AAT L4 Transfer Pricing and Divisional Performance 2 — Questions and Answers
Question 1: Division P has variable costs of £20 and fixed costs of £8 per unit. What is the transfer price under full cost-plus pricing with a 25% profit mark-up?
- £28
- £35 (Correct answer)
- £25
- £33.60
Correct answer: £35
Full cost = £20 + £8 = £28; with a 25% mark-up: £28 × 1.25 = £35.
Question 2: Which of the following is a disadvantage of using market price as a transfer price?
- It always leads to dysfunctional decision-making
- A reliable external market price may not always exist for the transferred product (Correct answer)
- It discourages the selling division from transferring internally
- It always benefits the buying division at the seller's expense
Correct answer: A reliable external market price may not always exist for the transferred product
Market-based transfer pricing requires a competitive external market, which may not exist for specialised or intermediate products.
Question 3: Residual Income is considered superior to ROI as a divisional performance measure because:
- It is simpler to calculate
- It encourages managers to accept any project that earns above the company's cost of capital (Correct answer)
- It can be compared easily across divisions of different sizes
- It requires no cost of capital estimate
Correct answer: It encourages managers to accept any project that earns above the company's cost of capital
Unlike ROI, RI increases for any project earning above the cost of capital, so it avoids the problem of managers rejecting value-adding investments.
Question 4: A selling division operates at full capacity of 10,000 units, all sold externally at £60. Variable costs are £35 per unit. A buying division requests 2,000 units. What is the minimum transfer price per unit?
- £35
- £25
- £60 (Correct answer)
- £45
Correct answer: £60
At full capacity the opportunity cost is the contribution foregone (£60 − £35 = £25), so minimum TP = £35 + £25 = £60.
Question 5: The Balanced Scorecard approach to performance measurement uses which four perspectives?
- Financial, Customer, Internal Business Processes, Learning and Growth (Correct answer)
- Financial, Marketing, Operations, Human Resources
- Profitability, Liquidity, Efficiency, Gearing
- Strategic, Tactical, Operational, Administrative
Correct answer: Financial, Customer, Internal Business Processes, Learning and Growth
Kaplan and Norton's Balanced Scorecard comprises Financial, Customer, Internal Business Process, and Learning and Growth perspectives.
Question 6: Which type of responsibility centre has managers responsible for revenues and costs but NOT capital investment decisions?
- Cost centre
- Revenue centre
- Profit centre (Correct answer)
- Investment centre
Correct answer: Profit centre
A profit centre manager controls both revenues and costs but has no authority over the level of capital employed by the division.
Question 7: An investment centre has a target ROI of 15% and a company cost of capital of 20%. A new project offers an ROI of 18%. Which statement is correct?
- The manager will accept the project because it exceeds the 15% target ROI
- The manager will reject it because it falls below the cost of capital
- ROI and Residual Income give conflicting signals in this scenario (Correct answer)
- The decision depends solely on the negotiated transfer price
Correct answer: ROI and Residual Income give conflicting signals in this scenario
Using ROI the manager may accept (18% > 15% target), but RI would be negative (18% < 20% cost of capital), showing the two measures give different signals.
AAT L4 Transfer Pricing and Divisional Performance 2
Division P has variable costs of £20 and fixed costs of £8 per unit.
What is the transfer price under full cost-plus pricing with a 25% profit mark-up?