Question

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, 2016:

Revenues-N. Region $3,780,000

Revenues-S. Region $5,673,000

Revenues-W. Region $5,130,000

Operating Expenses-N. Region $2,678,500

Operating Expenses-S. Region $4,494,890

Operating Expenses-W.Region $3,770,050

Corporate Expenses-Dispatching $182,000

Corportate Expenses-Equipment Mgmt $1,200,000

Corporate Expenses-Treasurer's $734,000

General Corporate Office Salaries $1,380,000

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 650 1,105 845

Number of Railroad Cars Inventory 6,000 8,400 9,600

Instructions 1. Prepare quarterly income statements showing income from operations for the three regions. Use three column headings: North, South, and West. Answer Check Figure: Income from operations, West Region, $820,800

2. Identify the most successful region according to the profit margin.

3. Provide a recommendation to the CEO for a better method for evaluating the performance of the regions. In your recommendation, identify the major weakness of the present method.

Answer 1

Part 1)

The quarterly income statements are given below:

1		North	South	West
2	Revenues	3,780,000	5,673,000	5,130,000
3	Operating expenses	2,678,500	4,494,890	3,770,050
4	Income from operations before service department charges	1,101,500	1,178,110	1,359,950
5	Less service department charges:
6	Dispatching [(182,000/(650 + 1,105 + 845) = $70]	45,500 (650*70)	77,350 (1,105*70)	59,150 (845*70)
7	Equipment Management [(1,200,000/(6,000 + 8,400 + 9,600) = $50]	300,000 (6,000*50)	420,000 (8,400*50)	480,000 (9,600*50)
8	Total service department charges	345,500	497,350	539,150
9	Income from operations	$756,000	$680,760	$820,800

___________

Part 2)

The profit margin for each division is calculated with the use of following table:

	Profit Margin
	North	South	West
Income from Operations (A)	756000	680760	820800
Revenues (B)	3780000	5673000	5130000
Profit Margin (A/B)	20.00%	12.00%	16.00%

Based on above calculations for profit margin, the most successful region is North.

___________

Part 3)

The assets invested in each division are not considered.

________

Explanation:

For evaluating divisional performance, it is important to measure the usage of assets in generating a rate of return. The present method doesn't take into account the level of asset utilization by each division in the generation of revenue. The present method works by identifying the amount of income from operations per dollar of earned revenue. This is the weakness of present method.