ACCA PM · Chapter 14
Divisional performance and transfer pricing MCQs with Answers
10 multiple-choice questions on Divisional performance and transfer pricing for ACCA PM Performance Management. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
Division D has capital employed of $4,000,000 and controllable profit of $640,000. The company's cost of capital is 12%. What is the division's return on investment (ROI)?
- A) 12%
- B) 4%
- C) 16%
- D) 28%
Show answer & explanation
Answer: C) 16%
ROI = controllable profit / capital employed = $640,000 / $4,000,000 = 16%.
Question 2
Division D has capital employed of $4,000,000 and controllable profit of $640,000. The company's cost of capital is 12%. What is the division's residual income (RI)?
- A) $640,000
- B) $160,000
- C) $480,000
- D) $563,200
Show answer & explanation
Answer: B) $160,000
Imputed interest = 12% x $4,000,000 = $480,000. RI = controllable profit - imputed interest = $640,000 - $480,000 = $160,000.
Question 3
Division D has capital employed of $4,000,000 and controllable profit of $640,000. The company's cost of capital is 12%. The divisional manager is considering a new project requiring investment of $500,000 and generating an annual controllable profit of $70,000. What would be the effect of accepting the project?
- A) ROI would fall to 14.0% and RI would increase by $10,000
- B) ROI would fall to 15.8% and RI would fall by $10,000
- C) ROI would fall to 15.8% but RI would increase by $10,000
- D) ROI would stay at 16% and RI would increase by $70,000
Show answer & explanation
Answer: C) ROI would fall to 15.8% but RI would increase by $10,000
New ROI = ($640,000 + $70,000) / ($4,000,000 + $500,000) = 15.8%, lower than the current 16%. Change in RI = $70,000 - (12% x $500,000) = $10,000 increase. A manager judged on ROI might reject a project that earns more than the cost of capital, which is a weakness of ROI.
Question 4
Which of the following is a disadvantage of residual income compared with return on investment as a divisional performance measure?
- A) It encourages managers to reject projects that earn more than the cost of capital
- B) It is an absolute measure, so it does not allow easy comparison of divisions of different sizes
- C) It ignores the cost of the capital tied up in the division
- D) It cannot reflect different levels of risk across divisions
Show answer & explanation
Answer: B) It is an absolute measure, so it does not allow easy comparison of divisions of different sizes
RI is expressed in $, so larger divisions tend to report higher RI, making comparisons between divisions of different sizes difficult. ROI is the measure that can lead to rejecting worthwhile projects, and RI explicitly charges for capital and can use different rates for divisions with different risk.
Question 5
A division's assets are measured at net book value. If profits remain constant and no new assets are acquired, what will happen to the division's ROI over time?
- A) It will increase as the assets depreciate
- B) It will decrease as the assets depreciate
- C) It will remain constant
- D) It will become negative once the assets are fully depreciated
Show answer & explanation
Answer: A) It will increase as the assets depreciate
As assets depreciate, their net book value and therefore capital employed fall. With constant profit, ROI rises over time even though performance has not improved. This can discourage managers from replacing old assets, since new investment would reduce ROI.
Question 6
Which of the following is a key objective of a transfer pricing system?
- A) Maximising the profit of the supplying division at the expense of the receiving division
- B) Ensuring that every transfer is made at full cost
- C) Encouraging divisional managers to make decisions that are in the best interests of the company as a whole
- D) Removing the autonomy of divisional managers
Show answer & explanation
Answer: C) Encouraging divisional managers to make decisions that are in the best interests of the company as a whole
A good transfer pricing system should promote goal congruence, allow fair performance evaluation of each division and preserve divisional autonomy. Maximising one division's profit at another's expense, or always using full cost, can lead to dysfunctional decisions.
Question 7
Division S makes a component with a variable cost of $30 and a full cost of $42 per unit. It has spare capacity and there is no external market for the component. Division R can buy an equivalent component from an outside supplier for $55. Within what range should the transfer price lie to encourage goal-congruent decisions?
- A) Between $30 and $55
- B) Between $42 and $55
- C) Between $30 and $42
- D) At or above $55, the external supplier's price
Show answer & explanation
Answer: A) Between $30 and $55
With spare capacity, the supplying division's opportunity cost is zero, so the minimum transfer price is its variable cost of $30. The maximum the receiving division would pay is the external price of $55. Any price in this range should lead both managers to favour the internal transfer. Using full cost ($42) as the floor ignores the spare capacity, and a price above $55 would push Division R to buy externally.
Question 8
Division S makes a component with a variable cost of $30 per unit. It is working at full capacity and sells all its output externally at $50 per unit, incurring selling costs of $2 per unit that would be avoided on internal transfers. What is the minimum transfer price that Division S should accept for transfers to Division R?
- A) $50
- B) $48
- C) $30
- D) $52
Show answer & explanation
Answer: B) $48
Minimum transfer price = marginal cost + opportunity cost. The opportunity cost is the contribution lost on an external sale: $50 - $2 - $30 = $18. Minimum price = $30 + $18 = $48. Equivalently, the external price less the selling costs saved: $50 - $2 = $48.
Question 9
Under a two-part tariff transfer pricing system, how are transfers charged?
- A) At full cost plus a percentage mark-up on every unit
- B) At market price for the supplying division and at marginal cost for the receiving division
- C) At marginal cost per unit, plus a fixed fee each period to cover the supplying division's fixed costs and a profit
- D) At a price negotiated afresh for each individual transfer
Show answer & explanation
Answer: C) At marginal cost per unit, plus a fixed fee each period to cover the supplying division's fixed costs and a profit
A two-part tariff charges units at marginal cost, so the receiving division makes decisions using the true incremental cost, plus a fixed periodic fee so the supplier recovers fixed costs and earns a profit. Recording different prices for each division describes dual pricing.
Question 10
Division S transfers a component to Division R at full cost plus 20%. Which problem is most likely to arise?
- A) Division S will never cover its fixed costs
- B) Division R will always buy more units than is optimal for the company
- C) Division R treats Division S's fixed costs and mark-up as variable costs, and may reject orders that would be profitable for the company
- D) The transfer price will always equal the external market price
Show answer & explanation
Answer: C) Division R treats Division S's fixed costs and mark-up as variable costs, and may reject orders that would be profitable for the company
To the receiving division the whole transfer price is a variable cost, even though part of it covers fixed costs and profit of the supplier. Division R may therefore turn down sales whose price exceeds the company's true marginal cost but not the inflated transfer price, which is not goal congruent.