acca f5 performance management june2015 - daniel … · · 2016-07-21acca f5 performance...

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Accounting Practise Center (A.P.C) www.globalapc.com

ACCA F5

Performance Management

June2015

Sample Note

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Chapter

Chapter1: Introduction .............................................................................................................. 3

Introduction to Management Accounting ................................................................................. 4

Chapter2: cost accounting techniques ...................................................................................... 9

Chapter3:budgeting................................................................................................................. 49

Chapter4: Standard Costing System ........................................................................................ 67

Chapter5: Performance Measurement ................................................................................... 86

Chater6: Information System……………………………………………………………………………………………………120

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Chapter1: Introduction

F5:

There are 5 questions within F5 and all of them are compulsory.

Total marks=100marks. You are given 15minutes of reading time and 3hours of

writing time in the exam.

The key to pass this paper is:

1, know the basic knowledge especially for the structures (covered in the

videos)

2, practice lots of past exam questions with tutors (covered in videos + live

course)

Your examiner now tends to set very practical examinations so make sure you

have covered the past exam papers from DEC2010 to DEC2013 exams (at

least).

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Introduction to Management Accounting

Management accounting① is to provide useful information② in assisting

management in the management activities③.

Overview:

If you want to open up a high fashion clothes manufacturing company in India

so what you should do?

Information required: internal & external

-existing financial information?

-company resources-staff?

-government report/industry report

Management activities: use the above information in:

-Planning: Plan future activities, budget

-Decision making: Whether to set up company and

what further investment that

company may try to make

-Control: Variance-Compare results of operation

with expected (meet sales/

cost target?)

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①Difference between Management Accounting & Financial Accounting

Idea: Management accounting is for the use of management to make decisions

Financial accounting is used for paying taxes, borrowing money from bank

or attracting investors.

Management accounting Financial Accounting

Use Internal External

Format Adapted Strict

Content Detailed

(reflect past and future)

Summary

(reflect past)

Information Financial +Non-financial Financial

Time Depends Per year

② information

1, Difference between Information and Data

-Data + meaning=information

-If I give you data profit is $5,000 and you may think it’s good but what if

I tell you that company has a sales revenue of $50m and you may think

that $5,000 is too small so you decide not to invest in this company.

-Without given context that $5,000 is just data (raw data) and you can’t

make your decision whether to invest in this company unless you are

given information, ie, incorporate the data with specific context (give

some meaning to it.)

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2, How to assess whether this Information is good?

Accurate

They should be accurate not too vague and if you’re given information that

company has made profit this year but not told how much then it’s useless

to help you make decisions.

Cost efficient

You should weigh the benefit you get after getting this information and the

cost you have to pay.

Complete If you are told that there’s a competitor emerging then you should need to

obtain its price and skills they have mastered as well.

User-focused Eg, a shop manager may wish to have a summary of the shop’s daily takings

and a sales manager may want detailed customers details to complete their

sales target.

Relevant If you want to know the price that competitor is currently charging so any

information provided about the history about the competitor may deem to

be irrelevant.

Authoritative The information should be reliable so if you are told that inflation rate this

year is 5% so you need to check where is this information coming from, eg,

from government report?

Timely Information must be produced in advance of the time when it’s needed. Eg,

budgets need to be set in advance of a period in order to compare with

actual performance as a benchmark.

Ease of use We need to make sure Information produced can be used by users, eg, easy

language.

3, Where does information come from?

Internal wage rate; production rate; sales volumes.

External government report; industry statistics.

Inflation rate; industry report.

4, How to sample information?

If you want to launch a new product then how to determine customers

are satisfied with your product you are going to launch? Well we need to

select samples from the populations and ask them whether they are

satisfied with the new products are hoping that they represent the

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whole population.

Approaches to sample:

Random sampling: Sample items at random and make sure that

every item would have an equal chance being sampled.

Systematic sampling: random sample first and sample at interval later.

Stratified sampling: stratified group first and then random sampling later.

③Management Activities

Once we’ve looked at how to generate into information we now need to know

where do we use these information for and by.

Where:

The information should be used to management activities

Planning (budget); [regularly]

Decision making; (launch new products/enter into new market) [any time]

Control (variance analysis) [regularly]

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By:

The information should be used by different level of management within the

business.

Strategic level (directors and senior management; more than 1year)

Tactical Level (divisional/departmental manager; somewhere between

1month-1year)

Operational Level (team leader; factory supervisor; daily/weekly)

To achieve better control over the organization, companies would always divide

themselves up into different centers.

