ACCA Performance Management (F5) Certification Practice Exam

How is Residual Income (RI) calculated?

1. Controllable profit + Capital employed

2. Controllable profit - Notional interest on capital

3. Net income - Operational expenses

4. Gross profit - Tax liabilities

The correct answer is: Controllable profit - Notional interest on capital

Residual Income (RI) is a performance measurement tool that evaluates the profitability of a business unit after accounting for the cost of capital. It helps determine whether the unit has generated sufficient profit to cover its capital costs. The calculation of RI involves taking the controllable profit (or net income) and subtracting the notional interest on the capital employed in that business unit. This adjustment is essential because it provides a clearer picture of whether the unit is truly adding value beyond just covering its capital costs. By considering the return that investors require for their investment in terms of capital costs, RI gives a more comprehensive measure of economic performance. In contrast, other options do not align with the definition and calculation of residual income. For instance, simply adding controllable profit to capital employed does not account for the cost of capital, which is critical for understanding whether the profits exceed the necessary returns expected by investors. Similarly, net income minus operational expenses or gross profit minus tax liabilities does not incorporate the cost of capital into the performance measure, making them irrelevant in the context of calculating RI.