Chapter 24 - Answer - MANAGEMENT ACCOUNTING Solutions...

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
MANAGEMENT ACCOUNTING - Solutions Manual CHAPTER 24 ADVANCED ANALYSIS AND   APPRAISAL OF PERFORMANCE:   FINANCIAL AND  NONFINANCIAL I. Questions 1. Return on investment (ROI) is the ratio of profit to amount invested for the business unit. 2. The measurement issues for ROI are: a. The effect of accounting policies, which affect the determination of net income. b. Other measurement issues for income, which include the handling of non-recurring items in the income statement, differences in the effect of income taxes across units, differential effect of foreign currency exchange, and the effect of cost allocation when two or more units share a facility or cost. c. Measuring investment: which assets to include. d. Measuring investment: allocating the cost of shared assets. 3. The advantages of return on investment are: a. It is intuitive and easily understood. b. It provides a useful basis for comparison among SBUs. c. It is widely used. The limitations of return on investment are: a. It has an excessive short-term focus. b. Investment planning uses discounted cash flow analysis while managers are evaluated on ROI. c. It contains a disincentive for new investment by the most profitable units. 4. The key advantage of residual income is that it deals effectively with the limitation of ROI, that is ROI has a disincentive for the managers of the most profitable units to make new investments. With residual income, no matter how profitable the unit, there is still an incentive for new profitable investment. In contrast, a key limitation is that since residual income is not a percentage, it suffers the same problem of profit SBUs in 24-1
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Chapter 24 Advanced Analysis and Appraisal of Performance: Financial and Nonfinancial that it is not useful for comparing units of significantly difference sizes. It favors larger units that would be expected to have larger residual incomes, even with relatively poor performance. Moreover, relatively small changes in the desired minimum rate of return can dramatically affect the residual income for different size units. And, in contrast to ROI, some managers do not find residual income to be as intuitive and as easily understood. 5. Economic value added (EVA) is a business unit’s income after taxes and after deducting the cost of capital. The idea is very similar to what we have explained as residual income. The objectives of the measures are the same – to effectively motivate investment SBU managers and to properly measure their performance. In contrast to residual income, EVA uses the firm’s cost of capital instead of a desired rate of return. For many firms the desired rate of return and the cost of capital will be nearly the same, with small differences due to adjustments for risk and for strategic goals such as the desired growth rate for the firm. Also, while residual income is intended to deal with the undesirable effects of ROI, EVA is used to focus managers’ attention on creating value for shareholders, by earning profits greater than the firm’s cost of capital. 6.
Background image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 07/18/2011 for the course ECON 102 taught by Professor Sadassad during the Spring '11 term at Abant İzzet Baysal University.

Page1 / 12

Chapter 24 - Answer - MANAGEMENT ACCOUNTING Solutions...

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online