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Home Decentralization, Segment Reporting and Transfer Pricing Criticism/Disadvantages or Limitations of Return on Investment (ROI) Method of Performance Evaluation

Criticism/Disadvantages or Limitations of Return on Investment (ROI) Method of Performance Evaluation:

Learning Objectives:

  1. What are the limitations of return on investment method of performance evaluation?

Although the return on investment is widely used in evaluating performance, it is not a perfect tool. The method is subject to the following criticism:

1. Just telling managers to increase ROI may not be enough. Managers may not know how to increase ROI; they may increase ROI in a way that is inconsistent with the company's strategy; or they may take actions that increase ROI in the short run but harm company the long run (such as cutting back on the research and development). This is why ROI is best used as part of a balanced scorecard. A balanced scorecard can provide concrete guidance to managers, making it more likely that action taken are consistent with the company's strategy and reducing the likelihood that short-run performance will be enhanced at the expense of long-term performance.

2. A manager who takes over a business segment typically inherent many committed costs over which the manager has no control. These committed costs may be relevant in assessing the performance of the business segment as an investment but make it difficult to fairly assess the performance of the manager relative to other managers.

3. A manager who is evaluated based on return on investment (ROI) may reject investment opportunities that are profitable for the whole company but that would have a negative impact on the manager's performance evaluation.

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You may also be interested in other articles from "decentralization, segment reporting and transfer pricing" chapter:

  1. Decentralization in organizations
  2. Traceable and common fixed costs
  3. Segment reporting and profitability analysis-segmented income statements
  4. Hindrances/Problems to Proper Cost Assignment in Segmented Reporting
  5. Segmented Financial Information on External Reports
  6. Return on Investment (ROI) for Measuring Managerial Performance
  7. Controlling and Improving Rate of Return on Investment
  8. Return on Investment (ROI) and Balanced Scorecard
  9. Criticism, Disadvantages or Limitations of Return on Investment (ROI)
  10. Residual Income-Another Method to Measure Managerial Performance
  11. Limitations, Criticism or Disadvantage of Residual Income Method
  12. Allow the managers involved in the transfer to negotiate their own transfer price (negotiated transfer pricing).
  13. Set transfer prices at cost using variable or full (absorption) cost
  14. Set transfer prices at the market price
  15. Divisional Autonomy and Sub optimization
  16. International Aspects of Transfer Pricing


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Managerial Accounting

Introduction to Managerial Accounting
Business and Quality Improvement Programs
Cost Terms, Concepts and Classification
Job Order Costing system
Process Costing System
Process Costing System - Addition of Materials & Beginning Inventory
Controlling and Costing Materials
Materials and Inventory Cost Control
By Products and Joint Products Costing
Variable Costing System
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Budgeting and Planning
Standard Costing and Variance Analysis
Gross Profit Analysis
Linear Programming Technique
Segment Reporting and Transfer Pricing
Capital Budgeting Decisions
Service Department Costing
Cash Flow statement
Financial statement Analysis
Pricing Products and Services
Managerial Accounting Terms and Definitions
Managerial / Cost Accounting Formulas

Financial Accounting

Bookkeeping and Bookkeeping Terms
Accounting Principles and Accounting Equation
Accounting For Bills of Exchange
Subdivision of Journal
Final Accounts
Capital and Revenue Items
Single Entry System/Accounting From Incomplete Records
Accounting For Non-Trading Concerns
Accounting for Consignment / Consignment Accounts
Accounting for Joint Ventures
Accounting for Depreciation

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