PAMANTASAN LUNGSOD NG MARIKINA

Rainbow St. cor. Sierra Madre St. SSS Village,

Concepcion II, Marikina City

In Partial Fulfillment of the Requirements for Management Accounting

Submitted by:
Mahinay, Geraldine L.

Submitted to:
Dr. Tiamzon

October 12, 2019

Managerial Accounting

FMC Corporation produces auto parts. The company acquires other companies when they are
considered a good strategic fit. Several years ago, FMC acquired Bitoy Company, a supplier or dashboards.
FMC decided to maintain Bitoy’s separate identity therefore established Bitoy division as one of its
investment centers.

FMC evaluate its division on the basis of ROI. Management bonuses are also based on ROI. All
investments in operating assets are expected to earn a minimum required rate of return of 15 percent.

Bitoy’s ROI has ranged from 15 percent to 22 percent since it was acquired by FMC. During the
past year, Bitoy’s has an investment opportunity that would have yielded an estimated rate of return of
18 percent. Bitoy’s management decided against the investment because it believed the investment
would decrease the division’s overall ROI.

Last year’s income statement for Bitoy’s Division is given below. The division’s operating assets
employed were P11,220,000 at the end of the year, which represents a 6 percent increase over the
previous year-end balance.

BITOY DIVISION
Divisional Income Statement
For the Year Ended, December 31, 2017
Sales P 26, 200, 000
Cost of Goods 12, 500, 000
Gross profit P 13, 700, 000
Less operating expenses:
Selling Expenses P 5, 422, 000
Administrative Expenses 6, 278, 000

Net operating Expenses 11, 700, 000

Net Income P 2, 000, 000

Required:

1. Compute the following performance measures for Bitoy Division:

a. ROI where the investment base is the average operating assets (based on the beginning of the
year plus the end of the year assets divided by two).

Answer:
𝑏𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝑜𝑓 𝑡ℎ𝑒 𝑦𝑒𝑎𝑟 𝑎𝑠𝑠𝑒𝑡𝑠 + 𝑒𝑛𝑑 𝑜𝑓 𝑡ℎ𝑒 𝑦𝑒𝑎𝑟 𝑎𝑠𝑠𝑒𝑡𝑠
Average Operations Assets =
2
11,220,000+10,584,906 21,804,906
= =
2 2

= 10,902,453
 ROI = Net Income / Average Total Assets x 100%

ROI = 2,000,000 / 10,902,453 X 100%

ROI = 18.34%

b. Residual Income

Answer:

RI = Operating Income – (Operating Assets x Target Rate of Return)

Income from operations before income taxes P 2, 000, 000

Less: Imputed interest charge
Average productive Assets: P 10,902,453
Imputed interest 15%
Imputed interest charge P 1, 635, 368
Residual Income P 364, 632

2. Would management of Bitoy Division have been more likely to accept the investment opportunity it
had last year if residual income was used a performance measure instead of ROI? Explain your answer.

Answer:

Yes, the management of Bitoy Division would have accepted the investment opportunity if residual
income was used. The investment opportunity would have lowered Bitoy’s ROI because the investment’s
expected return of 18% was lower than the Bitoy’s ROI (15 percent to 22 percent) as well as its actual ROI
(18.34%). Possible reason for the management to reject the proposal would have been their incentives
which may be tied up with the performance and return generated from the investment. If in case the
residual income is being used then management will make use of this investment as it will increase the
performance measurement.

3. FMC’s corporate management is reconsidering the design of its division management compensation
package. Which of the following compensation design characteristics are consistent with FMC’s current
compensation arrangement (based on ROI)? How do you think the compensation package should be
restructured?

Answer:

Management bonuses is consistent with FMC’s current compensation arrangement (based on ROI).
Commission and bonus programs should be effectively aligned with the business strategy in order to
maximize the ROI on compensation,