Tutorial 7 (Responsibility Accounting) 1. What are margin and turnover? E plain ho! each can lead to improve pro"itability.

#. What are the advantages and disadvantages o" (i) R$%& (ii) Residual income. '. E plain ho! residual income overcomes one o" the R$% advantages. (. )* presented t!o years o" data "ro its +porting )oods ,ivision and its *amping ,ivision. Sporting Goods Division: -ear 1 (R.) -ear # (R.) +ales 7/&///&/// 70&///&/// $perating income #&1//&/// '&///&/// Average operating assets #/&///&/// #/&///&/// Camping Division: +ales $perating income Average operating assets -ear 1 (R.) #(&///&/// 1&#//&/// 1/&///&/// -ear # (R.) #0&///&/// 1&///&/// 1/&///&///

Required: a. *ompute the R$% and the margin and turnover ratios "or each year "or the +porting )oods ,ivision and *amping ,ivision. b. E plain the change in R$% "rom -ear 1 to -ear # "or each division. 0. A multinational corporation has a number o" divisions& t!o o" !hich are the 2aci"ic Rim and the European ,ivision. ,ata on the t!o divisions are as "ollo!s3 2aci"ic Rim European Average operating assets R.5//&/// R.5&///&/// $perating income R.1#6&/// R.1&'0/&/// .inimum re4uired return 1#7 1#7 a. *ompute residual income "or each division. 8y comparing the residual income& it use"ul to ma9e a use"ul comparison o" divisional per"ormance? E plain. b. *ompute the residual rate o" return. %s it possible to say that one division outper"orm the other ? E plain. c. *ompute the return on investment "or each division. *an !e ma9e meaning"ul comparison o" divisional per"ormance? E plain. d. Add the residual rate o" return computed in (b) tot eh re4uired o" return o" return. *ompare these rates !ith R$% computed in (*) . Will this relationship al!ays be the same?

+olution "or Tutorial :Responsibility accounting (1) .argin ; <et income=+ales& and Turnover ; +ales=Average operating assets. 8y brea9ing R$% into margin and turnover& more in>sight into !hy R$% may change "rom one period to the ne t is possible. (#) Advantages o" ROI include3 (1) R$% encourages managers to pay attention to the relationships among sales& e penses& and investment. (#) R$% encourages cost e""iciency. (') R$% discourages e cessive investment in operating assets. %ncreased pro"itability can be achieved (all other things being e4ual) by increasing revenues& decreasing e penses& or lo!ering investment. ,isadvantages o" ROI are3 (1) R$% may discourage managers "rom investing in pro?ects that !ould increase the pro"itability o" the "irm but decrease the division@s R$%. (#) %t also may encourage managers to "ocus on short>run pro"itability and to ta9e actions that may harm long>run pro"itability. Advantages o" Residual income include3 (1) encourages managers to ma9e investments that are pro"itable "or the entire company. (#) manager !ill tend to ma9e better decisions concerning investment pro?ects. ,isadvantages o" Residual income include3 (1) it is an absolute measure o" return and (#) it doest not discourage myopic behavior& encourage a short>run orientation. (') it can@t be used to compare the per"ormance o" divisions o" di""erent siAes. (') Residual income is the di""erence bet!een net income and the minimum dollar return re4uired on an investment. Residual income encourages investment in all pro?ects that earn at least the minimum rate o" return. (() (a) +porting )oods ,ivision R$%3 -ear 13 B#&1//&///=B#/&///&/// ; 1(7 -ear #3 B'&///&///=B#/&///&/// ; 107 +porting )oods ,ivision .argin3 -ear 13 B#&1//&///=B7/&///&/// ; (./7 -ear #3 B'&///&///=B70&///&/// ; (./7 +porting )oods ,ivision Turnover3 -ear 13 Turnover3 B7/&///&///=B#/&///&/// ; '.0 -ear #3 Turnover3 B70&///&///=B#/&///&/// ; '.70 (b) *amping ,ivision R$%3 -ear 13 B1&#//&///=B1/&///&/// ; 1#7 -ear #3 B1&///&///=B1/&///&/// ; 1/7 *amping ,ivision .argin3 -ear 13 B1&#//&///=B#(&///&/// ; 0./7 -ear #3 B1&///&///=B#0&///&/// ; (./7 *amping ,ivision Turnover3 -ear 13 Turnover3 B#(&///&///=B1/&///&/// ; #.( -ear #3 Turnover3 B#0&///&///=B1/&///&/// ; #.0

(c) R$% "or the +porting )oods ,ivision increased "rom 1(7 to 107. This in>crease is due entirely to the increase in turnover "rom '.0 to '.70. (.argin "or this division stayed the same "rom -ear 1 to -ear #.) The *amping ,ivision& on the other hand& e perienced a drop in R$% "rom 1#7 to 1/7. .argin in this division decreased "rom 07 to (7& and the small increase in turnover ("rom #.( to #.0) !as not enough to overcome the margin decline.

(0)

(a) 2aci"ic>Rim3 B1#6&/// : (/.1# C B5//&///) ; B11&/// European3 B1&'0/&/// : (/.1# C B5&///&///) ; B#7/&/// Residual income is an absolute dollar measure& so it does not ad?ust "or the relative siAes o" the divisions. (b) 2aci"ic>Rim3 B11&///=B5//&/// ; #7 European3 B#7/&///=B5&///&/// ; '7 %t is no! possible to say the European ,ivision is relatively more pro"itable than the 2aci"ic>Rim ,ivision. (c) 2aci"ic>Rim3 B1#6&///=B5//&/// ; 1(7 European3 B1&'0/&///=B5&///&/// ; 107 R$% can be used to compare relative divisional pro"itability. (d) 2aci"ic>Rim3 #7 D 1#7 ; 1(7 European3 '7 D 1#7 ; 107 The residual rate o" return and the re4uired rate o" return !ill al!ays sum to the R$%.