Cherrylawn Appliance Stores is a nationwide chain of kitchen appliance stores. The company operates with a widely based retail and distribution system that has led to a highly decentralized management structure. Each area manager is responsible for purchasing and distributing products (from an approved corporate list) in one of eight geographical areas of the country.

Area managers are evaluated using a performance measure that is calculated as the area's contribution to corporate profits before taxes less a 12 percent investment charge on the area's investment base. The investment base of each area is the sum of its year-end balances of accounts receivable, inventories, and other assets. Corporate policies dictate that areas minimize their investments in receivables and inventories. Investments in other assets are decisions jointly made by the area and corporate managers based on proposals made by area managers, available corporate funds, and general corporate policy.

The Southeast Area Manager (SAM) prepared the year 1 and preliminary year 2 budgets for the area late in year 0. Final approval of the year 2 budget took place in late year 1 after adjustments for trends and other information developed during year 1. Preliminary work on the year 3 budget also took place at that time. In early November of year 2, the area manager asked the area controller to prepare a report that presents performance for the first nine months of year 2. The report follows:

CHERRYLAWN APPLIANCE STORES Southeast Area $(000) Year 2 Year 1 Annual Three-Quarter Actual Annual Budget Budget (to Date) Budget Actual Sales. . . . . . $25,480 $19,1 10 $20,020 $22.750 $22,113 Area costs and expenses Cost of sales . . . . . . . . . . . . . . . . $14,896 $11,172 $11,930 $12,600 $12,460 Leases . . . . . .. 780 585 620 620 755 Maintenance and repairs . . . . . . . . . . . . . . . . . 560 420 168 490 448 Depreciation on leasehold improvements. . . 924 693 693 847 847 Administration. . . . . . . . . . . . . . . . .... 1,008 756 756 756 840 Total area costs and expenses . . . . . . . . . $18,168 $13,626 $14,167 $15,313 $15,350 Area margin. . . . . .. $ 7,312 $ 5,484 $ 5,853 $ 7,437 $ 6,763 Allocated corporate fixed costs. 3,528 2,646 2,352 3,332 3,136 Area profits . .. $ 3,784 $ 2,838 $ 3,501 $ 4,105 $ 3,627 Year 2 Year 1 Budgeted Budgeted Actual Budgeted Actual Balance Balance Balance Balance Balance 12/31/Year 2 9/30/Year 2 9/30/Year 2 12/31/Year 1 12/31/Year 1 Area investment Accounts receivable $ 2,352 $ 2,842 $ 2,450 $ 2,450 $ 2,450 Inventories. . . . . . 14,000 14,000 18,200 12,600 13,300 Other assets . 2,310 2,362 1,925 2,010 1,925 Total . . .. $18,662 $19,204 $22,575 $17,060 $17,675 The area's sales occur uniformly throughout the year