acca f5 revision 2011

F5 – Performance Management

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ACCAPAPER F5

PERFORMANCE MANAGEMENTJUNE 2011 REVISION CLASS

ACCAPAPER F5

PERFORMANCE MANAGEMENTJUNE 2011 REVISION CLASS

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Prepared by Gbenga Okubadejo

F5 - Management accounting

AMG PROFESSIONALS


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To provide a revision tool to students writing paper F5

To provide exam focus study that saves time

Presentation Objective


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Outline

F2 revision

Modern management accounting

Cost volume profit (CVP) analysis

The Concept of limiting factor analysis

Pricing decisions

Short-term decisions

Risk and uncertainty

Budget and budgetary control

Quantitative analysis in budgeting

Standard costing and variance analysis

Performance measurement


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1 F2 – Management accounting revisionF2 – Management accounting revision


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Introduction to Management accounting

Costing is the process of determining the cost of products, services or activities. Methods include absorption costing and process costing.

Direct cost = D.M + D.L + D. EXP

All direct production costs are referred to as PRIME COSTS.

Addition of all indirect costs = Overheads.

Direct + indirect = Total factor cost.

Absorption costing is a method of sharing out overheads incurred amongst units produced. It follows three processes: AllocationApportionmentAbsorption: may lead to under/over absorbed overhead

F2 – Management Accounting gave the background to paper f5. It is better you’re confident with the concepts and techniques learnt at the lower level.


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F2 revision

When sales fluctuate because of seasonality in sales demand but production is held constant, absorption costing avoids large fluctuations in profit. Prices based on marginal cost (minimum prices) does not guarantee profit.Absorption recognises that all costs are variable in the long run.It is the method allowed by accounting standards.

For absorptionFor absorption It shows how an organisation's cash flows and profits are affected by changes in sales volumes since contribution varies in direct proportion to units sold. By using absorption costing and setting a production level greater than sales demand, profits can be manipulated.Total costs need separation for decision making For short-run decisions in which fixed costs do not change, fixed costs are irrelevant.

For marginal costingFor marginal costing1 2


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2 Modern management accounting techniquesModern management accounting techniques

Activity based costing (ABC)

Target costing

Life cycle costing

Throughput accounting

Environmental accounting


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Activity based costing (ABC)

Steps to follow in ABC1Identify major activities.2 Identify cost drivers (factors which determine thesize of an activity/cause the costs of an activity).3 Collect costs associated with each activity intocost pools.4 Charge costs to products on the basis of thenumber of an activity’s cost driver they generate.

Cost drivers•Volume related (eg labour hrs) for costs that varywith production volume in the short term (eg powercosts)• Transactions in support departments for other costs(eg No of visit for site supervisor costs)

Why ACT is not enoughOne basis of absorption – volumeCompanies now produce variety of ProductsMay hide inefficiency.Allocate more ohds to volume-based product


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Target costingInvolves setting a target cost by subtracting adesired profit margin from a competitive marketprice The target cost may be less that the initialproduct cost but it is expected to be achievedby the time the product reaches maturityThere is a focus on price-led costing, customerrequirements and designSteps in target costiing1. Do market research to obtain a competitive price2. Determine the required magin3. Cal. target cost = estimated SP – req’d margin4. Compare the estimated costs with the target5. Cost gap exists if estimated > target.


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Life cycle costing

This method tracks and accumulates costsand revenues over a product’s entire life. This cycle include1. Development 2. Introduction 3. Growth 4.Maturity 5. Decline

1. Design costs out of products2. Minimise the time to market3. Minimise breakeven time4. Maximise the length of the life span5. Minimise product proliferation6. Manage the product’s cashflows

Maximising returns over the product life cycle


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Life cycle costing

Introduction Growth Maturity Decline

Sales

Profit

Time

Sales Volume


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Throughput accounting

In the short run, all costs except materials are fixed In a JIT environment, the ideal inventory level is zero. So unavoidable, idlecapacity in some operations must be accepted The factory spends money when goods are produced and a product makes money when it sold. Overall profitability is determined by how fast the product makes money compare to how the factory spends.

