ACCA Strategic Professional · Advanced Performance Management · Non-financial performance measurement
Hollis Pharma is judged by its board on short-term earnings per share. Its research division has a pipeline of drugs with uncertain but potentially very large future cash flows, and R&D is expensed as incurred in management accounts. Which combination of limitations of financial measures is most relevant to assessing this division?
Short-term EPS is backward-looking and does not capture intangible value such as a drug pipeline. Because R&D is expensed, cutting it lifts current earnings while destroying future value. Non-financial indicators such as pipeline progress and innovation measures are needed to supplement the financial measures.
- AFinancial measures ignore intangible value drivers and encourage cutting R&D to meet short-term targets, and they are backward-lookingCorrect
- BFinancial measures are too forward-looking and hence speculative for R&D
- CFinancial measures fail only because they are compared with a budget
- DFinancial measures cannot be audited, so the pipeline value is unreliable
Explanation
Expensing R&D reduces current EPS while the value created is intangible and appears later. This gives an incentive to cut R&D and means reported figures are historic and miss innovation capability. Financial measures are not forward-looking, so the second option is the opposite of the truth.
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