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The capital investment decision in the multidivisional company

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Accounting for Management Control

Summary

The need for the accounting information system to promote behaviour congruence is possibly most pronounced for investment centre managers. The importance of capital projects to the long-term effectiveness of the company means that the interactions between results, action and personal controls cannot be overlooked.

In-depth studies of the capital budgeting process indicate the significant influence which divisional managers may exercise over project generation and the estimation of associated cash flows. Discounted cash flow techniques are recommended to evaluate such projects but the divisional manager’s financial results may be evaluated on an accruals income basis. A fundamental concern is that managers will propose projects which improve short-term accounting profit for the division but which are second-best ones for the company. Alternatively, projects acceptable to the company will not be formally submitted if divisional profit — however measured — falls.

A detailed examination of the equivalence of residual income (or rate of return on investment) and net present value (or internal rate of return) when annuity depreciation is used, indicates a technical solution. However, the cumbersome nature of this solution is revealed when cash flow operating budgets are employed. This analysis prompts the question, ‘Why measure divisional performance by means of income?’. For investment centre managers in multinational companies, the inclusion of budgeted versus actual cash flow as a complementary performance measure compatible with achieving behaviour congruence appears worthy of consideration.

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© 1990 Clive Emmanuel, David Otley and Kenneth Merchant

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Emmanuel, C., Otley, D., Merchant, K. (1990). The capital investment decision in the multidivisional company. In: Accounting for Management Control. Springer, Boston, MA. https://doi.org/10.1007/978-1-4899-6952-1_12

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  • DOI: https://doi.org/10.1007/978-1-4899-6952-1_12

  • Publisher Name: Springer, Boston, MA

  • Print ISBN: 978-0-412-37480-7

  • Online ISBN: 978-1-4899-6952-1

  • eBook Packages: Springer Book Archive

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