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ACCA P5 Advanced Performance Management www.globalapc.com

ACCA P5 Advanced Performance Management

Tuition Note

For exams in June 2015

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© Lesco Group Limited, April 2016

All rights reserved. No part of this publication may be reproduced, stored in a

retrieval system, or transmitted, in any form or by any means, electronic,

mechanical, photocopying, recording or otherwise, without the prior written

permission of Lesco Group Limited.

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Content

Chapter1: Help company success............................................................................. 5

Session 1.1: Avoid corporate failure ............................................................................................................................6

General indicators ............................................................................................................................................6

Corporate failure prediction.............................................................................................................................7

Chapter 2: Management Accountant Traditional role ............................................. 11

Session 2.1 Traditional Role: ..................................................................................................................................... 12

Session 2.2 Gap analysis ............................................................................................................................................ 13

Session 2.3 Strategy .................................................................................................................................................. 15

1, definition of strategy ................................................................................................................................. 15

2, Johnson and Scholes has classified strategy into 3 levels(types): ............................................................. 15

Session 2.4 Costing .................................................................................................................................................... 31

Session2.4.1 JIT [just-in-time] system ........................................................................................................... 32

Session2.4.2 Total quality management ....................................................................................................... 34

Session2.4.3 Absorption costing VS Activity based costing .......................................................................... 36

Session2.4.4 Job costing ................................................................................................................................ 41

Session2.4.5 Batch costing ............................................................................................................................ 43

Session2.4.6 Target costing ........................................................................................................................... 44

Session2.4.7 Lifecycle costing ....................................................................................................................... 47

Session2.4.8 Environmental management accounting: ................................................................................ 48

Session2.4.9 Benchmarking ........................................................................................................................... 57

Session2.4.10 Standard costing:.................................................................................................................... 65

Session2.4.11 Kaizen costing: ....................................................................................................................... 78

Session 2.5 Budgeting ............................................................................................................................................... 83

Session 2.5.1 Basic knowledge about budgeting .......................................................................................... 83

Session2.5.2 Budgeting Types ....................................................................................................................... 92

Session2.5.3 Beyond budgeting .................................................................................................................... 95

Session2.5.4 Budgeting in pubic sector ......................................................................................................... 98

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Session 2.6 Pricing ..................................................................................................................................................... 99

Session2.7 Decision making .................................................................................................................................... 105

Session 2.8 Performance Measurement ................................................................................................................. 113

Session 2.8.1 financial and non financial measurement ............................................................................. 114

Session2.8.1.2 Human Resource Management .......................................................................................... 138

Session2.8.1.3 Balanced scorecard: ............................................................................................................ 141

Session2.8.1.4Performance pyramid .......................................................................................................... 143

Session2.8.1.5 Performance prism .............................................................................................................. 148

Session2.8.1.6 Building blocks model: used in service industry ................................................................. 154

Session2.8.1.7 Six Sigma .............................................................................................................................. 160

Session 2.8.2 behavior aspects .................................................................................................................... 165

Session2.8.3 Divisions performance measurement .................................................................................... 165

Chapter3 Current issues ...................................................................................... 184

Session3.1 Management Accountant Changing role: ................................................................................. 184

Sessoin3.2 Manage information system (MIS):........................................................................................... 187

Session3.3 Business process change ........................................................................................................... 191

Session3.4 Organizational change ............................................................................................................... 194

Session3.5 Integrated report ....................................................................................................................... 194

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Chapter1: Help company success

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Session 1.1: Avoid corporate failure

General indicators

Operational issues

-loss of key staff

-Poor internal control system

-lack of production/service introduction

Financing issues

-profitability problem

-liquidity problem

-gearing problems

Compliance issues

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Corporate failure prediction

Quantitative measure: Altman Z score

Z = 1·2X1 + 1·4X2 + 3·3X3 + 0·6X4 + X5

Where:

X1 is working capital/total assets (WC/TA);

X2 is retained earnings reserve/total assets (RE/TA);

X3 is Profit before interest and tax/total assets (PBIT/TA);

X4 is market value of equity/total long-term debt (Mve/total long-term debt);

X5 is Revenue/total assets (Revenue/TA).

Key to remember:

If the score is 3 or above they are financially sound

Between 1.81 and 2.99 they need further investigation [grey area]

Below 1.81 they are in danger of bankruptcy

What to do to prevent failure?

See the signs and take action.

Seek external advice.

Management accept there is a problem.

Make strategic changes as necessary.

Put in more controls and management systems.

Qualitative measure: Argenti A score

Qualitative models such as Argenti use a variety of qualitative and some non-accounting factors such

as management experience, dependence on one or a few customers or suppliers, a history of qualified

audit opinions and the business environment including the industry and economic situation.

Argenti developed a model, which is intended to predict the likelihood of company failure based on

three connecting areas that indicate likely failure:

defects,

mistakes

symptoms of failure

Which are all awarded a specific score.

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Sources

of

problems

Variable Score

A Management defects

Chief Executive is an autocrat 8

Chief Executive also holds position of Chairman 4

Passive Board of Directors 2

Unbalanced Board of Directors, not representing all business

functions or overweight in one discipline

2

Weak Finance Director

2

Poor management in team 1

Accounting defects

No budgets or budgetary controls

3

No cash flow forecasts, or not up to date 3

No costing system: costs and contribution of each product or

service are not known

3

Poor response to change: old-fashioned product or service, obsolete

production facilities, out-of-date marketing methods; old directors

15

43

B Management mistakes(as a result from the above defects)

High gearing 15

Overtrading 15

Failure of a big project 15

45

C Symptoms of trouble(as a result from the above defects and

mistakes)

Financial indicators forecasting poor results[poor Z-score]

4

Creative Accounting

4

Non-financial signs (eg high staff turnover). 4

12

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Score Maximum permitted

A 10

B 15

C 0

25

If any score which are more than 25 then it will need immediate action to avoid company insolvency.

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Strengths and weaknesses of quantitative and qualitative models for predicting

corporate failure

Quantitative models:

Advantages:

Quantitative models such as the Altman Z-score use publicly available financial information

about a firm in order to predict whether it is likely to fail within the two-year period.

The advantages of such methods are that they are simple to calculate and provide an objective

measure of failure.

Disadvantages:

However, they only give guidance below the danger level of 1·8 and there is potential for a

large grey area [1.81-2.99] in which no clear prediction can be made.

Additionally, the prediction of failure of those companies below 1·8 is only a probabilistic one,

not a guarantee. This means not every company with Z score under 1.8 will go bankruptcy.

These models are open to manipulation through creative accounting which can be a feature of

companies in trouble.

Qualitative models:

Advantages:

The advantage of the method is the ability to use non-financial as well as financial measures

and the judgment of the investigator

Disadvantages:

But this is subjective and will vary from different investigators.

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Chapter 2: Management Accountant Traditional role

Management accounting is to provide information relating to planning, decision making and controlling.

Planning:

Gap analysis - Strategy

Costs

Budgets

Pricing decision

Decision making：

Risks and uncertainties decision rules

Controlling：

Performance measurement

Different ratios

Divisions’ measurement

Transfer pricing

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Session 2.1 Traditional Role

Traditionally, it was thought that management accountants needed to be independent from

operational managers in order to allow management accountants to objectively judge and report their

accounting information to senior management.

What management accountant does is to:

1. Compiling information: collect costs relating to each material, labor, overhead etc. focusing on

internal and external information such as existing financial information/ company resources staff

/government report such as inflation rate, predicted exchange rate, consumer expenditure

etc/industry report.[using different costing systems]

2. Analyzing those costs: making sure costs are accurate (how they come with the costs); favorable or

adverse (variance); etc.

3. Preparing budgets using best estimates, ie, sales budget, cash budget etc.

And management accountant would help senior management in the following management

activities:

Planning: [what to do, like strategy]

Plan future activities, budget

Decision making: [do it]

Whether to set up company and what further investment that company may try to make

Control: [if plan is not correct we can correct it later on again]

Variance-Compare results of operation with expected (meet sales/ cost target?)

