Pike Enterprises has three operating divisions. The managers of these divisions are evaluated on their division operating

Question:

Pike Enterprises has three operating divisions. The managers of these divisions are evaluated on their division operating income, a figure that includes an allocation of corporate overhead proportional to the revenues of each division. The income statements (in thousands) for the first quarter of 2007 are as follows:

John Moore, the manager of the Andorian Division, is unhappy that his profitability is about the same as the Orion Division's and is much less than the Tribble Division's, even though his revenues are much higher than either of these divisions. Moore also knows that he is carrying one line of products with low profitability. He was going to replace this line of business as soon as more-profitable product opportunities became available, but he has kept it because the line is marginally profitable and uses facilities that would otherwise be idle. Moore now realizes, however, that the revenues from this product line are attracting a large amount of corporate overhead because of the allocation procedure in use. This low-margin line of products had the following characteristics (in thousands) for the most recent quarter:
– Revenues: $800
– Cost of goods sold: $600
– Avoidable division overhead: $100
Required
1. Prepare the income statement for Pike Enterprises for the second quarter of 2007. Assume that revenues and operating results are identical to the first quarter except that Moore has discontinued the low-margin product line.
2. Is Pike Enterprises better off from discontinuing the low-margin product line?
3. Is Moore better off from discontinuing the low-margin product line?
4. Suggest changes for Pike's system of division reporting and evaluation that will motivate division managers to make decisions that are in the best interest of Pike Enterprises as a whole. Discuss any potential disadvantages of your proposal?