Limitations of Residual Income

Limitations of Residual Income

Limitations of residual income may be expressed in terms of accounting performance measurement, size of project, understandability.

1.    Accounting Performance Measure

Residual income is accounting performance measure, and accounting profit can easily be manipulated by the management by adopting different accounting polices & procedures. Accounting profit are subject to management biased, therefore cannot be considered a good performance measuring tool.

2.    Size Influences

Residual income is greatly influenced (affected) by the size of the capital employed. Therefore it cannot be used to compare the performance of investment center with different size. Larger size investment center (large capital employed) will always show the improve performance than other investment center.

3.    Difficult to Understand

Residual income method is difficult to understand & apply. This method cannot be easily applied and require a deep accounting and financial management knowledge. Accountant may not be interested in this method due to its rarely used terminologies.

4. imputed interest Rate Decision

   Imputed interest rate decision requires a lot of expert knowledge of financial management.        Moreover, there are numbers of rates is available for imputed interest rate and management      has to decide to use one of them as interest rate.