Performance measurement

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Session 2.2 Gap analysis

This is a difference between current position and the ideal position.

Current position: if you continue to offer ACCA products, you can have $100 return.

Ideal position: shareholders actually want $1,000 of return rather than $100.

And hence $900 is a gap.

But the future forecasts may not be appropriate because it’s subject to uncertainty.

Our aim is to close/minimize that gap.

Ultimate objective GAP

$ Revenue

Future

project

s

Current

operatio

ns

Years

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But how?

The way we are going to close the gap is to set appropriate/additional strategies, ie, developing new

products which may give us a better return.

Ansoff growth vector matrix:

A market penetration strategy aims to increase sales within existing markets.

A market development strategy aims to find additional markets for existing products.

A product development strategy aims to find additional products for an organization’s

existing customers.

A diversification strategy aims to reduce the risks of a business or to increase its growth

prospects by entering new industries.

Other strategies:

Efficiency strategies which are designed to increase profits (or throughput) by making

better use of resources in order to reduce costs.

Also it is possible to reduce a planning gap that is measured in terms of profit by divesting

of loss-making business units.

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Session 2.3 Strategy

Definition of strategy

Pathways that company uses in order to arrive at vision

Johnson and Scholes has classified strategy into 3 levels (types):

Corporate, business and operational strategy

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Corporate strategy

Within corporate strategy there are 4things:

1. Vision, mission and values

Vision: final destination of company, ie, be a leader in the industry.

Mission: how to do that? Ie, provide high quality services.

Values: core characteristics, ie, fair.

The mission would usually be documented with a mission statement:

A mission statement will commonly contain the following:

- Purpose of the organization.

- Overall strategy of the organization.

- The core values of the organization.

In order to realize the mission, company would usually set lots of objectives to ensure it can meet

with the mission. Objectives are more specific and seek to translate the mission into a series of

mileposts for the organization to follow. So company should firstly identify what are the most

important things for company to succeed (CSF) before setting any specific objectives(KPIs).

Critical success factor (CSF):

Critical success factors are those elements that an organization must perform properly in order to

succeed. These often link with competences. For example, punctuality for train. Customer satisfaction.

We often use balanced scorecard to help us generate into ideas of what CSFs that company should

maintain:

Financial

Non-financial

Customers

Internal

Innovation and learning

Key Performance Indicator (KPI)

KPIs are set to measure the CSR.

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Objective [KPI] setting criteria:

(SMARTIE)

Specific – clear statement, easy to understand;

Measurable – to enable control and communication down the organization;

Attainable – It is pointless setting unachievable objectives;

Relevant – appropriate to the mission and stakeholders;

Timed – have a time period for achievement.

Innovative – come up with new ideas

Environmentally friendly

2. Which industry should company go into or leave

3. Portfolio of company

Parental company [step by step teaching sub; allow sub to use parent’s resources]

Synergy creator

Portfolio manager [hands off approach]

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4. Possible strategies

Hold

Build up

Harvest

Divest

But the above strategies are based on 2 theories:

1. Lifecycle theory

2. BCG matrix

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Business strategy

Three Steps:

This means how company would compete with different competitors.

There are three steps for this:

Step1: review your current strategic position

We are focusing on SWOT of the company.

Internal: resources and competences; value chain

External: PESTEL/Porter’s five forces.

International business: Porter’s diamond

Stakeholders’ analysis using Mendlow’s mapping.

Step2: make strategic choices

Generic strategic options

Ansoff’s growth vector matrix

Ways to grow business

Step3: evaluate those choices

SFA test.

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Step1: Review your current strategic position

We are going to use SWOT analysis to summarize strength, weaknesses, opportunities and threats of

the company.

[Internal] strengths and weaknesses (SW)

Resources and competences

The resources and competences would stand for the strengths and weaknesses that company has and

this is also referred to as strategic capability defined by Johnson and Scholes.

But what is the difference between resource and competence?

Resource is something that company has and competence is things the company does.

So we can identify different resources and competences that company has such as following:

Machinery

Money

Materials

Men and Women

Makeup (culture)

Markets (products)

Management information

Management

Methods (processes).

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Porter’s value chain analysis

The five primary activities are:

Inbound logistics: buying raw materials and storage.

Operations: work in progress

Outbound logistics: distribution of product/service

Marketing& Sales: marketing campaign and face to face selling to customers

After sale service: customer service: deal with compliant/maintenance

The four secondary (support) activities are:

Firm infrastructure: organizational structure

Human Resource Management: how to recruit, retain and manage people

Technology Development: research and development

Procurement: getting materials for the company not the individual products, like electricity.

Porter suggests that for each cost in the business which is either value adding or non value adding.

Value-adding: extra benefit > extra cost

Non value-adding: extra benefit < extra cost. Porter suggests than non value-adding activities could

be outsourced.

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[External] opportunities and threats [OT]

*Identify opportunity that company has: (model: PESTEL)

Political – includes government policies on education and infrastructure.

Economic – includes the state of the economy, interest rates and tax levels.

Social – includes attitudes, demographics and household structure.

Technological – includes new technologies making current products obsolete.

Environmental – includes the move towards environmentally cleaner products.

Legal – includes changes in law making it e.g. harder / more expensive to operate.

*Identify threats that company is facing: (model: porter’s 5 forces)

New Competitors [threat of new entrants]

New entrants always drive down profit margins (as companies have to spend more on marketing or

lower prices to keep customers). New competitors are only kept out by barriers to entry. These

barriers include: High fixed costs, High capital requirements.

Existing Competitors [current rivalry]

If there is a lot of rivalry in an industry then profit margins will be lower as companies constantly fight

to retain their customers.

There will tend to be higher rivalry (and lower profits) when A Market growth is slow.

Customers [power of customers]

Powerful customers prevent companies from putting prices up or implementing other changes.

Customers will be powerful if there is standardization within the industry (making it easier to switch to

another supplier).

Suppliers [power of suppliers]

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Powerful suppliers might put their prices up or impose other changes on the company.

Suppliers will be powerful if there are high switching costs or there are a limited number of suppliers.

Substitutes

If there are many substitutes for a product then it becomes harder to raise prices.

There are three main kinds of substitute:

Direct substitute: where the customer buys the same product from a different manufacturer

Indirect substitute: where the customer buys a product from a different industry to meet the same

need

Monetary substitute: where different industries are competing for the same part of a customer’s

income.

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Step2: Make strategic choices

*Generic strategic options Michael Porter comes up with three generic strategic options that company may use, they are:

Option1: to be a cost leader

Option2: to be a product differentiator

Option3: to focus on a particular group of customers (niche strategy)

*Ansoff’s growth vector matrix

Another way of coming up with strategic choices would be to use “Ansoff’s growth vector matrix”.

Each option would be detailed below:

1, Market penetration:

Increasing market share in existing markets utilizing existing products.

The main aim is to increase market share using existing products within existing markets.

Data and information should already have been captured making this the least risky option.

Couple this with the experience of the markets and products and knowledge should be present.

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Approach:

First, attempt to stimulate usage by existing customers

– New uses advertising / promotions / sponsorships / quantity discounts

Then attempt to attract non-users and competitor customers via

– Pricing / Promotion and advertising / Process redesign e.g. Internet/E- commerce

2, Market development:

Entering new markets and segments using existing products.

This aims to increase sales by taking the present product to new markets (or new segments).

Entering new markets or segments may require the development of new competencies which

serve the particular needs of customers in those segments.

E.g. cultural awareness / linguistic skills.

Movement into overseas markets often quoted as good example as the organization will need to build

new competencies when entering international markets.

Approaches:

Direct exporting – selling directly to overseas customers.

- Advantages – the company gets to know the needs of the final customer

- Disadvantages – it may be costly to build up customer awareness.

