MODULE CODE: ACU 08212/ AFU 08607
MODULE NAME: PERFORMANCE MANAGEMENT
BAC 3 & BAIT 3
TUTORIAL QUESTIONS : PERFORMANCE MEASUREMENT
QUESTION 1
Sports Co is a large manufacturing company specializing in the manufacture of a wide
range of sports clothing and equipment. The company has two divisions: Clothing
(Division C) and Equipment (Division E). Each division operates with little intervention
from Head Office and divisional managers have autonomy to make decisions about long-
term investments.
Sports Co measures the performance of its divisions using return on investment (ROI),
calculated using controllable profit and average divisional net assets. The target ROI for
each of the divisions is 18%. If the divisions meet or exceed this target the divisional
managers receive a bonus.
Last year, an investment which was expected to meet the target ROI was rejected by one
of the divisional managers because it would have reduced the division’s overall ROI.
Consequently, Sports Co is considering the introduction of a new performance measure,
residual income (RI), in order to discourage this dysfunctional behaviour in the future. Like
ROI, this would be calculated using controllable profit and average divisional net assets.
The draft operating statement for the year, prepared by the company’s trainee accountant,
is shown below:
Division C Division E
$’000 $’000
Sales revenue 3,800 8,400
Less variable costs (1,400) (3,030)
Contribution 2,400 5,370
Less fixed costs (945) (1,420)
Net profit
1,455 3,950
Opening divisional controllable net assets 13,000 24,000
Closing divisional controllable net assets 9,000 30,000
Notes:
(1) Included in the fixed costs are depreciation costs of $165,000 and $460,000 for Divisions C
and E respectively.
30% of the depreciation costs in each division relates to assets controlled but not owned by Head
Office.
Division E invested $2m in plant and machinery at the beginning of the year, which is included
in the net assets figures above, and uses the reducing balance method to depreciate assets.
Division C, which uses the straight-line method, made no significant additions to non-current
assets. It is the policy of both divisions to charge a full year’s depreciation in the year of
acquisition.
(2) Head Office recharges all of its costs to the two divisions. These have been included in the
fixed costs and amount to $620,000 for Division C and $700,000 for Division E.
(3) Sports Co has a cost of capital of 12%.
Required:
(a) (i) Calculate the return on investment (ROI) for each of the two divisions of Sports Co.
(ii) Discuss the performance of the two divisions for the year, including the main reasons why
their ROI results differ from each other. Explain the impact the difference in ROI could have on
the behaviour of the manager of the worst performing division.
(b) (i) Calculate the residual income (RI) for each of the two divisions of Sports Co and briefly
comment on the results of this performance measure.
(ii) Explain the advantages and disadvantages of using residual income (RI) to measure
divisional performance.
QUESTION TWO
Pace Company (PC) runs a large number of wholesale stores and is increasing the number of
these stores all the time. It measures the performance of each store on the basis of a target return
on investment (ROI) of 15%. Store managers get a bonus of 10% of their salary if their store’s
annual ROI exceeds the target each year. Once a store is built there is very little further capital
expenditure until a full four years have passed.
PC has a store (store W) in the west of the country. Store W has historic financial data as follows
over the past four years:
2005 2006 2007 2008
Sales ($’000) 200 200 180 170
Gross profit ($’000) 80 70 63 51
Net profit ($’000) 13 14 10 8
Net assets at start of year ($’000 100 80 60 40
The market in which PC operates has been growing steadily. Typically, PC’s stores generate a
40% gross profit margin. Required:
(a) Discuss the past financial performance of store W using ROI and any other measure you feel
appropriate and, using your findings, discuss whether the ROI correctly reflects Store W’s actual
performance.
(b) Explain how a manager in store W might have been able to manipulate the results so as to
gain bonuses more frequently.
PC has another store (store S) about to open in the south of the country. It has asked you for help
in calculating the gross profit, net profit and ROI it can expect over each of the next four years.
