Q21RQ - Horngren'S Financial And Managerial Accounting

Question

Question: How is RI calculated?

Step-by-Step Solution

Answer

Answer

Residual income is computed by taking the difference between operating income and targeted return.

Step 1: Meaning of Operating Income

Operating income refers to the income generated by a business entity from its core operations. It is computed by taking the difference between sales revenue and associated costs such as variable and fixed.

Step 2: Computation of residual income

Residual income is the difference between operating income and the target rate of return on the company’s average total assets.

The formula for computing residual income is as follows: 

$\mathit{R}\mathit{e}\mathit{s}\mathit{i}\mathit{d}\mathit{u}\mathit{a}\mathit{l}\mathbf{ }\mathit{i}\mathit{n}\mathit{c}\mathit{o}\mathit{m}\mathit{e}\mathbf{=}\mathit{O}\mathit{p}\mathit{e}\mathit{r}\mathit{a}\mathit{t}\mathit{i}\mathit{n}\mathit{g}\mathbf{ }\mathit{i}\mathit{n}\mathit{c}\mathit{o}\mathit{m}\mathit{e}\mathbf{-}\left(Target rate of return\times Average total assets\right)$