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(a) (i) Possible counter-productive behaviour resulting from using the current ROCE calculation for performance appraisal
Under the current method of performance appraisal, managers are judged on the basis of the ROCE that their divisions earn, the ROCE being calculated using the net book value of noncurrent assets. The use of ROCE as a method of appraising performance has disadvantages.
As managers are judged on the basis of the ROCE that their divisions earn each year, they are likely to be motivated into taking decisions which increase the division's short-term ROCE and rejecting projects which reduce the short-term ROCE even if the project is in excess of the company's target ROCE and hence is desirable from the company's point of view.
Suppose that the manager of B division was faced with a proposed project which had a projected return of 20%. He would be likely to reject the project because it would reduce his division's overall ROCE to below 22%. The investment would be desirable from Cordeline's point of view, however, because its ROCE would be in excess of the company's target ROCE of 15%. This is an example of a lack of goal congruence in decision making.
A similar misguided decision would occur if the manager of C division, say, was worried about the low ROCE of his division and decided to reduce his investment by scrapping some assets not currently being used. The reduction in both depreciation charge and assets would immediately improve the ROCE.
Equally he may choose to write down his assets to nil as quickly as possible to improve future
ROCE levels.
Alternatively he could look to improve his ROCE by manipulating and overstating his profit.
The current method bases the calculation of ROCE on the net book value of assets. If a division maintains the same annual profits and keeps the same asset without a policy of regular replacement of non-current assets, its ROCE will increase year by year as the assets get older. Simply by allowing its assets to depreciate a divisional manager is able to give a false impression of improving performance over time.
The method used to calculate ROCE therefore also provides a disincentive to divisional mangers to reinvest in new or replacement assets because the division's ROCE would probably fall. From the figures provided it is obvious that C division has replaced assets on a regular basis, the difference between original and replacement costs of its assets being small.
The manager of B division, on the other hand, has not replaced assets, there being a marked difference between original and replacement cost of the division's assets.
The level of new investment in non-current assets by C division was over three times that of B division in 20X3 and nearly 13 times that of B division in 20X4. B division is using old assets that have been depreciated to a much greater extent than those of C division and hence the basis of the ROCE calculation is much lower. Consequently it is able to report a much higher ROCE.