Management Accounting · Performance measurement - application

Divisional Performance: ROI, Residual Income and Transfer Pricing

Updated 11 October 2026 · Fact-checked

ROI = divisional profit ÷ capital employed × 100%. Residual income (RI) = profit − (capital employed × required return). Accept a project if it beats the target ROI or gives positive RI. Transfer price is the price one division charges another. A common minimum is marginal cost plus opportunity cost.

Understand Divisional Performance: ROI, Residual Income and Transfer Pricing

A company with several divisions needs to judge how well each one performs. Profit alone is unfair, because a large division will usually earn more profit than a small one. So you compare profit with the capital invested.

Return on investment (ROI) shows profit as a percentage of capital employed. It is easy to compare across divisions of different sizes. Its weakness is that a manager may reject a project that is good for the company. If the project's return is above the company's required return but below the division's current ROI, the manager's ROI falls, so they say no.

Residual income (RI) is profit after deducting an interest charge on capital employed. The charge uses the company's required rate of return. RI is positive when the division earns more than the required return. Managers who maximise RI will accept any project that earns above the required return, so it fits the company's interests better. Its weakness is that it is an absolute figure, so you cannot compare large and small divisions directly.

Performance of a manager should be judged on controllable items. Costs the manager cannot influence, such as head office cost allocations, should be excluded when assessing the manager. They may stay in when assessing the division as an investment.

A transfer price is the price charged when one division sells goods or services to another. It sets the revenue of the seller and the cost of the buyer. A poor transfer price can lead divisions to make choices that reduce group profit. The general minimum price is the seller's marginal cost plus any contribution lost by selling internally. The maximum is what the buyer would pay externally, or the net revenue the buyer gets from the product.

Key formulas to remember

Return on investment: ROI = divisional profit ÷ capital employed × 100%; Use the profit measure and capital figure the question states, usually profit before interest and tax, and capital employed at the start or year end as instructed.
Residual income: RI = divisional profit − (capital employed × required rate of return); The deduction is called the imputed interest charge. The answer is in money, not a percentage.
Decision rule for ROI: Accept if project ROI > target ROI (company view); manager accepts if new ROI > current divisional ROI; The two rules can conflict. That conflict is a common exam point.
Decision rule for RI: Accept if project RI > 0, that is, project return > required return; Compare the project profit with the capital charge on the project.
Minimum transfer price: Minimum = marginal cost + opportunity cost per unit to the selling division; With spare capacity, opportunity cost is zero, so minimum = marginal cost. At full capacity, opportunity cost is the contribution lost on external sales.
Maximum transfer price: Maximum = lower of external market price for the buyer and net marginal revenue to the buyer; The buyer should not pay more than it could buy for elsewhere.

How to solve Divisional Performance: ROI, Residual Income and Transfer Pricing questions

Use this order for any divisional performance or transfer pricing question.

1Read what is asked: ROI, RI, a decision on a project, or a transfer price. Note the required return and whether profit is before or after interest.
2For performance measures, identify the profit figure. Remove non-controllable items if judging the manager.
3Identify the capital employed to use. Use the figure the question gives. Check whether a project adds to it.
4Calculate ROI as profit ÷ capital employed × 100%, or RI as profit minus the capital charge.
5For a project, compute the new divisional figure and compare it with the current figure and the required return. Keep the manager's view and the company's view separate.
6For transfer pricing, check spare capacity in the selling division. Then work out the minimum price (marginal cost plus opportunity cost) and the maximum price.
7State the conclusion in one line: accept or reject, or the range of acceptable prices. Add a short reason if the question asks for comment.

Quickest way: Three-line check for objective test questions

When to use it: Use for two-mark multiple choice and number entry questions where you have about two minutes.

For RI, write: profit − capital × rate. Do the multiplication first, then subtract.
For a project decision, compare the project's own return with the required return. If it is higher, RI rises and the company should accept. Only then check the manager's ROI view if asked.
For transfer price, ask one question: is the seller at full capacity? If no, minimum = marginal cost. If yes, add the lost contribution per unit.
Check units and whether the answer needs a percentage or a money amount before you enter it.

