Fundamentals of Cost Accounting Study Set 4

Business

Quiz 14 :
Business Unit Performance Measurement

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Quiz 14 :
Business Unit Performance Measurement

Divisional performance management Performance measures are developed to assess the divisional performance. Performance measures should be consistent with authority granted and performance measures should assess the effectiveness of actions. Company should also consider those actions of divisional managers that improve the divisional performance but are unfavorable to organization performance. Divisions are assessed on income earned because divisions have revenue and cost both. Advantages and disadvantages of divisional income Advantages of divisional income are: - •It is easy to compute and understand divisional income because the income of a company is also computed in the same way the financial accounting income is calculated •Divisional income indicates the results of divisional manager's decisions •This is result of all decisions taken for costs and revenue •It becomes easy to compare different divisions because unit measure and method of measure is same. Disadvantages of divisional income are: - •Comparison of two division may not indicate the correct picture because the size of two divisions may be different. The larger division shall easily indicate higher revenue. Hence, divisions may not indicate the performance of divisional manager. •Divisional income may not indicate manager authority because manager of one division manager may have the authority to make investment (assets) only. Such authority does have impact on divisional income except to the extent of depreciation expense on assets. Hence, divisional income may not be true reflector of divisional manager's authority etc.

Computation of divisional income and income of the firm is done in a similar manner that is revenue minus costs. Divisional income is used to measure the performance of the division and income of the firm is used to measure the performance of the firm. Computation of divisional income, however, is not subject to compliance with the generally accepted accounting principles (GAAP) as it is an internal performance measure. Computation of the income of the firm is strictly subject to compliance with the generally accepted accounting principles because it is used as both internal and external performance measure.

Using absolute value of division profits as a performance evaluation technique for measuring business unit performance is simple and easy to compare. But, this performance measure suffers from two limitations/disadvantages that are the divisions should be same in size and its investment (assets) should be same. If, the divisions are at different sizes and/or its investment (assets) are differ then using "absolute value of division profits" as performance measure is ineffective. To come out of the two limitations/disadvantages that the management should use return on investment (ROI) technique for measuring the business unit performance. Therefore, the advantages of return on investment (ROI) technique are as follows: i) Return on investment (ROI) adjusts divisional income for different size business units. ii) Return on investment (ROI) takes assets acquisition, usage and disposal in to consideration while measuring the divisional performance.