exp accaf5

8/22/2019 ExP ACCAF5

1/39

ACCA Paper F5Performance Management

For exams in 2011

Notes

theexpgroup.com


2/39

ExPress Notes

ACCA F5 Performance Management

Page | 2 2011 The ExP Group. Individuals may reproduce this material if it is for their own private study use only. Reproduction by any means for anyother purpose is prohibited. These course materials are for educational purposes only and so are necessarily simplified and summarised. Alwaysobtain expert advice on any specific issue. Refer to our full terms and conditions of use. No liability for damage arising from use of these noteswill be accepted by the ExP Group.

theexpgroup.com

Contents

About ExPress Notes 3

1. Specialist Cost & Management AccountingTechniques

7

2. Decision Making Linear Programming 103. Pricing Decisions 124. Make-or-buy and other short-term decisions 165. Risk and Uncertainty in Decision Making 196. Budgeting an Introduction 227. Budgeting and Standard Costing #1 268. Budgeting and Standard Costing #2 329. Performance Measurement & Control 35


3/39

ExPress Notes



theexpgroup.com

STARTAbout ExPress Notes

We are very pleased that you have downloaded a copy of our ExPress notes for this paper.

We expect that you are keen to get on with the job in hand, so we will keep the introduction

brief.

First, we would like to draw your attention to the terms and conditions of usage. Its a

condition of printing these notes that you agree to the terms and conditions of usage.

These are available to view at www.theexpgroup.com. Essentially, we want to help people

get through their exams. If you are a student for the ACCA exams and you are using these

notes for yourself only, you will have no problems complying with our fair use policy.

You will however need to get our written permission in advance if you want to use these

notes as part of a training programme that you are delivering.

WARNING! These notes are not designed to cover everything in the syllabus!

They are designed to help you assimilate and understand the most important areas for the

exam as quickly as possible. If you study from these notes only, you will not have covered

everything that is in the ACCA syllabus and study guide for this paper.

Components of an effective study system

On ExP classroom courses, we provide people with the following learning materials:

The ExPress notes for that paper The ExP recommended course notes / essential text or the ExPedite classroom

course notes where we have published our own course notes for that paper

The ExP recommended exam kit for that paper. In addition, we will recommend a study text / complete text from one of the ACCA

official publishers, but we do not necessarily give this as part of a classroom course,

as we think that it can sometimes slow people down and reduce the time that they

are able to spend practising past questions.

ExP classroom course students will also have access to various online support materials,

including:

The unique ExP & Me e-portal, which amongst other things allows view again ofthe classroom course that was actually attended.

ExPand, our online learning tool and questions and answers databaseEverybody in the World has free access to ACCAs own database of past exam questions,

answers, syllabus, study guide and examiners commentaries on past sittings. This can be


4/39

ExPress Notes



theexpgroup.com

an invaluable resource. You can find links to the most useful pages of the ACCA database

that are relevant to your study on ExPand at www.theexpgroup.com.

HowtogetthemostfromtheseExPressnotesFor people on a classroom course, this is how we recommend that you use the suite of

learning materials that we provide. This depends where you are in terms of your exam

preparation for each paper.

Your stage instudy foreach paper

These ExPressnotes

ExPrecommendedcourse notes, orExPedite notes

ExPrecommendedexam kit

ACCA onlinepast exams

Prior tostudy, e.g.deciding whichoptional papersto take

Skim throughthe ExPress notesto get a feel forwhats in thesyllabus, the

size of the paperand how much itappeals to you.

Dont use yet Dont use yet Have a quicklookat the twomost recent real

ACCA exampapers to get afeel forexaminers style.

At the start ofthe learningphase

Work througheach chapter ofthe ExPress notes

in detail beforeyou then workthrough yourcourse notes.

Dont try to feelthat you have tounderstandeverything justget an idea forwhat you areabout to study.

Dont make anyannotations onthe ExPress notesat this stage.

Work through indetail. Revieweach chapter after

class at least once.

Make sure that youunderstand eacharea reasonablywell, but also makesure that you canrecall keydefinitions,concepts,approaches to examquestions,mnemonics, etc.

Nobody passes anexam by what theyhave studied we

pass exams bybeing efficient inbeing able to provewhat we know. Inother words, youneed to haveeffectively input theknowledge and beeffective in theoutput of what youknow. Exampractice is key to

this.Try to do at leastone past examquestion on thelearning phase foreach major chapter.

Dont use atthis stage.


5/39

ExPress Notes



theexpgroup.com

Your stage instudy for eachpaper

These ExPressnotes

ExPrecommendedcourse notes, or

ExPedite notes

ExPrecommendedexam kit

ACCA onlinepast exams

Practice phase Work throughthe ExPress notesagain, this timeannotating toexplain bits thatyou think are easyand be braveenough to crossout the bits thatyou are confident

youll rememberwithout reviewingthem.

Avoid readingthrough yournotes again. Tryto focus on doingpast examquestions first andthen go back toyour course notes/ExPress notes iftheres something

in an answer thatyou dontunderstand.

