Week 10: Advanced Management Accounting

Question 1

What is Divisionalisation?

Answer 1

The creation of responsibility centres and the concept of responsibility accounting, which allows the operation of divisional performance measures.

Question 2

What are the 3 types of financial performance measures ?

Answer 2

1) Return on Investment (ROI)
2) Residual Income (RI)
3) Economic Value Added (EVA)

Question 3

What is the formula for Return on Investment (ROI) ?

Answer 3

Operating profit / Investment

(Investment= Total assets- Current liabilities)

Question 4

What is the Formula for Residual Income (RI) ?

Answer 4

Operating profit - (Cost of Capital* Investment)

Question 5

Why could RI be argued to be better than ROI ?

Answer 5

ROI does not consider the cost of capital unlike RI and it can potentially lead managers to reject profitable projects.

Question 6

Despite RI being better, why is ROI more widely used ?

Answer 6

It is simpler and less complex.

Question 7

What is Economic Value Added (EVA) ?

Answer 7

It is a variation of the Residual Income. It focuses on economic profit rather than juts accounting profit. E.g. takes into account things like advertising and R&D.

Question 8

Whats an advantage and disadvantage of Economic Valued Added?

Answer 8

It can provide more accurate representation of the divisions/ managers economic performance but can be complicated and costly to operate.

Question 9

What are the advantages of Financial performance measures?

Answer 9

1) Cheap
2) Comparable
3) Allows outsiders to assess the performance of divisions

Question 10

What are the disadvantages of Financial performance measures?

Answer 10

1) Employees may try to manipulate performance measures.
2) short- termism
3) Doesn’t take into account non-financial factors