ACCA Applied Skills · Performance Management · Divisional performance and transfer pricing
Division Beta's manager is appraised on residual income. Head office decides to charge the division $40,000 for a new group IT system the manager did not choose. Beta's profit before this charge is $310,000, and its controllable net assets are $1,500,000 with a cost of capital of 12%. What residual income should be used to assess the manager's performance?
Residual income is $130,000. The imposed $40,000 IT charge is non-controllable and is left out, so profit of $310,000 less a capital charge of $180,000 (12% of $1,500,000) gives $130,000. Including the charge would wrongly understate the manager's performance.
- A$130,000Correct
- B$90,000
- C$270,000
- D$310,000
Explanation
The IT charge is imposed by head office so it is excluded from the manager's appraisal. Residual income = 310,000 - (12% x 1,500,000 = 180,000) = $130,000. Including the charge would give $90,000.
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