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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

Divisional performance analysis and evaluation

 The vice president of operations of Free Ride Hike Company is evaluating the performance of two divisions organized as investment centers. Invested assets and condensed income statement data for the past year for each division are as follows:

  Road Bike Division Mountain Bike Division
Sales $1,728,000 $1,760,000
Cost of goods sold 1,380,000 1,400,000
Operating expenses 175,200 236,800
Invested assets 1,440,000 800,000

 Instructions

  1. 1. Prepare condensed divisional income statements for the year ended December 31, 20Y7, assuming that there were no service department charges.
  2. 2. Using the DuPont formula for    return on investment, determine the profit margin, investment turnover, and return on investment for each division. Round percentages and the investment turnover to one decimal place.
  3. 3. If management’s minimum acceptable return is 10%, determine the residual income for each division.
  4. 4. Discuss the evaluation of the two divisions, using the performance measures determined in parts (1), (2), and (3).

(1)

To determine

Income statement: The financial statement which reports revenues and expenses from business operations and the result of those operations as net income or net loss for a particular time period is referred to as income statement.

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 operations XXX
Less minimum acceptable income from operations as a percent of invested assets XXX
Residual income XXX

Table (1)

To prepare: The income statements for RB and MB Divisions of Company FRB for the year ended December 31, 20Y7

Explanation

Prepare divisional income statements for RB and MB Divisions of Company FRB for the year ended December 31, 20Y7.

Company FRB
Divisional Income Statements
For the Year Ended December 31, 20Y7
  RB Division MB Div...

(2)

To determine
Profit margin, investment turnover, and return on investment of RB and MB Divisions

(3)

To determine
Residual income of for RB and MB Divisions

(4)

To determine
The profitable division by using the performance measures of income from operations, ROI, and residual income

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