Management Accounting · Divisional Performance Measurement

Residual Income Formula and Examples for CMA Inter

Updated 10 October 2026 · Fact-checked

Residual income (RI) is the profit a division earns above the minimum return required on the capital invested in it. Calculate RI = Divisional operating profit − (Capital employed × Required rate of return). A positive RI means the division adds value; a negative RI means it earns less than the required return.

Understand Residual Income (RI)

Every division uses money that investors have put in. That money has a cost. Residual income asks a simple question: after charging the division for the capital it uses, how much profit is left?

To find it, first take the divisional profit, usually operating profit before interest and tax unless the question says otherwise. Then compute a capital charge, which is capital employed multiplied by the required rate of return (also called the cost of capital or target rate). Subtract the charge from the profit. What remains is RI.

ROI gives a percentage: profit ÷ capital employed. It can make a manager reject a good project. Suppose a division earns 25% ROI and the required rate is 15%. A new project returning 20% is worth doing, since it beats 15%. But it would pull the division's ROI down from 25%, so an ROI-judged manager may refuse it. RI avoids this. The project adds a positive RI, so the manager accepts it.

This is why RI is said to promote goal congruence: the manager's interest and the company's interest point the same way. RI is an absolute amount in rupees, so it is not good for comparing divisions of very different size. A large division can show a bigger RI simply because it is large.

In exams, you are usually asked to compute RI, compare it with ROI, and say which division performs better or whether a project should be accepted. Always give a short conclusion in words.

Key rules to remember

Residual income: RI = Divisional profit − (Capital employed × Required rate of return); Use the profit measure the question gives. The product in brackets is the capital charge.
Capital charge: Capital charge = Capital employed × Required rate of return; Use the capital figure stated in the question, such as opening, closing or average.
Return on investment: ROI = (Divisional profit ÷ Capital employed) × 100; Compare with the required rate to judge the division.
Decision rule: Accept a project or division if RI > 0; Equivalent to ROI of the project exceeding the required rate of return.

How to solve Residual Income (RI) questions

Follow this order for any RI question. It keeps your layout clean and earns step marks.

1Identify the profit figure to use (operating profit, or profit as defined in the question). Adjust only if the question tells you to.
2Identify the capital employed to use: given figure, or average of opening and closing if stated.
3Note the required rate of return or cost of capital as a percentage.
4Compute the capital charge = capital employed × required rate.
5Compute RI = profit − capital charge, and show the working in a neat statement.
6If asked, compute ROI = profit ÷ capital employed × 100 for each division or option.
7Compare the results and write a one or two line conclusion, such as which division or project to prefer and why.
8For project decisions, compute the project's own RI (added profit less charge on added capital) and accept if positive.

Quickest way: Capital charge first, then subtract

When to use it: Use this in MCQs and when time is short, especially when several divisions are given.

Multiply capital employed by the required rate in your head or in the margin.
Subtract it from the profit to get RI directly.
For a project decision, skip ROI. Compare the project's return with the required rate: if higher, RI is positive.
Check the sign. A negative RI means the division earns below the required rate.

Common mistakes in Residual Income (RI)

Subtracting the required rate percentage from ROI and calling it RI.
Both use the same rate, so students mix a percentage with a rupee amount.
Fix: RI is always in rupees. Convert the rate into a capital charge and subtract it from profit.
Using the wrong capital figure, such as closing capital when average is asked.
Students skip reading the data note quickly.
Fix: Underline the capital basis in the question before calculating.
Rejecting a project because it lowers divisional ROI.
Students judge only by ROI.
Fix: Check if the project return exceeds the required rate. If so, RI rises and the project should be accepted.
Deducting interest from profit and then also charging the capital cost.
Confusion about which profit measure is being used.
Fix: Use profit before interest when capital charge is applied, unless the question states otherwise.
Declaring the division with the higher RI as the better performer without comment on size.
RI is an absolute figure and rewards size.
Fix: Mention that RI is size-dependent and support the comparison with ROI.

Worked examples

Example 1

Division A has operating profit of ₹6,00,000 and capital employed of ₹30,00,000. Division B has operating profit of ₹2,70,000 and capital employed of ₹12,00,000. The required rate of return is 14%. Compute ROI and RI for each division and comment.

Show the solution

Division A ROI = 6,00,000 ÷ 30,00,000 × 100 = 20%.
Division A capital charge = 30,00,000 × 14% = ₹4,20,000.
Division A RI = 6,00,000 − 4,20,000 = ₹1,80,000.
Division B ROI = 2,70,000 ÷ 12,00,000 × 100 = 22.5%.
Division B capital charge = 12,00,000 × 14% = ₹1,68,000.
Division B RI = 2,70,000 − 1,68,000 = ₹1,02,000.

Answer: A: ROI 20%, RI ₹1,80,000. B: ROI 22.5%, RI ₹1,02,000. B earns a higher return per rupee invested, while A adds more absolute value because it is larger. Both beat the 14% requirement, so both create value.

Example 2

Division C has operating profit of ₹4,50,000 on capital employed of ₹20,00,000. The required return is 15%. It can invest ₹5,00,000 more in a project that earns ₹90,000 a year. Should the manager accept it under ROI and under RI?

Show the solution

Current ROI = 4,50,000 ÷ 20,00,000 × 100 = 22.5%.
Project return = 90,000 ÷ 5,00,000 × 100 = 18%.
New profit = 4,50,000 + 90,000 = ₹5,40,000. New capital = ₹25,00,000.
New ROI = 5,40,000 ÷ 25,00,000 × 100 = 21.6%, which is lower than 22.5%.
Current RI = 4,50,000 − (20,00,000 × 15%) = 4,50,000 − 3,00,000 = ₹1,50,000.
New RI = 5,40,000 − (25,00,000 × 15%) = 5,40,000 − 3,75,000 = ₹1,65,000.

Answer: ROI falls from 22.5% to 21.6%, so an ROI-judged manager would reject the project. RI rises from ₹1,50,000 to ₹1,65,000, an increase of ₹15,000, so the project should be accepted. The project's 18% return exceeds the 15% required rate.

Exam tips

Show the capital charge as a separate line. Examiners give marks for it even if a later figure is wrong.
Always add a short interpretation: positive RI, negative RI, or which option to prefer.
In ROI versus RI questions, state the goal congruence point: RI avoids rejecting projects that beat the required rate.
In MCQs, check whether the answer asks for RI in rupees or a percentage before choosing.
Note any remark on limitations: RI is size-biased and depends on the rate chosen.

Practice questions from Divisional Performance Measurement

Residual Income (RI) in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Residual Income (RI): frequently asked questions

What is the formula for residual income?

RI = Divisional profit − (Capital employed × Required rate of return). The bracket is the capital charge. Use the profit and capital measures given in the question.

What is the difference between ROI and residual income?

ROI is a percentage return on capital, while RI is a rupee amount left after a capital charge. ROI can discourage projects that earn above the required rate but below current ROI. RI generally supports such projects.

Can residual income be negative?

Yes. If profit is lower than the capital charge, RI is negative. It means the division earns less than the required return on its capital.

Which is better for comparing divisions, ROI or RI?

ROI is better for comparing divisions of different sizes since it is a percentage. RI is better for decisions on whether to take up additional investment. Many answers use both.