Daunita White manages a division of Miami Chemical. She is evaluated on the basis of return on investment and residual income. Near the end of November 2001, Ms. White was at home reviewing the division’s financial information as well as some activities projected for the remainder of the year. The information she was reviewing is given below.
1. Sales for the year are projected at 100,000 units. Each unit has a selling price of $30. Ms. White has received a purchase order from a new customer for 5,000 units. The purchase order states that the units should be shipped on January 3, 2002, for arrival on January 5.
2. The division had a beginning inventory for the year of 500 units, each costing $10. Purchases of 99,500 units have been made steadily throughout the year, and the cost per unit has been constant at $10. Ms. White intends to make a purchase of 5,200 units before year end. This purchase will leave her with a 200 unit balance in inventory after she makes the shipment to the new customer. Carrying costs for the units are quite high, but ordering costs are extremely low. The division uses a LIFO cost flow assumption for inventory.
3. Ms. White has just received a notice from her primary supplier that he is going out of business and is selling his remaining stock of 15,000 units for $9.00 each. Ms. White makes a note to herself to place her final order for the year from this supplier.
4. Shipping expenses are $0.50 per unit sold.
5. Advertising is $5,000 per month. The advertising for the division is in newspapers and television spots. No advertising has been discussed for December; Ms. White intends to have the sales manager call the paper and TV station early next week.
6. Salaries are projected through the end of the year at $700,000. This assumes that the position to be vacated by Ms. White’s personnel manager is filled on December 1. The personnel manager’s job pays $66,000 per year. Ms. White has an interview on Monday with an individual who appears to be a good candidate for the position.
7. Other general and administrative costs for the full year are estimated to total $590,000.
8. As Ms. White is preparing her pro forma income statement for the year, she receives a telephone call from the maintenance supervisor at the office. He informs Ms. White that electrical repairs to the office heating system are necessary, which will cost $10,000. She asks if the repairs are essential, to which the supervisor replies, “No, the office won’t burn down if you don’t make them, but they are advisable for energy efficiency and long term operation of the system.” Ms. White tells the supervisor to see her on Monday at 8:00 a.m. Ms. White was fairly pleased with her pro forma results. Although the results did provide the 13 percent rate of return on investment desired by corporate management, the results did not reach the 16 percent rate needed for Ms. White to receive a bonus. Ms. White has an asset investment base of $4,500,000.
a. Prepare a pro forma income statement for Ms. White’s division. Determine the amount of residual income for the division.
b. Ms. White’s less than scrupulous friend, Ms. Green, walked into the house at this time. When she heard that Ms. White was not going to receive a bonus, Ms. Green said, “Here, let me take care of this for you.” She proceeded to recompute the pro forma income statement and showed Ms. White that, based on her computation of $723,000 in income, she would be receiving her bonus. Prepare Ms. Green’s pro forma income statement.
c. What future difficulties might arise if Ms. White acts in a manner that will make Ms. Green’s pro forma income statement figures a reality?