please see the attached file.

Managerial Accounting Dual Income

Swan Systems develops and manufactures under-the-sink residential water filtration units that remove chlorine and other chemicals from drinking water. This Dutch company has successfully expanded sales of its units in the European market for the past 12 years. Six years ago, Swan started a U.S. manufacturing and marketing division and three years ago an Australian manufacturing and marketing division. The following are summary operating data for the last fiscal:

SWAN SYSTEMS
Summary of Operations
Last Fiscal Year
(millions of Dutch guilders)

Australia Netherlands United States Total

Sales 50 55 75 180
Divisional expenses 38 33 58 129
Net income 12 22 17 51

Senior management is in the process of evaluating the relative performance of each division. While the Netherlands division is the largest and generates the most profit, it also has the largest asset investment, as indicated by the following:

SWAN SYSTEMS
Miscellaneous Operating Data
Last Fiscal Year
(millions of Dutch guilders);

Australia Netherlands United States Total

Divisional net assets 80 195 131 406
Allocated corporate overhead* 4 4 6 14
Cost of capital 8.0% 8.0% 8.0%

After careful consideration, senior management has decided to examine the relative performance of the three divisions using several alternative measures of performance: ROI (measured by net assets, or total assets less liabilities), residual income (net income less the cost of capital times net assets), and both of these measures after subtracting allocated corporate overhead from divisional income. The cost of capital in each division is estimated to be the same (8%). (Assume that this 8% estimate is accurate.)

There has been much debate about whether corporate overhead should be allocated to the divisions and subtracted from divisional income. Senior management has decided to allocate back to each division the portion of corporate overhead that is incurred to support and manage it. The allocated corporate overhead items include worldwide marketing, legal expenses, accounting, and administration. Sales revenue has been selected as the allocation base. It is simple to use and best represents the cause-and-effect relationship between the divisions and the generation of corporate overhead.

a. Calculate ROI and residual income (1) before any corporate overhead allocations and
(2) after corporate overhead allocations for each division.

(1) before any corporate overhead allocations

ROI = Division income/Division assets

Australia Netherlands United States
Net income 12 22 17
Divisional net assets 80 195 131
ROI 15% 11.28% 12.98%

Investment Center Profit 12.0 22.0 17.00
Less: Investment charge 6.4 15.6 10.48
Residual income 5.6 6.4 6.52

(2) after corporate overhead allocations

Australia Netherlands United States
Net income 8 18 11
Divisional net assets 80 195 131
ROI 10% 9.23% 8.40%

Investment Center Profit 12.0 22.0 17.00
Less: Investment charge 6.4 15.6 10.48
Residual income 5.6 6.4 6.52

b. Discuss the differences among the various performance measures.

From the ROI measure, we can see that the ROI after corporate overhead allocations for each division will be reduced while the residual income for both before and after corporate overhead allocations is the same. This is because residual income concentrates on earnings in excess of the minimum desired return. However, with ROI, a segment may reject a project that exceeds the minimum return if the project will decrease the segments overall ROI. For example, a project that earns ROI of 10%, which is greater than the target rate of 8%, might be rejected if the segment is currently earning 15%, because the project will decrease the segment's ROI. This would not occur with residual income.

c. Based on the data presented in the case, evaluate the relative performance of the three
operating divisions. Which division do you think performed the best and which performed the worst?

Residual income is often preferred over return on investment (ROI) as a performance evaluation because residual income concentrates on maximizing absolute dollars of income rather than a percentage return as with ROI. Therefore, the division that I think performed the best is the United States division while the worst is the Australia division.