Indirect exporting – selling to intermediaries such as retailers who then sell to final consumer.

- Advantages – the company gets access to the local company’s knowledge

- Disadvantages – the company will not see all of the profits.

Overseas production – the company manufactures and sells the products in the target country.

- Advantages – distribution costs will be reduced

- Disadvantages – may require a large capital investment.

Contract manufacture (licensing) – the product is made abroad by another company.

- Advantages – lower risk since no need to build manufacturing plant

- Disadvantages – may lose control over areas such as quality.

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Joint ventures – the company goes into partnership with a local company.

- Advantages – lower risk since local knowledge gained and costs shared

- Disadvantages – lower returns since profits shared.

3, Product development:

Developing new products to serve existing markets.

This focuses on the development of new products for existing markets.

It offers the advantage of dealing with known customer/consumer bases.

Company needs to be innovative and strong in the area of R&D and have an established,

reliable marketing database.

Constant innovation allows for the developing sophistication of consumers and customers and

ensures that any product-related competitive advantage is maintained.

Products of the company can be balanced by classifying each products based on their market

share and market growth. So here introduces the model of BCG matrix (Boston consulting

group matrix)

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BCG matrix uses two criteria:

1, Relative market share

This seeks to relate the market share of our SBU in relation to the market share of our largest rival.

This will be expressed as a multiple.

BCG suggests that market share gives a company cost advantages from economies of scale and

learning effects. Thus market share is seen as a strategic asset of sorts.

The dividing line is set at 1 - A figure of 4 suggests that SBU share is four times greater than the

nearest rival. 0.1 suggests that the SBU is 10% of the sector leader.

This is something that can be improved upon by management action and strategy and can be used as

a performance measure.

2, Market growth rate

This represents the growth rate of the market sector concerned. Management often have to react to

this as it is difficult to influence

High growth industries offer a more favorable competitive environment and better long term prospects

than slow-growth industries.

The dividing line is set at 10% though this is often modified to “high growth” and “low growth”

For different products:

1, Cash cows are in the mature or decline stage of the life cycle:

The threat of new competitors is low and the high market share makes the threats from substitutes

and existing competitors low as well.

This product should be earning reasonable profits.

The product cannot grow any further (since the market is already mature).

2, Stars also have a high market share:

The market is growing (introduction or growth stage of the life-cycle) so new competitors will be

attracted into the market

Prices may need to be kept low to maintain market share

Marketing costs might also need to be high to keep sales up

Profits may not be high.

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3, Question marks (problem child) have a lot of potential due to the high growth. Decision is whether

to:

Spend money to build up market share

Spend money to hold market share

Leave market.

4, Dogs have low market share and low growth. They should be closed unless needed by one of the

other products.

Could be ‘niched’ – small segment but focused product ensures success

Over time a resurgence possible and new life cycle started

May require investment just to keep product in portfolio, especially if the company is offering a ‘one

stop shop’ or is using the product as a ‘loss leader’.

4, Diversification

This involves taking new products to new markets – the riskiest option?

Critics argue that it is madness to take resources away from known markets and products only to

allocate them to businesses that the company essentially knows nothing about. This risk has to be

compensated for by higher reward which may or may not exist.

Brand stretching ability is often seen as being the critical success factor for successful diversification.

The new business and its strategy may well have ‘teething problems’ with its implementation and this

may damage brand reputation. Thus there is significant risk.

Reasons suggested for diversification:

Objectives can no longer be met in known markets – possibly due to a change in the external

environment restricting the business in some way.

Company has excess cash and powerful shareholders.

Possible to ‘brand stretch’ and benefit from past advertising and promotion in other SBUs;

Diversification promises greater returns and can spread risk by removing the dependency on

one product.

Power base increases as presence in more markets - buying power.

Efficiency gains – spreading costs.

Greater use of distribution systems and corporate resources such as research and development,

market research, finance and HR leading to synergies. Referred to as “stretching corporate

parenting capabilities”.

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Synergy – the idea that value can be added by combination of units. The value of the whole being

greater than the value of the individual parts

Diversification can take two main forms:

1. Related diversification (concentric diversification)

Growth into similar industries where there is some linkage ie, selling clothes + shoes.

Vertical Integration

– Backward – secure materials supply, ie, a manufacturing company acquires a company supplying

raw materials.

– Forward-secure the sale of product by acquiring a shop.

Horizontal Integration

– In order to sell similar products, ie, sell ACCA courses as well as CIMA courses; selling shoes as well

as glasses.

2. Unrelated diversification (conglomerate diversification)

Completely new areas with which the business shares no common ground and so seen as the last of

the growth strategies, ie, selling shoes + selling ACCA courses.

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Step3: Strategic evaluation

After considering all of the potential strategic choices that we are going to choose, the next thing we

can do is to evaluate these choices to see if choices are reasonable.

So we can use a test called “SFA” test derived by Johnson and Scholes.

*Suitability-fit in to strategy?

Will it meet organizational objectives? – Financial & non-financial

Will it take advantage of opportunities?

Will it build on our strengths?

*Feasibility – will it work?

Enough resources including capital and other recourses such as human resources.

*Acceptability-will it be accepted by stakeholders?

Risks and rewards.

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Session 2.4 Costing

Absorption costing VS Activity based costing

Job costing

Batch costing

Quality focused management accounting techniques:

(i) Kaizen costing

(ii) Target costing

(iii) Just-in-time

(iv) Total quality management

Environmental accounting

Lifecycle costing

Standard costing

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Session2.4.1 JIT [just-in-time] system

This means to get the right quantity of goods at the right place and at the right time.

This can be split into two parts:

1. purchasing

2. production

Key elements: [mnemonics: PRAISE]

P: Pull approach(demand driven) rather than push approach.

R: match payables to suppliers with receivables from customers.

Order goods from supplier on 1/Jan/2014 and settle the invoice on 6/Jan/2014.

Deliver to customers on 3/Jan/2014 and expect customers to pay on 7/Jan/2014.

So here matching payables with receivables[in this example, only 1 day to finance inventory]

A: any non-value adding activities should be eliminiated so for example, set up time; inspection time;

move time; queue time; storage time etc.

S:Good relationship with suppliers and suppliers should not be too far away from your courenty.

E:There should be easy products, ie, small products lines like only 5 products within your company

rather than hunders of them.

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Comment:

Advantages:

lower working capital requirements;

factory floor space savings;

increased flexibility in meeting the customer’s individual needs (faster response times to

product specification changes) because this is a pull approach[demand approach].

Disadvantges:

There will be an increased reliance on suppliers and hence increase their power.

For company there could be difficulty in finding local suppliers who are capable of meeting the

required component and delivery standards needed in order to run such a system.

Quality costs will increase as we emphasize on product quality.

If there is any delay in materials delivery then this will result in stock out and hence company

would lose sales revenue.

Multi skills workers would be needed because we need to best utilise resources within company

and maybe it’s hard to train those multi skill workers and also there would be costs associated

with them.

Also company needs to use appropriate measures to measure bottlenecks in production in

order to increase its efficiency like using throughput accounting and if this is not the case then

JIT system will not be successfully implemented.

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Session2.4.2 Total quality management

Basic principles:

1. Getting things right first time,

On the basis that the cost of correcting mistakes is greater than the cost of preventing them from

happening in the first place.

2. Continuous improvement,

Which is the belief that it is always possible to improve, no matter how high quality may be already.

How to apply?

1. in relation to design.

Products and processes should be designed with quality in mind (so that faults are not incorporated

from the outset). For example, COMPANY would need to ensure that specifications for product were

100% correct.

2. In relation to product production.

The quality of output depends on the quality of input materials and so TQM would require procedures

for acceptance and inspection of goods inwards and measurement of rejects. Inspection of output

could take place at various key stages of the production process to provide a continual check that the

production process is under control.

Machines should be maintained so that quality production occurs.

3. In relation to sales.

Some sub-standard output will inevitably be produced.

