The performance of the manager of Division A is measured by residual income. Which of the following would decrease the manager's residual income?

Question

BlackTom AI · Accepted Answer

Question restatement: The performance of the manager of Division A is measured by residual income. Which of the following would decrease the manager's residual income?

Option 1: Increase in sales.
- Residual income is typically calculated as operating income minus (minimum required return on operating assets). An increase in sales would generally increase operating income, assuming costs don’t rise disproportionately, which would tend to increase residual income rather than decrease it. Therefore, this change is unlikely to reduce residual income and may actually boost it.

Option 2: Decrease in expenses.
- A decrease in operating expenses lowers total costs, which increases operating income. Since residual income subtracts a charge for the minimum required return on assets from operating income, higher operating income from lower expenses would raise residual income, not lower it. Thus this option would not decrease residual income.

Option 3: Increase in the minimum required rate of return.
- The residual income formula is operating income minus the minimum required return on assets (often = cost of capital × average operating assets). An increase in the minimum required rate raises the charge against operating income, reducing residual income. This directly works to lower the residual income figure.

Option 4: Decrease in operating assets.
- A decrease in operating assets reduces the base upon which the minimum required return is calculated. While this can reduce the amount charged for the minimum return, the net effect on residual income depends on how operating income changes with the asset base. If operating activities are maintained, the reduced asset base lowers the capital charge and could increase residual income; however, since the question asks which would decrease residual income, this option does not reliably reduce residual income and, in many cases, would tend to increase it by lowering the required return on assets.

Summary of reasoning: Options 1 and 2 typically boost residual income by increasing operating income or decreasing costs. Option 4 reduces the asset base and can lower the charge for the minimum return, potentially increasing residual income rather than decreasing it. Option 3 directly raises the hurdle rate used to compute the minimum required return, which increases the deduction from operating income and thus reduces residual income. Therefore, the change most likely to decrease residual income is the increase in the minimum required rate of return.

The performance of the manager of Division A is measured by residual income. Which of the following would decrease the manager's residual income?单项选择题

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