P2: Performance control

Answer: C. A profit centre is a responsibility centre where the manager controls both revenues and costs and is assessed on profit, but does not have authority over capital investment decisions. An investment centre goes further — its manager also controls capital investment and is typically assessed using a return-on-investment or residual income measure. A cost centre only controls costs, with no revenue responsibility, and a revenue centre only controls revenues without cost accountability. The division described controls both revenues and costs but not capital decisions, making profit centre the correct classification.

Answer: D. Holding managers responsible for costs they cannot control — such as head-office allocations or group-wide insurance — demotivates them, produces unfair performance assessments, and can lead to sub-optimal behaviour as managers attempt to manage costs that are outside their influence. Performance evaluation should focus on what the manager can genuinely influence. The distinction is highly practically relevant, not merely theoretical, and not all costs incurred within a division are controllable by the divisional manager — many are imposed from above or outside.

Answer: A. Setting deliberately undemanding targets to make them easy to achieve — building in a comfortable margin — is the classic example of budget slack. It protects the manager's performance rating at the cost of the organisation receiving a less ambitious plan. Goal congruence is the alignment of individual and organisational goals, which budget slack actively undermines. Budget bias relates to inflating cost requests to obtain more resources, which is related but distinct. Dysfunctional behaviour more broadly describes actions that conflict with organisational goals; budget slack is a specific form of it, not the general phenomenon of abandoning the process entirely.

Answer: B. ROI = operating profit ÷ net assets = £300,000 ÷ £2,000,000 = 0.15 = 15%. Since 15% exceeds the 12% target, the division is meeting the target. A common error is to divide net assets by profit (£2,000,000 ÷ £300,000 = 6.67, which is not a ROI percentage). The 30% figure might arise from dividing profit by a misremembered asset figure (e.g. £300,000 ÷ £1,000,000). The 12% figure is the target, not the actual result. ROI is simply profit as a percentage of the investment base — here net assets.

Answer: C. Residual income = operating profit − (net assets × cost of capital) = £300,000 − (£2,000,000 × 12%) = £300,000 − £240,000 = £60,000. The £60,000 is positive, meaning the division is earning more than the required return on capital, which is the signal that residual income is designed to give. The £240,000 figure is the capital charge alone, not the residual income. The £300,000 is the operating profit before subtracting the capital charge. The negative figure would arise only if the capital charge exceeded profit, which is not the case here.

Answer: D. The new investment earns 14%, which exceeds the 10% cost of capital — it creates value for shareholders. A manager assessed purely on ROI would reject it because it dilutes the division's existing 18% ROI average, even though accepting it increases shareholder wealth. A manager assessed on RI would accept it, since RI only deducts the cost of capital charge, and the investment earns above that charge. This is a classic example of ROI creating goal incongruence — the manager optimises their own metric at the expense of the organisation. RI leads to the correct decision here.

Answer: A. The minimum transfer price is the selling division's opportunity cost — here, with spare capacity, this equals variable cost only (£30), since there are no foregone contribution margins. The maximum transfer price is the buying division's external market price (£50), since Division B would not rationally pay more than it can source the component for externally. Any transfer price within the £30–£50 range is acceptable to both divisions: Division A makes at least a contribution above variable cost, and Division B pays no more than its external alternative. Reversing the range or fixing the price at either extreme ignores the legitimate interests of one of the two divisions.

Answer: B. With no spare capacity, every internally transferred unit displaces an external sale. Division S must therefore recover not only its variable cost (£40) but also the contribution it forgoes on the lost external sale: lost contribution = £70 − £40 = £30. Minimum transfer price = variable cost + lost contribution = £40 + £30 = £70. This equals the external market price, which makes sense — if Division S can sell externally for £70, it will not sell internally for less. The £40 answer applies only when there IS spare capacity and no opportunity cost. Midpoint and zero pricing ignore the economic reality of the opportunity cost.

Answer: C. A dual pricing system sets different transfer prices for the selling and buying divisions — often the selling division charges full cost (or market price) to cover its true cost of supply, while the buying division pays only variable cost, better reflecting the incremental cost to the group. Head office then adjusts the group accounts. This allows the performance of both divisions to be fairly assessed without either being penalised by a transfer price that benefits only the other. It does not aim to maximise profit at the expense of fairness, zero-price all transfers, or force market-price transfers in all cases.

Answer: D. Competitive benchmarking involves comparing performance against direct competitors, typically using publicly available financial or operating data rather than shared internal information — exactly the scenario described. Internal benchmarking compares performance across different parts of the same organisation. Functional benchmarking looks outside the competitor set to compare a specific process against organisations known for best practice in that function, regardless of sector. Collaborative benchmarking involves a formal arrangement where organisations agree to share internal data — the opposite of using only publicly available information.

