(Adjusting income for ROI purposes; advanced) Imelda Sanchez, manager of the Arias Division of Ponce Chemical, is evaluated based on the division’s return on investment and residual income. Near the end of November 2006, she was reviewing the division’s financial information as well as some activi¬ ties projected for the remainder of the year. The information she was re¬ viewing 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. The purchase order states that the units should be shipped on January 3, 2007, for arrival on January 5.

2. The division’s 2006 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 in¬ tends 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 LIFO cost flow assumption for inventory.

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.

5. Division advertising is $5,000 per month for newspaper inserts and tele¬ vision spots. No advertising has yet been purchased for December, but Sanchez intends to have her sales manager call the paper and TV station early next week.

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 per¬ sonnel 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.

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 is neces¬ sary. 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.

Using her information, Imelda prepared a pro forma 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 2006 pro forma income statement for the Arias Division. De¬ termine 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, Juan 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 re¬ compute the pro forma income statement and showed Imelda that, based on his computation of $723,000 in income, she would receive her bonus. Prepare Greer’s pro forma income statement.
C. What future difficulties might arise if Sanchez acts in a manner that will make Greer’s pro forma income statement figures a reality?