Cost Center: Break group costs into different areas like in products line;

managers; location; region; location; department;

Revenue Center: Break group revenue into different areas like in products

line; managers; location; region; location; department. Eg, Sales department.

Profit Center: senior management here will control both revenue and costs in

order to maximize profit. Usually this would be divisions within organization.

Investment Center: they are not only responsible for control over revenue

and costs but also for some capital. This would be done by quite senior persons

within business usually.

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Chapter2: cost accounting techniques

In this session we will be going through:

1, cost classification

2, costing methods:

Absorption costing method(AC)

Activity based costing method(ABC)

Target costing method

Life cycle costing method

Throughput accounting method

Environmental costing method

Marginal costing

-basic theory behind marginal costing

-relevant costs

-CVP analysis

-Linear programming

-Pricing

-Risk and uncertainty

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1, Cost classification

Since we know that cost is important to business then we should try to control

the costs incurred within business.

Cost can be classified through the following 4 categories:

By Nature

By Traceability

By Cost behavior

By production & Non production costs

By nature:

This means that it can be classified as material costs, labor costs and other

expenses.

By traceability:

This means that it can be classified as direct cost and indirect cost.

Direct cost is the cost that can be traced back to the production of product.

Indirect cost is the cost that is difficult to be traced back to the production of

product.

Typical direct cost: direct material and labor into production of product.

Typical indirect cost: electricity expenses

The sum of direct costs would be prime costs while the sum of indirect costs

would be overhead costs.

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By costs behavior:

This means costs can be classified depending on different the behavior of costs

at different volume of production or sales.

The costs can be classified either variable costs or fixed costs .

Variable cost: Are the cost which can’t be linked to the product directly.

Fixed cost: Are the cost still incurred even though business is not operating .

Within variable costs it would be step costs and semi-variable costs.

Variable costs: If the level of activity changes then cost changes.

If you produce more tables then you need more materials as

well as labors.

Eg, direct material, direct labor, variable overhead (Repair

and maintenance, Power, fuel, Indirect labor etc.)

LofA

Total cost Variable

cost/unit

LofA

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Fixed costs: If the level of activity changes then cost would not change.

Eg, rent bills; fixed salary.

Step costs: If the level of activity hits a point then fixed cost changes.

If the capacity of your factory doesn't satisfy the current production

plan then you need to open up a new factory and this

Total

costs

LofA LofA

Fixed

cost/unit

LofA

Total

costs

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Semi-variable costs: This is a cost containing both variable and fix element.

Example: phone bill(fixed connection fee and variable costs/call)

By production & non-production costs

Production cost: costs must be incurred to produce this products.

Material, labour, machine etc.

Forms cost of sales within Income Statement.

Non-production cost: costs not necessarily incur to produce products.

Tax expenses; administration expenses; finance cost etc.

Forms other expenses within Income Statement.

Income statement:

Sales revenue X

Costs of sales(production costs) (X)

Gross profit X

Other expense (non-production costs) (X)

Profit after tax X

Total

costs

LofA

Fix

element

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Example: Tonic Water

If you were to manufacture a bottle of tonic water:

Materials Labor Other

expenses

Soda water Front line production workers Electricity

Sugar Factory supervisor Insurance costs

Aluminum -sales manager Utilities

Machine -human resource manager Royalties

Factory building

Lorry

Required:

State costs which can be classified under:

(i) Nature

(ii)Traceability

Answer:

Materials Labor Other

expenses

(D)Soda water (D)Front line production workers (ID)Electricity

(D)Sugar (ID)Factory supervisor (ID)Insurance

costs

(D)Aluminum -sales manager (ID)Utilities

(ID)Machine -human resource manager (ID)Royalties

(ID)Factory building

(ID)Lorry

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High low method:

We can use high low method to separate fixed and variable cost within

semi-variable costs.

We assume a linear relationship that changes in totals cost are because of the

changes in the level of activities.

1, Total costs= total variable costs + total fixed cost

2, Total variable costs = variable costs/unit X level of activity

variable cost/unit = cost at highest level – cost at lowest level

Highest level activity-lowest level activity

3, Total fixed cost= total costs-total variable costs

4, Use formula to predict future costs given the level of activity.

Note: we must ensure that any variable cost/unit is constant and the total fixed

cost is constant as well.

Q Kenny (High low method)

Kenny manufactures bottles for tonic water and the following information is

presented as the output of the number of bottles that Kenny made and the

related costs as well.

Output 65,000 units 105,000 units

Cost $133,000 $210,000

Required:

Use the above data calculate:

(i) The fixed and variable costs for Kenny;

(ii) The total costs if the output if 200,000 units.

