
Expenses Seggregation:
East = 233,100*1350/5550 = $56,700
West = 233,100*2100/5550 = $88,200
Central = 233,100*2100/5550 = $88,200
2 Profit Margins for each division
East West Central
Income from operations 176,700 235,120 465,860 a
Total revenue 878,000 1,042,000 1,880,000 b
Profit Margins 20.13% 22.56% 24.78% c=a/b
From the above we can conclude that central division is the most profitable division with a profit margin of 24.78%
3 Answer for the 3rd already mentioned in the given question.