### Practice As You Learn

#### Medium Practice Test

Follow these steps when preparing a segment income statement:

1) Sort the costs between fixed and variable

2) Determine total variable costs by multiplying cost per unit x # of units sold.
Variable costs will always be traceable/direct

3) Sort fixed costs between traceable/direct and nontraceable/common/allocated

Traceable/direct is reported in each segment column

Nontraceable/common/allocated are not reported for each segment, they are reported in the total company column only

4) Write the format and drop in numbers determined in steps 1) through 3)

Memorize this format:

Sales
– Variable cost of production
– Variable period costs
= Contribution Margin
– Traceable / fixed costs
= Division segment margin (profit)
– Common / nontraceable costs
= Total company operating income

Performance Evaluation:
You must memorize the formulas.
Write the formulas and drop in the numbers:

Return on Investment  =

Operating Income
Average Operating Assets

Operating Income     X                       Sales
Sales                      Average Operating Assets

“Profit Margin”         “Asset Turnover”

Net Operating Income is: income before interest expense and tax expense
Average Operating Assets = beginning + ending / 2

Long term assets are considered at book value, not fair market value

Residual Income:

Actual Operating Income
– Required Operating Income (see below)
= Residual Income

Average Operating Assets
X Required Rate of Return %
= Required Operating Income

Segment Reporting – Practice as You Learn – Problem 1.

A manufacturing company produces and markets two product lines: Stick Glue and Bottled Glue. The following data was gathered on activities for the month:

 Stick Bottled Sales in units 150,000 150,000 Variable selling expense per unit \$0.50 \$ 0.12 Traceable fixed selling expenses \$ 10,000 \$15,000 Variable production cost per unit \$1 \$ 0.45 Allocated non traceable selling expenses \$ 28,000 \$28,000 Sales price per unit \$4 \$ 2.50 Traceable fixed production cost \$200,000 \$300,000 Allocated corporate expenses \$120,000 \$120,000 Non traceable allocated production costs \$ 45,000 \$45,000

Prepare a segment income statement for the total company.

1) Sort the costs between fixed and variable

Variable
Variable production cost per unit
Variable selling expense per unit

“Per unit” is always variable

Fixed
Traceable fixed selling expenses
Allocated non traceable selling expenses
Traceable fixed production cost
Allocated corporate expenses
Non traceable allocated production costs

Assume fixed cost if it does not say variable or does not give a cost per unit.

2) Determine the total variable costs by multiplying cost per unit x # of units.
All variable costs are traceable / direct

Variable production cost per unit:

Stick                   Bottled

150,000            150,000
x \$ 1                     x \$.45
\$150,000          \$67,500

Variable selling expense per unit:

Stick                   Bottled

150,000            150,000
x \$.50                   x \$.12
\$75,000           \$ 18,000

3) Sort fixed costs between traceable/direct and nontraceable/common/allocated

 Traceable/direct: Stick: Bottled: Traceable fixed selling expenses \$ 10,000 \$ 15,000 Traceable fixed production cost \$200,000 \$300,000

Report for each segment in the segment column

 Nontraceable/common/allocated: Stick: Bottled: Total: Allocated non traceable selling expenses \$ 28,000 \$ 28,000 \$ 56,000 Allocated corporate expenses 120,000 \$120,000 \$240,000 Non traceable allocated production costs \$ 45,000 \$ 45,000 \$ 90,000

Show total in the total company column only

4) Write the format and drop in numbers determined in steps 1) through 3)

First, drop in amounts in the segment columns. Second, put in common / nontraceable only in the total company column. Total all rows to get the total company operating income.

 Stick Bottled Total Company Sales \$600,000 \$375,000 \$975,000 – Variable cost of production \$150,000 \$67,500 \$217,500 – Variable period costs \$75,000 \$18,000 \$93,000 = Contribution Margin \$375,000 \$289,500 \$664,500 – Traceable fixed costs: Traceable fixed selling expenses \$10,000 \$15,000 \$25,000 Traceable fixed production cost \$200,000 \$300,000 \$500,000 = Division segment margin (profit) \$165,000 (\$25,500) \$139,500 – Common / nontraceable costs: Allocated Non Traceable selling expenses \$56,000 Allocation corporate expenses \$240,000 Non traceable allocated production costs \$90,000 = Total operating income (\$246,500)

Performance Evaluation – Practice as You Learn – Practice Problem 2.

A company reported the following for a division for the current year:

 Sales \$1,700,000 Operating expenses \$800,000 Operating Assets on 1/1 \$1,800,000 Cost of goods sold \$600,000 Operating Assets on 12/31 \$2,200,000 Required rate of return 10%

A. Calculate the return on investment showing profit margin and asset turnover
B. Calculate residual income

You need operating income and average operating assets to work the formulas. Calculate them first if they are not given.

```Sales                                   \$1,700,000
-  Cost of goods sold           \$600,000
= Gross profit		            \$1,100,000
-  Operating expenses        \$800,000
= Operating income            \$300,000```

```Beginning operating assets	  \$1,800,000
+ Ending operating assets        \$2,200,000
Subtotal                                     \$4,000,000
/  2                                                  /  2
= Average operating assets       \$2,000,000```
```
A. Return on Investment: Write the formula and drop in the numbers.
```

```  Operating Income                                  Sales
Sales			X	 Average Operating Assets

\$300,000		X		\$1,700,000
\$1,700,000				\$2,000,000

17.65%               X                  .85    =       15%

```

ROI =

```  Operating Income          =      \$300,000
Average Operating Assets     \$2,000,000```

B. Residual Income. Write the formula and drop in the numbers.

```   Average Operating Assets                         \$2,000,000
X  Required Rate of Return %                            10%
=  Required Operating Income                   \$200,000

Actual Operating Income 		                  \$300,000
-  Required Operating Income (see below)      \$200,000
= Residual Income                                           \$100,000
```

The division earns \$100,000 over and above the required 10% return on assets.