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	$ 884,000
Revenues—West	1,050,000
Revenues—Central	1,870,000
Operating Expenses—East	568,100
Operating Expenses—West	623,520
Operating Expenses—Central	1,170,540
Corporate Expenses—Shareholder Relations	157,000
Corporate Expenses—Customer Support	407,000
Corporate Expenses—Legal	261,000
General Corporate Officers’ Salaries	270,750

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	2,160	2,290

	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

Final Questions

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

there is no weakness. The present method works well.

the service department charges are incorrectly allocated.

the assets invested in each division are not considered.

nonfinancial drivers are not identified.

a full year’s income is needed for assessment.

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).

Utilizing transfer pricing between divisions.

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

Focusing on controllable revenues and expenses.

None of these. The present method works well.

Completing a balanced scorecard for each service department.

Including direct and indirect operating expenses for each division.

Answer 1