The Northern Division of the Smith Company had average total operating assets of $150,000 last year. Its minimum required rate of return was 12%. The division reported operating income of $20,000. What was the residual income for the Northern Division last year?

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BlackTom AI · Accepted Answer

Question restatement: We’re given the Northern Division’s average operating assets of 150,000, a minimum required rate of return of 12%, and operating income of 20,000. The task is to compute residual income for last year.

Option A: $2,000. This is the residual income, calculated as residual income = operating income − (minimum required rate of return × average operating assets) = 20,000 − (0.12 × 150,000) = 20,000 − 18,000 = 2,000. Therefore, this option reflects the correct computation.

Option B: $20,000. If one misinterprets residual income as the full operating income without subtracting the minimum return, they would report 20,000. This ignores the capital charge for the required return on assets, so it’s incorrect.

Option C: $5,000. This could result from a miscalculation such as subtracting a smaller charge, e.g., 15,000, or assuming a different asset base or rate. However, with a 12% charge on 150,000, the correct charge is 18,000, not 15,000 or another amount, so 5,000 is not supported by the given data.

Option D: $18,000. This figure represents the minimum required return itself (12% of 150,000 = 18,000), not the residual income. It’s the capital charge, not the residual amount, so it’s not the residual income value.

In summary, the calculation follows the standard residual income formula: operating income minus the product of the minimum required rate of return and average operating assets. The only choice that matches 20,000 minus 18,000 is 2,000, making Option A the correct residual income and the others incorrect for various reasons.

The Northern Division of the Smith Company had average total operating assets of $150,000 last year. Its minimum required rate of return was 12%. The division reported operating income of $20,000. What was the residual income for the Northern Division last year?

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