Customer complaints should be monitored in the form of letters of complaint, returned goods, penalty

discounts and so on.

4. In relation to suppliers.

Supplier quality assurance schemes could be established so that suppliers would guarantee the quality

of goods supplied. The onus would then be on the supplier to carry out the necessary quality checks or

face cancellation of the contract.

5. In relation to employees.

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Quality should be the primary concern of every employee at every stage of production. Workers must

therefore be empowered and take responsibility for the quality of COMPANY's products, stopping the

production line if necessary. Quality circles might be set up, perhaps with responsibility for

implementing improvements identified by the circle members.

6. In relation to the information system.

The information system should be designed to get the required information to the right person at the

right time.

Costs of non-conformance:

Quality costs

Cost of products that do not meet the prescribed quality standards.

1. Costs of internal failure are money spent repairing a product BEFORE a customer

receives a product that has been found to be faulty.

Examples relevant to the business of COMPANY could include the cost of products scrapped

due to inefficiencies in goods inwards procedures, the cost of products lost in process and the

cost of products rejected during any inspection process.

2. Costs of external failure are money spent repairing a product AFTER the customer has

received a faulty product. Examples include meeting warranty costs.

Costs of conformance:

Ensuring that products are at the acceptable quality standard.

3. Costs of prevention represent the money spent BEFORE products are made to prevent

problems occurring.

Examples include staff training, design and process engineering and machine maintenance.

4. Costs of appraisal are the costs of assessing the level of quality achieved.

This means money spent AFTER products are made to check quality is acceptable.

Examples applicable to COMPANY could be the cost of any goods inwards checks and the

costs of any supplier vetting.

Reduction of non-conformance costs requires an increase in conformance costs in order to

prevent product failures

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Session2.4.3 Absorption costing VS Activity based costing

The aim of these methods is to set up full cost/unit.

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

AC:

OAR = budgeted overhead

Budgeted level of activities

Use OAR X activities (such as machine hours) to calculate overhead for each product.

ABC:

Steps:

Steps1: cost/driver

Step2: total overhead consumed by each products.

Comment about AC:

Advantage:

Can only work in single product and simple manufacturing environments

Disadvantage:

Inappropriate bases to link overheads to products

Comment about ABC:

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

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Q: Universal Motors [AC VS ABC]

Universal Motors wants to establish the cost of its products and find when using different costing

method which will lead to different result and detailed information has been given below:

Direct labor costs $6 per hour and production overheads are absorbed on a machine hour basis if

absorption costing approach is used.

Total production overheads are $654,500 and further analysis shows that the total production

overheads can be divided as follows:

%

Costs relating to set-ups 35

Costs relating to machinery 20

Costs relating to materials handling 15

Costs relating to inspection 30

100

Hours per unit Materials

Cost per unit ($)

Production units

Labour

hours

Machine

hours

Eco 0.5 1.5 20 750

Eco Plus 1.5 1 12 1,250

Eco Lite 1 3 25 7,000

Figure 2: Information relevant to the cost of each types of car

The following total activity volumes are associated with each product line for the period as a whole:

Number of set ups Number of material

movements

Number of

inspections

Eco 75 12 150

Eco Plus 115 21 180

Eco Lite 480 87 670

670 120 1,000

38


Required:

1. Compare full costs per unit using absorption costing and activity based costing(show

your calculation in an appendix) (11marks)

2. Briefly describe advantages and disadvantages of activity based costing (2marks)

Answer to Q: Universal Motors:

(ii)

Using absorption costing:

Full cost/unit

Eco Eco Plus Eco Lite

Direct material 20 12 25

Direct labour

0.5hrs X$6/hr

1.5hrs X$6/hr

1hrs X$6/hr

3 9 6

Overhead

1.5hrs X$28/hr

1hr X$28/hr

3hrs X$28/hr

42 28 84

Full cost/unit 65 49 115

Overhead absorption rate=budgeted total overhead

Level of activities

= $654,500

1.5hrsX750units+1hrX1, 250units +3hrsX7, 000units (23375hrs)

= $28/hr

39


Using activity based costing:


Direct material 20 12 25

Direct labour

0.5hrs X$6/hr

1.5hrs X$6/hr

1hrs X$6/hr

3 9 6

Overhead (W) 95 79 69

Full cost/unit 118 100 99

W: Steps1: cost/driver

Activities Cost% Cost pool Cost driver No of drivers Cost/driver

Set up 35 229,075 No of set up 670 342

Machine hrs 20 130,950 No of hrs 23,375 6

Materials 15 98,175 No of

handling

120 818

inspection 30 196,350 No of

inspection

1,000 196

100% $654,500

40


Step2: total overhead consumed by each products.


Activities Costs Activities Costs Activities costs

Set up 75 25,643 115 39,319 480 164,113

machine hrs

1.5X750

1X1250

3X7,000

1,125 6,300 1,250 7,000 21,000 117,600

Materials handling 12 9,817 21 17,181 87 71,137

Inspection 150 29,453 180 35,343 670 131,554

71,213 98,843 484,444

Units produced 750 1,250 7,000

Overhead/unit $95/unit $79/unit $69/unit

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

41


Session2.4.4 Job costing

Used in environment where each job is unique to customer specifications

Job card:

$

Direct material X

Direct labour X

Prime cost X

Production overhead X

Total production cost X

Non production overhead(% of prime

cost/production overhead)

X

Total cost X

Markup/margin X

Selling price X

42


Q kitty Ltd

Kitty Ltd is a local jobbing company has just completed a one-off job which involved making a

specialist iron frame. The item was given the job number 505.

Materials issued were as follows:

Steel grade A: 400 metres at a cost of $5.00 per metre

Steel grade B: 800 metres at $6.00 per metre

Note 60 metres of grade B steel were unused and were returned to store.

The iron frame involved two production departments:

Welding: 220 normal hours, 100 overtime hours

Finishing: 100 normal hours, 100 overtime hours

Hourly rate

Welding: $4.00 per normal hour, $1.00 overtime premium

Finishing: $5.00 per normal hour, $1.50 overtime premium

Production overheads are absorbed at the rate of $3.00 per direct labour hour in each department.

Note the company uses cost plus pricing of work and adds 40% to the cost of a job to determine price.

The company is very busy and would not normally work overtime on a job of this nature

Required:

Calculate the cost for Job 505.

43


Session2.4.5 Batch costing

Very same as job costing.

But instead completing each job card

Here we are going to complete many units within the batch.

Q Story Ltd

Story Ltd operates a batch costing system. For a particular order, 8units are produced in a batch.

The following costs were incurred producing the batch:

Direct materials £230

Direct labour £180

Direct labour is paid at £7.50 per hour.

Production overheads are absorbed at a rate of £12 per direct labour hour and nonproduction

overheads are absorbed at a rate of 30% of total production cost.

Required:

Calculate the cost/unit in the batch.

44


Session2.4.6 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 about target costing:

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.

45


Q: june2010 Q5 (target costing)

The Better Electricals Group (BEG) which commenced trading during 2002 manufactures a range of

high quality electrical appliances such as kettles, toasters and steam irons for domestic use which it

sells to electrical stores in Voltland.

The directors consider that the existing product range could be extended to include industrial sized

products such as high volume water boilers, high volume toasters and large steam irons for the hotel

and catering industry. They recently commissioned a highly reputable market research organization to

undertake a market analysis which identified a number of significant competitors within the hotel and

catering industry.

At a recent meeting of the board of directors, the marketing director proposed that BEG should make

an application to gain ‘platinum status’ quality certification in respect of their industrial products from

the Hotel and Catering Institute of Voltland in order to gain a strong competitive position. He then

stressed the need to focus on increasing the effectiveness of all operations from product design to the

provision of after sales services.

An analysis of financial and non-financial data relating to the application for ‘platinum status’ for each

of the years 2011, 2012 and 2013 is contained in the appendix.

