Reference no: EM133098556
Question - Rotary Berhad produces machine accessories for manufacturers. The company acquired Kotora Sdn. Bhd several years ago. Rotary managed the two entities as separate business units with the acquired Kotora treated as a separate divisional investment centre.
As measures of performance for any of its divisions, Rotary used both unit contribution and return on average investment (ROI). Here, company policy state that any investments will be defined as the average operating assets employed. One of the employee incentive is yearend bonuses, the decision whether to reward employees with bonuses or the amount to be given depends on whether the division can achieve its targeted ROI.
All investments in operating assets are expected to earn a minimum return of 13 percent before income taxes.
Kotora's cost of goods sold is considered to be wholly variable, while the division's administrative expenses are not dependent on volume of sales or production. Selling expenses comprises fixed and variable elements with the variable portion comprising 40% of the total.
Kotora is considering to acquire a near competitor that gives an estimated ROI of 15.0% However, the management of Kotora decided against the investment because it believed that the investment would reduce Kotora's overall ROI.
The 2020 operating statement for Kotora is shown below.
For the Year Ended June 30, 2020
|
Sales revenue
|
|
RM28,000,000
|
|
Less expenses:
|
|
|
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Cost of goods sold
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RM18,500,000
|
|
|
Administrative expenses
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4,955,000
|
|
|
Selling expenses
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2,500,000
|
25,955,000
|
|
Operating income before income taxes
|
|
RM 2,045,000
|
The division's operating assets employed were RM12,960,000 at June 30, 2020, a 8 percent increase over the 2019 year-end balance.
Required -
(a) Calculate the unit contribution (rounded to the nearest cent) for Kotora if 1,190,000 units were produced and sold during the year ended June 30, 2020.
(b) Calculate the following performance measures for 2020 for Kotora:
(i) Pretax return on average investment in operating assets employed (ROI).
(ii) Residual income calculated on the basis of average operating assets employed.
(c) Explain why the management of Kotora would have been more likely to accept the contemplated capital acquisition if residual income rather than ROI were used as a performance measure.