20RQ - Horngren'S Financial And Managerial Accounting

Question

What is the biggest disadvantage of using ROI to evaluate investment centers?

Step-by-Step Solution

Answer

The absence of consideration for a cash as a measure is one of the drawbacks of ROI.

Meaning of Investment centers

The enterprise division, office, unit or liability center of an organization is known as the investment center. This entity is classified by the organization as an investment center rather than a cost or profit center.

The most significant disadvantage of using ROI to evaluate investment centers

ROI has one significant flaw that it does not consider cash as measure therefore it ignores those projects which have positive cash flow but negative income.

Division managers are encouraged to only embrace initiatives that will preserve or grow their present ROI when their performance is evaluated only on ROI, which might have a detrimental influence on the company's goal congruence.