This isyour mostimportant toolat this stage. Youshould aim tohave workedthrough andunderstood atleast two or threequestions on eachmajor area of the

syllabus. You passreal exams bypassing mockexams. Dont betempted to fallinto passiverevision at thisstage (e.g.reading notes orlistening to CDs).Passive revisiontends to be awaste of time.

Download thetwo most recentreal examquestions andanswers.

Read through thetechnicalarticles writtenby the examiner.

Read through thetwo most recentexaminersreports in detail.Read throughsome other olderones. Try to see ifthere are anyrecurringcriticisms he orshe makes. Youmust avoid these!

The nightbefore the realexam

Read throughthe ExPressnotes in full.Highlight the bitsthat you think areimportant but youthink you are mostlikely to forget.

Unless there arespecific bits thatyou feel you mustrevise, avoidlooking at yourcourse notes. Giveup on any areasthat you still dontunderstand. Itstoo late now.

Dont touch it! Do a final reviewof the two mostrecentexaminersreports for thepaper you will betaking tomorrow.

At the door ofthe exam roombefore you goin.

Read quicklythrough the fullset of ExPressnotes, focusing onareas youvehighlighted, keyworkings,approaches toexam questions,etc.

Avoid looking atthem in detail,especially if thenotes are very big.It will scare you.

Leave at home. Leave at home.


6/39

ExPress Notes



theexpgroup.com

Our ExPress notes fit into our portfolio of materials as follows:

Notes Notes NotesProvide a baseunderstanding ofthe most importantareas of thesyllabus only.

Provide acomprehensivecoverage of thesyllabus andaccompany ourface to faceprofessional examcourses

Provide detailedcoverage ofparticular technicalareas and are usedon our ProfessionalDevelopment andExecutiveProgrammes.

To maximise your chances of success in the exam we recommend you visit

www.theexpgroup.com where you will be able to access additional free resources to help

you in your studies.

START

About The ExP Group

Born with a desire to be the leading supplier of business training services, the ExP Group

delivers courses through either one of its permanent centres or onsite at a variety of

locations around the world. Our clients range from multinational household corporate

names, through local companies to individuals furthering themselves through studying for

one of the various professional exams or professional development courses.

As well as courses for ACCA and other professional qualifications, our portfolio of expertisecovers all areas of financial training ranging from introductory financial awareness courses

for non-financial staff to high level corporate finance and banking courses for seniorexecutives.

Our expert team has worked with many different audiences around the world ranging from

graduate recruits through to senior board level positions.

Full details about us can be found at www.theexpgroup.com and for any specific enquiries

please contact us at [email protected].


7/39

ExPress Notes



theexpgroup.com

Chapter 1

Specialist Cost & ManagementAccounting Techniques

KEY KNOWLEDGEActivity Based Costing (ABC)

ABC is a method that seeks to group overhead costs according to the activities causingthose costs. The activities giving rise to the costs are called cost drivers. By linking costs toactivities (cost drivers), it becomes possible to charge costs to the agents undertaking thoseactivities.

EXAMPLE

A factory clinic with total annual costs of $500,000 serves two Workshops A and B.Workshop A has 200 employees and Workshop B has 300 employees.


8/39

ExPress Notes



theexpgroup.com

A conventional way of apportioning the cost would be on the basis of employees:

Workshop A: (200/500) x 500,000 = 200,000Workshop B: (300/500) x 500,000 = 300,000

500,000

An ABC approach might look at the number of visits to the clinic by the employees of A andB.

Workshop A: 150 visits p.a.Workshop B: 70 visits p.a.

In this case, the apportionment could be:

Workshop A: (150/220) x 500,000 = 340,909Workshop B: ( 70/220) x 500,000 = 159,091

500,000

The different levels of usage may reflect different degrees of occupational hazard present inthe two workshops.

ABC advantages: provides a more precise way to determine costs per unit of output,especially since not all overhead costs are driven by production volumes.

Budgetary planning, pricing decisions and managing performance are all facilitated by ABC.

ABC disadvantages: it can be complex and costly to implement. It is not a plug-in-and-gosystem! It is therefore imperative that management carefully weigh the costs against the(expected) benefits from ABC before deciding to implement it.

KEY KNOWLEDGETarget costing

This is a market-oriented approach to costing which starts by identifying the likely price thata product can fetch in the market, deducts the profit that the product is expected to earn,and arrives at the maximum (target) cost of manufacturing the product.

Such a method usually requires successive iterations in order to close a cost gap, i.e.where the costs are above the targeted level. Product re-design, alternative materials andproduction processes are examined in order to achieve the desired level of costs.


9/39

ExPress Notes



theexpgroup.com

KEY KNOWLEDGELife-cycle costing

A product normally lives beyond one accounting period and the costs connected to itsdevelopment/design, launch and maintenance fall unevenly across time periods. Thismethod takes a comprehensive view of the costs relating to the product throughout its life-cycle.