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Q John (consider other costs as well)

John has the following total costs at two activity levels:

Output 17,000 units 22,000 units

Cost $140,000 $170,000

Variable cost per unit is constant in this range of activity and there is a step cost

of $5,000 in the total fixed costs when activity exceeds 19,000 units.

Required:

Use the above data calculate:

(i) The fixed and variable costs for John;

(ii) The total costs if the output if 21,000 units.

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2, costing methods:

1, Absorption costing

Aim: establish the full production cost/unit.

How: Link direct and indirect cost (production overhead) to one unit.

Steps:

1, Year start:

Calculate absorption cost for the product (budgeted) to determine the selling

price.

2, during the year/Year end:

1, Allocate direct cost to one unit.

2, Apportion (Spread) indirect cost from production cost center over a fair

basis.

3, Reapportion indirect cost from production service center over a fair basis.

4, Absorb costs to unit.

3, Compare step 1 and step2 =over/under absorption

Why:

1, Valuation of closing inventory (need production cost, ie, cost of sales)

2, used to establish selling price.

3, Budgeting.

4, Variance analysis.

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Notes:

What are overheads?

Sum of indirect costs (electricity, power costs, admin costs)

Production (direct) overheads costs?-indirect costs that relating to production of

one unit directly.

Power for factory; factory supervisor costs;

Non-production overheads?

Head office rent, sales staff salary.

Production cost centers

Involved in the production of units of output

Service cost centers

Don't produce physical units but they provide support to the production cost

center, eg, machine maintenance departments (engineers in it)

Reciprocal servicing cost center:

When service cost centers each provide a service to the other service cost

center.

Q Maggie (Allocation)

Maggie wants to manufacture a table.

Direct material per unit used is 4kg and $5/kg;

Direct labor per unit involved is 3hours and $3/hour.

Indirect cost incurred per unit:

-Variable overhead is $2 per unit;

-Fixed overhead is $3 per unit.

Required:

Calculate the full production cost/unit.

Q John (Apportionment)

John has overhead expenses:

Rent and rates is $25,000.

The floor areas of production department is as follows:

Production department A Production department B

Floor areas 5,000 4,000

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Required:

Calculate overhead expenses to be apportioned over these two departments.

Q Steve (Reapportionment)-elimination method

Steve incurred the following overhead expenses used by different departments:

Production department Service

department

A B C

45,000 75,000 32,000

% usage of C 60% 40% -

Required:

Calculate the amount to be reapportioned over production department A&B.

Q Clare (Reapportionment)-repeated distribution method

Clare incurred the following overhead expenses used by different departments:

Production department Service department

A B C D

$5 $4 $3 $3

% usage of C 60% 30% - 10%

% usage of D 30% 40% 30% -

Required:

Calculate the reapportionment expenses over departments by service

department using repeated distribution method.

Q Lucy (Reapportionment)-Algebraic method

Production department Service department

A B C D

$5 $4 $3 $3

% usage of C 60% 30% - 10%

% usage of D 30% 40% 30% -

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Required:

Calculate the reapportionment expenses over departments by service

department using Algebraic method.

At the year start

Q Betty (Absorption- one rate/blanket rate)

In order to set up the selling price, Betty needs to calculate the costs incurred.

The total direct material costs +total direct labor costs +variable overhead costs

is $15/unit.

The rent of factory is $700,000 per year and the budgeted units Betty is going

to produce is 5,000units.

Required:

Calculate full (absorption) cost for Betty.

Q Betty continued (absorption - different department)

Betty now expands her business into making desks and chairs.

The direct material and direct labor into making desks and chairs are $20/desk

and $10/chair.

The rent of factory is $700,000per year splitting $300,000 in assembly

department and $400,000 in finishing department and total hours to produce

desks +chairs in assembly department is 100,000hours and 40,000hours in

finishing department.

To produce a desk in assembly department takes 3hours and 0.5hour for a chair.

To produce a desk in finishing department takes 1hour and 0.5hour for a chair.

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Required:

Calculate full (absorption) cost for Betty.

At the year end

The budgeted production was 11,000units at the year start and the actual

production is 10,000units.

The total direct material, direct labor and variable overhead is $10.

The fixed overhead per unit is $2.

(i) Actual overhead at the year-end incurred is $120,000.

(ii)Actual overhead at the year-end incurred is $140,000.

Required:

Calculate the total absorption cost at the year start and whether there’s

over/under absorption.

