Question

Discuss the motivation for excluding "nonproductive" assets from invested capital when computing return. What circumstances justify excluding intangible assets from invested capital? In addition, why must income used in computing return on invested capital be adjusted to reflect the capital base (denominator) used in the computation?

Answer 1

Discuss the motivation for excluding "nonproductive" assets from invested capital when computing return.

The Non productive Assets is an Asset which does not generate any output for the organization, since no revenue or any other kind of income is earned by those assets. Since the non productive assets does not contribute anything towards the income, hence for that reason the non productive assets are excluded when computing return. If the facts are considered, we will find that no revenue or any kind of income is being generated by the non productive assets, so these kinds of the assets does not contribute anything towards the Income of the Company, and since there is no contribution of anykind towards the Company, the non-productive assets are excluded.

What circumstances justify excluding intangible assets from invested capital?

The evaluation of return on invetsed capital involves many factors.The inclusion and exclusion of extraordinary gains and losses ,the use and non use of trends the effect of acquisitions accounted for as pooling and their chance of recurrence the effect of discontinued operations and the possibility of averaging net income are just a few factors of the many factors.

why must income used in computing return on invested capital be adjusted to reflect the capital base (denominator) used in the computation

The formula for computing the return on investment is net income divided by Total Invested capital.Whenever we modify the defination of the investment base by say omitting certain items like the liabilities,idle assets,intangibles etc we must also adjust the corresponding income figure to make it consistent with modified asset base.