KEY KNOWLEDGEBack-flush Accounting

This is a simplified costing method which can be used in conditions of short operationalcycles and low inventories. Companies working on a Just-In-Time (JIT) basis may practise it,as it avoids the detailed tracking of costs during production; instead, it records costs whengoods are completed. These costs are then back-flushed through the system based onstandard costs.

KEY KNOWLEDGEThroughput accounting

This method is also consistent with a JIT environment and focuses on the bottlenecks in aproduction process; by eliminating these bottlenecks, it raises the amount of output that canflow through the process (assuming there is demand for the output the idea is not toproduce for inventory!).

The throughput accounting approach itself considers all costs (including direct labour) asfixed and treats only direct materials as being variable in the short term.


10/39

ExPress Notes



theexpgroup.com

Chapter 2

Decision Making LinearProgramming

KEY KNOWLEDGEMulti-limiting factors and the use of linearprogramming and shadow pricing.

When resources are scarce, or other limiting factors are present in a given situation, thenmanagement is concerned with achieving the most efficient allocation of available resources.

Whereas planning with one limiting factor involves the use of key factor analysis (in whichtypically one seeks to maximize the contribution per unit of the limited, or bottleneck,resource see Paper F2), the presence of several limiting factors requires the use of linear

programming.

In such cases, linear programming is typically used to either maximise contribution or tominimize costs. The usual steps to be followed are:

1) Define the variables2) Define the objective function3) Express the constraints as equations4) Solve the equations simultaneously as well as feasible values corresponding to

the corner points;5) Determine the combination of specific values that satisfies the objective function.


11/39

ExPress Notes



theexpgroup.com

The answer can also be graphed and Step 5 determined visually. A graph also shows thefeasible region of value combinations that are consistent with the constraints.

EXAMPLE

An aircraft manufacturing company producing propellers and wing ribs operates under thefollowing conditions:

Propellers Wing ribs (set)Materials (kg) 6 12

Labour (hrs) 8 6Contribution ($) 50 30

Materials are limited to 120 kg. per week while labour must not exceed 100 hours.

1) Define the variables:p = propellersw = wing ribs

2) Maximise contribution = 50p + 30w3) Materials: 6p + 12w 120Labour: 8p + 6w 1004) Simultaneous solving results in: p = 8 and w = 6; the feasible corner points are p =

12.5 (when w=0) and w = 10 (when p=0)

5) Calculate the highest contribution at each of the combinations in Step 4This can also be graphed for easier visualisation of the feasible region and solution.

Shadow (dual) price

A shadow price is the additional value to be obtained (usually an increase in contribution) byhaving available one more unit of a scarce resource. In the example above, the shadowprice of 1 kg of material can be determined by re-solving the simultaneous equations with121 (kg) substituted for 120. Similarly, the shadow price of an additional hour of labour canbe expressed by re-solving the equations with labour equal to 101, and determining whatthe increase in contribution will be.

Slack

This represents the amount of a resource that has not been exhausted (i.e. its availabilitydoes not act as a constraint or limiting factor in a given set of circumstances).


12/39

ExPress Notes



theexpgroup.com

Chapter 3

Pricing Decisions

STARTThe Big Picture

The pricing of a product or service is crucially influenced by several factors:

Internal: How much does it cost us to produce it?

External: How much is a customer willing to pay for it?

The latter is further influenced by how much the competition is charging for the same (orsimilar) product or service.

KEY KNOWLEDGEThe price elasticity of demand (PED)

This measures the sensitivity of (customer) demand to a change in prices. There is usuallyan inverse relationship: when price goes up, demand goes down (and vice versa).

PED = % change in demand% change in price


13/39

ExPress Notes



theexpgroup.com

EXAMPLE

A cinema increases its ticket prices from $4 to $6; as a result, the number of cinema goersdrops from 2,000 to 1,500.

The PED = (500/2000) = 25% = 0.5 (Note:Ignore + or signs; take the absolute value)(2/4) 50%

In the above example, demand is considered inelastic, because the PED < 1. When PED >1, then demand is considered elastic.

KEY KNOWLEDGEDemand Equation

Whereas the PED is expressed in percentages, the demand equation (or function) isportrayed as a downward sloping straight line which shows price and demand combinationsin their full values. The equation is expressed as

P = a bQ

Where:

P = price corresponding to the dependent variable (y-axis) on a graph;

Q = (Quantity) demanded corresponding to the independent variable (x-axis);

a = the maximum price (where Q = 0) -- corresponding to the y-intercept; and

b = the slope of the (negatively-sloping) line (change in P / change in Q)

EXAMPLE

On an average Saturday night, a cinema (capacity: 225) attracts 150 visitors at a price of$5. If the price of the ticket is decreased by $0.50 then 25 more people will come.

