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CFO Fundamentals: Your Quick Guide to Internal Controls, Financial Reporting, IFRS, Web 2.0, Cloud Computing, and More by ALLISON I. SHIM, JOEL G. SIEGEL, JAE K. SHIM

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CHAPTER SEVENTEEN

Performance of Investment Centers and Transfer Pricing

THE ABILITY TO measure performance is essential in developing management incentives and controlling the operation toward the achievement of organizational goals. A typical decentralized subunit is an investment center that is responsible for an organization’s invested capital (operating assets) and the related operating income. There are two widely used measurements of performance for the investment center: the rate of return on investment (ROI) and residual income (RI).

RATE OF RETURN ON INVESTMENT

How do you calculate ROI?

ROI relates a division’s operating income to operating assets:

Example 17.1

Consider the following financial data for a division:

RESIDUAL INCOME

What is residual income?

RI is another approach to measuring performance in an investment center. RI is the operating income that an investment center is able to earn above some minimum rate of return on its operating assets. RI, unlike ROI, is an absolute amount of income rather than a specific rate of return:

RI = Operating income – (Minimum required rate of return × operating assets)

Example 17.2

In Example 17.1, assume the minimum required rate of return is 13 percent. Then the residual income of the division is:

$18,000 – (13% × $100,000) ...

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