Throughput accounting ratio= Return per factory hour

Total conversion cost per factory hourTPAR > 1 = Continue ProductTPAR < 1 = Cease Product Before cessation, consider other qualitative factors. Or consider working on the product for TPAR to > 1.

Basic concept of throughput

F5 – Performance Management Environmental management accounting (EMA)

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The generation and analysis of both financial andnon-financial information in order to supportenvironmental management processes.

Definition

Typical environmental costs

Consumables and raw materialsTransport and travelWaste and effluent disposalWater consumptionEnergy

Importance Identifying environmental costs associatedwith individual products and services canassist with pricing decisions Ensuring compliance with regulatorystandards Potential for cost savings

F5 – Performance ManagementCost volume profit (CVP analysis)

How to calculate a multi-product breakeven point

1. Calculate the contribution per unit.

2. Calculate the contribution per mix.

3. Calculate the breakeven point in number of mixes.

4. Calculate the breakeven point in units and revenue.

How to calculate a multi-product C/S (or profit volume or P/V) ratio

Calculation of breakeven sales:

5. Calculate the revenue per mix.


7. Calculate the average C/S ratio.

8. Calculate the total breakeven point.

9. Calculate the revenue ratio per mix.

10.Calculate the breakeven sales.

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It is vital to remember that for multi-product Breakeven analysis, a constant product sales mix must be assumed.

F5 – Performance ManagementCost volume profit (CVP analysis)

Target profits


2. Calculate the required number of mixes.

3. Calculate the required number of units and

4. sales revenue of each product.

Limitations of CVP analysis It is assumed that fixed costs are the same in total and

variable costs are the same per unit at all levels of output It is assumed that sales prices will be constant at all

levels of activity Production and sales are assumed to be the same Uncertainty in estimates of fixed costs and unit variable

costs is often ignored

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F5 – Performance ManagementDecision making time

“Decision making is an important aspect of the Paper F5 syllabus, and questions on this topic will be common…….but this article will focus on only one: linear programming.”

Excerpts from technical article by

Geoff Cordwell former examiner for

Paper F5.

“…….The first step in any linear programming problem is to produce the equations for constraints and the contribution function. This should not be difficult at this level.”

F5 – Performance ManagementLinear programming

Formulating the problem

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Steps in linear programming

1. Define variable

2. Construct objective function

3. Establish constraints

4. Graph

5. Find the optimal solution

There are two methods of finding the optimal solution:

1. Graphical method

2. Using equations

F5 – Performance ManagementLinear Programming

Shadow price

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SurplusSlack

Occurs when maximum availability of a resource is not used.The resource is not binding at the optimal solution. Slack is associated with ≤ constraints.

Occurs when more than a minimum requirement is used.Surplus is associated with ≥ constraints eg a minimum production requirement

It is the increase in contribution created by the availability of an extra unit of a limited resource at its original cost. It is the maximum premium an organisation should be willing to pay for an extra unit of a resource.It provides a measure of the sensitivity of the result.It is only valid for a small range before the constraint becomes non-binding or different resources become critical.

F5 – Performance ManagementPricing decisions

Influence on price

1. Cost

2. Demand

3. Income level

4. Competition

5. Quality perception

6. Market structure

7. Product life cycle

8. E.c.t.

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A measure of the extent of change in market demand for a good, in response to a change in its price= change in quantity demanded, as a % of demand ÷ change in price, as a % of price

Price elasticity of demand (η)

Inelastic demand η < 1 Demand falls by a smaller % than % rise in price Pricing decision: increase prices

Elastic demand η > 1 Demand falls by a larger % than % rise in price Pricing decision: decide whether change in cost will be less than change in revenue.

NB: For pricing strategy to be adopted, make reference to PED.

F5 – Performance ManagementProfit Maximisation

Profits are maximised when

MC = MR.