The following information is provided:
Sales volume in the first year will be 18,000 units. Sales volume will grow at the rate of 10%
for years two and three but no further growth is expected in year 4. Sales price will start at $12
per unit for the first two years but then reduce by 5% per annum for each of the next two years.
Gross profit will start at 40% but will reduce as the sales price reduces. All purchase prices on
goods for resale will remain constant for the four years.
Overheads, including depreciation, will be $70,000 for the first two years rising to $80,000 in
years three and four.
Store S requires an investment of $100,000 at the start of its first year of trading.
PC depreciates non-current assets at the rate of 25% of cost. No residual value is expected on
these assets.
Required:
(c) Calculate (in columnar form) the revenue, gross profit, net profit and ROI of store S over
each of its first four years.
(d) Calculate the minimum sales volume required in year 4 (assuming all other variables remain
unchanged) to earn the manager of S a bonus in that year.
QUESTION 3
The diagram below shows Amahoro Mount Limited (AML) group company structure, the
company was founded twenty years ago and is involved almost in every business sector including
farming, transport, hotel, and leisure industry among others.
Amahoro Mount
Eastern
subsidiary
Northern
subsidiary
Fig 1. Company structure
AML is currently evaluating its own performance and that of its subsidiaries. You have been
provided with the following information as their external performance analyst to do a review and
write reports on various issues
AML divisional performance
AML has a subsidiary in the northern region, the manager of the northern subsidiary is not happy
at about the review parameters being used on her performance evaluation, these are Return on
investment (ROI) and residual income (RI). She argues that these do not reflect her performance
at all as they use financial figures which are prone to manipulation and factors beyond her control.
she argues that she should be evaluated on factors such as growth in market share, which according
to her has increased by more than 50% over the two-year period. This is reflected growth in revenue
AML wants all its division to achieve ROI of at least 20%
Below are the results for the north subsidiary
Year 2022 2023
TZS million TZS million
Sales revenues 6,200 9,600
Less variable cost 3,005 5,076
Contribution 3,195 4,524
Less fixed costs 2,000 2,500
Net profits 1,195 2 ,024
Opening controllable assets 14,000 8,000
Closing controllable assets 8,000 25,000
Additional information:
1. Allocated head office cost amounted to 48% and 18% of variable cost in year 2022 and
year 2023 respectively
2. Cost of capital to the division is 15.5%
Required:
(i) Calculate the Return on Investment (ROI) and Residual Income (RI) for each
of the two years presented above and comment.
(ii) Referring to calculations in (a) above, Explain the effect of changes in ROI
would have on a manager’s behavior in investments undertakings.
(iii) Explain the advantages and disadvantages of using residual income (RI) as
measure of divisional performance.
QUESTION 4
Urukundo Limited is a manufacturing company fully registered to do manufacturing and related
activities in Rwanda. This company has two divisions; the soft drink and Liquor division. In the
first half of the year 2023, the Liquor division is planning to launch a new product. Urukundo
limited will invest TZS 50,000 million in a new machinery needed to manufacture the new product.
The company will do a major marketing campaign on behalf of the Liquor division in support of
the new product launch.
The company`s weighted average cost of capital is 12.5% and the return on investment is 16% The
management accounting department believes that this is appropriate for both divisions. The
divisional performance for two last years were as follows;
Particulars Soft drink division Liquor division
2022 2021 2022 2021
TZS TZS TZS TZS
Million Million Million Million
Revenue 103,000 100,000 140,0000 125,000
Controllable costs 59,000 57,000 70,000 66,000
Traceable costs 13,000 12,000 31,000 16,000
Apportioned head office costs 17,000 14,000 21,500 18,000
Net capital investment 185,000 125,000 275,000 265,000
Additional information:
Expected sales from the new investment is TZS 45,500 million
Operating costs specific to the new investment are 80.5% of the cost of the new investment
Required:
(a) Using traceable profits determines the Return on investment for the two
divisions for the years 2021 and year 2022
(b) Calculate the Residual income figures for the two years.
(c)Comment on the effects of the new investment on the general financial soundness of
Urukundo limited.
