Abstract The article discusses some of the limitations of residual income in internal reporting and then describes interest-adjusted income, a modification of residual income, which mitigates some of these limitations. The residual income of a division is the net income of the division less the product of the capital of the division times a required rate of return. Despite its many advantages there are at some limitations of residual income. This can be that residual income is subject to all the imperfections of historical cost net asset valuation. There are some pitfalls in using residual income in conjunction with generally accepted accounting rules for performance evaluation. However, residual income can be used in conjunction with other accounting rules, eliminating some of the problems associated with it. Moreover, the allocation of imputed interest to accounting periods is arbitrary under residual income in that all imputed interest is expensed. But some imputed interest may have future service potential and therefore should be capitalized.
Keith Shwayder (Wed,) studied this question.