Financial & Managerial Accounting With Connect Plus Access Code: The Basis For Business Decisions
Financial & Managerial Accounting With Connect Plus Access Code: The Basis For Business Decisions
17th Edition
ISBN: 9781259183973
Author: Jan Williams, Susan Haka, Mark Bettner, Joseph Carcello
Publisher: McGraw-Hill/Irwin
Question
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Chapter 25, Problem 1CTC

a.

To determine

Compute the Return on investment (ROI) and residual income of Printer division.

a.

Expert Solution
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Explanation of Solution

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.

Residual income: It is an amount by which an operating income (earnings) exceeds a minimum acceptable return on the average capital invested.

Calculate the return on investment for Printer division:

Given, Operating margin $6,000,000 and average total assets $50,000,000.

Returnoninvestement(ROI)=OperatingmarginAveragetotalassets×100=$6,000,000$50,000,000×100=12%

Therefore, Return on investment (ROI) is 12 %.

Calculate the residual income for Printer division:

Residual income=[Operating earnings(Minimum acceptable return×Averagetotalassets)]=[$6,000,000(10%×$50,000,000)]=$1,000,000

Therefore, the residual income is $1,000,000.

Note: Here, average total assets are considered invested capital.

b.

To determine

Evaluate the statements made by Person G and Person L.

b.

Expert Solution
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Explanation of Solution

  • Both statements are correct. Selling of printers at $300 each is more profitable rather than selling them for $250. If the Printer division transfers an additional of 10,000 XLC Printers to mail-order last year, then it would have lost contribution margin generated by selling these units to customers who are outside.
  • Therefore, the operating margin will be only $4,500,000 (2), which results in a return on investment of only 9% (3).

Working notes:

Calculate the new contribution margin:

New Contributionmargin=[(SalepriceperunitManufacturingcost)×Additionlunitstransferred]=($250$100)×10,000units=1,500,000

(1)

Calculate the new operating margin:

NewOperatingmargin=ExistingOperatingmarginNewContributionmargin=$6,000,000$1,500,000(1)=$4,500,000

(2)

Calculate the return on investment for Printer division:

Returnoninvestement(ROI)=New OperatingmarginAveragetotalassets×100=$4,500,000(2)$50,000,000×100=9%

(3)

c.

To determine

Suggest some solution to resolve the situation and show the way in which the suggestions will affect the Printer division’s results last year.

c.

Expert Solution
Check Mark

Explanation of Solution

  • The problem lies in using the cost as a transfer price for the output of a profit center. If market value is used as the transfer price, it will be profitable for Printer division to supply printers to Mail-Order for selling it to outsiders. This eliminates the interdepartmental friction and allows Company W to benefit from selling XLC printers at $300 instead of $250.
  • If market price is been used as a transfer price last year, the Printer division will recognize $150 in contribution margin on every unit transferred to the Mail-Order Division ($250 sales price, less $100 manufacturing cost). Thus, the Printer division’s contribution margin and operating earnings would have been $750,000 (4) higher than actually reported. This in turn, will result in a ROI of 13.5% (5) and residual income of $1,750,000 (6).

Working notes:

Calculate the new contribution margin:

New Contributionmargin=[(ActualsalespriceperunitNewsalespriceperunit)×Additionlunitsproducedandtransferred]=($300$250)×(10,000units+5,000units)=$50×15,0000units=$750,000

(4)

Calculate the return on investment for Printer division:

Returnoninvestement(ROI)=OperatingMarginAveragetotalassets×100=$6,000,000+$750,000$50,000,000×100=13.5%

(5)

Note: Operating margin includes additional operating margin.

Calculate the residual income for Printer division:

Residual income=[NewOperating margin(Minimum acceptable return×Investedcapital)]=[$6,750,000(10%×$50,000,000)]=$1,750,000

(6)

Note: New Operating margin include Existing operating margin and additional operating margin.

d.

To determine

Explain whether the comments stated in subpart c can raise an ethical dilemma to be resolved by management of Company W and explain the nature of the potential problem and suggest recommendations to resolve it.

d.

Expert Solution
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Explanation of Solution

  • It is suggested that transfer prices must reflect market prices rather than cost. Suppose, if this policy came into effect from last year, then the residual income of the printer will be $750,000(4) higher than the actually reported result. The division manager receives bonus equal to 1% of residual income, therefore Person L might feel that bonus of $7,500 is lost due to use of faulty accounting methods.
  • Actually, using transfer price, $750,000(4) in contribution margin relating to $5,000 XLC Printers from the printer division to the mail-order division is transferred. Therefore, Person L complains that the bonus of $7,500 which is paid to Person G. It is advisable for management to take some corrective action, if needed.

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Chapter 25 Solutions

Financial & Managerial Accounting With Connect Plus Access Code: The Basis For Business Decisions

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