JOSHI, KRISNA O.

ACCOUNTING CASE 2

CASE 2: Arias Division of Poncé Chemical

(Adjusting income for ROI purposes; ethics) Imelda Sanchez, manager of the Arias Division of
Poncé Chemical, is evaluated based on the division’s return on investment and residual income.
Near the end of November 2010, she was reviewing the division’s financial information as well as
some activities projected for the remainder of the year. The information she was reviewing follows.

1. Annual sales were projected at 100,000 units, each with a selling price of $30. Sanchez has
received a purchase order from a new customer for 5,000 units. Th e purchase order states that the
units should be shipped on January 3, 2011, for arrival on January 5.
Porjected sales: 100,000 units x $30 = 3,000,000
Purchase order: 5,000 units (Nasa Inventory pa)

2. The division’s 2010 beginning inventory was 500 units, each with a cost of $11. Purchases of
99,500 units have been made steadily throughout the year, and the per-unit cost has been constant
at $10. Sanchez intends to make a purchase of 5,200 units before year-end, providing a 200-unit
balance in inventory after making the shipment to the new customer. Carrying costs for the units
are quite high, but ordering costs are extremely low. The division uses a last-in, first-out (LIFO)
cost flow assumption for inventory.
Beg Inv.: 500 units x $11 = 5,500
Purchases: 99,500 units x 10 = 995,000
Before year-end purchase: 5,200
Ending Inv.: 200units
3. Shipping expenses are $0.50 per unit sold.

4. Sanchez 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 each. She makes a note to herself to place her
final order for the year from this supplier.
Sold: 15,000 units x $9 = 135,000
5. Division advertising is $5,000 per month for newspaper inserts and television spots. No
advertising has yet been purchased for December, but Sanchez intends to have Her sales manager
called the paper and TV station early next week.
Advertising expense: $5,000 x 12 = 60,000 – 5,000 = 55,000

6. Salaries through the end of the year are projected at $700,000. This amount assumes that the
position to be vacated by the division’s personnel manager will be filled on December 1. The
personnel manager’s job pays $66,000 per year. Sanchez has an interview on Monday with an
individual who appears to be a good candidate for the position.
Salaries expense: 700,000 – 66,000 = 634,000
7. Other general and administrative costs for the full year are estimated to total $590,000.

8. As Sanchez was reviewing the divisional information, she received a phone call from the
division’s maintenance supervisor. He informed her that $10,000 of electrical repairs to the office
heating system are necessary. When asked if the repairs were essential, the supervisor replied,
“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.” Sanchez tells the supervisor to see her on
Monday at 8:00 a.m.

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 JOSHI, KRISNA O. ACCOUNTING CASE 2

Using her information, Sanchez prepared a budgeted income statement and was fairly pleased with
the division’s results. Although providing the 13 percent rate of return on investment desired by
corporate management, the results did not reach the 16 percent rate needed for Sanchez to receive
a bonus for the year.

(a) Prepare a 2010 budgeted income statement for the Arias Division. Determine the
division’s residual income, assuming that the division has an asset investment base of
$4,500,000.

(b) Sanchez’s less-than-scrupulous friend, John Greer, walked into the house at this time.
When he heard that she was not going to receive a bonus, Greer said, “Here, let me
take care of this for you.” He proceeded to recompute the budgeted income statement
and showed Sanchez that, based on his computation of $723,000 in income, she would
receive her bonus. Prepare Greer’s budgeted income statement.

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 JOSHI, KRISNA O. ACCOUNTING CASE 2

(c) What future difficulties might arise if Sanchez acts in a manner that will make
Greer’s pro forma income statement figures a reality?
Future difficulties that may arise will be the overstatement of current sales due to the
inclusion of the future sale of 5,000 units in the current year. Moreover, a problem in the expected
outcome of the company may emerge because of the involvement of actual sales in the budget
report. This may affect the users of financial reports and the company itself.

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