ACCT 2920

What are the differences between ROI and RI?

ROI is a percentage and RI is a dollar amount

What is return on investments (ROI)? How is it used to analyze financial performance?

ROI is most common measure of investment center short-run financial performance; the higher the percentage, the better the indicated financial performance

What accounting policies and methods affect the ROI calculation? Know if each affects the profit and/or investment amount.

depreciation policy: affects both income and investment capitalization policy: expensed item reduces numerator of ROI, capitalized item reduces denominator of ROI inventory measurement methods: affects income and investment full costing: affects income disposition of variances: affects income

How should shared assets be allocated when calculating ROI?

allocate assets that cannot be traced - on a basis that is as close to actual usage as possible

What is the most common way to measure assets for the ROI calculation? What other ways are common?

historical cost is most common other ways are net book value, gross book value, replacement cost, and liquidation value

What does asset turnover represent?

the amount of dollar sales achieved per dollar of investment, measures the manager's ability to increase sales from a given level of investment

Why are financial performance indicators used to evaluate the performance of investment center managers?

- motivate managers to exert a high level of effort to achieve the goals of the firm (increase ROI) - provide the right incentive for managers to make decisions that are consistent with goals of top mgmt (goal congruence) - fairly determine the rewards earned by the managers for their effort and skill (ROI = sound basis for comparison between units of different size)

What are the advantages and disadvantages of both ROI and RI?

Advantages: congruent with top management goals for return on assets/invested capital, comprehensive financial measures - includes all elements important to top mgmt: revenues, costs, and level investment, comparability: expands top mgmt's span of control by allowing comparison across SBUs Disadvantages:may mislead strategic decision making, accounting issues, short term focus

What are the advantages and disadvantages of using ROI for performance evaluation?

Advantages: easily understood by managers, comparable to interest rates and the rates of return on alternative investments, widely used and reported in the business press Disadvantages: goal congruence issue: incentive for high ROI units to invest in projects with ROI higher than the minimum rate of return but lower than unit's current ROI, comparability across investment centers can be problematic

What are the advantages and disadvantages of using RI for performance evaluation?

Advantages: supports incentive to accept all projects with ROI > minimum rate of return, can use minimum rate of return to adjust for differences in risk, can use a different minimum rate of return for different types of assets Disadvantages: favors large units when the minimum rate of return is low, not as intuitive as ROI, may be difficult to obtain a minimum rate of return at the subunit level

What is residual income (RI) and how is it used to evaluate financial performance?

income earned by an investment center less a charge for the assets used to generate that income

What does return on sales represent?

profit margin; measures the manager's ability to control expenses and increase revenue to improve profitability

Be able to calculate ROI directly, and using return on sale and asset turnover.

return on sales x asset turnover (profit / sales) x (sales / average assets)