acca p5 presentation

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P5Advanced Performance

Management

Okey Umeano ACCA FRM

mbewej

This does not have the feel of a revision course. Instead, it feels like an attempt to teach the subject, but in the very limited time available, these slides may just prove to be too much.I suggest the following way forward:1. Summarise core areas2. Identify appropriate exam-standard/exam-sstyle questions which will be used in each of the areas

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Aim

• To apply relevant knowledge and skills and to exercise professional judgment in selecting and applying strategic management accounting techniques in different business contexts, and to contribute to the evaluation of the performance of an organization and its strategic development

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Core Areas

• Strategic planning and control• External influences on organisational performance• Performance measurement systems and design• Strategic performance measurement• Performance evaluation and corporate failure• Current developments and emerging issues in

performance management.

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Planning & Control

• Planning is about:

- where an organization wants to be, and

- how it will get there

• Control is concerned with monitoring the achievement of objectives and suggesting corrective action.

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The Performance Hierarchy

• Mission• Strategic plans and objectives• Tactical plans and objectives• Operational plans and targets

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Strategic Management Accounting

• The Strategic planning process includes strategic analysis, strategic choice, and strategic implementation.

• Strategic management accounting - provides information on the financial aspects of

strategic planning using information from internal and external sources, monitoring performance in line with organisational objectives.

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• Critical Success Factors (CSF)s are areas in which the business must do well to achieve its objectives

• The achievement of CSFs is measured by establishing Key Performance Indicators (KPIs).

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Tools used in strategic analysis

• Benchmarking – use of a best-in-class yardstick to compare performance.Things to know: - types of benchmarking - the process - benefits and problems of benchmarking

• SWOT analysis• Gap analysis

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Environmental Influences

• External Analysis- can be analysed using PESTEL and Porter’s 5-forces.

• Impact of Stakeholders & Stakeholder conflict - Mendelow’s matrix - managing conflicting objectives by prioritisation, negotiation and ‘satisficing’, sequential attention, side payments and exercise of power

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• Impact of ethical issues- corporate social responsibility (CSR)

• Impact of government policy- fiscal and monetary policy- legislation and regulation- competition policy

• Risk and uncertainty- tools for incorporating risk and uncertainty: 1. scenario planning

Environmental Influences contd.

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2. computer simulations

3. sensitivity analysis

4. expected values

5. maximin, maximax, and minimax regret

Expected Values

- Calculated by multiplying the value of each possible outcome (x), by the probability of that outcome (p), and summing the results.

EV = Σpx


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Maximin, Maximax, and Minimax Regret

The risk tolerance of management will determine which of the 3 will be used.

Maximin rule- selects the alternative that maximises the minimum payoff achievable – pessimist.

Maximax rule- selects the alternative that maximises the minimum payoff achievable – optimist.

Minimax regret- selects the strategy that minimises the maximum regret (opportunity loss from making the wrong decision) – sore loser.


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• Classwork – maximin,etc


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Approaches to Budgets• A budget is a financial plan prepared for a

specific time period.

• Purposes of budgeting include – planning, control, communication, co-ordination, evaluation, motivation, authorisation, delegation.

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• Methods of BudgetingNote: Know all the methods, their advantages/disadvantages.

a. Fixed budget – budget prepared at a single level of activity.

b. Flexible budget – budget prepared with the cost behaviour of all cost elements known and classified as either fixed or variable. May be prepared at a number of activity levels and can be ‘flexed’.

Approaches to Budgets contd.

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c. Incremental budget – starts with the previous period’s budget or actual results, and adds (or subtracts) an incremental amount to cover inflation and other known changes.

d. Zero-based budget (ZBB) – requires each cost element to be specifically justified, as though the activities to which the budget relates were being undertaken for the first time.

e. Rolling budget – one that is kept continuously up to date by adding another accounting period (e.g. month or quarter) when the earliest period has expired.


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f. Activity-based budget – uses principles of activity based costing to estimate the firm’s future demand for resources and hence can help the firm to acquire these resources more efficiently.

Beyond budgeting

This is a leadership philosophy that relates to an alternative approach to budgeting which should be used instead of traditional annual budgeting.

Budgeting in Not-For-Profit Organisations

Considerations include: no profit motive, non-quantifiable benefits, no revenue generated, multiple stakeholders, objectives.


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Forecasting

Recall the methods from F5:

- high-low method - regression analysis

- time series analysis - the learning curve model

Wright’s Law – as output doubles, the average time per unit falls to a fixed percentage of the previous average time.

The learning curve effect is calculated using: y=axb

where: y= average time per unit/batch; a= time for the first unit/batch

x= output in units/batches; b= log r (r = rate of learning)

log 2


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ClassworkAmmy Ltd. wants to estimate the labour costs of a new product.

The product, DSC, will have a life of 12months. Sales are budgeted to be 110,000 in the year, in batches of 100 units. An 75% learning curve will apply for the first 500 batches, after which a steady state production time will apply, with the labour time per batch after the first 500 batches being equal to the 500th batch. The labour cost of the first batch was measured at $1,800. This was for 300hours at $6 per hour.