Muzehe Limited, an overseas division of Mukuru limited located in northern province has
provided the following details.
Particulars 2022 2021
TZS `000` TZS
`000`
Operating profit 6,500,000 5,500,000
Interest expense 1,000,000 900,000
Further information is as follows:
1. The allowance for doubtful debts was TZS 300 million at 1 January 2021, FRW 250,
Million at 31 December 2021 and TZS 350 million at 31 December 2022.
2. Research and development costs of TZS 500 million were incurred during each of the years
2021 and 2022 on Project Z. These costs were expensed in the income statement, as they did
not meet the requirements of financial reporting standards for capitalization. Project Z is not
yet completed.
3. At the end of 2020, the company had completed another research and development project,
Project X. Total expenditure on this project had been TZS 1,500 million none of which had
been capitalized in the financial statements. The product developed by Project X went on sale
on 1 January 2021, and the product was a great success. The product’s life cycle was only two
years, so no further sales of the product are expected after 31 December 2022.
4. The company incurred non-cash expenses of TZS 15 million in both years.
5. Capital employed (equity plus debt) per the statement of financial position was TZS 33,
500 million at 1 January 2021, and TZS 37, 000 million at 1 January 2022.
6. The pre - tax cost of debt was 5% in each year. The estimated cost of equity was 12% in
2021 and 14% in 2022. The rate of corporate income tax was 27% during both years.
7. The company’s capital structure was 60% equity and 40% debt.
Required:
(e) Calculate economic value-added value (EVA) for year 2021 and 2022
(f) Calculate ROI for the year 2022
Interpret the residual income of the year 2021
QUESTION FIVE
Vilagio Engineering (VE) is a listed company, manufacturing pumps and valves for use in the
irrigation Sector. These highly engineered components are integrated into plant and equipment.
The company has grown significantly via acquisitions in the last 20 years to become a worldwide
business. The overall objective of the company is ‘to deliver sustainable growth in value to the
shareholders by working in partnership with customers to deliver innovative and value-for-money
solutions utilising the skills of the highly-trained workforce.’ The Chief Executive Officer (CEO)
has recognised that the company has been so focused on making acquisitions to the detriment of
establishing sound management practises. The CEO has therefore tasked you to assess Vilagio’s
performance using Economic Value Added.
Income Statement extract for the year:
2022 2021
GH¢ million GH¢
million
Revenue 608 520
Pre-tax accounting profit 134 108
Taxation (37)
Profit after Tax 71
Dividends (29) (24)
Retained earnings 59 47
Statement of Financial Position extract for the year ending:
2022 2021
GH¢ million GH¢
million
Non-current assets 250 192
Net current assets 256 208
506 400
Financed by:
Shareholders’ funds 380 312
Medium and long-term bank loans 126 88
506 400
Additional information:
i) Capital employed at the end of 2020 amounted to GH¢350 million ii) VE had non capitalised
leases valued at GH¢16 million in each of the years 2020 to 2022. Ignore amortisation calculations.
iii)VE’s pre-tax cost of debt was estimated to be 9% in 2021 and 10% in 2022.
iv) VE’s cost of equity was estimated to be 15% in 2021 and 17% in 2022. v) The target capital
structure is 70% equity, 30% debt. vi) The rate of taxation is 30% in both 2021 and 2022.
vii) Economic depreciation amounted to GH¢64 million in 2021 and GH¢72 million in
2022. These amounts were equal to the depreciation used for tax purposes and depreciation
charged in the income statements.
viii) Interest payable amounted to GH¢6 million in 2021 and GH¢8 million in 2022.
ix) Other non-cash expenses amounted to GH¢20 million per year in both 2021 and
2022
Required:
a) Estimate the Economic Value Added (EVA) for Vilagio Engineering for both 2021 and
2022, and Comment on the company’s performance.
b) State THREE (3) advantages and TWO (2) disadvantages of EVA.
c) Explain the relationship between EVA and Net Present Value (NPV).