In order to fill up the cinema, the ticket price would have to be set at:


14/39

ExPress Notes



theexpgroup.com

5 = a (0.50/25) x 150; therefore, a = 8, and

P = 8 0.02Q

At Q = 225, P = $3.50

KEY KNOWLEDGETotal Cost Function

An equation can also be formulated to express the relationship between total costs andvariable costs:

Y = aX + b

Where:

Y = Total costs;

X = Output corresponding to the independent variable;

a = fixed cost corresponding to the Y-intercept;

b = the variable cost per unit -- corresponding to the slope of the total cost line

EXAMPLE

The variable cost per unit of a bottling process is 10 cents per unit. Fixed costs amount to$5,000. At an output level of 20,000 units, what is the total cost?

Y = $5,000 + ($0.10) x 20,000

= $7,000

When working with bulk discounts and other sales volumes, it is important to make surethat fixed costs remain unchanged over the output range covered. If they increase (as aresult of expanding the production capacity, for example) then the new (higher) level offixed costs need to be included in the calculation of total costs.


15/39

ExPress Notes



theexpgroup.com

KEY KNOWLEDGEPricing Strategies

There are a variety of pricing strategies with which one should be familiar:

Cost plus:A mark-up is added to a given cost base (which can be variable or full production

cost).

Skimming: Enter the market at a high price to catch customers willing and able to pay the

price.

Penetration pricing: Go in at a very low price to win market share.

Premium pricing: Maintain a high price due to the nature of the product.

Target pricing: This method backs into the price by calculating the required profit and the

possible production costs first.

Promotional Pricing: These are in support of campaigns to raise customer awareness of a

product.

Perceived value pricing: Plays on perception of value and what the market is willing to pay.

Value Pricing: Increasing the value content of the product so as to defend market share (intimes of difficult economic conditions or competition).

Product-line pricing: Sell a core product cheaply and price high related products.

Volume-discounting pricing: The bigger the order, the lower the price per unit.

Discriminatory pricing: Pricing the same product at different levels in different markets

(geographical) or market segments (customers).

Psychological Pricing: Plays on the emotion of the consumer.

Product Bundle Pricing: Combining products into one pack and pricing it overall.

Complementary product pricing: This refers to products that are used in conjunction withother products (e.g. printers and cartridges, razor grips and blades, staplers and staples,automobiles and spare parts). Typically, the approach to pricing may be low for the mainproduct and more expensive for the re-fills.

Relevant cost pricing: Basing the price on a keen (accurate) understanding of the real costsof the product or service.


16/39

ExPress Notes



theexpgroup.com

Chapter 4

Make-or-buy and other short-term

decisions


One of managements responsibilities involves making decisions affecting the firm in the

short-run based on relevant costs.

What is relevance?

A relevant cost is a cash cost which is uniquely incurred (or avoided) as a consequence of

taking a decision; cash, because it is the main determinant of value (unlike accounting

profit); and unique in the sense that is not common to the alternative choices that are under

consideration.


17/39

ExPress Notes



theexpgroup.com

EXAMPLE

A company seeking to determine whether to continue to transport its products by truck or to

switch to the railroad discovers that insurance costs are identical in both choices; in that

case, insurance costs are not relevant to the decision.

If, however, there is a difference in the two insurance costs, then one can speak of the

difference between the two choices as being incremental; this difference (referred to in

some places as the differential) is relevant to the decision under consideration.

Future

Relevant costs refer to the future, i.e. they can be influenced prospectively by choice. It

follows that:

Sunk costs are not relevant: They have already taken place and cannot be reversed.

Committed costs, if they cannot be avoided, are likewise not relevant, even if the timing of

their occurrence is in the future. Their unavoidability has already been established in the

past (making them effectively the equivalent of sunk costs).

In keeping with the above logic, relevant costs therefore involve cash, are incremental and

relate to the future.

Relevant costs need to be identified with care, as they may include opportunity costs.

EXAMPLE

A company considers building a storage facility on the site of a parking lot. If the parking lot

had been generating parking fees which will now be lost, then this foregone revenue is an

opportunity cost.

Make-Buy

A make-buy decision requires the determination of all relevant costs.


18/39

ExPress Notes



theexpgroup.com

EXAMPLE

An automotive components producer can supply itself externally with car heaters for $210

per unit. In considering whether to make these internally, the company calculates that an

equivalent unit can be made in 2 labour hours using $100 worth of materials.

Labour is currently at full capacity producing carburettors which generate contribution of

$100. A carburettor takes 2.5 hours to produce. Labour costs $10 per hour. The carburettor

also absorbs fixed overhead costs at the rate of $20 per labour hour.

The relevant costs are ($):

Materials: 100

Contribution lost (carburettors): 80

Labour (added-back): 20

200

It is cheaper to produce internally.

Shut Down decisions

Whether to close a plant making (accounting) losses depends on relevant costs:

Superior

Revenues (m) 40

Costs (m) (44)

Profits (m) (4)

If 25% of the costs are fixed costs allocated by H.O., then it appears that closing the plantwill leave the company worse off, as 40m in revenues and only 33m in costs will disappear.

