Armadillo Limited assesses its divisions using return on investment (ROI), with managers being awarded a bonus of $500 per full percentage point above their target for a given year.

The North division's manager has been reviewing her prospects for bonus for this year and the following year and is a little concerned about her short-term prospects for earnings. She has worked hard and feels she should be rewarded accordingly.

The financial projections before any last-minute change of strategy are as follows:

	2018	2019
	$m	$m
Turnover	260	285
Locally controlled costs	-185	-205
Controllable profit	75	80
Head Office costs	-42	-49
Taxation (allocation)	-5	-6
Net profit	37	25
Opening capital employed	550	625
Target ROI	12%	12%

Notes on the financial projections

1. The basis of head office allocations will change slightly in 2019 with those divisions that do not collect their own receivables bearing a little more of the central cost. North does not at present collect its own debts.
2. Right at the end of 2018, the North division is planning to invest in a new project costing $80m. Predictions are strongly positive for the 10-year project, and the expectation is for strong growth in revenue and profit margin as a result.
3. Taxation is calculated centrally and allocated to the divisions based on turnover.

The business' year end is 31st December and it is now 30th November 2018. The new investment has not yet been made.

Armadillo's CEO feels that both head office costs and taxation should be allocated to the divisions on the basis of turnover and taken into account when calculating ROI. This is unpopular with the local managers.

The head office currently deals with all recruitment, marketing, finance and accounting for all the divisions. It also provides IT support and taxation planning, ensuring that best use of divisional losses are reliefs are claimed for everyone. It is generally accept that they do a good job in these regards. The head office has no income.

a) Discuss the arguments for the treatment of head office costs and taxation as shown above. Your answer should include a discussion as to:·

• whether head office costs should be allocated;
• how the allocation should be made;
• whether allocated costs should be included in the ROI calculation;
• the fairness of the taxation costs (no detailed knowledge of taxation rules is expected).

b) Calculate the North division’s ROI based on controllable profit for both years, and the related bonus that could be expected.

c) Briefly discuss the suggestion and consider the impact of the new project being delayed for 3 months. You should consider performance metrics, potential bonuses and any other relevant factor. Calculations are not required.

Answer rating: 100% (QA)

a The arguments for the treatment of head office costs and taxation as shown above are as follows 1 ... View the full answer