A condensed income statement for the Electronics Division of Great Industries for the year ended 30 June 2020, is as follows: Sales $1,575,000 Cost of goods sold 891,000 Gross profit $ 684,000 Operating expenses 558,000 Income from operations $ 126,000 Assume that the Electronics Division received no charges from service departments. If operations are to continue, the CEO of Great Industries has indicated that the division’s rate of return on a $1,050,000 investment must be increased to at least 18% by the end of the next year. The division manager is considering the following three proposals. Proposal 1: Transfer equipment with a book value of $300,000 to other divisions at no gain or loss and lease similar equipment. The annual lease payments would be less than the amount of depreciation expense on the old equipment by $31,500. This decrease in expense would be included as part of the cost of goods sold. Sales would remain unchanged. Proposal 2: Reduce invested assets by discontinuing a product line. This action would eliminate sales of $180,000, reduce cost of goods sold by $119,550, and reduce operating expenses by $60,000. Assets of $120,000 would be transferred to other divisions at no gain or loss. Proposal 3: Purchase more and new efficient machinery and thereby reduce the cost of goods sold by $189,000 after considering the effects of depreciation expense on the new equipment. Sales would remain unchanged, and the old machinery, which has no remaining book value, would be scrapped at no gain or loss. The new machinery would increase invested assets by $918,750 for the year. - Determine the residual income (RI) for the Electronics Division for the past year and for each proposal. - Which proposal should the division manager adopt? Explain. Would using ROI or RI lead to a different conclusion? Explain. - If the profit margin in the Electronics Division cannot be increased, how much would the investment turnover have to increase to meet the CEO’s required 18%? How can the manager increase the investment turnover without increasing sales?
Reporting Cash Flows
Reporting of cash flows means a statement of cash flow which is a financial statement. A cash flow statement is prepared by gathering all the data regarding inflows and outflows of a company. The cash flow statement includes cash inflows and outflows from various activities such as operating, financing, and investment. Reporting this statement is important because it is the main financial statement of the company.
Balance Sheet
A balance sheet is an integral part of the set of financial statements of an organization that reports the assets, liabilities, equity (shareholding) capital, other short and long-term debts, along with other related items. A balance sheet is one of the most critical measures of the financial performance and position of the company, and as the name suggests, the statement must balance the assets against the liabilities and equity. The assets are what the company owns, and the liabilities represent what the company owes. Equity represents the amount invested in the business, either by the promoters of the company or by external shareholders. The total assets must match total liabilities plus equity.
Financial Statements
Financial statements are written records of an organization which provide a true and real picture of business activities. It shows the financial position and the operating performance of the company. It is prepared at the end of every financial cycle. It includes three main components that are balance sheet, income statement and cash flow statement.
Owner's Capital
Before we begin to understand what Owner’s capital is and what Equity financing is to an organization, it is important to understand some basic accounting terminologies. A double-entry bookkeeping system Normal account balances are those which are expected to have either a debit balance or a credit balance, depending on the nature of the account. An asset account will have a debit balance as normal balance because an asset is a debit account. Similarly, a liability account will have the normal balance as a credit balance because it is amount owed, representing a credit account. Equity is also said to have a credit balance as its normal balance. However, sometimes the normal balances may be reversed, often due to incorrect journal or posting entries or other accounting/ clerical errors.
A condensed income statement for the Electronics Division of Great Industries for the year ended 30 June 2020, is as follows: Sales $1,575,000 Cost of goods sold 891,000 Gross profit $ 684,000 Operating expenses 558,000 Income from operations $ 126,000 Assume that the Electronics Division received no charges from service departments. If operations are to continue, the CEO of Great Industries has indicated that the division’s
- Determine the residual income (RI) for the Electronics Division for the past year and for each proposal.
- Which proposal should the division manager adopt? Explain. Would using ROI or RI lead to a different conclusion? Explain.
- If the profit margin in the Electronics Division cannot be increased, how much would the investment turnover have to increase to meet the CEO’s required 18%? How can the manager increase the investment turnover without increasing sales?
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