Common mistakes in Divisional Performance: ROI, Residual Income and Transfer Pricing

Using ROI as the company's decision rule for projects.
Students compare the project return with the current divisional ROI because that is what the manager does.
Fix: For the company, compare project return with the required return. Mention the ROI conflict only as a behavioural issue.
Writing residual income as a percentage.
It is confused with ROI because both use capital employed.
Fix: RI is an amount of money. Always include the currency, such as $ in ACCA questions.
Forgetting to deduct the capital charge on the full capital employed.
Students deduct the charge only on new investment or skip it.
Fix: Multiply total capital employed (including any new project) by the required rate, then subtract from total profit.
Including non-controllable costs when judging the manager.
Students use the profit figure as given without checking its source.
Fix: Remove allocated head office costs and other items the manager cannot influence when assessing the manager.
Using full cost as the minimum transfer price.
Full cost feels safer, and fixed costs seem part of the price.
Fix: Minimum is marginal cost plus opportunity cost. Fixed costs are already incurred and are not relevant unless they change.
Ignoring spare capacity.
Students apply one formula to every case.
Fix: Always read the capacity information first. It decides whether opportunity cost is zero.

Worked examples

Example 1

Division A has profit of $240,000 and capital employed of $1,200,000. The company's required return is 15%. A new project needs $200,000 of capital and earns profit of $34,000 a year. Calculate the current ROI and RI, then say whether the manager and the company would accept the project.

Show the solution

Current ROI = 240,000 ÷ 1,200,000 × 100% = 20%.
Current RI = 240,000 − (1,200,000 × 15%) = 240,000 − 180,000 = $60,000.
Project return = 34,000 ÷ 200,000 × 100% = 17%.
With the project: profit = 274,000; capital = 1,400,000.
New ROI = 274,000 ÷ 1,400,000 × 100% = 19.57%, which is below 20%.
New RI = 274,000 − (1,400,000 × 15%) = 274,000 − 210,000 = $64,000.
Project RI = 34,000 − (200,000 × 15%) = 34,000 − 30,000 = $4,000, which is positive.

Answer: Current ROI is 20% and RI is $60,000. An ROI-based manager would reject the project because ROI falls to 19.57%. The company should accept, because the project return of 17% exceeds 15% and RI rises by $4,000 to $64,000.

Example 2

Division X makes a component with a marginal cost of $18 per unit and sells it externally for $30. Division Y wants to buy it. Y can buy the same component externally for $28. X has spare capacity. Then suppose X has no spare capacity and all its output sells externally at $30. State the range of transfer prices in each case, assuming no external selling costs saved.

Show the solution

Case 1: X has spare capacity, so opportunity cost is zero.
Minimum price = marginal cost = $18.
Maximum price = the external price Y would pay = $28.
Acceptable range in case 1 is $18 to $28.
Case 2: X has no spare capacity. Each internal unit loses an external sale.
Opportunity cost = contribution lost = 30 − 18 = $12.
Minimum price = 18 + 12 = $30.
Maximum price is still $28, so minimum is above maximum.

Answer: With spare capacity the transfer price should lie between $18 and $28. With no spare capacity the minimum of $30 exceeds Y's maximum of $28, so no internal transfer is worthwhile and Y should buy externally.

Exam tips

Read the capital employed and profit definitions line by line. Questions often include items such as depreciation or allocated costs that change the answer.
In multiple response questions about ROI and RI, look for the standard points: ROI can cause rejection of good projects, RI uses an absolute figure and suits the company's required return.
Do the RI calculation in full even for a quick question. The deduction step is where marks are lost.
For transfer pricing, check capacity first. It decides the answer to most numerical questions.
In number entry questions, check whether the answer is a percentage, a money amount or a price per unit, and enter it in that form.

Practice questions from Performance measurement - application

Divisional Performance: ROI, Residual Income and Transfer Pricing in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Divisional Performance: ROI, Residual Income and Transfer Pricing: frequently asked questions

What is the difference between ROI and residual income?

ROI is a percentage: profit divided by capital employed. Residual income is a money amount: profit minus a capital charge at the required return. ROI allows comparison between divisions of different sizes. RI better encourages managers to accept any project that beats the required return.

How do you calculate residual income in ACCA MA?

Multiply capital employed by the required rate of return to get the capital charge. Subtract this from divisional profit. The result is the residual income, which is positive if the division earns more than the required return.

Why can ROI lead to poor decisions?

A manager with a high ROI may reject a project whose return is below the current ROI but above the company's required return. Accepting it would lower the manager's ROI, even though it adds value to the company. This is called a lack of goal congruence.

What is the minimum transfer price?

It is the selling division's marginal cost plus the opportunity cost of selling internally. If it has spare capacity, the opportunity cost is zero and the minimum is the marginal cost. At full capacity it includes the contribution lost on external sales.