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Hi, when calculating the residual income we will take controllable contribution less capital employed. In terms of the capital employed calculation, we take the cost of capital % * asset value. For that asset value, I see an example where they take the current assets – current liabilities to calculate the net assets that are then multiplied by the company’s cost of capital %. Why do we take the net assets and not just the current asset balance?
You should remember from Paper FA (or whatever exempted you) that the total capital employed (equity plus debt) is always equal to the net assets of the business. It is the total capital employed that is generating the profit of the business.
(Incidentally, we take the controllable profit of the division (assuming the are measuring the performance of the manager) and not the controllable contribution!)
If they use radical income to make the decision then they would be indifferent as to whether or not to accept it. (Although they almost certainly would not accept it because all the figures used are only estimates and it would be usually considered too risky to accept because the estimates might obviously be wrong.)
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