The managing director of BEG recently returned from a seminar, the subject of which was ‘The Use of

Cost Targets’. She then requested the management accountant of BEG to prepare a statement of total

costs for the application for platinum status for each of years 2011, 2012 and 2013. She further asked

that the statement detailed manufacturing cost targets and the costs of quality.

The management accountant produced the following statement of manufacturing cost targets and the

costs of quality:

Required:

(a)Explain how the use of cost targets could be of assistance to BEG with regard to their application

for platinum status. Your answer must include commentary on the items contained in the statement of

manufacturing cost targets and the costs of quality prepared by the management accountant.

(8 marks)

46


Answer to june2010 Q5:

Variable costs and fixed costs

Both variable costs and fixed costs are expected to increase which may be indicative of an

increase in the level of activity.

Quality costs:

Internal failure costs

Internal failure costs are money spent repairing a product BEFORE a customer receives a

product that has been found to be faulty. Eg, the cost of products lost in process and the cost

of products rejected during any inspection process.

External failure costs

External failure costs are money spent repairing a product AFTER the customer has received

a faulty product. Examples include warranty costs.

Prevention costs

Prevention costs represent the money spent BEFORE products are made to prevent problems

occurring, Eg, staff training costs.

Appraisal costs

This means money spent AFTER products are made to check quality is acceptable, eg,

inspection costs.

Trend:

Internal failure costs are expected to fall from 21.9% (2,500/ (8,400 + 3,000))of the cost

target to 7.5%(1,200/(12,600+3,400)) from 2011 to 2013.

External failure costs are expected to decline from 27.2% (3,100/(8,400 + 3,000)) of cost

target to 6.1% from 2011 to 2013.

Prevention costs are expected to fall from $4·2m in 2011 to $1·32m in 2013.

Appraisal costs are expected to decrease by $100,000 to $0·7m in 2012 and to remain at that

level during 2013.

Implication:

In a traditional manufacturing approach to quality, management spend more on conformance

costs(prevention and appraisal) to reduce non-conformance costs(failure costs) but as costs of

conformance are high, especially to secure zero defects, there is an acceptable level of defects.

However in a TQM system, management would aim for zero defects and spend on conformance

costs to reduce total quality costs over time. The emphasis is on getting things right first time

and designing in quality.

BEG is projecting a decrease in all categories of quality cost over the three years which

suggests a TQM approach is being taken.

It would be useful for BEG to obtain some data on costs of quality from the competition in the

hotel and catering industry to get a benchmark for what reasonable costs of quality are since

projections seem a little ambitious.

47


Session2.4.7 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.

48


Session2.4.8 Environmental management accounting:

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

operation of business.

The question is why care?

From a financial perspective:

Raw material

Transport and travel

Water consumption

Energy costs

Clean up costs

Taxations

From a non-financial perspective:

Reputation

Ethics

Stakeholder’s needs

Pressure on resources

49


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

Environmental costs categories:

1, Conventional costs

Such as raw material costs and energy costs which should also include the cost of waste

through inefficiency.

These and other conventional costs (such as regulatory fines) are often hidden within

overheads and therefore will not be a high priority for management control unless they are

separately reported.

2, Contingent costs

Such as the cost of cleaning industrial sites when these are decommissioned.

These are often large sums that can have significant impact on the shareholder value

generated by a project. As these costs often occur at the end of the project life, they can be

given low priority by a management that is driven by short-term financial measures (e.g.

annual profit) and make large cash demands that must be planned at the outset of the project.

3, Relational costs

There are relational costs such as the production of environmental information for public

reporting.

This reporting will be used by environmental pressure groups and the regulator and it will

demonstrate to the public at large the importance that PLX attaches to environmental issues.

4, Reputational costs

If the company is failing to address environmental issues and if this is made public then it

would impair company’s reputation and hence company would lose sales revenue.

50


How to account for it?

1, input/output analysis:

= + + +

Analyze 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.

c 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

3, activity based costing

There are:

① environmentally related costs which can be specifically attributed to an environmental cost center,

eg, sewerage plants.

②environmentally 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.

100%

Input

80%finish

ed goods

10%scrap

value 10%

waste

51


4, lifecycle costing

It considers costs and revenue 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 cleanup costs.

Q Pilot paper Q4 [lifecycle costing + environmental management accounting]

Refinery Co is a large oil refinery business in Kayland. Kayland is a developing country with a large

and growing oil exploration and production business which supplies PLX with crude oil. Currently, the

refinery has the capacity to process 200,000 barrels of crude oil per day and makes profits of $146m

per year. It employs about 2,000 staff and contractors. The staff are paid $60,000 each per year on

average (about twice the national average in Kayland).

The government of Kayland has been focused on delivering rapid economic growth over the last 15

years. However, there are increasing signs that the environment is paying a large price for this growth

with public health suffering. There is now a growing environmental pressure group, Green Kayland

(GK), which is organizing protests against the companies that they see as being the major polluters.

Kayland’s government wishes to react to the concerns of the public and the pressure groups. It has

requested that companies involved in heavy industry contribute to a general improvement in the

treatment of the environment in Kayland.

As a major participant in the oil industry with ties to the nationalized oil exploration company (Kayex),

PLX believes it will be strategically important to be at the forefront of the environmental developments.

It is working with other companies in the oil industry to improve environmental reporting since there

is a belief that this will lead to improved public perception and economic efficiency of the industry. PLX

has had a fairly good compliance record in Kayland with only two major fines being levied in the last

eight years for safety breaches and river pollution ($1m each).

The existing information systems within PLX focus on financial performance. They support financial

reporting obligations and allow monitoring of key performance metrics such as earnings per share and

operating margins. Recent publications on environmental accounting have suggested there are a

number of techniques (such as input/ output analysis, activity-based costing (ABC) and a lifecycle

view) that may be relevant in implementing improvements to these systems.

PLX is considering a major capital expenditure program to enhance capacity, safety and efficiency at

the refinery. This will involve demolishing certain older sections of the refinery and building on newly

acquired land adjacent to the site. Overall, the refinery will increase its land area by 20%.

Part of the refinery extension will also manufacture a new plastic, Kayplas. Kayplas is expected to

have a limited market life of five years when it will be replaced by Kayplas2. The refinery accounting

team have forecast the following data associated with this product and calculated PLX’s traditional

performance measure of product profit for the new product:

52


All figures are

$m’s

2012 2013 2014 2015 2016

Revenue generated 25.0 27.5 30.1 33.2 33.6

Costs：

Production costs

13.8

15.1

16.6

18.3

18.5

Marketing costs 5.0 4.0 3.0 3.0 2.0

Development costs 5.6 3.0 0.0 0.0 0.0

Product profit 0.6 5.4 10.5 11.9 13.1

Subsequently, the following environmental costs have been identified from PLX’s general overheads as

associated with Kayplas production.

2012 2013 2014 2015 2016

Waste filtration 1.2 1.4 1.5 1.9 2.1

Carbon dioxide exhaust extraction 0.8 0.9 0.9 1.2 1.5

Additionally, other costs associated with closing down and recycling the equipment in Kayplas

production are estimated at $18m in 2016.

The board wishes to consider how it can contribute to the oil industry’s performance in environmental

accounting, how it can implement the changes that this might require and how these changes can

benefit the company.

Required:

(a) Discuss and illustrate four different cost categories that would aid transparency in environmental

reporting both internally and externally at PLX. (6 marks)

(b) Explain and evaluate how the three management accounting techniques mentioned can assist in

managing the environmental and strategic performance of PLX. (9 marks)

(c) Assess the impact of implementing an input/output analysis on the information systems used in

PLX.

(3 marks)

(d) Evaluate the costing approach used for Kayplas’s performance compared to a lifecycle costing

approach, performing appropriate calculations.

(7 marks)

(25marks)

53


Answer to pilot paper Q4:

(a)

Conventional costs

Such as raw material costs and energy costs which should also include the cost of waste

through inefficiency.