A careful examination of all costs needs to be made before arriving at a final decision.


19/39

ExPress Notes



theexpgroup.com

Chapter 5

Risk and Uncertainty in DecisionMaking


Risk, whichever way it is defined, is a quantification of probability. In other words, it issusceptible to measurement, statistically or mathematically. Risk may be viewed as relatingto objective probabilities.

Uncertainty, in contrast to risk, is not capable of being quantified. It has also been referredto as subjective probability (or unmeasurable uncertainty).

Expected Value

Profit/(Loss) ProbabilityExpectedValue

340 10% 34.0

766 20% 153.2

278 50% 139.0

450 18% 81.0

(230) 2% (4.6)

100% 402.6


20/39

ExPress Notes



theexpgroup.com

KEY KNOWLEDGESensitivity

Sensitivity Analysis

This asks the following question: What happens to the NPV of a project if certain keyvariables are altered. It is a one-dimensional approach as it isolates and alters each (key)variable in turn in order to measure the impact.

Sensitivities by scenario

One can also go beyond determining project sensitivity to one variable and define scenarios,in which several variables move simultaneously (as outlined in the previous paragraph).Based on these scenarios, the NPV outcomes can be evaluated.

KEY KNOWLEDGESimulation

Simulation -- Monte Carlo

This is a simulation model that uses probability distribution analysis to analyze the possibleoutcomes of a project. It is built on the simultaneous changes of many variables, therelationships between these variables being defined in advance, e.g. if price is reduced, howmuch demand may go up.

Each variable itself has a probability distribution and the combinations of variables aremodeled through running the model repeatedly by computer, resulting in a distribution ofsimulation results.


21/39

ExPress Notes



theexpgroup.com

KEY KNOWLEDGEMaximax, maximin and minimax regret

In the absence of (numerical) probabilities, a decision maker may act on the basis of hisattitude toward uncertainty. Here are examples of three techniques as they relate to thefollowing choices regarding developing a business:

Profits Strategy1 2 3

Outcomes:A 25 30 20

B 50 35 55C 60 40 45

Maximax going for the upside: Chooses Strategy 1 (to keep the door open to a profit of60).

Maximin limit the downside: Choose Strategy 2 (one cannot do worse than 30).

Minimax regret limit the opportunity cost of getting it wrong.

To determine this, one needs to quantify the regrets under each Outcome. For example:

If the Outcome turns out to be A, then Strategy 2 (=30) would have been the best strategy.

Regrets: Choosing Strategy 1 (=25) would have missed by 5 (30-25); whileChoosing Strategy 3 (=20) would have missed by 10 (30-20).

We can modify the table above to show all the regrets (opportunity costs) under eachOutcome:

Regrets Strategy1 2 3

Outcomes: A (5) Best (10)B (5) (20) BestC Best (20) (15)

Maximum regrets (5) (20) (15)

Conclusion: Minimizing the maximum regret leads to Strategy 1.


22/39

ExPress Notes



theexpgroup.com

Chapter 6

Budgeting an introduction


Budgets

A budget is a quantitative plan addressing the future.

Budgetary control systems seek to monitor performance against the budget in a timely wayso that deviations can be identified and rectified. The system can only work as well as thecare and thought that went into defining performance targets to be measured, and theincentives (and sanctions) that follow from achievement (or not) of those targets.

Goal congruence at all levels of the organisation corporate, divisional and individual mustexist for a budget, and its attendant control systems, to be effective.

Problems frequently encountered when using conventional budgets:

They invite gaming of the system; They can be inflexible; They are often imposed from the top Top Down; There is an indirect connection with the companys strategy; They are used for too many different purposes; They reinforce centralising tendencies in the company; There is a lack of goal congruence between corporate, divisional and individual goals


23/39

ExPress Notes



theexpgroup.com

KEY KNOWLEDGEBudgetary Systems / Types of Budgets

Fixed

A fixed budget is not adjusted to the actual volume of output (activity level)

Flexible vs. Flexed

The distinction is sometimes overlooked:

Flexible: designed to change according to actual volumes of output; usually donebefore the start of the budgetary period as a sort of scenario planning;

Flexed: This is done after the fact and is based on the actual level of activityachieved.

Zero-based (ZBB)

Each year, budget owners must justify the entire budget (build it from zero) At odds with incremental budgeting (where only changes need justification, hence

encouraging the spend it or lose it mentality)

A three-step approach to ZBB:1. Define decision packages (i.e. activities that result in costs or revenues),

distinguishing between mutually exclusive packages (alternative activities to

achieve the same result) and incremental packages (base level of input needed

+ additional inputs)

2. Evaluate and rank packages (based on the benefit to the organisation)3. Allocate resources across packages, considering ranking and seniority of

responsible managers

Activity-based (ABB)

No budget owners (departments, functions), but budgeted activity cost (ABC costing) Budgeted activity cost = demand for activity * unit cost of activity More detailed and accurate than traditional budgets, especially regarding indirect

costs


24/39

ExPress Notes



theexpgroup.com

Incremental

Such budgets are based on what went on during the period before. Typically, this approach

results in modest changes and adjustments to the earlier budget. At worst, they retain andperpetuate inefficiencies and old assumptions. This might be termed the lazy mansbudget.

