Question

A-One Freight Inc. has three regional divisions organized as profit centers. The chief executive officer (CEO) evaluates divisional performance using operating income as a percent of revenues. The following quarterly income and expense accounts were provided from the trial balances as of December 31, 20Y3.

            

Revenues-Air Division			$5,000,000
Revenues-Rail Division			6,000,000
Revenues-Truck Division			9,000,000
Operating Expenses-Air Division			4,100,000
Operating Expenses-Truck Division			4,900,000
Operating Expenses-Rail Division			7,555,000
Corporate Expenses-Shareholder Relations			220,000
Corporate Expenses-Customer Support			990,000
Corporate Expenses-Legal			880,000
General Corporate Officers Salaries			500,000

The company operates three service departments: Shareholder Relation, Customer Support, and Legal. The Shareholder Relations Department conducts a variety of services for shareholders of the company. The Customer Support Department is the company’s point of contact for new service, complaints, and requests for repair. The department believes that the number of customers 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

			Air	Rail	Truck
Number of customers contacts			1,500	4,500	16,000
Number of hours billed			900	2,400	6,700

Division management does not control activities related to the shareholder relations department and general corporate officers’ salaries.

Instructions

1. Prepare quarterly income statements showing operating income for the three divisions.Use three column headings: Air, Rail.and Truck.
2. Identify the most successful division according to operating income as a percent of revenues. Round to one decimal place.
3. Provide a recommendation to the CEO for a better method for evaluating the performance of the divisions. In your recommendation, identify the major weakness of the present method.

Answer 1

	AIR	RAIL	TRUCK
Revenues	5000000	6000000	9000000
Operating Expenses	4100000	4900000	7555000
Corporate Expenses - Customer Support	67500	202500	720000
Corporate Expenses- Legal	79200	211200	589600
Operating Profit	753300	686300	135400

To identify the most successful division we need to calculated operating margins.

Formula for the same is Operating Income/Revenues

AIR= 753300/5000000 = 15.1% (15.066) (is the most profitable since it has the highest operating margin)

RAIL = 686300/6000000 = 11.4%

TRUCK = 135400/9000000 = 1.5%

The only flaw I see in the current system is that costs for 2 service departments Shareholders's division and Officer's salaries is not getting allocated to the profit centers in any manner.

Workings:

1) Corporate Expenses - Customer Support = 990,000

Total No. of customer contacts = 1500+4500+16000=22000

Cost per customer contact = $45 (990000/22000)

Corporate Expenses - Customer Support

AIR = 45*1500 = 67500

RAIL = 45*4500 = 202500

TRUCK = 45*16000 = 720000

2) Corporate Expenses-Legal = 880,000

Total No. of hours billed = 900+2400+6700= 10000

Cost per hour = $88 (880000/10000)

Corporate Expenses - Customer Support

AIR = 88*900 = 79200

RAIL = 88*2400 = 211200

TRUCK = 88*6700 = 589600