Question

Calculating Residual Income

East Mullett Manufacturing earned operating income last year as shown in the following income statement:

Sales	$531,250
Cost of goods sold	280,000
Gross margin	$251,250
Selling and administrative expense	183,200
Operating income	$68,050
Less: Income taxes (@ 40%)	27,220
Net income	$40,830

At the beginning of the year, the value of operating assets was $390,000. At the end of the year, the value of operating assets was $460,000. East Mullett requires a minimum rate of return of 10%.

Required:

For East Mullett, calculate:

1. Average operating assets	$
2. Residual income	$

Answer 1

Answer:

Average Operating Assets         = (Beginning Operating Assets + Ending Operating Assets) / 2         = ( $ 390,000 + $ 460,000 ) / 2          =    $ 425,000

Average Operating Assets    =    $ 425,000

Residual income           = Net operating income - (Average operating assets x minimum required rate of return)           =   $ 68,050 (-) ( $ 425,000 x 10% )           =   $ 68,050 (-) $ 42,500           =    $ 25,550

Residual income =    $ 25,550