Impact of Decisions to Capitalize or Expense on Performance Measurement: Oil and gas companies inevitably incur costs on exploration ventures that are unsuccessful. These ventures are called dry holes. There is a continuing debate over whether those costs should be written off as period expense or whether they should be capitalized as part of the full cost of finding profitable oil and gas ventures. PMX Drilling Company has been writing these costs off to expense as incurred. However, this year a new management team was hired to improve the profit picture of PMX's oil and gas exploration division. The new management team was hired with the provision that they would receive a bonus equal to 10 percent of any profits in excess of base-year profits of the division. However, no bonus would be paid if profits were less than 20 percent of end-of-year investment. The following information was included in the performance report for the division:

During the year, the new team spent $1 million on exploratory activities, but $900,000 was spent on ventures that were unsuccessful. The new management team has included the $900,000 in the current end-of-year investment base because, they state. "You can't find the good ones without hitting a few bad ones."

Required:

a. What is the ROI for the base year and the current year?

b. What is the amount of the bonus that the new management team is likely to claim?

c. If you were on the board of directors of PMX, how would you respond to the new management's claim for the bonus?

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Sales revenues Costs incurred: Dry holes Depreciation and other amortization Other costs Division profit This Base Year Year Increase over Base Year $4,100,000 $4,000,000 -0- 780,000 1,600,000 800,000 750,000 1,550,000 $1,720,000 $ 900,000 $820,000 $8,100,000* $6,900,000 End-of-year investment Includes other investments not al issue here..