2, Activity based costing (ABC)

AC:

OAR = budgeted o/h /budgeted level of activities

ABC:

Overhead cost items—cost pools—cost/unit based on cost driver

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Comment:

Advantages:

1. More accurate product costing.

2. Is flexible enough to analyze costs by activity providing more useful costing

data.

Disadvantages:

1. Cost vs benefit.

2. ABC information is historic and internally.

3. Difficult to apply in practice.

4. Focuses on the allocation of cost rather than minimizing the cost incurred

Q ABC plc (ABC costing)

ABC plc manufactures product A and incurs the following overhead expenses:

Material handling costs =$100,000

Power costs= $120,000

The cost drivers identified by the business:

Material handling: quantity of material used: 1,000kg.

Power: number of power drills operations: 120.

Required

Calculate full cost for product A using ABC costing method.

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3, Target costing

Traditionally:

cost/unit $10

mark-up 40% $4

selling price $14

now:

start with selling price:

target price = $8

profit margin = $1.6

(20%of price)

Target cost/unit $6.4

Actual cost/unit $10

Cost gap $3.6 (so we need to close the cost gap)

Make process more efficient

Comment:

Key advantages:

1, Cost reduction and control

Possible elimination of non-value added elements and activities in production

process.

2, Market based costing

Selling price considers what customer might want to pay for the product.

3, Customers

Customer requirements for quality, cost, and time are incorporated into

product and process decisions. The value of product features to the

customers must be greater than the cost of providing them.

4, Design

Cost control is emphasized at the design stage so any engineering changes

must happen before production starts.

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4, lifecycle costing

Not focusing on accounting period

Lifecycle cost/unit = total lifecycle costs/expected life cycle volumes

Comment:

1, better understand overall costs relating to short life products.

2, avoids products having changing product costs during the life of the product.

Q life ltd

Life ltd wants to produce a brand new pad. The following information is

available:

R&D: $100,000

Budgeted total sales/year =10,000 units

Production costs/ year = $150,000

Life of product = 2years

Required:

Calculate the life cost/unit for the pad.

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5, Throughput accounting method

In the past most business only focuses on increasing the individual process

efficiency without considering if one process slows down then other processes

will slow down as well.

If one process slows down then the inventory will be piled up, workers are idled

but still gets paid and these will increase the overall costs to the organization.

Throughput accounting underpins the idea that inventory should be eliminated

during the process of the production. It is not just focusing on individual process

but rather focus on the factory as a whole.

As mentioned before one process slows down which will make other processes

slow down as well and this is called bottle neck.

So how to increase the overall output and profit for the organization given bottle

neck exist in the organization?

Well this introduces “throughput accounting” method.

‘throughput’ is the rate at which the system generates money through sales

So we can calculate “throughput accounting ratio (TPAR)” and say:

If TPAR=1 then the business is not making or losing money (break even);

If TPAR>1 then the business is making money and

If TPAR<1 then the business is losing money.

But how can we calculate “TPAR”?

TPAR= Return/factory hour (W1)

Cost /factory hour (W2)

W1: return/factory hour=sales price/unit-direct material cost/unit

Factory hours per unit (bottleneck hrs)

W2: cost/factory hour= Total factory costs

Total factory hours

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Note:

Throughput accounting is very similar like marginal costing because you can see

the calculation of TPAR, return/factory hour is similar to contribution/hour.

Before we move on we would like to see the difference between marginal costing

and throughput accounting.

Marginal costing Throughput accounting

Variable costs Direct material

Direct labor

Variable overhead

Direct material only

Fixed costs Costs don’t vary with activity

levels

Called “total factory cists”.

Direct labor costs +all overheads

Contribution Sales-variable costs Sales-direct material costs

Q Through ltd

Through ltd has 2 production departments: assembly and finishing department.

It makes 2 products: A&B. Through ltd operates a JIT manufacturing system.

Processing capabilities are shown below:

Processing time in hours

Assembly Finishing

Product A 0.5 0.75

Product B 0.5 1

Hours available 12,000hours 12,000hours

Factory overhead and direct labor expense for the period is $180,000.

Cost data is as follows:

Product A Product B

Unit sales price $20 $15

Direct material costs/unit $11 $9

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Required:

1, identify the bottleneck process.

2, calculate TPAR for each product.

3, interpret the TPAR and suggest how Through ltd can improve the TPAR.

Environmental management accounting

This topic in the F5 exam is just on the surface and everything here is just

business common sense.

Nowadays, business needs to take into account the environmental impact that it

has during its operation of business.

The questions is why care?

