Page 86 - DMGT514_MANAGEMENT_CONTROL_SYSTEMS

Unit 4: Responsibility Centers

3. Disposition of assets: If the assets are included in the investment base at the original cost, Notes
the business unit managers are motivated to dispose them, even if they have some usefulness
because the investment base of the business unit is reduced by the full cost of the assets
disposed off.
4. Leased assets: Suppose the business unit whose financial statement as shown in (1) above
sells its fixed assets of book value of ` 350,000, returns the proceeds of the sale to corporate
office and then lease back the assets at a rental of ` 70,000 per year, the impact on ROI and
RI will be as follows:
(` 000)

As in (1) above If Assets are Leased
Revenue 1200 1200
Expenses other than depreciation and 1000 1000
rental
Depreciation 50 -
Rental - 70
1050 1070
Income before tax 150 130
Capital charge 10% on 600 60 10% on 250 25
EVA 90 105
ROI 150 = 25% 130 = 52%
600 250

From the above table, it is clear that business units income before taxes would be reduced
because the rental charges are higher than depreciation charges that has been eliminated.
But EVA will increase because the higher cost would be more than offset by the decrease
in the capital charge. ROI also increases from 25% to 52% because of reduction in the asset
base. Hence, business unit managers are inclined to lease assets rather than own them.
5. Idle Assets: If the business unit has idle assets that can be used by other units, it may be
permitted to exclude them from the investment base if it classifies them as available.
This will encourage business unit managers to release underutilized assets to units that
may have better use for them.
6. Other valuation methods: Some companies depart entirely from the accounting records
and use an approximation of the current value of the asset. They arrive at this amount by
periodical appraisal of assets (say, every five years or when a new business unit manager
takes over) or by adjusting original cost by an index of changes in equipment prices, or by
using insurance values. One point to be noted that although published indexes of
replacement costs of plant and equipment can be used, more price indexes are not entirely
relevant, because they do not consider impact of changes in technology.
These are following problems in using non-accounting values:
(a) They tend to be subjective, as contrasted with accounting values which appear to be
objective and generally, not subject to argument. Business unit managers will regard
the system of using non-accounting values as playing a game of numbers.

(b) Business unit profitability will be inconsistent with the corporate profitability as
reported to the shareholders. As a practical matter, some managers regard net income

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