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Transfer Pricing and Divisional Performance Flashcards

7 cards from real AAT L4 practice questions. Tap to flip, then mark Knew It or Still Learning — missed cards come back until you master them.

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  1. Division A has operating profit of £150,000 and net assets of £600,000. What is Division A's Return on Investment (ROI)?

    Answer: 25%

    ROI = Operating Profit ÷ Capital Employed = £150,000 ÷ £600,000 = 25%.

  2. What is the MINIMUM transfer price a selling division should accept when operating at full capacity?

    Answer: Variable cost plus contribution foregone on lost external sales

    At full capacity there is an opportunity cost; the minimum transfer price must cover variable cost plus the contribution foregone from displaced external sales.

  3. Residual Income (RI) is calculated as:

    Answer: Operating profit minus imputed interest on capital employed

    RI = Operating Profit − (Cost of Capital × Capital Employed), deducting a capital charge to reflect the cost of funding.

  4. A company has a cost of capital of 12%. Division B has capital employed of £500,000 and operating profit of £80,000. What is Division B's Residual Income?

    Answer: £20,000

    Imputed interest = 12% × £500,000 = £60,000; RI = £80,000 − £60,000 = £20,000.

  5. Which of the following is an advantage of using Return on Investment (ROI) as a divisional performance measure?

    Answer: It is widely understood and can be compared across divisions of different sizes

    ROI is expressed as a percentage, making it straightforward to compare performance across divisions of different absolute sizes.

  6. Division X can sell its product externally for £50 per unit. Variable costs are £30 per unit. Division X has spare capacity. What is the minimum transfer price it should charge Division Y?

    Answer: £30

    With spare capacity there is no opportunity cost, so the minimum transfer price equals variable cost only — £30 per unit.

  7. Which statement best describes goal congruence in the context of transfer pricing?

    Answer: A transfer price should motivate divisional managers to make decisions that maximise overall company profit

    Goal congruence means divisional managers' individual decisions align with the company's overall objectives, which a well-designed transfer price should encourage.