Page 65 - DCOM409_CONTEMPORARY_ACCOUNTING

Contemporary Accounting

Notes EVA also helps in brand valuation. The brand equity or value created by a particular
business unit for its brand could be equated with the value of wealth that the brand has
generated over a period of time.

Task Make a discussion on some other approaches of value addition.

Self Assessment

Fill in the blanks:
10. The success of EVA lies only in its linking with the …………… plan.
11. EVA makes managers care about managing assets as well as income, and helps them
properly assess the …………between the two.
12. The mechanism of EVA forces management to expressly recognize is …………in all its
decisions from the boardroom to the shop floor.

4.5 Shortcomings of EVA

The EVA concept is criticised for the following reasons:
EVA ignores inflation and it is biased against new assets. Whenever a new investment is
made, capital charge is on the full cost initially, so EVA figure is low. But as the depreciation
is written off, the capital charge decreases and hence EVA goes up. This problem existed
with measures like ROI.

Since EVA is measured in rupee terms, it is biased in favour of large, low return business,
Large business that have returns only slightly above the cost of capital can have higher
EVA than smaller business that earn returns much higher than the costs. This makes EVA
a poor metric for comparing businesses.

In the short run, EVA can be improved by reducing assets faster than the earnings and if
this is pursued for long it can lead to problems in the longer run when new improvements
to the asset base are mode. This new investment can have a high negative effect of EVA
because the asset base would have been reduced to a large extent and improvements will
involve will huge investments.

Notes Suggestions to Improve EVA

EVA is just a refinement of residual income. Residual income is defined as the difference
between profit and the cost of capital. It differs from EVA in the fact that profits and capital
employed are book figures i.e., the same appearing in the financial statements. No
adjustment to profit and capital employed figures as reported in profit and loss account
and balance sheet are made unlike EVA. It can be improved in any of the following ways:
Increasing NOPAT with the same amount of capital.
Reducing the capital employed without affecting the earnings i.e., discarding the
unproductive assets.
Investing in those projects that earn a return greater than the cost of capital.
Contd...

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