Answer: A. The balanced scorecard's four perspectives are financial (how do we look to shareholders?), customer (how do customers see us?), internal business process (what must we excel at?), and learning and growth (can we continue to improve and create value?). The other options mix some genuine BSC-related concepts with invented or related-but-incorrect terminology — none of them correctly names all four perspectives as Kaplan and Norton defined them. The BSC is designed to balance financial measures with the non-financial leading indicators that drive future financial performance.

Answer: B. The BSC is intended to translate strategy into measurable operational objectives, so measures must be linked to what actually drives the specific organisation's competitive success — otherwise the scorecard becomes a generic reporting dashboard that could apply to any business, rather than a tool focused on what matters for this particular strategy. Widely used metrics are not universally valid regardless of strategic fit; what drives success differs by business model and strategy. Strategy-linked measures also do not automatically ensure equal representation across all four perspectives — that requires deliberate design beyond just strategic linkage.

Answer: C. Big data and advanced information systems can enhance performance management by providing richer and more timely data, enabling faster identification of performance variances and more granular analysis of the underlying drivers — supporting better-informed management decisions. They do not eliminate the need for human judgement; data still requires interpretation and contextual understanding. Big data complements rather than replaces financial KPIs, and it has extensive practical applications in performance management, from customer analytics to operational dashboards.

Answer: D. A customer satisfaction score measured through surveys is a non-financial performance indicator that directly reflects how customers perceive the organisation's products or services, making it well suited to the customer perspective of a balanced scorecard. Net profit margin, return on capital employed and earnings per share are all financial measures that would typically belong in the financial perspective rather than the customer perspective, even though they may be influenced indirectly by customer satisfaction levels.

Answer: A. An investment centre extends beyond a profit centre by giving the manager authority over capital investment decisions, assessed via ROI or residual income. A profit centre controls revenues and costs but not capital. The two are meaningfully distinct, not identical, and the reversed description in the distractor has the authority incorrectly assigned.

Answer: B. Goal congruence occurs when the performance measures faced by divisional managers lead them to make decisions that maximise their own metrics while also advancing the organisation's overall goals. Poor performance measure design (such as ROI inducing rejection of value-creating projects) creates goal incongruence. It is not automatic from budget-setting and applies regardless of whether divisions are similar in size.

Answer: C. The project earns 16% > 12% cost of capital and creates value. The manager rejects it because it dilutes the 20% ROI average — optimising the divisional metric at the expense of the organisation. This is classic ROI-induced goal incongruence. Residual income would not create this conflict, since RI credits any return above the cost of capital charge. The cost of capital is precisely the critical threshold.

Answer: D. A benchmarking exercise must first establish what is being benchmarked and what metrics will be used for comparison — without this, no meaningful exercise can follow. Only then can an appropriate partner or data source be identified. Implementing changes and communicating results are later steps, after data is gathered and gaps are identified.

Answer: A. Division A's minimum = its variable cost = £25 (no external market or opportunity cost beyond this). Division B's maximum = the price at which its contribution falls to zero: £80 − TP − £15 = 0 → TP = £65. Any price within £25–£65 benefits both divisions and keeps the group contribution of £80 − £25 − £15 = £40 unchanged — the transfer price only determines how that £40 is split between the two divisions, not its total.

Answer: B. Residual income = operating profit − (net assets × cost of capital) = £180,000 − (£1,500,000 × 10%) = £180,000 − £150,000 = £30,000. The positive RI of £30,000 indicates the division is earning above its required return, adding value. The £180,000 figure is the operating profit before the capital charge. The £150,000 is the capital charge itself, not the RI. The negative figure (−£30,000) would occur only if the capital charge exceeded operating profit.

Answer: C. RI credits the division with a positive result for any investment earning above the cost of capital, so a manager assessed on RI will accept a new project earning 16% when the cost of capital is 10%, since it adds to RI. A manager assessed on ROI may reject the same project if the 16% return dilutes their existing average ROI of (say) 20%. RI therefore aligns the manager's incentive with the company's interest in value creation. ROI and RI can and do give different decisions in exactly this way, and RI does not encourage uncontrolled asset-base growth — it penalises acquiring assets that earn below the cost of capital.

Answer: D. Full cost per unit = variable cost + allocated fixed cost = £35 + £20 = £55. Transfer price = full cost × (1 + mark-up) = £55 × 1.15 = £63.25. A common error is to apply the mark-up to variable cost only (£35 × 1.15 = £40.25), omitting fixed costs. Another is to quote the full cost (£55) before the mark-up is applied. The variable cost alone (£35) is the floor for further-processing decisions but is not the cost-plus transfer price.

