9SE - Horngren'S Financial And Managerial Accounting

Question

Refer to the information in Short Exercise S24-7. Compute each division’s RI. Interpret your results. Are your results consistent with each division’s ROI?

Step-by-Step Solution

Answer

The residual income of Snow Sports is $457,000 and for non-snow sports is $737,000. Both the divisions have positive residual income.

Step 1 Computation of residual income Snow Sports

$\begin{array}{c}\mathrm{Residual} \mathrm{Income}=\mathrm{Operating} \mathrm{Income}-\left(\mathrm{Average} \mathrm{total} \mathrm{assets}\times \mathrm{Minimum} \mathrm{required} \mathrm{rate} \mathrm{of} \mathrm{return}\right)\\ =990,000-\left(4,100,000\times 13\mathrm{\%}\right)\\ =\mathrm{\$}457,000\end{array}$

Step 2 Computation of residual income of Non-Snow Sports

$\begin{array}{c}\mathrm{Residual} \mathrm{Income}=\mathrm{Operating} \mathrm{Income}-\left(\mathrm{Average} \mathrm{total} \mathrm{assets}\times \mathrm{Minimum} \mathrm{required} \mathrm{rate} \mathrm{of} \mathrm{return}\right)\\ =1,530,000-\left(6,100,000\times 13\mathrm{\%}\right)\\ =\mathrm{\$}737,000\end{array}$

Step 3 Interpretation of results

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