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 $

1) $2,500,000

2) $425,000

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

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