Answer (D) is correct . Residual income is the excess of the return on investment over a targeted amount equal to an imputed interest charge on invested capital. Of the choices presented, this one is the most likely to present the divisional managers with an incentive to focus on increasing profitability for the firm as a whole.
Answer (A) is incorrect because Flexible budget variances are a short-term measure focused on current divisional operations, not long-term overall firm profitability.
Answer (B) is incorrect because Operating income does not include the effects of financing charges; such a focus would be detrimental to the firm’s overall profitability.
Answer (C) is incorrect because A focus on controllable costs would lead each division manager to cut his/her own costs without regard to the effect on the firm’s overall bottom line.
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