18E - Horngren'S Financial And Managerial Accounting

Question

Refer to the data in Exercise E24-17. Calculate each division’s RI. Interpret your results.

Step-by-Step Solution

Answer

The residual income of Residential is $15,360 and for professionals is $60,300. Both the divisions have positive residual income.

Step 1 Computation of residual income

$\begin{array}{rcl}\mathbf{Residential}\mathbf{\text{'}}\mathbf{s}\mathbf{ }\mathbf{of}\mathbf{ }\mathbf{Residual}\mathbf{ }\mathbf{Income}& \mathbf{=}& \mathbf{Operating}\mathbf{ }\mathbf{Income}\mathbf{-}\left(\mathrm{Average} \mathrm{total} \mathrm{assets}\times \mathrm{Minimum} \mathrm{required} \mathrm{rate} \mathrm{of} \mathrm{return}\right)\\ & \mathbf{=}& \mathbf{65}\mathbf{,}\mathbf{280}\mathbf{-}\left(192,000\times 26\%\right)\\ & \mathbf{=}& \mathbf{\$}\mathbf{15}\mathbf{,}\mathbf{360}\end{array}$

$\begin{array}{rcl}\mathbf{Professional}\mathbf{\text{'}}\mathbf{s}\mathbf{ }\mathbf{Residual}\mathbf{ }\mathbf{Income}& \mathbf{=}& \mathbf{Operating}\mathbf{ }\mathbf{Income}\mathbf{-}\left(\mathrm{Average} \mathrm{total} \mathrm{assets}\times \mathrm{Minimum} \mathrm{required} \mathrm{rates} \mathrm{of} \mathrm{return}\right)\\ & \mathbf{=}& \mathbf{164}\mathbf{,}\mathbf{820}\mathbf{-}\left(402,000\times 26\%\right)\\ & \mathbf{=}& \mathbf{\$}\mathbf{60}\mathbf{,}\mathbf{300}\end{array}$

Step 2 Interpretation of results

As computed in step 1 it is clearly visible both the divisions have positive residual income. This means that the division are income at the rate that is more than the expectations of the management’s minimum expectations.