From a financial perspective:

Raw material

Transport and travel

Water consumption

Energy costs

Clean up costs

taxations

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From a non-financial perspective:

Reputation

Ethics

Stakeholders needs

Pressure on resources

Possible strategies:

1, end of pipe strategy-just pay after the pollution

2, process improvement strategy-improve process to decrease pollution

3, prevention strategy-prevent pollution happening by further improving your

process

How to account for it?

1, input/output analysis:

= + +

Analyses costs throughout the process and minimize the cost.

2, flow cost accounting:

The aim of flow cost accounting is to reduce the quantities of material which

should be beneficial to the environment and saving costs for the organizations.

It uses material flows and organizational structures to make material flows

more transparent and it divides the material flows into:

1, material-these are costs and values of materials involved in the production

processes.

2, system-these are costs and values of internal handling of materials, eg,

personal costs

3, delivery and disposal-these are costs of material flows leaving the company,

eg, transport costs or waste disposal

100%

Input

80%finish

ed goods

10%scrap

value

10%

waste

r

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3, activity based costing

There are:

1, Environmentally related costs which can be specifically attributed to an

environmental cost center, eg, sewerage plants.

2, Environmentally driven costs which do not relate to a specific cost center but

relate to environmental drivers, eg, higher staff costs due to more toxic

emission during the production process.

In order to allocate the environmentally driven costs to cost centers it’s

important to find adequate costs drivers such as volumes of water and toxicity

of emissions.

4, life cycle costing

It considers costs and revenues throughout the life of a product from initial

design stage to the end of its life to be removed from market.

This allows an early focus which can help decision making such as pricing and

the design of the product taking into account of future environmental costs such

as clean up costs.

Marginal costing based decision making techniques

1, make or buy decision

Make: marginal (variable) cost

Buy: purchase price

Idea: because fixed overhead will incur irrespective of the level of activity

changes so we ignore fixed cost when making the decision.

Example:

A B

Price 17 25

Variable cost 14 28

Fixed overheads 4 4

Total costs 18 32

Required:

Should we make or buy product A & B?

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2, discontinued decision

Whether to discontinued part of the business we should look at whether after

shutting down that business we will need to pay more?

Example:

Division A B

Sales 100 40

Variable costs (60) (30)

Fixed costs (20) (20)

Profit/losses 20 (10)

After shutting down the division B 40% of fixed costs relating to admin staff of

B will be saved and the remainder being allocated arbitrarily to the divisions

from head office.

Required:

Suggest whether to shut down division B or not.

3, limiting factor decisions

How to best use the scare resources-raw material, skilled labor, machine

capacity, finance(capital rationing in F9)

Fixed cost not change.

Steps:

1, contribution per unit of sale

2, contribution per unit of scarce resource

3, ranking which higher contribution

4, use up the resource

Example

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the hours involved in producing the brand new pad are limited to 5,000hours.

Information about the pad 1 and pad 2 are as follows:

Products(per unit) Pad 1 Pad 2

Selling price($) 40 30

Variable costs($) 16 15

Fixed costs($) 10 8

Profit($) 14 7

Machine hours 8 3

Budgeted sales(units) 600 500

Required:

1, calculate the contribution per scarce resource.

2, calculate the total contribution if best use up the resources.

3, calculate the total profit if best use up the resources.

4, further processing decision

This arises in a manufacturing company that produces a product in a process or

a sequence of processes. The output from a process might have a selling price.

However, there might also be an opportunity to further process the output to

produce a finished item with a higher selling price.

So we need to compare the additional (incremental) revenue (subsequent

selling price-original selling price) and the additional (incremental) costs.

Example:

cleaning fluids, JIN and LON. The two fluids are manufactured in a joint process.

Every Lon 8,000 liters of materials input to the joint process produces 4,000

liter of JIN and 3,200 of LON.

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$

DM 1,600

DL 200

Variable production overheads 300

Fixed production overheads 2,000

Product JIN sells for $1.10 per liter and product LON for $0.75 per liter.

Company could put product JIN through another production process, where

there is spare production capacity. The further processing would produce

another cleaning product, Killer. Every one liter of input to the further process

will produce 0.90 liters of Killer.

The costs of further processing would be:

Product JIN: 4,000litres $

Additional DM 400

DL 40

Variable overheads 80

Apportioned fixed overheads 400

Total 920

Killer would sell for $1.40 per liter.

Required:

Suggest whether company should sell Jin or further process it?

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Relevant costs

Uses:

Minimum pricing

Limiting factor decisions: how to use of the scarce resources

Investment appraisal

Discontinued decision

Further processing decision

What:

This is a incremental future cash flow.