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Determining the profit-maximising selling price/output level

Full cost plusAdvantagesQuick, simple, cheap methodEnsures company covers fixed costs.DisadvantagesDoesn’t recognise profit maximising price and outputBudgeted output needs to beestablishedSuitable basis for overheadabsorption needed

Penetrating pricingSkimming pricingProduct-line pricingComplimentary pricing

Other Pricing strategy

Pricing strategy

F5 – Performance ManagementShort-term decisions

Future e.g sunk not relevant

Incremental e.g the amount by which fixed cost steps up

Cash flows e.g provisions, notional costs, absorbed overheads not relevant.

N.B:

1. Useful for one-off contract

2. Minimum pricing

3. The key note is “I don’t want to be worse off”. if I can’t make money then I don’t wanna loose any!

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Compare internal differential production costs with supplier’s quotation.Consider other qualitative factors before sub-contracting or outsourcing

Relevant costs are Make or Buy

F5 – Performance ManagementShort-term decision

Further processing decision

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Determine the contribution earned on the current operation.Calculate incremental costs and revenueCompare the results and act accordingly.Bear in mind that some fixed costs may no longer be incurred if the decision is to shut down and they are therefore relevant to the decision.Consider the size of the incremental contribution that would be earn.Lastly, consider other qualitative factors e.g current brand loyalty, legal implication, social effect, accuracy of data available.

Any short-term decision must consider qualitativefactors related to the impact on employees, customers, competitors and suppliers

Shut down decision

F5 – Performance ManagementRisk and uncertainty

The technique that a decision maker will use in dealing with risk and uncertainty will be dependent on his risk attitude.

Attitude to risk Risk seeker A decision maker interested in the

best outcomes no matter how small the chance that they may occur

Risk neutral A decision maker concerned with what will be the most likely outcome

Risk averse A decision maker who acts on the assumption that the worst outcome might occur

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F5 – Performance ManagementMethods of dealing with risk and uncertainty

Methods of dealing with risk and uncertainty

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Market research: Primary & secondary Expected values (EV) - indicate what an outcome is

likely to be in the long term with repetition. The expected value will never actually occur. EV = PR * OUTCOME

Decision rule: This involves calculation of 1. Maximax2. Maximin3. Minimax regret rule Sensitivity analysis Simulation Brainstorming or scenario building

F5 – Performance ManagementBudgeting and budgetary control

Ensure the organisation’s objectives are achieved

Compel planning Communicate ideas and

plans Co-ordinate activities Provide a framework for

responsibility accounting Establish a system of control Motivate employees to

improve their performance

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Objectives of a budgetary planning and control system

At the planning stage– Managers may fail to co-ordinate plans with those of other budget centres.– They may build slack into expenditure estimates. When putting plans into action– Minimal co-operation and communication between managers.– Managers might try to achieve targets but not beat them. Using control information– Resentment, managers seeing the information as part of a system of trying to find fault with their work.– Scepticism of the value of information if it is inaccurate, too late or not understood.

Negative effects of budgets include

F5 – Performance ManagementBudgetary systems

Traditional budgetary systems

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This involves adding a certain percentage to lastyear’s budget to allow for growth and inflation. Itencourages slack and wasteful spending to creepinto budgets.

Incremental budgeting

These are prepared on the basis of an estimatedvolume of production and an estimated volume ofsales. No changes are made to the budgets and are not adjusted (in retrospect) toreflect actual activity levels.

Fixed budget

These are budgets which, by recognising different cost behaviour patterns, change as activity levels change. At the planning stage, flexible budgets can be drawn up to show the effect of the actual volumes of output and sales differing from budgeted volumes. At the end of a period, actual results can be compared to a flexed budget (what results should have been at actual output and sales volumes) as a control procedure.

Flexible budget

F5 – Performance Management Zero-based budgeting

This approach treats the preparation of the budget for each period as an independent planning exercise: the initial budget is zero and every item of expenditure has to be justified in its entirety to be included. It is usually developed as a package.

