(a) Meldo Division is part of a vertically integrated group where all divisions sell externally and transfer goods to other divisions within the group. Meldo Division management performance is measured using controllable profit before as the performance measurement criterion.
(i) Show the cost and revenue elements which should be included in the calculation of controllable divisional profit before tax.
(ii) Discuss ways in which the degree of autonomy allowed to Meldo Division may affect the absolute value of controllable profit reported. (9 marks)
(b) Kitbul Division management performance is measured using controllable residual income as the performance criterion. Explain why the management of Kitbul Division may make a different decision about an additional investment opportunity where residual income is measured using:
(i) Straight-line depreciation or
(ii) Annuity depreciation based on the cost of capital rate of the division.
Use the following investment information to illustrate your answer: Investment of £900 000 with a three year life and nil residual value.
Net cash inflow each year of £380 000.
Cost of capital is 10 per cent. Imputed interest is calculated on the written-down value of the investment at the start of each year. Present value of an annuity of £1 for three years at 10 per cent interest is £2.487.