Chapter 10, Problem 2PB

(1)

To determine

Prepare the income statements for N, S, and W Divisions of Incorporation TR for the quarter ended December 31.

Explanation of Solution

Income statement: The financial statement which reports revenues and expenses from business operations and the result of those operations as net income or net loss for a particular time period is referred to as income statement.

Service department charges: These are the indirect expenses incurred by profit center. These are charged for the services received by the department or division, based on the activity base of the service department.

Profit margin: This ratio gauges the operating profitability by quantifying the amount of income earned from business operations from the sales generated.

Formula of profit margin:

  $\text{Profit margin}=\frac{\text{Income from operations}}{\text{Sales}}$

Prepare divisional income statements for N, S, and W Divisions of Incorporation TR for the quarter ended December 31.

Incorporation TR
Divisional Income Statements
For the Quarter Ended December 31
	N Division	S Division	W Division
Sales	$3,780,000	$5,673,000	$5,130,000
Operating expenses	2,678,500	4,494,890	3,770,050
Income from operations before service department charges	1,101,500	1,178,110	1,359,950
Less: Service department charges:
Dispatching	(1) 45,500	(2) 77,350	(3) 59,150
Equipment management	(4)300,000	(5) 420,000	(6) 480,000
Income from operations	$756,000	$680,760	$820,800

Table (1)

Working Notes:

(1) Determine the service charges to be charged for dispatching department of N Division.

  $\begin{array}{c}\begin{array}{l}\text{Dispatching }\\ \text{department}\end{array}\}\text{= }\left\{\begin{array}{l}\text{Number of scheduled trains for N Division}\times \\ \text{Rate per scheduled trains}\end{array}\right\}\\ \text{=}\left\{\begin{array}{l}\text{Number of scheduled trains for N Division}\times \\ \frac{\text{Dispatching department expenses}}{\text{Total number of scheduled trains}}\end{array}\right\}\\ \text{= 650 scheduled trains × }\frac{\text{\$182,000}}{\left\{\begin{array}{l}\left(\text{650+1,105+845}\right)\\ \text{scheduled trains}\end{array}\right\}}\\ \text{= \$45,500}\end{array}$

(2) Determine the service charges to be charged for dispatching department of S Division.

  $\begin{array}{c}\begin{array}{l}\text{Dispatching }\\ \text{department}\end{array}\}\text{= }\left\{\begin{array}{l}\text{Number of scheduled trains for S Division}\times \\ \text{Rate per scheduled trains}\end{array}\right\}\\ \text{=}\left\{\begin{array}{l}\text{Number of scheduled trains for S Division}\times \\ \frac{\text{Dispatching department expenses}}{\text{Total number of scheduled trains}}\end{array}\right\}\\ \text{= 1,105 scheduled trains × }\frac{\text{\$182,000}}{\left\{\begin{array}{l}\left(\text{650+1,105+845}\right)\\ \text{scheduled trains}\end{array}\right\}}\\ \text{= \$77,350}\end{array}$

(3) Determine the service charges to be charged for dispatching department of W Division.

  $\begin{array}{c}\begin{array}{l}\text{Dispatching }\\ \text{department}\end{array}\}\text{= }\left\{\begin{array}{l}\text{Number of scheduled trains for W Division}\times \\ \text{Rate per scheduled trains}\end{array}\right\}\\ \text{=}\left\{\begin{array}{l}\text{Number of scheduled trains for W Division}\times \\ \frac{\text{Dispatching department expenses}}{\text{Total number of scheduled trains}}\end{array}\right\}\\ \text{= 845 scheduled trains × }\frac{\text{\$182,000}}{\left\{\begin{array}{l}\left(\text{650+1,105+845}\right)\\ \text{scheduled trains}\end{array}\right\}}\\ \text{= \$59,150}\end{array}$

(4) Determine the service charges to be charged for equipment management department of N Division.

