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Profit center responsibility reporting for a service company Red Line Railroad Inc. has three regional divisions...

Profit center responsibility reporting for a service company

Red Line Railroad Inc. has three regional divisions organized as profit centers. The chief executive officer (CEO) evaluates divisional performance, using operating income as a percent of revenues. The following quarterly income and expense accounts were provided from the trial balance as of December 31:

Revenues—East $1,400,000
Revenues—West 2,000,000
Revenues—Central 3,200,000
Operating Expenses—East 800,000
Operating Expenses—West 1,350,000
Operating Expenses—Central 1,900,000
Corporate Expenses—Shareholder Relations 300,000
Corporate Expenses—Customer Support 320,000
Corporate Expenses—Legal 500,000
General Corporate Officers' Salaries 1,200,000

The company operates three support 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 a cost driver for this work. The Legal Department provides legal services for division management. The department believes that the number of hours billed is a cost driver for this work. The following additional information has been gathered:

   East    West    Central
Number of customer contacts 1,500 2,800 5,700
Number of hours billed 750 1,750 1,500

Required:

1. Prepare quarterly income statements showing operating income 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
East West Central
Revenues $ $ $
Operating expenses
Operating income before support department allocations $ $ $
Support department allocations:
Customer Support $ $ $
Legal
Total support department allocations $ $ $
Operating income $ $ $

2. What is the profit margin of each region? Round percentages to the nearest whole number.

Division Profit Margin
East Region %
West Region %
Central Region %

Identify the most successful region 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 regions?

  1. A better divisional performance measure would be return on investment, residual income as these methods consider the assets used by the division.
  2. The current performance measures are based on the operating income per dollar of earned revenue. This method meets the requirement.
  3. A better divisional performance measure would be return on investment, and residual income as these methods consider the dollar revenue earned by the division.

Solutions

Expert Solution

1.

Red Line Railroad Inc.
Divisional Income Statements
For the Quarter Ended December 31
East West Central
Revenues 1400000 2000000 3200000
Operating expenses 800000 1350000 1900000
Operating income before support department allocations 600000 650000 1300000
Support department allocations:
Customer support 48000 89600 182400
Legal 93750 218750 187500
Total support department allocations 141750 308350 369900
Operating income 458250 341650 930100

Working:

Customer support:
East: $320000 x 1500/(1500 + 2800 + 5700) = $48000
West: S320000 x 2800/(1500 + 2800 + 5700) = $89600
Central: $320000 x 5700/(1500 + 2800 + 5700) = $182400
Legal:
East: $500000 x 750/(750 + 1750 + 1500) = $93750
West: $500000 x 1750/(750 + 1750 + 1500) = $218750
Central: $500000 x 1500/(750 + 1750 + 1500) = $187500

2. Profit margin = Operating income/Revenues

Division Profit margin
East 33%
West 17%
Central 29%

Most successful division: East Division

3. A better divisional performance measure would be return on investment, residual income as these methods consider the assets used by the division.

ekkarill92 answered 1 year ago
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