Kenkah Ltd provides buffer storage for many companies throughout the country. The company has two divisions, namely Abura and Keta. Each division is autonomous and makes its own long-term investment decisions.
Kenkah Ltd measures the performance of its divisions using Return on Investment (ROI), calculated using controllable profit and average divisional net assets. The company has a cost of capital of 12% but a targeted ROI of 18%. The divisional managers’ annual bonus is determined by the extent to which the ROI earned by the division exceeds the target.
At the beginning of the year, the two divisions, Abura and Keta, bought assets worth GH¢12.5 million and GH¢18.2 million respectively. The assets have a five-year life span with no residual value. The company uses the straight-line depreciation method. The other assets are being controlled by the head office.
Over the years, Kenkah Ltd has used ROI in evaluating the performance of managers. However, to discourage dysfunctional behavior, Kenkah Ltd is considering introducing Residual Income (RI) as a performance measure. Like ROI, RI is calculated using controllable profit and average divisional assets.
The current year’s draft operating statement is shown below:
|
Abura (GH¢000) |
Keta (GH¢000) |
| Sales |
15,350 |
17,020 |
| Less controllable Variable Cost |
7,505 |
8,950 |
| Contribution |
7,845 |
8,070 |
| Less Fixed Cost [i) & ii)] |
6,335 |
6,910 |
| Profit |
1,510 |
1,160 |
Additional Information:
i) Included in fixed costs are the current year depreciation charges of GH¢3,125,000 and GH¢4,550,000 for division Abura and Keta, respectively. Twenty percent (20%) of the depreciation cost in each division is from assets owned and controlled by the head office.
ii) Head office allocates some of its overhead costs to the two divisions using activity-based costing. These costs have been included in the fixed costs and amounted to GH¢210,000 and GH¢230,000 for Abura and Keta, respectively.
iii) The Management Accountant stated at a recent board meeting that “Responsibility accounting is based on the application of the controllability principle.” Hence, he would resist any attempt by management to deviate from this basic principle.
Required:
a) Explain the “controllability principle” and why its application is difficult in practice.
(4 marks)
b) Calculate the current year controllable profit for both divisions of Kenkah Ltd.
(4 marks)
c) Calculate the current year ROI for each of the two divisions of Kenkah Ltd.
(3 marks)
d) Calculate the current year RI for each of the two divisions of Kenkah Ltd.
(4 marks)
e) Discuss the performance of the two divisions for the year.
