Page 89 - DMGT514_MANAGEMENT_CONTROL_SYSTEMS

Management Control Systems

Notes Problem 2: The JKL Company used the residual income method for measuring divisional profit
performance. The company charges each division a 5% return on its average current assets and
a 10% return on its average fixed assets. Listed below are some financial statistics for three
divisions of the JKL Company:

Division
Budget data (‘000) J K L
2004 budgeted profit 90 55 50
2004 budgeted current assets 100 200 300
2004 budgeted fixed assets 400 400 500
Actual data (‘000)
2004 Profits 80 60 50
2004 current assets 90 190 350
2004 Fixed assets 400 450 550

Required:
1. Calculate the ROI objective and actual ROI for each division for 2004.
2. Calculate the EVA objective for each division for 2004.
3. Calculate the actual EVA for each division for 2004 and calculate the extent that it is above
or below objective.
4. Listed below are four management actions, together with the financial impact. For each of
these situations, calculate the impact on the budgeted ROI and EVA for each division.
Situation 1: An investment in fixed assets is made. This action increases the average fixed assets
by ` 1, 00,000 and profits by ` 10,000.

Situation 2: An investment in Fixed Assets is made. This action increases the average fixed
assets by ` 1, 00, 000 and profits by ` 7000.
Situation 3: A programme to reduce inventories is instituted as a result inventories are reduced
by ` 50,000. Increased costs and reduced sales resulting from the lower inventory levels reduce
profits by ` 5000.

Situation 4: A plant is closed down and sold. Fixed assets are reduced by ` 75,000 and profits
(from reduced sales) are decreased by ` 7500.
Solution:

Budget 2004 J K L
Profit 90 55 50
Current assets 100 200 300
Fixed assets 400 400 500
Total assets 500 600 800
18% 9.17% 6.25%
Profit
ROI = × 100
Total Assets

Charges – 5% of current assets 5 10 15
Charges – 10% of fixed assets 40 40 50
Total charges 45 50 65
EVA = Profit minus charges 45 5 -15

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