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Concept explainers
Determining missing items from computations
Data for the North, South, East, and West divisions of Free Bird Company are as follows:
- A. Determine the missing items, identifying each by the letters (A) through (L). (Round percentages and investment turnover to one decimal place.)
- B. Determine the residual income for each division, assuming that the minimum acceptable
return on investment established by management is 12%. - C. Which division is the most profitable in terms of (1) return on investment and (2) residual income?
(a)
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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:
Investment turnover: This ratio gauges the operating efficiency by quantifying the amount of sales generated from the assets invested.
Formula of investment turnover:
Return on investment (ROI): This financial ratio evaluates how efficiently the assets are used in earning income from operations. So, ROI is a tool used to measure and compare the performance of a units or divisions or a companies.
Formula of ROI according to Dupont formula:
Residual income: The remaining income from operations after deducting the desired acceptable income is referred to as residual income.
Formula of residual income:
Income from operations | XXX |
Less minimum acceptable income from operations as a percent of invested assets | XXX |
Residual income | XXX |
Table (1)
To compute: The missing items
Explanation of Solution
1)
Compute income from operations.
2)
Compute invested assets.
Note: Refer to missing amount (a) for value of income from operations.
3)
Compute investment turnover.
4)
Compute sales value.
5)
Compute sales value.
Note: Refer to missing amount (d) for value of sales.
6)
Compute ROI.
Note: Refer to missing amount (e) for value of invested assets.
7)
Compute income from operations.
8)
Compute profit margin.
Note: Refer to missing amount (g) for value of income from operations.
9)
Compute investment turnover.
10)
Compute ROI.
11)
Compute profit margin.
12)
Compute investment turnover.
(b)
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Explanation of Solution
1)
Determine residual income of N Division.
Step 1: Compute minimum acceptable income from operations as a percent of invested assets for N Division.
Note: Refer to missing amount (b) of part (a) for value of invested assets.
Step 2: Determine residual income of N Division.
Particulars | Amount ($) |
Income from operations | $60,200 |
Less minimum acceptable income from operations as a percent of invested assets | 41,280 |
Residual income | $18,920 |
Table (2)
Note: Refer to missing amount (a) of part (a) for value of income from operations, and Step 1 for value and computation of minimum acceptable income.
2)
Determine residual income of S Division.
Step 1: Compute minimum acceptable income from operations as a percent of invested assets for S Division.
Note: Refer to missing amount (e) of part (a) for value of invested assets.
Step 2: Determine residual income of S Division.
Particulars | Amount ($) |
Income from operations | $51,300 |
Less minimum acceptable income from operations as a percent of invested assets | 36,000 |
Residual income | $15,300 |
Table (3)
Note: Refer to Step 1 for value and computation of minimum acceptable income.
3)
Determine residual income of E Division.
Step 1: Compute minimum acceptable income from operations as a percent of invested assets for E Division.
Step 2: Determine residual income of E Division.
Particulars | Amount ($) |
Income from operations | $102,000 |
Less minimum acceptable income from operations as a percent of invested assets | 81,600 |
Residual income | $20,400 |
Table (4)
Note: Refer to missing amount (g) of part (a) for value of income from operations, and Step 1 for value and computation of minimum acceptable income.
4)
Determine residual income of W Division.
Step 1: Compute minimum acceptable income from operations as a percent of invested assets for W Division.
Step 2: Determine residual income of W Division.
Particulars | Amount ($) |
Income from operations | $89,600 |
Less minimum acceptable income from operations as a percent of invested assets | 67,200 |
Residual income | $22,400 |
Table (5)
Note: Refer to missing amount (g) of part (a) for value of income from operations, and Step 1 for value and computation of minimum acceptable income.
(c) 1
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Explanation of Solution
The division with highest return on investment is considered as the most profitable division. Hence, N Division is the most profitable division with highest ROI of 17.5%.
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Chapter 23 Solutions
Financial & Managerial Accounting, Loose-Leaf Version
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