Required: Calculate the labour cost for production of DSC. Note: At a learning rate of 75%, learning factor b is -0.415.

Limitations: For the learning curve effect to work; there must be no breaks in production, the product should be new, and the process should be complex, labour-intensive, and repetitive.


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Changes in Business Structure

Business Integration- means that all aspects of the business must be aligned to

secure the most efficient use of the organisation’s resources so that is can achieve its objectives effectively.

- Four aspects that need to linked include:

people, operations, strategy, and technology.

- Tools that can be used here include Porter’s Value Chain and the McKinseys 7s model.

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Business Process Re-engineering

This is the fundamental rethinking and radical redesign of business processes to achieve dramatic improvements in critical, contemporary measures of performance, such as cost, quality, service, and spread. BPR is aimed at improved customer satisfaction.

Staff Empowerment- the delegation of certain aspects of business

decisions to those lower down in the hierarchy.

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Information

Important Issues

Sources: Internal and External

Costs of information

Quantitative & Qualitative data

Qualities of good information – ACCURATE accurate, complete, cost<benefit, understandable, relevant, adaptable to user needs, timely, easy to use.

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Behavioural Aspects of Performance Management

Performance Measures & Human Resource Mgt (HRM)

HRM is the strategic and coherent approach to the management of the people working in an organisation, who individually and collectively contribute to the achievement of its objectives for sustainable competitive advantage.

Theories of HRM:

a. The Vroom expectancy modelforce = valence x expectancy

b. Agency theory

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Important Issues:- Relationship between performance management and

performance measurement

- Performance measurement and reward systemsMethods of Reward: 1. Basic pay2. Performance-related pay3. Benefits

- Wrong signals and inappropriate actionmisrepresentation, gaming, misinterpretation, short-termism, measure fixation, tunnel vision, sub-optimisation, ossification.


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Management styles of performance appraisal-

- Budget constrained style

- Profit-conscious style

- Non-accounting style


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Financial Performance Measures in the Private Sector

The primary objective of profit-seeking organisations is maximisation of shareholder wealth. This further broken down into profit, survival, and growth.

Growth can be identified in the following ways:

Financial: profitability, revenue, return on investment, cash flow

Non-Financial: market share, number of employees, number of products

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- ROCE - EPS- EBITDA - NPV- IRR - MIRR- Liquidity & Gearing Ratios

ROCE is a measure of profitability

ROCE = Net profit x 100

Capital employed

Merits Demerits


- Easily understood by shareholders.- Figures are readily available.- Measures how well a business is

using investors’ funds

- Research shows poor correlation between ROCE and shareholder value.

- Care must be taken to compare like with like

- Can be gamed using certain accounting treatments.

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EPS – is a measure of the profit attributable to each ordinary share.

EPS = profit after tax less preference dividends

weighted average number of ordinary shares outstanding

Classwork:

ABC Ltd. share capital is as follows:

ordinary shares ($1 each) $2,000,000

6% preference shares $ 500,000

ABC’s profits before tax were $1,800,000. Tax rate is 32%.

Required:

Calculate ABC’s EPS.


mbewej

Need exam-standard and exam-style question

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EPS contd.

Merits Demerits

EBITDA

Earnings before interest, tax, depreciation and amortization

Merits Demerits- Easy to calculate and understand.- It is a proxy for cash flow from

operations

- Research shows poor correlation between EPS and shareholder value.

- Can be gamed using certain accounting treatment.


- Easily understood by shareholders.- Figures are readily available.- Calculation precisely defined,

avoiding ambiguity.

- Ignores changes in working capital and its impact on cash flow

- Can be gamed using certain accounting treatment.

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Liquidity ratios:- Current ratio - Quick ratio (acid test)- Raw material period

= (ave. value of raw materials/purchases) x 365- WIP period = (ave. value of WIP/cost of sales) x 365- Receivables period = (ave. receivables/sales) x 365- Payables period = (ave. payables/purchases) x 365

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Gearing ratios:- Gearing = (long-term debt/shareholder funds) x 100% or

- Gearing = long-term debt x 100%

long-term debt + shareholder funds

Interest cover = PBIT/interest charges

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Ways to reduce short termism:- Use both financial and non-financial measures- Switch from a budget-constrained style to a profit-

conscious or non-accounting style- Use share options- Use bonuses linked to profits- Use NPV to appraise investments- Reduce decentralisation- Use value-based techniques.

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Divisional Performance Appraisal and Transfer Pricing

Problems associated with a divisional structure:- Co-ordination difficulties- Goal congruence- Inter-dependence of divisions- Head office costs- Transfer prices- Controllability

Types of divisions- Cost centre – incurs costs, no revenue stream- Profit Centre – incurs costs, has revenues, manager

has no investment authority- Investment Centre – has costs, revenues, and

investment authority

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- Return on Investment (ROI)

ROI = PBIT x 100

capital employed

ROI is the divisional equivalent of ROCE.

Decision rule: If ROI > cost of capital (required return), accept the project.

