Managerial Accounting 5.10.20
Performance evaluation systems and ROI
Performance evaluation systems
o Objective of the systems is to help the company implement the strategy
o Can ensure companies meet objectives
o Usually based on accounting measures of performance
- Readily available
- Easy to understand and evaluate
o Can alternatively use share price (market measures)
- But many factors affect share price
- Very volatile measure
- Unavailable for private companies
Return on investment (ROI)
- Earnings before interest expenses and taxes/assets employed
- ROI=Income/Invested capital (capital employed)
- Income: earnings before interest before depreciation
- If project ROI < average ROI of centre, project is rejected
- Managers can use this to evaluate new projects
- Income: $30,000 (Profit)
- Invested capital: $200,000 (Net assets)
30,000/200,000 = 15%
Disadvantages:
- Can lead to over/under investment because it can provide incentives to managers to reject
profitable projects (ROI lower than mean ROI may mean managers reject)
- Net income does not include value increases
- Companies may keep old assets in the books to make figures look better
- Accounting net income is conservative
- Total assets exclude intangible assets
Performance evaluation systems and ROI
Performance evaluation systems
o Objective of the systems is to help the company implement the strategy
o Can ensure companies meet objectives
o Usually based on accounting measures of performance
- Readily available
- Easy to understand and evaluate
o Can alternatively use share price (market measures)
- But many factors affect share price
- Very volatile measure
- Unavailable for private companies
Return on investment (ROI)
- Earnings before interest expenses and taxes/assets employed
- ROI=Income/Invested capital (capital employed)
- Income: earnings before interest before depreciation
- If project ROI < average ROI of centre, project is rejected
- Managers can use this to evaluate new projects
- Income: $30,000 (Profit)
- Invested capital: $200,000 (Net assets)
30,000/200,000 = 15%
Disadvantages:
- Can lead to over/under investment because it can provide incentives to managers to reject
profitable projects (ROI lower than mean ROI may mean managers reject)
- Net income does not include value increases
- Companies may keep old assets in the books to make figures look better
- Accounting net income is conservative
- Total assets exclude intangible assets