Changes as ignore sunk costs ignore depreciation

a result of book value and other accounting

adjustment

decision

Types:

Relevant costs Non-relevant costs

Opportunity cost Sunk cost

Incremental cost Committed cost

Variable cost Fixed O/H absorbed

Depreciation (non-cash flows)

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Cost Volume Profit (CVP) analysis

Using this technique we can know when we will make no profit or loss

(breakeven) as the sales volume drops to a certain level/sales revenue drops to

a certain level.

Selling price-variable costs=contribution=fixed cost +profit

Required sales volume (revenue) = target Contribution

(breakeven) Contribution/unit (sales revenue)

Ex1: (volume)

Selling price=$35/unit

Variable cost=$15/unit

Fixed cost=$10,000

Required:

1, Calculate the sales volume breakeven point.

2, if the required profit is $16,000 then calculate the sales units.

Ex2: (sales revenue)

Selling price=$35/unit

Variable cost=$15/unit

Fixed cost=$10,000

Required:

1, Calculate the sales revenue breakeven point.

2, if the required profit is $16,000 then calculate the sales units.

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Margin of safety:

Budgeted sales units=4,000units

Breakeven sales unit=1,000units

Required:

Calculate the margin of safety both in absolute and relative figure and explain

what that means.

Chart:

Sales

Revenue & cost

Total cost(FC+VC)

Fixed cost

Level of activity

P/V chart(profit/volume) chart:

PROFIT

0

300units/

LOSS @$6/unit=$1,800

Fixed cost

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If the company is trying to sell off multiple products, then we can prepare

for a multiple product P/V chart:

Products

A B

Selling price 40 45

Variable costs 30 30

Contribution 10 15

Budgeted sales 1,000units 2,000units

Fixed cost 25,000

Required:

Draw the multi product P/V chart if the company plans to sell a constant mix of

products A+B for 1:2.

Draw the multi product P/V chart if the company plans to get to its breakeven

point quicker.

Limitations:

1, Once costs and revenues have been determined, it is usually assumed that

they will have a linear relationship.

2, Fixed costs will be constant over the relevant range

3, Selling price will remain unchanged

4, The analysis covers either a single product or a mix of products at which it is

assumed that the proportion of each product will remain the same as volume

increases or decreases.

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Linear Programming

Theory: there are multiple limiting factors within the factory so we need to take

into account of those and produce an optimal production plan.

This is based on the limiting factor analysis learnt before which only considers

the one limiting factor within the factory rather than multiple ones.

Steps: (DDDGO)

1, Define variables (products)

2, Define constraints

3, Define Objective (maximum contribution)

4, Graph

5, Optimal production plan

Shadow price (pay above the normal price: consider you have binding

resources and you determine to outsource or make labour work

overtime)

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Q JAMA

JAMA plans to manufacture two products, JAMA A and JAMA B and the unit

contribution is estimated to be $50 for JAMA A and $70 for JAMA B.

For their manufacture both products require inputs of machine processing time,

raw materials and labor.

JAMA A JAMA B

Machine processing time 3hours 10hours

Raw materials 16units 4units

Labor 6hours 6hours

Limiting factors:

Machine processing time 330hours

Raw materials 400units

Labor 240hours

The technology of the manufacturing process is such that at least 12 units of

JAMA B must be made in any given time.

Sales department of JAMA has forecast to sell 50 units of each product next

month.

Required:

1, How many units of JAMA A and JAMA B should be produced in order to

maximize contribution?

2, identify and calculate the binding and slack resources.

3, calculate shadow prices for each binding resources.

39


Pricing

Before we set up a selling price, we need to consider 3C’s:

Costs

Competition

Customer reaction

Then we need to consider are there any techniques to help us set up the selling

price?

Cost plus pricing

Marketing based pricing

Demand based pricing

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1, cost-plus pricing (full absorption cost-plus approach or marginal

cost-plus approach)

full absorption cost-plus approach:

Cost card $

Direct materials 10

Direct labor 8

Variable overhead 5

Fixed overhead _ ($500,000 estimated and absorbed under 10,000units

produced budgeted)

Full cost 28

Margin(20%) 5.6

Price 33.6

Ad:

Easy to apply

“guarantee” profitability

Disad:

Ignores outside

Ignore any effect on selling price on demand

Problem of estimation the level of production (this leads to marginal cost plus

approach)

Marginal cost-plus approach

Cost card $

Direct materials 10

Direct labor 8

Variable overhead 5

marginal cost 23

Margin(40%) 9.2

Selling price 32.2

41


Ad:

Easy to apply

“guarantee” profitability

Disad:

Ignores outside

Ignore any effect on selling price on demand

Problems dealing with % to make sure it’s enough to cover fixed costs in order

to generate into profit.