Answer: A. Contribution variance = actual contribution − budgeted contribution = £185,000 − £200,000 = −£15,000. Since actual is below budget, this is an adverse variance of £15,000. A favourable variance would mean actual exceeded budget. Quoting the full budgeted or actual figure as the variance conflates the two values. The sign convention is important: adverse means actual is worse (lower, for income; higher, for cost) than budget.

Answer: B. Non-financial KPIs often measure factors — such as customer satisfaction, delivery reliability, or product quality — that drive future financial performance but may not appear in current financial results until later. Including them alongside financial measures gives a more timely and complete picture of divisional performance, highlighting leading indicators rather than only lagging financial outcomes. Financial measures are important but do not fully capture all performance dimensions, and non-financial KPIs are widely used in commercial businesses, not limited to the public sector.

Answer: C. Separating a total variance into planning (attributable to the original budget being set incorrectly, e.g. failing to anticipate a foreseeable price rise) and operational (reflecting the manager's actual performance against a more realistic benchmark) makes the performance assessment fairer and more informative. The planning variance shows where the budgeting process failed; the operational variance isolates what the manager could actually control. Attributing a planning error to the operational manager would be unfair and would reduce the incentive to set realistic budgets — it should be absorbed at a more senior level.

Answer: D. Market-based transfer pricing is most appropriate when an active external market exists for the transferred product — this provides an objective, arm's-length benchmark that reflects the product's genuine economic value and avoids either division being subsidised by the other. Without an external market, a market price is unavailable (not merely theoretical), making cost-based or negotiated prices more common. The objective is to create a fair basis for both parties, not necessarily to minimise one division's costs. Tax-motivated transfer pricing is a separate, compliance-driven practice governed by arm's-length standards, not purely an internal policy choice.

Answer: C. Comparing different units within the same organisation is internal benchmarking. Its advantage is data accessibility; its limitation is that performance is bounded by the organisation's own ceiling. Competitive benchmarking uses external rivals; functional uses best-in-class regardless of sector; strategic compares overall business models. Its main limitation is that performance is bounded by the organisation's own ceiling — comparing within the group cannot benchmark against external best practice.

Answer: D. Shifting profit from 30%-tax Country X to 10%-tax Country Y saves the group 20% tax per pound transferred. A low transfer price reduces X's taxable profit and increases Y's, achieving this. This is why arm's-length transfer pricing rules exist — to prevent artificial profit shifting for tax purposes. Arm's-length transfer pricing rules under OECD guidelines (and most domestic tax codes) exist precisely to prevent this kind of profit-shifting for tax purposes.

Answer: A. ROCE is a financial measure of shareholder value, suited to the financial perspective. Customer satisfaction belongs in the customer perspective. Training hours sit in the learning and growth perspective. Defect rates belong in the internal business process perspective. Measures in the customer perspective might include customer satisfaction scores, retention rates or on-time delivery — all non-financial but directly relevant to the customer relationship.

Answer: B. Volume: 9,500 < 10,000 → adverse. Price: £54 > £50 → favourable. The two variances move in opposite directions — a common exam scenario designed to test whether candidates can distinguish between them independently. This combination — fewer units sold but at a higher price per unit — is common when quality or scarcity signals drive up price even as volume softens.

Answer: C. A cost centre manager controls only costs, so performance assessment should use cost variances comparing actual costs to budget. ROCE, revenue growth and net profit margin all incorporate revenues or capital that the manager cannot influence, creating unfair accountability. Using ROCE, revenue growth or net profit margin for a cost centre manager would create incentives over outcomes they cannot influence, undermining both fairness and motivation.

Answer: D. Training days per employee measures investment in employee development and organisational learning capacity — the defining focus of the learning and growth perspective. It is not a customer metric, a direct financial return, or an operational process efficiency measure, even though it ultimately contributes to all three. Contrast this with the financial perspective (revenue, ROCE) or customer perspective (satisfaction scores) — both are outcome measures rather than the enabling investments that sit in learning and growth.

Answer: A. Division B's contribution = £90 − TP − £45. Setting this to zero: TP = £90 − £45 = £45. At any price above £45, Division B earns a negative contribution from the transaction and would refuse. Division S's minimum is £30 (variable cost), so the negotiated range is £30–£45. Group contribution = £90 − £30 − £45 = £15 per unit, unchanged by the specific price within that range. £90 is the final selling price, which ignores Division B's own £45 of further costs.

Answer: B. ROI = operating profit ÷ net assets = £240,000 ÷ £1,600,000 = 0.15 = 15%. A common error divides net assets by profit (£1,600,000 ÷ £240,000 = 6.7), which reverses the calculation. The 24% figure might arise from dividing £240,000 by £1,000,000. The 12% is the cost of capital used in the RI calculation for the same division, not the ROI.