  $\begin{array}{c}\begin{array}{l}\text{Equipment }\\ \text{management }\\ \text{department}\end{array}\}\text{= }\left\{\begin{array}{l}\text{Number of railroad cars for N Division}\times \\ \text{Rate per railroad car used}\end{array}\right\}\\ \text{=}\left\{\begin{array}{l}\text{Number of railroad cars for N Division}\times \\ \frac{\text{Equipment management department expenses}}{\text{Total number of railroad cars used}}\end{array}\right\}\\ \text{= 6,000 cars × }\frac{\text{\$1,200,000}}{\left(\text{6,000+8,400+9,600}\right)\text{ cars}}\\ \text{= \$300,000}\end{array}$

(5) Determine the service charges to be charged for equipment management department of S Division.

  $\begin{array}{c}\begin{array}{l}\text{Equipment }\\ \text{management }\\ \text{department}\end{array}\}\text{= }\left\{\begin{array}{l}\text{Number of railroad cars for S Division}\times \\ \text{Rate per railroad car used}\end{array}\right\}\\ \text{=}\left\{\begin{array}{l}\text{Number of railroad cars for S Division}\times \\ \frac{\text{Equipment management department expenses}}{\text{Total number of railroad cars used}}\end{array}\right\}\\ \text{= 8,400 cars × }\frac{\text{\$1,200,000}}{\left(\text{6,000+8,400+9,600}\right)\text{ cars}}\\ \text{= \$420,000}\end{array}$

(6) Determine the service charges to be charged for equipment management department of W Division.

  $\begin{array}{c}\begin{array}{l}\text{Equipment }\\ \text{management }\\ \text{department}\end{array}\}\text{= }\left\{\begin{array}{l}\text{Number of railroad cars for W Division}\times \\ \text{Rate per railroad car used}\end{array}\right\}\\ \text{=}\left\{\begin{array}{l}\text{Number of railroad cars for W Division}\times \\ \frac{\text{Equipment management department expenses}}{\text{Total number of railroad cars used}}\end{array}\right\}\\ \text{= 9,600 cars × }\frac{\text{\$1,200,000}}{\left(\text{6,000+8,400+9,600}\right)\text{ cars}}\\ \text{= \$480,000}\end{array}$

(2)

To determine

Ascertain the Profit margin and indicate the most profitable division.

Explanation of Solution

Compute profit margin for N Division.

  $\begin{array}{c}\text{Profit margin}=\frac{\text{Income from operations}}{\text{Sales}}\\ =\frac{\text{\$756,000}}{\$3,780,000}\\ \text{= 0}\text{.20 or 20\%}\end{array}$

Note: Refer to part (a) for value and computation of income from operations of N Division.

Compute profit margin for S Division.

  $\begin{array}{c}\text{Profit margin}=\frac{\text{Income from operations}}{\text{Sales}}\\ =\frac{\text{\$680,760}}{\$5,673,000}\\ \text{= 0}\text{.12 or 12\%}\end{array}$

Note: Refer to part (a) for value and computation of income from operations of S Division.

Compute profit margin for W Division.

  $\begin{array}{c}\text{Profit margin}=\frac{\text{Income from operations}}{\text{Sales}}\\ =\frac{\text{\$820,800}}{\$5,130,000}\\ \text{= 0}\text{.16 or 16\%}\end{array}$

Note: Refer to part (a) for value and computation of income from operations of W Division.

The division with highest profit margin is considered as the most profitable division. Hence, N Division is the most profitable division with highest profit margin of 20%.

(3)

To determine

Recommend the chief executive officer to use better measure to evaluate the performance or profitability of the division

Explanation of Solution

The following are the recommendations:

• ■ Profit margin is used as the performance measure to evaluate the profitability of the divisions. But profit margin measures the operating profitability only.
• ■ ROI is used to evaluate the operating income earned from the resources invested. So, the profitability of all the divisions of a decentralized company could be compared on the basis of operating income earned from the assets invested by the division.
• ■ Residual income from operations after deducting the desired acceptable income.