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:

RevenuesEast	$ 866,000
RevenuesWest	1,030,000
RevenuesCentral	1,890,000
Operating ExpensesEast	565,700
Operating ExpensesWest	627,360
Operating ExpensesCentral	1,170,060
Corporate ExpensesShareholder Relations	156,000
Corporate ExpensesCustomer Support	320,000
Corporate ExpensesLegal	255,200
General Corporate Officers Salaries	273,500

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 companys 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	5,000	6,000	9,000
Number of hours billed	1,100	2,060	2,640

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?

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

there is no weakness. The present method works well.

the assets invested in each division are not considered.

the service department charges are incorrectly allocated.

a full years income is needed for assessment.

nonfinancial drivers are not identified.

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

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

Completing a balanced scorecard for each service department.

Utilizing transfer pricing between divisions.

None of these. The present method works well.

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

Focusing on controllable revenues and expenses.

Including direct and indirect operating expenses for each division.