Chapter 12: Divisional Performance
Measuring divisional performance and setting internal prices without losing organisational perspective
About this Chapter
Divisional performance measures are linked here to the authority given to managers, addressing LO 4.3. The chapter distinguishes cost, profit and investment centres, then examines return on investment and residual income, including the different incentives they can create when new projects are considered. The second part covers transfer pricing between divisions, the effect of capacity and opportunity cost, and several pricing approaches. Throughout, the group perspective is kept separate from the way profit is reported within individual divisions.
Study Guide Highlights
Centres and controllable performance
Different responsibility centres should be judged on measures that match the decisions their managers control. Cost, revenue, profit and investment responsibilities are distinguished, with emphasis on controllable figures when performance is assessed. Central allocations or head-office recharges can distort a divisional result if they are outside the manager's influence, so the accounting measure used for evaluation needs to reflect the authority actually delegated.
ROI and residual income
Return on investment and residual income both assess investment-centre performance, but they can encourage different decisions. A manager protecting an existing percentage return may reject a project that still earns more than the organisation's required return, while residual income can point in another direction. Neither measure is presented as perfect; both depend on accounting figures and can influence behaviour as well as describe performance.
Transfer pricing and capacity
A transfer price determines how profit is shared when one division supplies another, without changing the total profit of the group. Spare capacity matters: when internal supply does not displace external sales, the supplier faces a different economic position from one operating at full capacity. Opportunity cost therefore becomes central when internal demand competes with an alternative use of the same divisional resources.
Pricing methods and conflict
Market-based, cost-plus, negotiated, two-part tariff and dual-pricing approaches each address part of the transfer-pricing problem. Their strengths, weaknesses and behavioural consequences are considered, including cost-control incentives and conflict between divisional autonomy and group objectives. A transfer price can improve local performance measures while leaving group profit unchanged, so management must distinguish internal reporting effects from decisions that genuinely change total organisational value.
If divisional profit includes head-office recharges or other apportioned group costs, consider whether they lie outside the manager's control. Performance assessment should focus on the profit that reflects controllable decisions.
In transfer-pricing questions, establish whether the supplying division has spare capacity before drawing conclusions. The economic effect changes when an internal transfer displaces external sales and therefore creates an opportunity cost.
Chapter Resources
Slides for this chapter.
PPT coming soon
PowerPoint SlidesCourse Navigation
- 01 Activity Based Costing
- 02 Target Costing and Life Cycle Costing
- 03 Limiting Factor Analysis
- 04 Linear Programming
- 05 Short-Term Decision Making
- 06 Calculating Forecasts
- 07 Introduction to Budgeting
- 08 Budgeting Processes
- 09 Further Aspects of Budgeting
- 10 Standard Costing and Variances
- 11 Performance Measurement and Control
- 12 Divisional Performance Current
- 13 Long-Term Decision Making
- 14 Impact of Technology