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ACCA Applied Skills · Performance Management

Divisional Performance and Transfer Pricing for ACCA PM

Divisional performance looks at how well a division and its manager do, using measures such as ROI and residual income. Transfer pricing sets the internal price for goods moving between divisions. To solve questions, calculate the measure or price, then judge its effect on goal congruence, motivation and autonomy.

What this chapter covers

This chapter covers two linked ideas. The first is how head office judges a division: by return on investment (ROI), residual income (RI), and by separating what the manager controls from what they do not. The second is transfer pricing: the price one division charges another for goods or services inside the same group.

Both ideas sit in the same setting, a decentralised business. Head office gives managers authority and then needs a fair way to measure them. A poor measure or a poor transfer price can push a manager to act in their own interest and harm the group. Examiners call this a lack of goal congruence.

The chapter links to the rest of PM. It uses relevant costing and limiting factors for the optimal transfer price. It links to budgeting and variance analysis for controllable costs. It also connects to the performance measurement chapters, where financial measures are weighed against non-financial ones. Expect it in Section A, in a Section B case, and as a Section C written and numerical question.

This chapter gives you both easy and hard marks. ROI and RI are short calculations that suit objective test questions, where answers are all or nothing and a small slip costs the full mark. Transfer pricing is a favourite for the longer constructed response questions, because it mixes calculation with discussion. If you can compute a minimum transfer price and then explain its behavioural effects, you can score well on a question that many students find confusing.

Divisional performance and transfer pricing: topics in the order to study them

  1. 1Divisional Performance Measures: ROI and Residual IncomeStart here because the formulas are the base for everything else and they are quick to learn and test.
  2. 2Controllable vs Non-Controllable Costs in DivisionsNext, learn which items belong in a manager's measure, since this changes how you use ROI and RI.
  3. 3Comparing Divisional Performance IssuesOnce you can calculate and adjust measures, practise comparing divisions and spotting why the figures mislead.
  4. 4Transfer Pricing Objectives and MethodsMove to transfer pricing now: learn the aims and the common methods before doing any calculation.
  5. 5Optimal Transfer Price CalculationsWith methods clear, build the minimum and maximum price rules and apply them to spare and full capacity.
  6. 6Transfer Pricing in MultinationalsFinish with tax, currency and regulation, which add extra factors on top of the core rules.

How to prepare Divisional performance and transfer pricing

Work from calculation to judgement. Most marks need both, so practise them together instead of in separate blocks.

  1. Learn the ROI and RI formulas and the exact way to measure profit and capital employed. Do five short calculations until they are automatic.
  2. Practise the behavioural point for each measure. Write one line on how ROI can discourage a good project and how RI can fix it.
  3. Sort cost lists into controllable and non-controllable for a manager. Then rebuild a divisional profit statement that shows the controllable result.
  4. Learn the transfer price rule: minimum price = marginal cost + opportunity cost; maximum price = lower of the external buying price and the net marginal revenue. Apply it to spare capacity and limited capacity cases.
  5. Do full past-style questions that ask for a price range, a recommendation and the effect on each division and the group.
  6. Add the multinational points as short written lists: tax rates, tariffs, exchange controls and the risk of tax authority challenge.
  7. Finish with timed objective questions on all topics, then one timed constructed response question, and check your layout and conclusions.

Common mistakes in Divisional performance and transfer pricing

  • Using the wrong profit or capital figure in ROI and RI, such as including non-controllable costs without saying so.

    Fix: State which profit and which capital base you use, and match them to whether you judge the manager or the division.

  • Comparing ROI of two divisions and concluding that the higher one performs better.

    Fix: Check differences in asset age, depreciation, risk, size and accounting policies, and note that RI and ROI can give opposite rankings.

  • Putting fixed costs into the minimum transfer price when the seller has spare capacity.

    Fix: Use only marginal cost plus any lost contribution. Fixed costs that do not change are not relevant.

  • Ignoring the buying division's external alternative when finding the maximum price.

    Fix: Always compare with the external purchase price and the net marginal revenue, then take the lower one.

  • Stopping after the calculation and giving no discussion of behaviour or group profit.

    Fix: End each answer with a clear recommendation and the effect on each division's motivation, autonomy and the group.

  • Writing generic points on multinational transfer pricing with no link to the case.

    Fix: Use the countries, tax rates and currencies given, and show which way profit would move and why.

Last-day revision: Divisional performance and transfer pricing

  • ROI = divisional profit ÷ capital employed × 100%.
  • RI = divisional profit − (capital employed × required rate of return).
  • ROI can make a manager reject a project that is good for the group if it lowers their ROI.
  • RI favours accepting any project that earns more than the cost of capital, so it supports goal congruence.
  • RI is an absolute figure, so it is hard to compare divisions of different sizes.
  • Judge a manager on controllable items only; judge the division on its full results.
  • Minimum transfer price = marginal cost of the selling division + opportunity cost to the group.
  • With spare capacity, the opportunity cost is usually zero, so the minimum price is the marginal cost.
  • Maximum transfer price = the lower of the external market price and the net marginal revenue of the buying division.
  • A negotiated price works only if the minimum is below the maximum.
  • Good transfer prices aim for goal congruence, fair performance measurement, autonomy and, where relevant, lower tax.
  • In multinationals, transfer prices may shift profit to low-tax countries, but tax authorities can challenge this.

Divisional performance and transfer pricing practice questions

Divisional performance 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 and transfer pricing: frequently asked questions

What is the difference between ROI and residual income?

ROI is a percentage return on capital employed. Residual income is profit left after charging for the capital used at a required rate. RI is an absolute amount and usually leads managers to better decisions for the group.

How do I find the minimum transfer price?

Add the selling division's marginal cost per unit to the opportunity cost per unit to the group. If the seller has spare capacity, the opportunity cost is normally zero. If capacity is limited, include the contribution lost from other uses.

Why do examiners ask about goal congruence in transfer pricing?

Because a transfer price that suits one division can harm group profit. You need to show whether the price leads managers to make the choice that is best for the whole group.

Is this chapter tested in objective questions or written questions?

Both. ROI, RI and simple price ranges suit objective test questions, while longer calculations with discussion suit constructed response questions in Section C.