Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 32

Effects of Current Cost on Performance Measurements

Upper Division of Lower Company acquired an asset with a cost of $600,000 and a four-year life. The cash flows from the asset, considering the effects of inflation, were scheduled as follows:

Year	Cash Flow
1	$225,000
2	255,000
3	285,000
4	300,000

The cost of the asset is expected to increase at a rate of 10 percent per year, compounded each year. Performance measures are based on beginning-of-year gross book values for the investment base. Ignore taxes.

Required

a. What is the ROI for each year of the asset’s life, using a historical cost approach?

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b. What is the ROI for each year of the asset’s life if both the investment base and depreciation are determined by the current cost of the asset at the start of each year?

Step 1 of 5

The following information is given in the question:

1. Total assets invested (Gross Book value) are $600,000.

2. Salvage value of assets at the end of the 4^th year is nil (Assumed).

3. Life of the asset 4 years, resulting straight-line depreciation at the rate of 25% per annum

4. Expected rate of increase in cost of assets is 10% per annum.

5. Annual operating cash flows, considering the effect of inflation, are as follows: