Dis

Evaluating Performance

When comparing various divisions within a company, describe what problems can arise from evaluating divisions that have different accounting methods, as described in Chapter 11 of your text.  Cite three examples of accounting methods that could cause divisions' profits to differ. Your initial post should be 200-250 words.

Response: 

1. When comparing divisions within a company, a problem that can arise using different accounting methods is the accuracy of the analysis could be skewed if one division uses a different method than another.  Another problem could be a benchmark set by upper management for all divisions based on one standard may not be achievable and comparable if some divisions use a different standard (Koenig & Nick, 2004). Another problem is the value of inventory, costs, or overhead could be understated or overstated in comparison between methods.  As Schneider (2012) stated, “the measurement of an asset is difficult enough without considering differing accounting methods being used.  If management expects to evaluate based on one standard, if another standard is use the profits could be over- or understated and the decision made could be ineffective” (p. 11.3). 

The first example causing profits to differ would be if one division uses FIFO (first-in first-out) inventory and another uses LIFO (last-in first out) inventory methods.  FIFO and LIFO are essentially opposites; while the remaining inventory of FIFO is inventory most recently bought, LIFO ending inventory consists of the earliest inventory purchased. A second example would be if one division uses Cash Basis Accounting and the other uses Accrual Basis. A third example would be the depreciation method used.  For instance, one division may use a per unit basis and another may use a straight line method. 

2.  When comparing various divisions within a company, there are multiple problems that can arise from evaluating divisions that have different accounting methods. For example, the accuracy of the analysis that is being completed may be inaccurate if the divisions use different accounting methods. According to ROI selling: Increasing revenue, profit, and customer loyalty through the 360 sales cycle, a benchmark that is set by management for all of the divisions could be unattainable for some of the divisions, due to the different accounting methods that each uses (Koenig, & Nick, 2004). This would make it unfair to some of the divisions. In this case, it would be best for each division to be held to separate standards based on the accounting method that they use.

Additionally, The Case Against ROI Control, HBR.com shows us that “conditions cause incongruities between divisional objectives and company goals, and which result in motivating division managers to take uneconomic actions (Dearden, 2017). The residual income method is a great example of this. Residual income is the amount of income that an individual has after all personal debts and expenses, including a mortgage, have been paid.

Finally, having divisions that use FIFO (first in, first out) and other divisions that use LIFO (last in, first out) can cause problems as well. This can cause major issues between the different divisions.