Question

Profit Center Responsibility Reporting for a Service Company

Thomas Railroad Company organizes its three divisions, the North (N), South (S), and West (W) regions, 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—N Region	$988,000
Revenues—S Region	1,171,800
Revenues—W Region	2,089,500
Operating Expenses—N Region	626,100
Operating Expenses—S Region	697,400
Operating Expenses—W Region	1,263,600
Corporate Expenses—Dispatching	533,200
Corporate Expenses—Equipment Management	196,000
Corporate Expenses—Treasurer’s	150,300
General Corporate Officers’ Salaries	331,800

The company operates three service departments: the Dispatching Department, the Equipment Management Department, and the Treasurer’s Department. The Dispatching Department manages the scheduling and releasing of completed trains. The Equipment Management Department manages the railroad cars inventories. It makes sure the right freight cars are at the right place at the right time. The Treasurer’s Department conducts a variety of services for the company as a whole. The following additional information has been gathered:

	North		South		West
Number of scheduled trains	4,300		5,200		7,700
Number of railroad cars in inventory	900		1,400		1,200

Required:

1. Prepare quarterly income statements showing income from operations for the three regions. Use three column headings: North, South, and West. Do not round your interim calculations.

Thomas Railroad Company
Divisional Income Statements
For the Quarter Ended December 31
	North	South	West
Revenues	$	$	$
Operating expenses
Income from operations before service department charges	$	$	$
Service department charges:
Dispatching	$	$	$
Equipment Management
Total service department charges	$	$	$
Income from operations	$	$	$

2. What is the profit margin of each division? Round to one decimal place.

Region	Profit Margin
North Region	%
South Region	%
West 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 divisions?

1. The method used to evaluate the performance of the divisions should be reevaluated.
2. A better divisional performance measure would be the rate of return on investment (income from operations divided by divisional assets).
3. A better divisional performance measure would be the residual income (income from operations less a minimal return on divisional assets).
4. None of these choices would be included.
5. All of these choices (a, b & c) would be included.

Answer 1

Divisional Income Statement
	North	South	West
Revenues	$988,000	$1,171,000	$2,089,500
Operating expenses	$626,100	$697,400	$1,263,600
Income from operations before service department charges	$361,900	$473,600	$825,900
Less : service department charges:
Dispatching (533200/(4300+5200+7700)	$133,300	$161,200	$238,700
	(31X 4300)	(31X 5200)	(31X 7700)
Equipment Management (196000/(900 + 1400 + 1200)	$50,400	$78,400	$67,200
	(56X900)	(56X1400)	(56X1200)
Total service department charges	$183,700	$239,600	$305,900
Income from operations	$178,200	$234,000	$520,000

Part-2
	Profit Margin
	North	South	West
Income from Operations (A)	$178,200	$234,000	$520,000
Revenues (B)	988,000	1,171,000	2,089,500
Profit Margin (A/B)	18.04%	19.98%	24.89%

Correct answer will be b and c