2, marketing based pricing

1, product (business/industry life cycle)

2, possible pricing strategy in each stage

42


Market skimming

Aim at small group of people and charge them at a high price for a small amount

of goods

Low risks

1, we don't have to develop too many products which costs us that much

2, we can drop the price down as we see fit.

3, High barrier to entry, Eg, technology

Market penetration

Aim at large group of people and charge them at a low price for a large

amount of goods

High risks

1, we have to develop too many products which costs us that much

2, we can’t drop the price down easily as we see fit.

3, No barrier to entry

Average (going rate) pricing

Charge the price based on the competitor average level.

Discount pricing

Large volume purchased then enjoy a lower price

Complementary product pricing

Razor is cheap but blade is expensive.

Product line pricing

Many products in the company vary from prices

Price discrimination

Charge at a different price to different people:

Eg, film tickets-child is for free but adults are charged at full price.

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3, demand based pricing

The demand for the product by customer would change if the price charged to

them changes.

Selling

price/un

it

Demand(unit

s)

Cost/un

it

Total

revenue

s

Tota

l

cost

s

Total

profi

t

Margin

al

revenu

e

Margin

al cost

16 100 14 1600 140

0

200

15.5 200 13.9 3100 278

0

320 1500 1380

15 300 13.8 4500 414

0

350 1400 1360

14 400 13.7 5800 548

0

320 1300 1340

So we can identify that when the marginal revenue < marginal costs then we

make a smaller profit and when marginal revenue=marginal costs then we can

maximize our profit figure.

Marginal revenue can be calculated through demand curve:

P=a-bQ

b= change in price

Change in quantity

a=price when Q=0

so we need to establish the demand curve and then calculate the marginal

revenue:

Q: calculator

we sell 500units calculators at a price of $25 and 700units at a price of $20.

Total cost=15,000(fixed cost) +5(variable cost)Q

Required:

1, What is the demand curve and marginal revenue?

2, units produced in order to maximize the profit.

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How to measure the change in price will lead to a change in the demand by

customers?

We use “demand elasticity”.

Price elasticity of demand (PED) = (Q2-Q1)/Q1

(P2-P1)/P1

If the PED is greater than one, the good is price elastic. Demand is responsive to

a change in price. If for example a 15% fall in price leads to a 30% increase in

quantity demanded, the price elasticity = 2.0.

If the PED is less than one, the good is inelastic. Demand is not very responsive

to changes in price. If for example a 20% increase in price leads to a 5% fall in

quantity demanded, the price elasticity = 0.25.

If the PED is equal to one, the good has unit elasticity. The percentage change

in quantity demanded is equal to the percentage change in price. Demand

changes proportionately to a price change.

If the PED is equal to zero, the good is perfectly inelastic. A change in price will

have no influence on quantity demanded. The demand curve for such a product

will be vertical.

Q PED

The price of a car is $1.20 per unit and the annual demand is 800,000 units.

Market research indicates that an increase in price of 10 cents per unit will result

in a fall in annual demand of 75,000 units.

Required:

Calculate the price elasticity of demand?

45


Decision making under risks and uncertainty

In the real world there are lots of decisions made by management associated

with different outcomes.

But which decision we are going to choose? We can plot them into the payoff

table then we can consider the choices we are going to make.

Risks-quantifiable outcome

Uncertainty- unquantifiable outcome

Q Laura

Miss Laura runs a market stall selling meat. She buys a product for $20 per case.

She can sell the product for $40 per case on her stall. The product is perishable

and it is not possible to store it, instead any cases unsold at the end of the day

can be sold off as scrap for $2 per case.

The following information has been collected by Miss Laura.

Demand/day Number of days

10 45

20 75

30 30

Required:

(a) Prepare a summary of possible net daily profit using a payoff table.

(b) Advise Miss Laura:

(i) How many cases to purchase if She uses expected values (on average-risk

neutral).

(ii) How many cases to purchase if She uses maximin (risk averse) / maximax (risk

seeker).

(iii) How many cases to purchase if She uses minimax regret.

(c) Miss Laura has been approached by marketing agent to provide her more

46


reliable estimate of her future demand, advise Miss Laura what maximum price

She should pay to gain the reliable information.

Expected values:

This is a weighted average value of all the possible outcomes. It does not reflect

the degree of risk, but simply what the average outcome would be if the event

were repeated a number of times.

The decision rule is to select the course of action with the highest expected

value of profit or the lowest expected value of cost.