These and other conventional costs (such as regulatory fines) are often hidden within

overheads and therefore will not be a high priority for management control unless they are

separately reported.

Contingent costs

Such as the cost of cleaning industrial sites when these are decommissioned.

These are often large sums that can have significant impact on the shareholder value

generated by a project. As these costs often occur at the end of the project life, they can be

given low priority by a management that is driven by short-term financial measures (e.g.

annual profit) and make large cash demands that must be planned at the outset of the project.

Relational costs

There are relational costs such as the production of environmental information for public

reporting.

This reporting will be used by environmental pressure groups and the regulator and it will

demonstrate to the public at large the importance that PLX attaches to environmental issues.

Reputational costs

If the company is failing to address environmental issues and if this is made public then it

would impair company’s reputation and hence company would lose sales revenue.

54


(b)

Lifecycle costing

It considers costs and revenue 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 cleanup costs.

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

Input/output analysis:

Input/output analysis (sometimes called mass balance) considers the physical quantities input

into a business process and compares these with the output quantities with the difference

being identified as either stored or wasted in the process.

These physical quantities can be translated into monetary quantities at the end of the tracking

process.

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 organzations.

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.

55


Comment about methods:

However, cost/benefit analysis will need to be undertaken for each of the systems.

This will be difficult, as benefit estimates will prove vague given the unknown nature of the

possible improvements that may accrue from using the techniques.

ABC and input/output analysis will require significant increases in the information that the

management accounting systems collect and so incur increased costs

(c)

Input/output analysis will require the information systems to collect not just monetary but also

physical measurements of the materials being processed through the refinery.

This may require additional records and costly changes to company’s existing database

structures.

Systems will have to be put in place to monitor physical volumes of raw materials, waste and

recycled material within the refinery’s processes.

(d)

Traditional costing:

This ignores capital costs, environmental costs and the cost of decommissioning.

Revenue 149.4

Production, marketing and development costs [use 149.4-41.5] 107.9

Product profit(over 5 years) 41.5

Profit margin 27.8%

Lifecycle costing:

A lifecycle analysis aims to capture the costs over the whole lifecycle of the product:

Revenue 149.4

Production, marketing and development costs[use 149.4-41.5] 107.9

Waste filtration 8.1

Carbon dioxide exhaust extraction 5.3

Decommissioning costs 18

revised product profit 10.1

Profit margin 6.8%

56


Comment:

When the environmental costs are all included, the forecast profit margin on the Kayplas

project is reduced from 27.8% to 6.8%, which makes it a much less attractive investment.

If the actual costs of decommissioning in five years time are higher than the forecast – for

example, due to changes in environmental legislation in the next five years - then the profit

margin will be reduced even further.

Lifecycle costing makes the post-production costs such as decommissioning costs visible at the

start of the project and in the design stage of the product and this should help PLX to minimize

those.

Eg, they could investigate whether they could design any of the equipment to be used to

produce Kayplas in such a way that it could also be used to produce Kayplas2.

57


Session2.4.9 Benchmarking

The idea of comparing performance is called benchmarking.

Benchmarking is the process of identifying “best practice” in relation to both products (including) and

the processes by which those products are created and delivered. The search for “best practice” can

take place both inside a particular industry, and also in other industries.

Benchmarking is the establishment, through data gathering, of targets and comparators, through

whose use relative levels of performance can be identified.

‘By adoption of identified best practices it is hoped that performance will improve’

Process:

1, Decide the areas to benchmark. I.e. improve efficiency.

2, Identify key performance drivers and indicators

The performance drivers have been provided and the indicators are based on the activity per driver.

3, Select organizations for benchmarking comparison

4, Measure performance of all organizations involved in benchmarking

This step would normally be more complex in a private sector situation as commercial secrecy would hinder the sharing of information.

5, Compare performances

6, Specify improvement projects

7, Implement and monitor improvements

58


Types:

Functional benchmarking

This is where a function of the business is compared to a similar function of another business.

The two businesses do not necessarily have to be competitors.

This sort of benchmarking can lead to innovation and dramatic improvements.

Competitive or performance benchmarking

Businesses consider their position in relation to performance of the best in the sector.

Competitors are unlikely to provide willingly any information for comparison so this type of

analysis is often undertaken through trade associations or third parties to protect

confidentiality.

Internal benchmarking

This involves comparing businesses or operations from within the same organisation (eg

business units in different countries).

Strategic benchmarking

This is a form of competitive benchmarking where businesses need to improve overall

performance by examining the long-term strategies and general approaches that have enabled

competitors to succeed to succeed.

It involves considering high level aspects such as core competencies and developing new

products.

Changes resulting from this type of benchmarking may be difficult to implement.

Again, the above can only be done if the company has adopted appropriate performance

measures.

59


Advantages and disadvantages:

Advantages:

Highlighting which processes need improvement.

Focusing managers on the need for change.

Helping with efficiency and effectiveness.

Helping to prevent failing to meet threshold competences.

Helping to identify that distinctive competences are in advance of rivals.

Disadvantages:

Implying that there is a single best way to do things which must be copied by all.

It is not appropriate if the industry is changing radically.

It can mean the company is always behind its rivals.

The wrong activities might be examined.

It depends on accurate measurements.

60


You are also required to calculate the following ratios:

1. Profitability

Return on Capital Employed.

Gross Profit Margin.

Asset Turnover.

2. Liquidity

Current ratio.

Acid ratio.

Inventory days.

Receivables days.

Payables days.

3. Gearing

Debt / Equity ratio.

61


Q June2012 Q4 [Benchmarking]

Ganymede University (GU) is one of the three largest universities in Teeland, which has eight

universities in total. All of the universities are in the public sector. GU obtains the vast majority of its

revenue through government contracts for academic research and payments per head for teaching

students. The economy of Teeland has been in recession in the last year and this has caused the

government to cut funding for all the universities in the country.

In order to try to improve efficiency, the chancellor of the university, who leads its executive board,

has asked the head administrator to undertake an exercise to benchmark GU’s administration

departments against the other two large universities in the country, AU and BU. The government

education ministry has supported this initiative and has required all three universities to cooperate by

supplying information.

The following information has been collected regarding administrative costs for the most recent

academic year:

The key drivers of costs and revenues have been assumed to be research contract values supported,

student numbers and total staff numbers. The head administrator wants you to complete the

benchmarking and make some preliminary comment on your results.

Required:

(a) Assess the progress of the benchmarking exercise to date, explaining the actions that have been

undertaken and those that are still required. (8 marks)

(b) Evaluate, as far as possible, Ganymede University’s benchmarked position.

(9 marks)

(17 marks)

62


Answer to june2012 Q4:

(a)

1. Decide the areas to benchmark. I.e. improve efficiency.

GU is trying to improve efficiency and is benchmarking all of its administration operations relating to teaching and

research.

2. Identify key performance drivers and indicators

The performance drivers have been provided and the indicators are based on the activity per driver. The drivers might

be improved by distinguishing between teaching staff and administrative staff.

3. Select organizations for benchmarking comparison

The government selected the three largest universities for benchmarking which excludes five other smaller universities.

4. Measure performance of all organizations involved in benchmarking

The basic data has been gathered as required by government. This step would normally be more complex in a private

sector situation as commercial secrecy would hinder the sharing of information.

5. Compare performances with other universities.

6. Specify improvement projects

The results of the comparison should lead to identification of areas for improvement. If GU is not demonstrating leading performance then it should send staff to the top performer to identify their best practice processes and devise projects to implement these at GU.

7. Implement and monitor improvements

Management should perform a post-project review in order to identify if the improvement has achieved or exceeded its goals and consider lessons that have been learned from the project.

