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ACCA Applied Knowledge · Management Accounting · Performance measurement - overview

Division Q has operating profit of $90,000 and capital employed of $600,000, giving ROCE of 15%. The company's cost of capital is 12%. Q is considering a project costing $100,000 that will earn $13,000 a year. Which statement is correct?

The manager would reject the project on ROCE grounds, because its 13% return is below the division's 15%, but it would increase residual income by $1,000 since 13% exceeds the 12% cost of capital. This shows ROCE can cause dysfunctional decisions.

  1. AThe divisional manager would reject the project on ROCE grounds, though it would increase residual incomeCorrect
  2. BThe divisional manager would accept the project on ROCE grounds, and it would increase residual income
  3. CThe divisional manager would reject the project, and it would also reduce residual income
  4. DThe divisional manager would accept the project on ROCE grounds, though it would reduce residual income

Explanation

Project ROI = 13,000/100,000 = 13%, below the division's 15%, so ROCE would fall and the manager would reject it. Its RI effect = 13,000 - 12% x 100,000 = $1,000, which is positive. This is the dysfunctional goal congruence problem with ROCE.

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