EV = px

P = probability of an outcome

x = value of an outcome

Comment:

Advantages of expected values

EV considers all the different possible outcomes and the probability that each

will occur.

Limitations of expected values

1. The EV shows a long term average, so that the EV will not be reached in the

short term and is therefore not very suitable for one-off decisions.

2. The accuracy of the results depends on the accuracy of the probability

distribution used.

3. EV takes no account of the risk associated with a decision but just a weighted

average figure.

47


Decision making (risks)

Maximax (risk seeker)

The decision maker will select the course of action with the highest possible

payoff

(the best of the best).

Maximin decision rule (risk averse)

The decision maker will select the course of action with the highest expected

return under the worst possible conditions.

Minimax regret decision rule

The decision maker selects the course of action with the lowest possible regret.

It aims at minimising the regret from making the wrong decision.

Regret is the opportunity cost of having made the wrong decision, giving the

actual conditions that apply in the future.

Risk neutral

A risk neutral decision-maker ignores risk in making a decision.

A risk neutral decision-maker will select the course of action with the highest

expected return, regardless of risk

Value of perfect information

If company wants to obtain the best information (eliminate uncertainty) then

what is the maximum of price that company needs to pay in order to do this?

The maximum price= expected value of the perfect information-expected value of

the non-perfect information

48


Decision making using decision trees

Steps:

1, draw a decision tree

2, left to right –probabilities and values

3, right to left-expected value

Q Thomas

The following information relates to Thomas who is considering whether to

develop and market a brand new PC.

Probability

Development

Being successful 0.75

Being unsuccessful 0.25

Estimated development costs would be $180,000

If successful, the product will be marketed with following probabilities:

Probability Profits / (Loss)

Being very successful 0.4 $540,000

Being moderately successful 0.3 $100,000

Being failure 0.3 ($400,000)

The above profits / losses figures include the effect of the development costs.

Required:

Draw a decision tree and recommend the best action by Thomas.

49


Chapter3:budgeting

In this session we will be focusing on:

Basic Budgeting theory

Types of budget

How to set up a budget

Forecasting techniques

- Regression analysis

- Time series

- Learning curve

50


1, Basic Budgeting techniques

Budget is part of a planning process.

It is a plan in numbered format.

The purpose of budgets (CRUMPET):

C: Co-ordination: co-ordinate all department, plan to sell 200units product then

production department needs to know they are going to produce 200units of

products to be sold.

R: Responsibility: by setting up the budget the sales manager for example is

responsible for the sales budget and co-ordinate activities within

department to achieve the sales target.

U: Utilization of resources, eg, set up a limit of $4,000 to purchase material so

utilize resources effectively.

M: Motivation, eg, target is set and we link this target to the bonus if so we can

motivate them.

P: Planning: by setting up the budget we can make management of the business

think about how to achieve this budget.

E: Evaluation of performance: use actual budget to compare with budget we

set.

T: Telling: it assist the communication between departments using budgets.

51


Budget preparation procedures:

Budget committee (senior management within the organization)

Budget manual (objective, administration of budgeting process and provide an

approach for management to prepare budget)

Department managers (receive the budget manual and prepare budget and

then submit to budget committee for approval.)

Different types of budget:

Establish Principal budget factor ie, factors limiting company’s activities, eg,

sales demand.

1, functional budget: relates to different areas of company

1, sales budget (units to sell)

2 production budget (units to produce)

3, materials budget (resource used to produce)

4, labor resource (resource used to produce)

2, master budget: summary

Cash budget

Budgeted income statement

Budgeted statement of financial position

Advantage of budget:

Motivate staff/management

Focus attention on key areas, eg, sales growth, cost reduction

Quantifiable performance measure

Disadvantages of budget:

May demotivate staff if it’s unrealistic

May result in dysfunctional behavior

52


Factors influence motivation:

Targets: must be challenging and attainable

Approach to budgeting:

1, Top down approach: senior executives set strategy and communicate

targets down

2, Bottom up approach: divisional level of management and staff encouraged

to have an input.

Functional budget:

1, sales budget:

Q Salon Ltd

Salon ltd produces 2 two products. S1 and S2.

Budgeted Sales Units Selling price

S1 2,000 $100

S2 4,000 $130

Required: prepare the sales budget for Salon Ltd.

2, production budget:

Salon ltd also has the following finished goods.

The finished stock budget is as follows:

S1 S2

Budgeted sales units 2,000 4,000

Opening stock units 500 800

Closing stock units 600 1,000

Required:

Prepare the production budget for Salon Ltd.

acca f5 performance management june2015 - daniel … · · 2016-07-21acca f5 performance...

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