63


(b)

GU ($) AU($) BU($)

Research [research/contract value]

Contract management 78 87 97

Lab 226 257 281

Teaching facilities management[exp/students] 951 1,197 920

Student support services[exp/students] 71 89 73

Other support services[exp/staff]

Teacher’s support services 506 532 544

Accounting 204 204 197

Human resources 156 156 191

IT management 817 803 737

General services 2,153 2,088 2,286

Research

GU has the lowest costs relative to the value of the research contracts supported, and it has also

earned the highest value contracts.

This may suggest that GU continues to maintain its good practice in cost controls.

Teaching facilities management & Student support services

AU spends significantly more per student on its teaching facilities and student support than the other

two universities but with fewer students.

The lower student numbers at AU may also reflect that it only wants to accommodate a smaller

number of students and therefore sets harder entry requirements than the other two.

So we can compare factors such as student drop out rates, pass rates, and students success rates in

gaining employment after they graduate.

Other support services

Teachers’ support services

Costs of BU is higher than the other two and it is with the highest amount of students and hence it

may suggest that students are interested in teachers support services.

Human Resources

BU’s human resource costs per staff member are 22% higher than the other two universities although

it’s with more staff than GU and it may suggest that GU is more efficient.

64


IT management

GU spends more (around 11%) on IT management than BU. However, this may be due to the subjects

being taught.

E.g. if GU offers more science and technology-based subjects this is likely to mean it will need greater

computing resources than if it offers more arts subjects.

Further investigation:

We need to obtain further information:

1. subjects being taught to determine the costs relating to IT management;

2. locations of universities to determine the staff costs levels.

65


Session2.4.10 Standard costing:

Standard cost card

$

Direct material(3kg/unitX$4kg) 12

Direct labor(2hrs/unitX$6/hr) 12

Variable overhead(2hrs/unitX$4/hr) 8

Standard variable cost 32

Fixed overhead(2hrs/unitX$8/hr) 16

Standard cost 48

Standard profit(50%mark up) 24

Standard selling price 72

The standard set by the company would be:

1, ideal standard:

Base on perfect standard-no efficiency in the process but demotivation

2, attainable standard:

Improves on current standard but still allows for small inefficiency in the process, e.g. want to improve

last year’s result and admit this is not perfect due to some factors.

3, current standard:

Standard an organisation is currently achieving. It does not provide inspiration for improvement but it

does provide a benchmark against which to measure day-to-day activity.

4, basic or historic standard:

This is a standard (e.g. cost/unit) that was set some time ago and has not been updated. It allows a

company to measure its progress over time.

But in the real life that the standard cost would be always different from the actual cost.

And we need to investigate reasons why there would be difference between the two (variance analysis)

66


Basic variance analysis:

Variance can be favorable or adverse.

1, FAVOURABLE VARIANCES occur when actual results are better than expected, producing higher

than expected profits.

2, ADVERSE VARIANCES occur when actual results are worse than expected, producing lower than

expected profits.

Cost variance:

1, Materials:

Standard cost: 3kg/unit X$4/kg $12

Actual:

Output 1,400units

Material used: 3,000kg $15,000

Required:

Calculate usage and price variance for materials.

Variance analysis

Material

variance

Labour

variance Variable

overhead

variance

Fixed

overhead

variance

Sales

variance

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Possible reasons for material variance:

Piece variance Usage variance

1, budget is wrong 1, budget is wrong

2, material quality changes 2, theft

3, purchasing issues (discount?) 3, material quality changes

4, external factors(inflation) 4, labour quality changes

2, Labor

Standard cost: 2hrs/unit X$6/hr =$12

Actual:

Output 1,400units

Labor: 3,000hrs 20,000

Required:

Calculate efficiency and rate variance.

Possible reasons for labour variance:

Efficiency Rate

Budget Labour quality

Labour quality Inflation

Motivation Unplanned changes/bonus

Idle time?

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3, Variable overhead variance

Standard: 2hrs/unit X $4/hr =$8/hr

Actual:

Output 1,400units

Actual variable overhead 3,000hrs $11,000

Required:

Calculate variable overhead variance.

Possible reasons:

Efficiency Expenditure

Same as labour efficiency Need to breakdown and investigate

4, Fixed overhead variance:

Budget Actual

Units 1,000 1,100

Hours 2,000 2,300

Fixed overhead Costs $10,000 $11,000

Required:

Calculate variances for fixed overheads

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Possible reasons:

Efficiency Capacity Volume Expenditure

Efficient labour? Labour worked

overtime?

Motivation?

Labour shortages?

Machine

breakdown?

Labour worked

overtime?

Motivation?

Labour shortages?

Machine

breakdown?

Need to breakdown

and investigate

Eg, saving in costs?

5, Revenue Variance:

Q Tony

Output:

Budgeted 1,000units

Actual 1,400units

Standard variable cost $32/unit

Standard full cost $48/unit

Standard selling price $70/unit

Actual selling price $$65/unit

Required:

Calculate the following variances for Tony:

1, sales volume variance

2, sales price variance

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Advanced variance analysis

1, Planning and operational variance

Planning variance is due to planning error and uncontrollable items by management so management

should not be measured based on planning variance.

E.g. if the standardized purchase price for the material is $50/kg and the actual is $60/kg then it may

suggest management has spent more to purchase the raw material then it should be of $10/kg. But if

I’m going to give you further information that there’s an inflation in the prices of 10% which means

10%X$50/kg=$5.kg is not controllable by the management and this is the planning variance. There’s

only $5/kg which is controllable by the management then this is operational variance.

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Planning variance

(replace actual with revised

standard)

Operational variance

(replace standard with revised

standard)

SQSP SQSP RSQRSP

Usage

AQSP RSQSP AQRSP

Price

AQAP RSQRSP AQAP

Q POPO

POPO involves in selling bottles and it incurred the following information when making a bottle.

Standards:

3kg/unit for $5/kg

Actual:

Output: 12,500units

Usage of material: 38,000kg

Costs: $195,500

Required:

Calculate the basic usage and price variance suggesting whether production and purchase

manager have done a good job.

Calculate the planning and operational variance if further investigation has suggested that due

to the poor harvest that POPO used poorer quality of material and increases the usage to

3.1kg/unit and due to inflation that purchase cost has increased to $5.15/kg.

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2, Mix and yield variance

Mix variance is saying a change in the material mix will have a higher or lower cost than standard

input cost.

Yield variance is saying a change in the material mix will have an impact on the output valued a

standard costs.

This is the sub analysis for the material usage variance.

Mix and yield variance applied where:

1, A mix-2 or more materials in making a product

2, material inputs are inter-changeable.

SQSP

Yield variance

AQ(SM)SP

Mix variance

AQSP

Price variance

AQAP

73


MM Ltd

MM ltd manufactures a special wine where three components apply:

Standard proportions Standard cost/tonne

% $

A 70 20

B 20 30

C 10 50

A production loss of 10% happened.

In May, 855 tonnes of wine were produced and inputs were as follows:

actual inputs (tonnes) Actual prices/tonnes

$

Actual cost

$

A 660 21 13,860

B 210 32 6,720

C 130 47 6,110

1,000 26,690

Required:

Calculate the material price, mix and yield variances

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3, Sales volume variance break down:

From our early study, we notice:

Volume variance= (AS-BS)SCM

= AS SCM – BS SCM

When a company has two or more products (products mix) we might need to analyze which product

we can sell more and which product we can sell less.

So breaking it down further:

AS SCM

Sales mix variance

AS(SM) SCM

Sales quantity variance

BS SCM

Q KITTY

Kitty has two products to sell: Gitty and Bitty

Standards (budget):

units Standard

price

Standard

cost

Sales

Gitty 1,500units $50 $40

Bitty 2,500units $80 $60

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Actual results:

units Standard

price

Sales

Gitty 2,000units $55

Bitty 2,250units $83

Required:

Calculate the sales mix and quantity variances.

*Market size and market share variances

Sales quantity variances we analyzed above simply saying whether the number of goods sold is

greater or less than expected.

This can be due to:

1, market size: the wider economic growth which leads to more demand in the goods and this is not

controllable by the management which is a planning variance.