KEY KNOWLEDGEQuantitative Analysis in Budgeting

The High-Low method and regression analysis have been covered in F2.

Learning Curves

Learning curve effects can be applied to variance analysis, as they allow standards to beadapted to a dynamic situation, i.e. one where the time to produce units declines with theincrease in output.

EXAMPLE

A product requires 20 hrs of labour per unit at a cost of $6 per hr.

A traditional labour standard would expect 4 units to be produced in 80 hrs at a labour costof $480.If a 90% learning curve effect applies, then one would expect the 4 units to be completed inless time. How long will they require?

Utilizing the formula: y = axb

Where:

y = cumulative time required per unita = time to produce the first unit (in the example above = 20)x = cumulative number of units produced ( = 4 units)b = log r/log2r = learning curve ( = 90%)


25/39

ExPress Notes



theexpgroup.com

We solve for: y = 20 X 4-.1522

= 16 (remember: this is the cumulative time per unit)

Therefore, 4 units will require 64 hrs (16x4)

Conclusion: Based on the above, 64 hrs define the standard against which the time requiredto produce 4 units should be compared when calculating the labour efficiency variance.

KEY KNOWLEDGEBehavioural Aspects of Budgeting

There are numerous inter-relationships between types of budgets, budgeting processes andthe motivation of employees:

Top-Down budgets may be necessary from a coordination point of view; however they canbe de-motivating to employees;

Bottom-Up budgets allow useful employee input, but they may create exaggeratedexpectations on the part of the employee that his/her voice will be heard.

Unrealistic budgets with unachievable targets can be de-motivating (as can budgetswhich are easily achieved, since most people stop working when they reach the targets!).


26/39

ExPress Notes



theexpgroup.com

Chapter 7

Budgeting and Standard Costing #1


Standard costs are useful in that they assist the budgeting and planning process before anactivity commences, as well as the analysis of actual costs (including variance analysis) as

the activity proceeds.

KEY KNOWLEDGEBasic Variances and Operating Statements

Variances

Variance analysis is the process by which the differences between actual and budgeted(standard) results are quantified and examined.

Variances can either be favorable (F)or adverse (A).


27/39

ExPress Notes



theexpgroup.com

EXAMPLE

The following is a fully-worked illustration based on the following data:

Cost card (per unit)Materials (5kgs x $9 per kg) 45Labour (3hrs x $6 per hr) 18Variable O/Hs (3 hrs x $3 per hr) 9Fixed O/Hs (3 hrs x $5 per hr) 15

87

BudgetProduction: 1,100 unitsSales: 1,000 unitsSales Price: $120 / unit

Actual resultsProduction: 1,000 unitsSales: 950 unitsMaterials: 4,900 kg, $45,025Labour: 3,100 hrs, $19,050

Variable O/Hs: $9,250Fixed O/Hs: $17,000Sales price: $115 / unit

Variances analysis is best performed by asking a series of parallel questions in a systematicway:

Material variances

(i) Material price variance Materials used (4,900 kg) should have cost @ $9 44,100 Materials (4,900 kg) did cost 45,025

Materials price variance $925 (A)


28/39

ExPress Notes



theexpgroup.com

(ii) Material usage variance 1,000 units should have used @ 5 kg 5,000 kg 1,000 units did use 4,900 kgMaterials usage variance 100 kg (F)

@ standard $9 $900 (F)

Materials total variance: $ 25 (A)

Labour variances

(i) Labour rate variance

Labour (3,100 hrs) should have cost @ $6 18,600 Labour (3,100 hrs) did cost 19,050

Labour rate variance $450 (A)

(ii) Labour efficiency variance 1,000 units should have taken @ 3 hrs 3,000 hrs 1,000 units did take 3,100 hrs

Labour efficiency variance 100 hrs (A)@ standard $6 $600 (A)

Labour total variance: $ 1,050 (A)

Note: Labour variances can be influenced by learning curve effects: as work processes aremastered, the time required to produce a given level of output should decline.

