Q23RQ - Horngren'S Financial And Managerial Accounting

Question

What is the biggest advantage of using RI to evaluate investment centers?

Step-by-Step Solution

Answer

RI evaluates the division's profitability and how well it employs its average total assets. The goal rate of return set by senior management is also included in RI.

Step 1: Meaning of Residual Income

The residual income strategy measures the net income that investment makes at a cutoff determined by the investment's minimum rate of return. Companies can more successfully communicate assets between resources by computing residual income.

Step 2: The most significant advantage of using RI to evaluate investment centers

Utilizing residual pay to assess divisional execution includes a number of benefits, including the following: 

1. It considers the opportunity cost of tying up assets within the division;
2. The least rate of return can change depending on the division's riskiness; 
3. Distinctive resources can be required to create different returns.