Advantages Disadvantages

1. Widely used & accepted 1. May lead to dysfunctional

decision making

2. Relative measure – can be 2. Different accounting

used for divisions of diff sizes policies can distort comparisons

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Residual Income

PBIT x

less imputed interest (capital employed x cost of capital) (x)

RI x

Decision Rule: accept the project if RI is positive

Advantages Disadvantages

1. Reduces problems of ROI 1. Difficult to decide right cost

of capital

2. Divisional managers are made 2. Not relative and so size-

aware of the cost of financing dependent

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Economic Value Added (EVA)

EVA = NOPAT less (capital employed x WACC)

Advantages

1. Should not lead to dysfunctional behaviour because it is consistent with NPV.

2. Based on cash flows, and so, less distorted by chosen accounting policies.

Disadvantages

3. Many assumptions

4. Ignores items such as brands and goodwill

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Classwork:

Division XYZ of a company has a PBIT of $25m. This PBIT is after a $5m charge for the launch of a new product expected to have a life of 5 years.

XYZ’s non-current assets (NCAs) are valued at $75m and net current assets $28m. The replacement cost of NCAs is estimated to be $80m.

The company’s WACC and tax rate are 10% and 30%, respectively.

Required: Calculate XYZ’s WACC.

mbewej

See slide 28

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Models used in divisional performance appraisal

Ansoff’s matrix:

New Markets

Existing Markets

Existing Products New Products

Protect/Build

Mkt. developmnt

Product devt.

Diversification

Low

High

High LowRelative market share

Star

Cash cow

Problem child

Dog

Market

Growth

BCG matrix:

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Transfer Pricing: 3 scenarios

Scenario 1: perfectly competitive market for product/service

Transfer price = market price less any cost saving due to transfer (e.g. packaging & carriage costs)

Scenario 2: the selling division has surplus capacity

Transfer price = marginal cost (less any savings), so long as the total is less than the external purchase price

Scenario 3: the selling division has no surplus capacity

Transfer price = marginal cost (less any savings) + lost contribution from other product, so long as the total is less than the external purchase price

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Treatment of fixed costs: In transfer pricing, standard costs are best used and fixed costs are treated as lump sums. This is to prevent the selling division from transferring the cost of slack to the buying division.

In summary, fairness has to be maintained in fixing transfer prices.

Classwork:

mbewej

Specify

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Performance Management in Not-For-Profit Organisations (NFPO)

Problems associated with performance measurement in NFPOs

1. Non-quantifiable costs and benefits- no readily available scale exists- time scale problems- how to trade off cost & benefits measured differently- externalitiessolution = cost-benefit analysis

2. Assessing the use of fundssolution = assess value for moneyuse the 3Es in the VFM assessment

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Performance Management in Not-For-Profit Organisations (NFPO)

3. Multiple and diverse objectives

Solution = problem can be overcome by prioritizing objectives or making compromises between objectives.

4. Impact of politics on performance measurement

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Non-financial performance indicators and corporate failure

Know typical NFPIs for - Competitiveness- Activity- Productivity- Quality of service- Customer satisfaction- Quality of working life- Innovation

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Non-financial performance indicators and corporate failure

Models for evaluating financial and non-financial performance

- Balanced Scorecard- Performance pyramid- Building Block Model

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Balanced Scorecard:- Customer perspective- Financial perspective- Internal business process- Innovation & learning

Within each of these perspectives a business should seek to identify a series of goals (CSFs) and measures (KPIs).

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Performance Pyramid

WasteQualityCycle

timeDelivery

Customer

Satisfaction Flexibility

Productivity

Market Financial

Corporate

Vision

- One drawback of the performance pyramid is that it does tend to concentrate on two groups of stakeholders – shareholders and customers.

External effectiveness Internal efficiency

Business operating systems

Divisions/SBUs

Departments

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Building Block ModelDimension

Competitiveness

Financial performance

Quality of service

Flexibility

Resource utilization

Innovation

Standards

Ownership

Achievability

Fairness

Measures

Clarity

Motivation

Controllability

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Corporate Failure

Reasons for corporate failure:- Failing to adapt to changes in the environment- Strategic drift

Assessing the likelihood of failure:

Red flags-- poor cash flow - lack of financial controls- internal rivalry - general economic

conditions- loss of key personnel- lack of new production/service introduction

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Corporate failure prediction modelsAltman’s Z-score:

z-score = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5where:X1 = working capital/total assetsX2 = retained earnings/total assetsX3 = EBIT/total assetsX4 = market value of equity/total liabilitiesX5 = sales/total assets

Decision rule:Less than 1.81 :- impending failure1.81 – 2.99 :- need further investigation3.0 and above:- financially sound

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Argenti’s A score- Defects – management weaknesses- Mistakes – high gearing, overtrading, failure of

big project- Symptoms of failure – deteriorating ratios or

creative accountingDecision rule: If the overall score is more than 25, the

company has many of the signs preceding failure and is therefore a cause for concern.

Know:

Limitations of qualitative & quantitaive models for predicting corporate failure.

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Current developments in performance management

• Six sigma• Kaizen costing• Target costing• Just-in-time• Total quality management• Quality assurance, control and management

- Quality-related costs –prevention, internal & external failure costs, and appraisal costs

• Performance prism

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