Question

Calculating Residual Income

Barnard Manufacturing earned operating income last year as shown in the following income statement:
Sales $4,000,000
Cost of goods sold 2,100,000
Gross margin $1,900,000
Selling and administrative expense 1,100,000
Operating income $800,000
Less: Income taxes (@ 40%) 320,000
Net income $480,000
At the beginning of the year, the value of operating assets was $2,700,000. At the end of the year, the value of operating assets was $2,300,000.
Barnard requires a minimum rate of return of 15%.
Required:
Calculate:
1. Average operating assets $______
2. Residual income $_______

Answer 1

1) $2,500,000

2) $425,000

Step-by-step explanation:

1)

The Average Operating Assets is given using the formula

= (Beginning Operating Assets + Ending Operating Assets) ÷ 2

on substituting the values from the question, we get

⇒ Average Operating Assets = (2,700,000 + 2,300,000) ÷ 2

⇒ Average Operating Assets = 5,000,000 ÷ 2

⇒ Average Operating Assets = $2,500,000

2)

The Residual Income is calculated as:

= Operating Income - (Minimum Rate of Return × Average Operating Assets)

on substituting the values from the question, we get

⇒ Residual Income = $800,000 – (15% × $2,500,000)

⇒ Residual Income = $800,000 - $375,000

⇒ Residual Income = $425,000