a.
Compute the
a.

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.
Therefore, Return on investment (ROI) is 12 %.
Calculate the residual income for Printer division:
Therefore, the residual income is $1,000,000.
Note: Here, average total assets are considered invested capital.
b.
Evaluate the statements made by Person G and Person L.
b.

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:
(1)
Calculate the new operating margin:
(2)
Calculate the return on investment for Printer division:
(3)
c.
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.

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:
(4)
Calculate the return on investment for Printer division:
(5)
Note: Operating margin includes additional operating margin.
Calculate the residual income for Printer division:
(6)
Note: New Operating margin include Existing operating margin and additional operating margin.
d.
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.

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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