2, market share: the profit we retained in the market so this is controllable and this is determined by

management action.

AS SCM

Market size variance

RS(actual market size) SCM

Market share variance

BS SCM

Q MZ ltd

MZ ltd has incurred the following information:

Budgeted (standard) sales volume=250,000units

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Actual sales volume=240,000units

Standard contribution margin=$6/unit

The total market volume shows a slump of 10%.

Required:

Calculate market size and market share variance.

4, idle time variances

This is the difference between hours paid and worked maybe there’s a material stock out or machine

breakdown or you retained some of the staff within your company in case you need them even though

there’s little work to do.

SH SR

Efficiency

AHW SR

Idle time

AHP SR

rate

AH AR

If budgeted idle time is incorporated:

SH SRW

Efficiency

AHW SRW

Idle time

AHP SRP

rate

AH ARP

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Q Jean Ltd

Labour situation within Jean Ltd is as follows:

Standard:

$6/hr X3hr/unit =$18/unit

Actual results:

Output: 1,200units

Hours worked: 4,200hours

Hours paid: 5,500hours

Labour cost: 432,000

(i) Calculate the labour efficiency variance, labour idle time variance and labour rate variance.

(ii) Calculate the labour efficiency variance, labour idle time variance and labour rate variance if we

expect to lose 20% of labour hours due to idle time.

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Session2.4.11 Kaizen costing: 【改-Kai; 善-Zen】

Kaizen can be translated as continuous improvement.

Kaizen costing applies functional analysis in the design phase to create a target cost for each

production function.

These are totalled to give a product target cost which, after the first year of production, is used as the

baseline for further on-going reductions. These reductions in turn reduce the baseline cost and so on

as the production process improves

The management attitude to employees is different in the standard costing system and Kaizen costing

system, as in continuous improvement systems they are the source of the improvement solutions

while in standard costing systems with its analysis of variances of labour rates and efficiencies, the

employees are often seen as the source of problems.

In the Kaizen system, the employees often work in teams and are empowered to make changes to

production that would have to be cleared through a management hierarchy in a more static standard

costing system. Changing the costing system would be likely to represent a major cultural change at

Tench with its history of bureaucratic control.

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Q: DEC2011 Q5 [Kaizen costing & JIT]

Tench Cars (Tench) is large national car manufacturing business. It is based in Essland, a country that

has recently turned from state communism to democratic capitalism. The car industry had been

heavily supported and controlled by the bureaucracy of the old regime. The government had stipulated

production and employment targets for the business but had ignored profit as a performance measure.

Tench is now run by a new generation of capitalist business people intent on rejuvenating the

company’s fortunes.

The company has a strong position within Essland, which has a population of 200 million and forms

the majority of Tench’s market. However, the company has also traditionally achieved a good market

share in six neighbouring countries due to historic links and shared culture between them and Essland.

All of these markets are experiencing growing car ownership as political and market reforms lead to

greater wealth in a large proportion of the population. Additionally, the new government in Essland is

deregulating markets and opening the country to imports of foreign vehicles.

Tench’s management recognizes that it needs to make fundamental changes to its production

approach in order to combat increased competition from foreign manufacturers. Tench’s cars are now

being seen as ugly, pollutive and with poor safety features in comparison to the foreign competition.

Management plans to address this by improving the quality of its cars through the use of quality

management techniques. It plans to improve financial performance through the use of Kaizen costing

and just-in-time purchasing and production. Tench’s existing performance reporting system uses

standard costing and budgetary variance analysis in order to monitor and control production activities.

The Chief Financial Officer (CFO) of Tench has commented that he is confused by the terminology

associated with quality management and needs a clearer understanding of the different costs

associated with quality management. The CFO also wants to know the impact of including quality costs

and using the Kaizen costing approach on the traditional standard costing approach at Tench.

Required:

Write to the CFO to:

(a) Discuss the impact of collection and use of quality costs on the current costing systems at Tench.

(6marks)

(b) Discuss and evaluate the impact of the Kaizen costing approach on the costing systems and

employee management at Tench. (8 marks)

(c) Briefly evaluate the effect of moving to just-in-time purchasing and production, noting the impact

on performance measures at Tench. (6 marks)

(20 marks)

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Answer to DEC2011 Q5:

(a)

The costs of quality will probably be hidden in overheads in the standard costing system at Tench.

The existing system will need to be modified to separate these costs.

Quality costs:

Internal failure costs

Internal failure costs are money spent repairing a product BEFORE a customer receives a

product that has been found to be faulty. Eg,the cost of products lost in process and the

cost of products rejected during any inspection process.

External failure costs

External failure costs are money spent repairing a product AFTER the customer has

received a faulty product. Examples include warranty costs.

Prevention costs

Prevention costs represent the money spent BEFORE products are made to prevent

problems occurring, E.g. staff training costs.

Appraisal costs

This means money spent AFTER products are made to check quality is acceptable, eg, inspection

costs.

The identification and collection of these costs will help Tench to raise the quality of its products

in order to compete more effectively with the new imports.

Reduction of non-conformance costs (failure costs) requires an increase in conformance costs

(prevention and appraisal costs) in order to prevent product failures

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(b)

Kaizen costing

The Kaizen costing process focuses on producing constant, small, incremental cost

reductions throughout the production process during the product’s life.

Kaizen can be translated as continuous improvement. Kaizen costing applies functional

analysis in the design phase to create a target cost for each production function.

These are totalled to give a product target cost which, after the first year of production, is

used as the baseline for further on-going reductions.

These reductions in turn reduce the baseline cost and so on as the production process

improves.

Change

For standard costs which are fixed over the relevant period but as process is continually

improving and hence standard costs have much less value.

And hence Kaizen costing can respond more easily to a dynamic business environment.

Control VS Reduction

Standard costing is used to control costs while Kaizen costing focuses on cost reduction.

In the standard costing system, employees are seen as cost burden.

In the Kaizen system, the employees often work in teams and encouraged to make

changes to production in order to make it more efficient.

And hence the change in the costing system would require a change in the corporate

culture, ie, from workers are getting command to workers are actively looking for problems.

Benefits of Kaizen costing:

It would allow company to address quickly the changing nature of Tench’s competitive

environment.

It will increase staff motivation because staff are involved in making decisions of how to

improve company efficiency.

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(c)

JIT

This means to get the right quantity of goods at the right place and at the right time.

This can be split into two parts: 1. Purchasing; 2. production

Key elements:

P: Pull approach(demand driven) rather than push approach.

R: match payables to suppliers with receivables from customers.

Order goods from supplier on 1/Jan/2014 and settle the invoice on 6/Jan/2014.

Deliver to customers on 3/Jan/2014 and expect customers to pay on 7/Jan/2014.

So here matching payables with receivables[in this example, only 1 day to finance inventory]

A: any non-value adding activities should be eliminiated so for example, set up time; inspection

time; move time; queue time; storage time etc.

S:Good relationship with suppliers and suppliers should not be too far away from your courenty.

E:There should be easy products, ie, small products lines like only 5 products within your

company rather than hunders of them.

Impact on Tench:

Advantages:

lower working capital requirements;

factory floor space savings;

increased flexibility in meeting the customer’s individual needs (faster response times to

product specification changes) because this is a pull approach[demand approach].

Disadvantges:

There will be an increased reliance on suppliers and hence increase their power.

For company there could be difficulty in finding local suppliers who are capable of meeting

the required component and delivery standards needed in order to run such a system.

Quality costs will increase as we emphasize on product quality.

If there is any delay in materials delivery then this will result in stock out and hence

company would lose sales revenue.

Multi skills workers would be needed because we need to best utilise resources within

company and maybe it’s hard to train those multi skill workers and also there would be

costs associated with them.

Also company needs to use appropriate measures to measure bottlenecks in production in

order to increase its efficiency like using throughput accounting and if this is not the case

then JIT system will not be successfully implemented.

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