Answer: C. RI = operating profit − (net assets × cost of capital) = £240,000 − (£1,600,000 × 12%) = £240,000 − £192,000 = £48,000. The positive RI confirms the division earns above its required return. The £192,000 is the capital charge, not the RI. The £240,000 is the operating profit before the charge. The division's ROI (15%) exceeds the cost of capital (12%), consistent with a positive RI.

Answer: D. Including costs that the manager cannot influence makes their performance assessment depend on decisions made by others, which is unfair and typically demotivating. The controllability principle holds that performance measures should reflect what the manager can actually control. Head-office costs are real costs — they are simply not controllable at divisional level. The issue is one of fair attribution, not whether to share overhead information at all.

Answer: A. Forcing Division A to transfer at variable cost when an external market exists at a higher price means Division A earns nothing above its costs on internal transfers — it would always prefer the external sale. This is likely to demotivate the manager and create resistance to internal trading. A well-designed transfer price should reflect opportunity cost, particularly when a competitive external market exists. Variable cost pricing is only appropriate when there is no alternative use for the output and no external market.

Answer: B. Order fulfilment cycle time is an internal operational process measure — it reflects the efficiency and reliability of a key process that delivers value to customers. Revenue growth is a financial measure. Employee satisfaction relates to the learning and growth perspective. Cost of capital is a financial metric used in investment decisions, not an operational process measure.

Answer: C. When managers participate in setting their own budgets, they are more likely to perceive the targets as fair, to commit to achieving them, and to use local knowledge that improves budget quality. This increases ownership and motivation. Participation does not automatically reduce costs — it can also create budget slack if managers exploit the process to set undemanding targets. Slack remains a risk and must be managed. Participation is valuable at many levels of the organisation, not limited to senior management.

Answer: D. The balanced scorecard is explicitly designed around cause-and-effect linkages — improvements in the learning and growth perspective (training) drive better internal processes (quality), which improve the customer perspective (satisfaction), which ultimately deliver financial results (revenue). This is precisely the logic that makes the BSC a strategic tool rather than just a reporting dashboard. The four perspectives are interconnected, not independent. The linkages run from non-financial leading indicators to financial lagging outcomes, not the reverse.

Answer: A. Transfer prices that are set primarily to shift profit to low-tax jurisdictions distort the profit reported by each division, making divisional profit figures unreliable for assessing whether divisional managers are actually performing well. This is a genuine tension: the price optimal for tax may be quite different from the price that best reflects the economic value added by each division. Conflict between these objectives is common in practice, which is why multinational groups sometimes use different bases for external tax reporting and internal management reporting.

Answer: D. The customer perspective asks how the organisation should appear to its customers, and typically includes measures such as customer retention, satisfaction, market share, and service-level metrics like on-time delivery. Return on capital employed belongs to the financial perspective (how the organisation appears to shareholders), employee training hours sits within the learning and growth perspective (the organisation's capacity to improve), and order-to-cash cycle time is an internal business process measure (what the organisation must excel at operationally) — each of the four perspectives asks a distinct strategic question, and mapping a measure to the wrong one undermines the scorecard's cause-and-effect logic.

Answer: B. Lag indicators report on results that have already occurred — historical, outcome-focused measures like profit or market share achieved. Lead indicators instead track the drivers believed to influence those future outcomes — such as customer satisfaction, employee engagement, or new product development activity — giving management an earlier signal of likely future performance, before the lag outcome itself becomes known. The balanced scorecard is built around this idea: non-financial perspectives (customer, internal process, learning and growth) largely provide lead indicators for the lag indicators reported in the financial perspective. The distinction isn't a strict financial/non-financial split, isn't meaningless, and isn't tied to a specific organisational level.

Answer: D. Under the residual income calculation, the full £200,000 was expensed in the year, reducing that year's profit by £200,000. Under EVA, the £200,000 is instead capitalised and amortised over 4 years — only £50,000 (£200,000 ÷ 4) is charged as an expense in the current year. This means EVA profit is £150,000 higher than the RI-basis profit for this adjustment alone (£200,000 originally expensed, versus only £50,000 amortised) — before considering that capitalising the R&D also increases the capital employed base used for EVA's capital charge, which works in the opposite direction but is a separate effect not asked about here.

Answer: D. EVA starts from accounting profit but makes a series of adjustments intended to strip out distortions caused by accounting conventions — for example, capitalising expenditure like R&D or major marketing campaigns (which generate future economic benefit) rather than expensing it immediately, and adjusting the capital employed base accordingly. A capital charge (adjusted capital employed x cost of capital) is then deducted from this adjusted profit figure to arrive at EVA. It is not simply a percentage return like ROI, does not ignore the cost of capital, and is a genuinely different calculation from unadjusted residual income, not just a rebranding of it.