Investment center is a term describing accounting units used by managers responsible for capital investment decisions, revenues and current costs in large corporations. It measures the profit contribution of a particular division in the corporation in terms of the rate of return on the department’s assets. This reflects and measures the manager’s job performance.
Flaws in the Rate of Return Calculations
To calculate the return on investment, one uses the current revenue and expense measurements and historical asset costs and depreciation in a formula. However, this is not always an adequate way to measure investment options. Investment in intangibles is recorded as a current expense at the time of the investment but doesn’t take into account its ongoing value.
Leased assets are not considered part of the investment base although they may signify a large investment commitment. Inflation also plays a part because it can cause distortions in the rate of return. Yet, adjustments for inflation are never made. When depreciation is recorded, it too distorts the calculation because it reduces the recorded value of investments.
If management solely relies on this calculation, they may be lead to make poor business decision based on distorted or inflated figures. In addition, these figures may imply the decision is beneficial for the investment center yet may be a poor business move for the corporation in its entirety. However, the accounting rate of return continues to be a common accounting practice primarily because income is measured and reported in general accounting terms.