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	$1,400,000
RevenuesWest	2,000,000
RevenuesCentral	3,200,000
Operating ExpensesEast	800,000
Operating ExpensesWest	1,350,000
Operating ExpensesCentral	1,900,000
Corporate ExpensesShareholder Relations	300,000
Corporate ExpensesCustomer Support	320,000
Corporate ExpensesLegal	500,000
General Corporate Officers Salaries	1,200,000

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	1,500	2,800	5,700
Number of hours billed	You are in Column East750	You are in Column West1,750	You are in Column Central1,500

	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 as whole number (e.g. 0.16 equals 16%).
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?

none

X

Quarterly Income Statements

1. Prepare quarterly income statements showing income from operations for the three divisions. Use three column headings: East, West, and Central.

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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

Solution

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

Points:

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Explanation

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Final Questions

2. Compute the profit margin for each division. Enter percentage as whole number (e.g. .16 equals 16%).

Division	Profit Margin
East Division
West Division
You are in Column DivisionCentral Division	You are in Column Profit Margin

Points:

Now identify the most successful division according to the profit margin: selector 1

• West
• East
• Central

Points:

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Explanation

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.

nonfinancial drivers are not identified.

the service department charges are incorrectly allocated.

the assets invested in each division are not considered.

a full years income is needed for assessment.

Points:

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

Including direct and indirect operating expenses for each division.

Utilizing transfer pricing between divisions.

Completing a balanced scorecard for each service department.

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

None of these. The present method works well.

Focusing on controllable revenues and expenses.

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

Points:

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Explanation

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