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Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094

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BuyFindarrow_forward

Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094
Textbook Problem

Determining missing items from computations

 Data for the North, South, Last, and West divisions of Free Bird Company are as follows:

  Sales Income from Operations Invested Assets Return on Investment Profit Margin Investment Turnover
North $860,000 (a) (b) 17.5% 7.0% (c)
South (d) $51,300 (e) (f) 4.5% 3.8
East $1,020,000 (g) $680,000 15.0% (h) (i)
West $1,120,000 $89,600 $560,000 (j) (k) (1)

 a. Determine the missing items, identifying each by the letters (a) through (l). Round percents and investment turnover to one decimal place.

 b. Determine the residual income for each division, assuming that the minimum acceptable return established by management is 12%.

 c. Which division is the most profitable in terms of (1) return on investment and (2) residual income?

a.

To determine

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:

Profit margin=Income from operationsSales

Investment turnover: This ratio gauges the operating efficiency by quantifying the amount of sales generated from the assets invested.

Formula of investment turnover:

Investment turnover=SalesInvested assets

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:

Return on investment = Profit margin × Investment turnover=Income from operationsSales×SalesInvested assets=Income from operationsInvested assets

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 operationsXXX
Less minimum acceptable income from operations as a percent of invested assetsXXX
Residual incomeXXX

Table (1)

To compute: The missing items

Explanation

Compute the missing items.

(a)

Compute income from operations.

Profit margin=Income from operationsSales7%=Income from operations$860,000Income from operations=$860,000×7%=$60,200

(b)

Compute invested assets.

Return on investment = Income from operationsInvested assets17.5%=$60,200Invested assetsInvested assets=$60,20017.5%=$344,000

Note: Refer to missing amount (a) for value of income from operations.

(c)

Compute investment turnover.

Investment turnover=SalesInvested assets=$860,000$344,000=2.5

(d)

Compute sales value.

Profit margin=Income from operationsSales4.5%=$51,300SalesSales=$51,3004.5%=$1,140,000

(e)

Compute sales value.

Investment turnover=SalesInvested assets3.8=$1,140,000Invested assetsInvested assets=$1,140,0003.8=$300,000

Note: Refer to missing amount (d) for value of sales.

(f)

Compute ROI.

Return on investment = Income from operationsInvested assets$51,300$300,000= 0

b.

To determine

Residual income of for each division

c.

To determine

Determine the most profitable company.

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