Variable O/H variances

(i) Variable O/H expenditure variance 3,100 hrs should have cost @ $3 9,300 3,100 hrs did cost 9,250

Variable O/H expenditure variance 50 (F)

(ii) Variable O/H efficiency variance 1,000 units should have taken @ 3 hrs 3,000 hrs 1,000 units did take 3,100 hrs

Variable O/H efficiency variance 100 hrs (A)@ standard $3 $300 (A)

Variable O/H total variance: $ 250 (A)


29/39

ExPress Notes



theexpgroup.com

Fixed O/H variances

Fixed O/H total variance

Overhead actually incurred $17,000 Overhead absorbed (1,000 units x $15) $15,000

Fixed O/H total variance $ 2,000 (A)

This can be broken down into two components:

(i) Fixed O/H expenditure variance Budgeted O/H should have cost (1,100 units x $15) 16,500 Actual O/H cost 17,000

Fixed O/H expenditure variance $500 (A)

(ii) Fixed O/H volume variance Budgeted production 1,100 units Actual production 1,000 units

Fixed O/H volume variance 100 units (A)@ standard $15 $1,500 (A)

Sales volume variance

The absorption costing system calculates sales volume variances as follows:

Budgeted sales volume 1,000 Actual sales volume 950

Sales volume variance 50 (A)@ standard margin ($120-$87) $1,650 (A)

Sales price variance

950 units should have sold @$120 114,000 Actual revenues (950 units x $115) 109,250

Sales price variance 4,750 (A)


30/39

ExPress Notes



theexpgroup.com

Operating statement

A reconciliation between profit budgeted (absorption costing) and that realized follows:

Budgeted profit 33,000

Sales volume variance 1,650 (A)Sales price variance 4,750 (A)

26,600

Cost variances:

Materials F APrice 925Usage 900

LabourRate 450Efficiency 600

VariableExpenditure 50Efficiency 300

FixedExpenditure 500Volume 1,500

950 4,275 3,325 (A)

Actual profit 23,275

Note: Closing inventory is valued at standard cost


31/39

ExPress Notes



theexpgroup.com

Marginal costing

A marginal approach to costing focuses on the variable (marginal) costs generated in a

business and considers fixed costs as period costs. This allows the company to be able toquantify the amount by which its costs rise, if it produces/sells an additional unit of output.

Based on the data above, an Operating Statement based on Marginal costing follows:

Budgeted contribution 48,000

Sales volume variance 2,400 (A)Sales price variance 4,750 (A)

40,850

Cost variances:

Materials F APrice 925Usage 900

LabourRate 450Efficiency 600

Variable

Expenditure 50Efficiency 300

950 2,275 1,325 (A)

Actual contribution 39,525

Fixed O/Hs Budgeted 16,500Fixed O/Hs Expenditure variance 500 (17,000)

Actual profit 22,525

Absorption costing and Marginal costing Operating Statements compared

When preparing the Operating Statements, note that Marginal Costing:

Starts with standard contribution (not profit); and Recognizes only Fixed O/H expenditure variance

Variance analysis can also be applied to the Activity-Based Costing (ABC) system.


32/39

ExPress Notes



theexpgroup.com

Chapter 8

Budgeting and Standard Costing #2

KEY KNOWLEDGEMix and Yield Variance

Mix and yield variance

When materials are combined in the production process in standard proportions, with thepossibility of substituting one for the other, then the materials usage variance can be brokendown into two further measures:

Mix: This examines the (monetary) impact of altering the proportions of the two materials.

Yield: This focuses on the total amount of inputs to produce the output achieved.

The sum of the mix and yield variances is equal to the materials usage variance.

EXAMPLE

One unit of product requires the following standard inputs:

$Material X: 5 kg @ $8 40Material Y: 10kg @ $3 30

70


33/39

ExPress Notes



theexpgroup.com

In a given period, actual production of 12 units required 50 kg of X and 145 kg of Y.

Mix variance:

Important!The analysis is made on the basis of actual usage: 195 kg (50 kg of X and 145 kg of Y):

X YThe standard mix of actual input should have been: 65 130 (X:Y = 5:10)

The actual mix was: 50 145

Mix variances (kg): 15 (F) 15 (A)Cost ($): $8 $3Variance ($): $120(F) $45(A)

Mix variance $75(F)

Interpretation: More of the cheaper material (Y) and less of the more expensive one (X)were used, resulting in an overall favorable variance relating to the mix.

Yield variance:

Important!The analysis is made on the basis of standard mix (X:Y = 5:10):

X YThe yield (12 units) should have used 180 kg 60 120

Actual input (195 kg) expressed in standard mix 65 130

Yield variances (kg): 5 (A) 10 (A)Cost ($): $8 $3Variance ($): $40(A) $30(A)

Yield variance $70(A)

Interpretation: This analysis eliminates the (distorting) influence of the differing mixes bynormalizing them (according to standard). It permits focus to be placed only on the impactof having used a greater amount of materials than the standard.

The sum of the mix and yield variances (above) equal the materials usage variance: $5 (F).


34/39

ExPress Notes



theexpgroup.com

Note: Some prefer an alternative approach to calculating the yield variance.

1) The actual usage (195 kg) should, according to the standard, produce 13 units(195/15 = 13)

2) The actual number of units produced: 12 units3) The difference of 1 unit (13-12) is adverse and valued at standard cost: $70 (A).

KEY KNOWLEDGEPlanning and Operational Variances

Due to changing market and technical circumstances, standards may become outdated. In

such cases, it may be necessary to alter a standard, even during a budget period already inprogress.

Planning and operational variances capture these changes in two steps:

Planning variance: Compares results based on the revised standard compared to the initialstandard. The result is usually considered to be outside the area of control of management.