QUESTION 6
a) You are the Management Accountant of the Alosman Ltd which manufactures an innovative
range of products to provide support for injuries to various human joints in the body. The
summary financial information for Alosman Ltd is as follows:
Income Statement for the year ended:
2023 2022
GH¢ GH¢
million million
Revenue 450 400
Profit before tax 117 96
Income tax expense (35) (29)
Profit for the period 82 67
Dividends (27) (23)
Retained earning 55 44
Statement of Financial Position as 2023 2022
at:
GH¢ GH¢
million million
Non-current assets 180 160
Current assets 215 180
395 340
Financed by:
Total equity 255 200
Long-term debt 140 140
395 340
Additional information:
i) Capital employed at the end of 2021 amounted to GH¢320 million.
ii) Alosman Ltd had non-capitalised leases valued at GH¢16 million in each of the years 2021
to 2023 which were not subject to amortisation.
iii)The company’s pre-tax cost of debt was estimated to be 10%. iv) The company’s cost of
equity was estimated to be 16% in 2022 and 18% in 2023.
v) The market value of total equity is 20% higher than the book value in both 2022 and 2023.
vi) The rate of taxation is 30% in both 2022 and 2023.
vii) Economic depreciation amounted to GH¢30 million in 2022 and GH¢32 million in
2023 while the accounting depreciation for tax purposes amounted to GH¢40 million and
GH¢45 million in 2022 and 2023 respectively.
viii) Interest payable amounted to GH¢6 million per year in both 2022 and 2023. ix)
Alosman Ltd uses market value of capital employed in all of its assessments.
Required:
Estimate the Economic Value Added (EVA) of the Alosman Ltd for both 2022 and 2023 and
comment briefly on the performance of the company.
QUESTION SEVEN
The Board of Otmost Beauty Ltd, a beauty care production company is planning
to introduce a new product. The Board has tasked the Divisional Manager of the
fragrance division to evaluate two options to buy a production plant. Both options
will have the same capacity and expected life of four years but they will differ in
capital costs and expected net cash flows as shown in the table below:
Option 1 Option 2
GH¢’million GH¢’million
Initial capital investment year 0 640 520
Net cash flows ( before tax)
Year 1 240 260
Year 2 240 220
Year 3 240 150
Year 4 240 100
Net present value at 16% p.a 31.6 19.0
All divisions of the company are expected to generate pre-tax returns on
divisional investments in excess of 16% per annum, which the fragrance
division currently is just managing to achieve. Anything less than 16% would
make the divisional managers ineligible for the annual performance bonus.
The performance bonus is linked to Return on Investment (ROI) and Residual
Income (RI) and also has an impact on the calculation of retirement benefits, as
the retirement benefits take into consideration the performance bonus earned
during the two preceding years. The manager of the fragrance division is due to
retire at the beginning of Year 3.
In calculating divisional returns, divisional assets are valued at the net book
values at the beginning of the year. Depreciation is charged on a straight line
basis with nil residual value.
Required:
i) Calculate the ROI and RI for years 1 to 4 and select the best option from the
point of view of the fragrance division based on ROI and RI criteria.
Explain why the fragrance Divisional Manager will not invest in the option showing the higher
NPV and comment on whether it will be acceptable to the Board
QUESTION 8
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 decision.
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 straight line depreciation
method. The other assets are being controlled by head office.
Over the years, Kenkah Ltd uses ROI in evaluating the performance of managers.
However, to discourage dysfunctional behaviour, Kenkah Ltd is considering
introducing Residual Income (RI) as a performance measure. Like ROI, RI is
calculated using controllable profit and average divisional asset.
The current year’s draft operating statement is shown below:
Abura Keta
GH¢000 GH¢000
Sales
15,350 17,020
Les 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 cost are the current year depreciation charge 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 cost to the two
divisions using activity based costing. These costs have been included in the fixed
cost 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 current year controllable profit for both divisions of Kenkah
Ltd.
c) Calculate the current year ROI for each of the two divisions of Kenkah Ltd.
d) Calculate the current year RI for each of the two divisions of Kenkah Ltd.
Discuss the performance of the two divisions for the year
