Q4 June 2015

I’m not sure that I understand you query. However, the question states:

“The Baby division has been very successful in using the ideas of the R&D division”

In terms of measuring performance of the baby division it is fair that that division bears some of the R&D costs as R&D have helped to make it successful. If it were a stand-alone company then it would have to bear its own R&D.

As the answer says:

“The key assumption in the calculation of both metrics is which profit figure to use.

Controllable profit relates to those revenues and costs under direct control of the divisional manager but this does not reflect the R&D costs, although it takes account of the revenues which new products are generating. It would be more appropriate to include these costs in an assessment of the divisional managers’ performance, especially if the product development was at the request of the divisional management and the transfer price was widely agreed. The assessment of the division itself should include all relevant operating costs and so the divisional profit would be the appropriate figure to use.”

In other words some judgement is needed when trying to measure performance. It would not be quite fair to give the divisional manager full credit for all revenue without perhaps charging some of the R&D.