Evaluating Performance Provide 1 response to each student post. Each response should be 150 words each. Turnitin is being used to check for plagiarism and Please use APA format. Anna Williams...

Anna Williams

Evaluating Performance

According to Schneider (2017), “Divisions being compared should have the same or similar accounting methods” (p.468). When the divisions being compared implement different accounting methods, there are certainly many different problems that could arise as explained in Chapter 11 of the text. The Return on Investment, Residual Income and the Economic Value added methods are all commonly used and the author of the text has illustrated the issues that can occur with comparing them within the different divisions in a company.

The Return on Investment or ROI method measures the gain or loss generated on an investment comparative to the amount of money invested. Now this particular method could cause divisions’ profits to differ in a few ways. Schneider XXXXXXXXXXconfirms that, “Implementing the ROI concept raises a number of issues. Problems exist in defining the profit numerator as well as the investment denominator. Even then, divisions within a company may be dissimilar, creating “apples and oranges” comparisons” (p XXXXXXXXXXThus, this results in comparing divisions that are completely different and shouldn’t not be correlated in any way as it would make no sense in doing so.

The Residual Income method is the measurement of the netincomethat an investment earns above the threshold established by the minimum rate of return assigned to the investment (Bragg, XXXXXXXXXXIt is obvious that this method differs greatly than that of the ROI which would automatically cause a difference in profit amounts. Schneider XXXXXXXXXXexplains that, “The stage of growth and other risk factors influence the potential profits that a division can generate. Consequently, top management might select different minimum desired rates of return for each division to recognize the unique role each plays in the organization” (p XXXXXXXXXXThus, this can result in management choosing inaccurate rates of return for each division.

The Economic Value Added method computes and evaluates the success of a company’s financials based on their excess income/profits. The problem with this method as explained by Schneider XXXXXXXXXXis that, “costs can be treated as assets that are amortized rather than as expenses, which would not be allowed for external reporting. The resulting profit number, the adjusted accounting profit, adds back these expenses to the accounting profit figure and therefore better reflects the division’s long-run profit potential” (p XXXXXXXXXXThis can allow a division to look more successful on paper than what they actually are. Thus, this can be very misleading.

References

Bragg, S XXXXXXXXXXThe Residual Income Approach. Retrieved from https://www.accountingtools.com/articles/what-is-the-residual-income-approach.html(Links to an external site.)Links to an external site.

Schneider, A XXXXXXXXXXManagerial Accounting: Decision making for the service and manufacturing sectors (2nd ed.) [Electronic version]. Retrieved from https://content.ashford.edu/

Sophia Muma

Return on Investment Approach (ROI)

Return on investment (ROI) method the divisions should have similar methods for accounting purpose to be able to compare the divisions otherwise it will be impossible to compare. Returns changes with the accounting standards and hence cannot be compared against themselves. The problem is the divisions within the company may be dissimilar creating an “apple and orange” comparisons Schneider XXXXXXXXXXTherefore, by using different depreciation methods in different divisions the final profit will vary thus the return will be different.

The Residual Income Approach

The Residual Income is proposed as an alternative to ROI. It focuses on maximization on the dollar amount and minimum expected return. It is the operating profit of a division less assessed charge for operating capital by a division. The profit that is earned over and above the profit that should be earned based on the resources. This method is preferred because it easily matches the company’s goals to the manager’s goals for example if a firm is looking at 15% incremental investment and the manager is looking at increasing the dollar amount both will concur. In ROI the investment an earning of less than 25% pulls down the divisions current ROI. Schneider XXXXXXXXXXThe main disadvantage with residual income arises when comparing different size divisions because a division with assets worth $ 50 million will be expected to have higher residual income than that with $2 million. The stage of growth might also affect the profit a division can generate as managers assign an initial low rate of return to divisions that just started versus mature divisions.

Economic Value Added (EVA)

The Economic Value Added is quite similar to residual income and used to evaluates performance. Like the residual income, the EVA approach deducts a minimum rate of return from the division’s profits hence the measure is also in dollar amount. The adjusted accounting profit is an after-tax profit with some expenses like training cost treated differently in external reporting requirements. Managers have, the incentives to reduce expenses by cutting amounts such as training costs to look good in the books or achieve short term goals, this shortsighted inclination can be counteracted by treating the costs as assets. EVA uses the actual cost of capital and this cost is derived based on the industry and risk characteristics of the divisions Schneider XXXXXXXXXXAll these can cause divisions profit to differ.

Reference

Schneider, A XXXXXXXXXXManagerial Accounting: Decision making for the service and manufacturing sectors (2nd ed.) [Electronic version]. Retrieved from https://content.ashford.edu/