Steps in ZBB

1. Define decision packages

2. Evaluate and rank packages on the basis of their benefit to the organisation.

3. Allocate resources according to the funds available and the ranking of packages.

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Zero-based budgeting

Identifies and removes inefficient and/or obsoleteoperations Provides a psychological impetus to employees toavoid wasteful expenditure Leads to a more efficient allocation of resources

Merit

F5 – Performance ManagementStandard costing

To act as a control device (variance analysis)

To value inventories and cost production

To assist in setting budgets and evaluating managerial performance

To enable the principle of ‘management by exception’ to be practiced

To provide a prediction of future costs for use in decision-making situations

To motivate staff and management by providing challenging targets

To provide guidance on possible ways of improving efficiency

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Types of standard

Uses of standard costing

Ideal Perfect operating conditions Unfavourable motivational impactAttainable Allowances made for inefficiencies and wastage Incentive to work harder (realistic but challenging)Current Based on current working conditions No motivational impactBasic Unaltered over a long period of time Unfavourable impact on performance

F5 – Performance ManagementVariance analysis

A standard cost card will look as follows:

$/unit

Direct material (20kg@$5/kg) 100

Direct labour (10hrs@$5/hr) 50

Prime costs 150

Variable Overheads(10hrs@$10/hr) 100

Total variable cost 250

Fixed cost (10hrs@$12/hr) 120

Total factory cost 370

Profit (25% mark-up) 92.50

Selling price 462.50

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F5 – Performance ManagementReasons for variances

Material price (F) – unforeseen discounts received

(A) – price increase, careless purchasing

Material usage (F) – material used higher quality than standard

(A) – defective material, waste, theft

Labour rate (F) – use of less skilled (lower paid) workers

(A) – rate increase

Idle time (always (A)) – machine breakdown, illness

Labour efficiency (F) – better quality materials

(A) – lack of training

Overhead expenditure (F) – cost savings

(A) – excessive use of services

Overhead volume - production greater or less than budgeted

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F5 – Performance ManagementPlanning and operation

Planning variances

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Caused by adverse/favourable operational performanceCalculated by comparing actual results with a realistic, revised standard/budget

Operational variances

Arise because of inaccurateplanning/faulty standards and sonot controllable by operationalmanagers but by senior management

Calculated by comparing anoriginal standard with a revisedstandard

F5 – Performance ManagementPerformance measurement

Financial performance indicators (FPI)

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Non-financial performance indicators (NFPI)Profitability ratio

ROCE Profit margin Sales growth Asset turnover Liquidity ratios

Inventory days Receivable days etc

Look at a wider range of variables Provide information on quality and customer satisfaction Better indicator of future prospects Can be provided quickly and tailored to circumstances

F5 – Performance ManagementBalanced Scorecard

Perspective Question Explanation

Customer What do existing and new customers value from us?

Gives rise to targets that matter to customers: cost,quality, delivery, inspection, handling and so on.

Internal What processes must we excel at to achieve our financial and customerobjectives?

Aims to improve internal processes and decisionmaking.

Innovation andlearning

Can we continue to improve and createfuture value?

Considers the business's capacity to maintain its competitive position through the acquisition of new skills and the development of new products.

Financial How do we create value for our shareholders?

Covers traditional measures such as growth, profitability and shareholder value but set through talking to the shareholder or shareholders direct.

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F5 – Performance ManagementNot-for-profit organisations

Problem with performance measurement

Multiple objectives Measuring outputs Lack of profit measure Nature of service provided Financial constraints Political, social and legal

considerations

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Judge performance in terms of inputs Use experts’ subjective judgment Use benchmarking Use unit cost quantitative measures

Suggested way out

F5 – Performance ManagementValue for money

3 E’S

Efficiency: Relationship between inputs and outputs (getting out as much as possible for what goes in)

Effectiveness: Relationship between outputs and objectives (getting done what was supposed to be done)

Economy: Obtaining the right quality and quantity of inputs at lowest cost (being frugal)

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For further reading: BPP revision kits


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acca f5 revision 2011

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