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ACCA Strategic Professional · Advanced Performance Management · Financial performance measurement

A group assesses divisional managers solely on residual income using the group's cost of capital. Which is a recognised advantage of residual income over ROI in this setting?

Residual income encourages managers to accept all projects earning above the cost of capital, even where the return is below the division's current ROI. This improves goal congruence with shareholder wealth. It is an absolute figure, so it is weaker for comparing divisions of different sizes.

  1. AIt allows direct percentage comparison between divisions of different sizes
  2. BIt encourages managers to accept any project earning more than the cost of capital, even if below current ROICorrect
  3. CIt removes the effect of accounting depreciation policy on profit
  4. DIt eliminates the need to decide how capital employed is measured

Explanation

Residual income rewards any investment returning above the cost of capital, improving goal congruence compared with ROI, where managers reject projects below their average return. It is an absolute measure so does not permit size-neutral comparison, and it still depends on depreciation and asset valuation choices.

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