Cost Accounting (14th Edition)

CHOOSING THE DETAILS OF THE PERFORMANCE MEASURES 815
This characteristic means that if managers use the net present value method to make
investment decisions (as advocated in Chapter 21), then using multiyear RI to evaluate
managers’ performances achieves goal congruence.
Another way to motivate managers to take a long-run perspective is by compensating
them on the basis of changes in the market price of the company’s stock, because stock
prices incorporate the expected future effects of current decisions.
Alternative Definitions of Investment
Companies use a variety of definitions for measuring investment in divisions. Four common
alternative definitions used in the construction of accounting-based performance
measures are as follows:
1. Total assets available—includes all assets, regardless of their intended purpose.
2. Total assets employed—total assets available minus the sum of idle assets and assets
purchased for future expansion. For example, if the New Orleans hotel in Exhibit 23-1
has unused land set aside for potential expansion, total assets employed by the hotel
would exclude the cost of that land.
3. Total assets employed minus current liabilities—total assets employed, excluding
assets financed by short-term creditors. One negative feature of defining investment
in this way is that it may encourage subunit managers to use an excessive amount of
short-term debt because short-term debt reduces the amount of investment.
4. Stockholders’ equity—calculated by assigning liabilities among subunits and deducting
these amounts from the total assets of each subunit. One drawback of this method is
that it combines operating decisions made by hotel managers with financing decisions
made by top management.
Companies that use ROI or RI generally define investment as the total assets available.
When top management directs a subunit manager to carry extra or idle assets, total assets
employed can be more informative than total assets available. Companies that adopt EVA
define investment as total assets employed minus current liabilities. The most common
rationale for using total assets employed minus current liabilities is that the subunit manager
often influences decisions on current liabilities of the subunit.
Alternative Asset Measurements
To design accounting-based performance measures, we must consider different ways to
measure assets included in the investment calculations. Should assets be measured at historical
cost or current cost? Should gross book value (that is, original cost) or net book
value (original cost minus accumulated depreciation) be used for depreciable assets?
Current Cost
Current cost is the cost of purchasing an asset today identical to the one currently held,
or the cost of purchasing an asset that provides services like the one currently held if an
identical asset cannot be purchased. Of course, measuring assets at current costs will
result in different ROIs than the ROIs calculated on the basis of historical costs.
We illustrate the current-cost ROI calculations using the data for Hospitality Inns
(Exhibit 23-1) and then compare current-cost-based ROIs and historical-cost-based ROIs.
Assume the following information about the long-term assets of each hotel:
San Francisco Chicago New Orleans
Age of facility in years (at end of 2012) 8 4 2
Gross book value (original cost) $1,400,000 $2,100,000 $2,730,000
Accumulated depreciation $ 800,000 $ 600,000 $ 390,000
Net book value (at end of 2012) $ 600,000 $1,500,000 $2,340,000
Depreciation for 2012 $ 100,000 $ 150,000 $ 195,000
Hospitality Inns assumes a 14-year estimated useful life, zero terminal disposal value for
the physical facilities, and straight-line depreciation.