Critically Evaluate Roi and Eva Encourages Short Term Decision Making in Managers
PART A
INTRODUCTION OF PERFORMANCE MEASUREMENT
Growing global competition has affected the organisational structure. Companies have moved to divisional structure, which generates the need for top management to assess the divisional performance. Divisions tend to be categorised into either a profit centre or an investment centre. While some measure of profit is used to measure the performance of profit centres, for investment centres many firms employ measures that are based on profit and invested capital(McGraw-Hill Higher Education).
C. Drury (2008) argues that performance measurement is one of the key functions of management accounting. Neely, Adams & Kennerly (2002) has defined performance measurement as the following:
“The process of quantifying the efficiency and effectiveness of past actions.”
Within this definition is a reference to non-financial measures, defined by Moulin (2002) as:
“The process of evaluating how well organisations are managed and the value they deliver for customers and other stakeholders.”
According to Dearden (1987), divisional financial performance measurement should distinguish between the performance of divisional managers and the economic performance of the divisional unit.
Performance measurement in investment centres is the main issue of this report.
There are three popular measures of investment centre performance, namely: 1. Economic value added (EVA) 2. Residual income (RI) 3. Return on investment (ROI)
Following the statement, only ROI and EVA is dealt in this report.
RETURN ON INVESTMENT
ROI is the most widely used financial measure of divisional performance. ROI expresses divisional profit as a percentage of the assets employed in the division. Skinner (1990) found evidence to suggest that firms prefer to use ROI because, being a ratio, it can be used for inter-division and inter-firm comparisons. ROI for a division can be compared with the return from other divisions within the
INTRODUCTION OF PERFORMANCE MEASUREMENT
Growing global competition has affected the organisational structure. Companies have moved to divisional structure, which generates the need for top management to assess the divisional performance. Divisions tend to be categorised into either a profit centre or an investment centre. While some measure of profit is used to measure the performance of profit centres, for investment centres many firms employ measures that are based on profit and invested capital(McGraw-Hill Higher Education).
C. Drury (2008) argues that performance measurement is one of the key functions of management accounting. Neely, Adams & Kennerly (2002) has defined performance measurement as the following:
“The process of quantifying the efficiency and effectiveness of past actions.”
Within this definition is a reference to non-financial measures, defined by Moulin (2002) as:
“The process of evaluating how well organisations are managed and the value they deliver for customers and other stakeholders.”
According to Dearden (1987), divisional financial performance measurement should distinguish between the performance of divisional managers and the economic performance of the divisional unit.
Performance measurement in investment centres is the main issue of this report.
There are three popular measures of investment centre performance, namely: 1. Economic value added (EVA) 2. Residual income (RI) 3. Return on investment (ROI)
Following the statement, only ROI and EVA is dealt in this report.
RETURN ON INVESTMENT
ROI is the most widely used financial measure of divisional performance. ROI expresses divisional profit as a percentage of the assets employed in the division. Skinner (1990) found evidence to suggest that firms prefer to use ROI because, being a ratio, it can be used for inter-division and inter-firm comparisons. ROI for a division can be compared with the return from other divisions within the
References: Drury, C. (2008). Management and Cost Accounting (illustrated, reprint ed.). Cengage Learning EMEA. Heath, Huddart, & Slotta. (2009). Retrieved July 27, 2013, from http://www.personal.psu.edu/sjh11/BA521/NEW/Class08/TransferPricing.pdf Hill, I Horngren, C. T., & Foster, G. (1991). Cost accounting: A managerial emphasis,. Prentice-Hall. Jain, P. K. (2000). Cost Accounting. Tata McGraw-Hill Education. Kinney, M. R., & Raiborn, C. A. (2012). Cost Accounting: Foundations and Evolutions (9th ed.). Cengage Learning. McGraw-Hill Higher Education. (n.d.). Retrieved July 28, 2013, from http://highered.mcgraw-hill.com/sites/dl/free/0074711903/50509/sample_ch13.pdf Moulin, M Neely, A. D., Adams, C., & Kennerley, M. (2002). The performance prism: the scorecard for measuring and managing business success (illustrated ed.). Financial Times/Prentice Hall. Skinner, R. C. (1990). The Role of Profitability in Divisional Decision Making and Performance Evaluation. Accounting and Business Research , 20 (78), 135-141.