Operational variance: Compares actual results with the budget based on the revisedstandard. This is often considered to be within the control of management.

The distinction above between controllable and uncontrollable factors is critical insofar asit relates to the idea of responsibility accounting, i.e. expecting people who have delegatedauthority to take responsibility for decisions within their area of control.

KEY KNOWLEDGEBehavioural Aspects of Standard Costing

Standard costing in the wrong environment can be like a duck out of water.

If products are non-standard; or Standards are changing rapidly (due to technical or market developments); or Manufacturing processes involve a high degree of automation with little labour input,

then standard costing may not be very useful.


35/39

ExPress Notes



theexpgroup.com

Chapter 9

Performance Measurement andControl

KEY KNOWLEDGE

The scope of performance measurement

Balanced scorecard

The balance scorecard addresses a number of parameters (or perspectives) in monitoring

business performance by asking the following questions:

Financial perspective: To succeed financially how should we appear to ourshareholders?

Customer perspective: To achieve our vision how should we appear to ourcustomers?

Internal business processes: To satisfy our shareholders and customers whatbusiness processes must we excel at?

Learning and growth: To achieve our vision how will we sustain our ability tochange and improve?


36/39

ExPress Notes



theexpgroup.com

Fitzgerald and Moon

This is another model of performance management.

Qualitative measures

Service quality is an area that can be difficult to assess in objective terms. Certain actionscan be measured numerically and serve as an indication for quality; for example, measuringthe turn-around time (in days or minutes) in responding to customer requests: naturally, thequicker (one reacts), the better. To be fully useful, however, such a measure assumes twothings: (1) that the action being measured is of value (or relevance) to the customer; and(2) that one has a rule or a benchmark as to what constitutes a maximum acceptable turn-around time (from the clients point of view).

Purely qualitative factors, such as client satisfaction, can be measured by employing a scale;e.g. a scale of 1-5, with 5 = Very satisfied, to 1 = Dissatisfied. (Note: to avoid confusion, itmay be better to use the labels without numbers, and to assign numbers when analyzingthe results.)

KEY KNOWLEDGEDivisional Performance and Transfer Pricing

There are various bases on which transfer prices can be determined:

Market price Outlay cost (standard) + opportunity cost to the seller Outlay cost (actual) + opportunity cost to the seller Outlay cost + notional mark-up Production cost (full absorption) Best bargain (negotiation between divisions)

Divisional performance and internal (transfer) pricing

Divisional objectives may not be aligned with one another or with corporate objectives.


37/39

ExPress Notes



theexpgroup.com

Return on Investment (ROI) at the Divisional Level

Earnings can be measured at the divisional level in relation to the financial resources they

use. The ROI measure is very similar to ROCE (return on capital employed) with the onlyexception being the use of profit in the formula:

ROI = Net ProfitCapital Employed

ROI as defined above is commonly used for investment appraisal and for business sector(divisional) performance, whereas ROCE is common at the overall corporate level.

EXAMPLE

A division head with an actual ROI of 20% may be reluctant to accept a project offering a

15% ROI, especially if his bonus is based on ROI achieved.

If the corporate overall ROI target is 12%, then the division head is missing a value-creating

opportunity.

Residual Income (RI)

Convert results into monetary magnitudes:

Residual Income = Divisional EBIT (minus) Imputed interest

Where

Imputed interest = Capital Employed X Capital charge (or cost of capital)

A positive result adds profits to the division beyond the incremental capital cost. Aninvestment should be accepted if the RI is positive.


38/39

ExPress Notes



theexpgroup.com

Drawbacks of RI and ROI

EXAMPLE

A division of a corporation currently generating an ROI of 12% is examining a new projectwhich requires an investment of $4.5m.

Cash inflows are expected to be $1.5m p.a. and the cost of capital: 10%

ROI and RI computations will be as follows:

Year 1 2 3 4

NBV initial 4500 3375 2250 1125

Net cash inflow 1500 1500 1500 1500

Depreciation -1125 -1125 -1125 -1125

Profit 375 375 375 375

Capitalcharge(10%) -450 -337.5 -225 -112.5

RI -75 37.5 150 262.5

ROI 8% 11% 17% 33%

From both RI and ROI points of view, the project does not look favorable to the division,even if it would be from the corporate point of view. (Eg, at a cost of capital of 10%, the

project has a positive net present value).

Performance analysis in not for profit organisations and the public sector

Not-for-profit organizations share many similar issues with profit-making firms in terms ofcareful management of costs and ensuring that organizational objectives are being fulfilled.


39/39

ExPress Notes


External considerations and behavioural aspects

Performance management systems which are completely internal (introverted) in focus risk

losing touch with the external world. A system of external bench-marking serves tocounteract the tendency of individuals to perform only to a sufficient level rather than to a

superior level.

Organizations that figure out how to motivate and actualize the true potential in people will

win.

(end of ExPress notes)

exp accaf5

Documents