35.The following scenario relates to four requirements.

Lens Co manufactures lenses for use by a wide range of commercial customers. The
company has two divisions: the Photographic Division (P) and the Optometry
Division (O). Each of the divisions is run by a divisional manager who has overall
responsibility for all aspects of running their division and the divisions are currently
treated as investment centres. Each manager, however, has an authorisation limit of
$15,000 per item for capital expenditure and any items costing more than this must
first be approved by Head Office.

During the year, Head Office made a decision to sell a large amount of the
equipment in Division P and replace it with more technologically advanced
equipment. It also decided to close one of Division Os factories in a country deemed
to be politically unstable, with the intention of opening a new factory elsewhere in the
following year.

Both divisions trade with overseas customers, choosing to provide these customers
with 60 days credit to encourage sales. Due to differences in exchange rates
between the time of invoicing the customers and receiving the payment 60 days
later, exchange gains and losses often occur.

The cost of capital for Lens Co is 12% per annum.

The following data relates to the year ended 30 November 20X6:

Division P Division O
$'000 $'000
Revenue 14,000 18,800
Gain on sale of equipment 400 -
14,400 18,800
Direct labour (2,400) (3,500)
Direct materials (4,800) (6,500)
Divisional overheads* (3,800) (5,200)
Trading profit 3,400 3,600
Exchange gain/(loss) (200) 460
Exceptional costs for factory closure - (1,800)
Allocated Head Office costs (680) (1,040)
Net divisional profit 2,520 1,220
*Depreciation on uncontrollable assets included in
320 460
divisional overheads

Division P Division O
$'000 $'000
Non-current assets controlled by the division 15,400 20,700
Non-current assets controlled by Head Office 3,600 5,200
Inventories 1,800 3,900
 Division P Division O
Trade receivables 6,200 8,900
Overdraft 500 -
Trade payables 5,100 7,200
To date, managers have always been paid a bonus based on the return on
investment (ROI) achieved by their division. However, the company is considering
whether residual income would be a better method.

(c) Briefly discuss whether it is appropriate to treat each of the divisions of

Lens Co as investment centres.
(2 marks)

(d) Discuss the problems involved in using ROI to measure the managers'
performance.
(4 marks)

(20 marks)