An adjustment is made to net income when calculating residual income to remove
A)noninterest-bearing current liabilities.
B)interest and the related tax effect.
C)financing costs that the manager is able to control.
D)accounting distortions.

Question

Quizplus · Accepted Answer

Residual income is calculated by subtracting the required rate of return on the invested capital from the net income. However, since the required rate of return reflects the cost of both equity and debt funding, interest and its related tax effect must be removed from net income to ensure that only the equity portion of the invested capital is considered in the calculation. Noninterest-bearing current liabilities, financing costs that the manager is able to control, and accounting distortions are not relevant to this calculation.

An Adjustment Is Made to Net Income When Calculating Residual