acca paper f5 performance management june 2011 revision class

F5 – Performance Management

ACCAPAPER F5

PERFORMANCE MANAGEMENTJUNE 2011 REVISION CLASS

ACCAPAPER F5

PERFORMANCE MANAGEMENTJUNE 2011 REVISION CLASS

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JUNE 2011 REVISION CLASSJUNE 2011 REVISION CLASS

Prepared by

Gbenga Okubadejo

AMG

PROFESSIONALS

Gbenga Okubadejo

F5 - Management accounting 2


� To provide a revision tool to students writing paper F5

� To provide exam focus study that saves time

Presentation Objective

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Outline

� F2 revision

� Modern management accounting

� Cost volume profit (CVP) analysis

� The Concept of limiting factor analysis

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� Pricing decisions

� Short-term decisions

� Risk and uncertainty

� Budget and budgetary control

� Quantitative analysis in budgeting

� Standard costing and variance analysis

� Performance measurement


1 F2 – Management accounting revisionF2 – Management accounting revision

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Introduction to Management accounting

Costing is the process of determining the cost of products, services or activities. Methods

include absorption costing and process costing.

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

All direct production costs are referred to as PRIME COSTS.

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

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Addition of all indirect costs = Overheads.

Direct + indirect = Total factor cost.

Absorption costing is a method of sharing out overheads incurred amongst units produced. It

follows three processes:

�Allocation

�Apportionment

�Absorption: may lead to under/over absorbed overhead


F2 revision

�When sales fluctuate because of seasonality in sales demand but production is held constant, absorption costing avoids large fluctuations in profit.

For absorptionFor absorption

�It shows how an organisation's cash flows and profits are affected by changes in sales volumes since contribution varies in direct proportion to units sold.� By using absorption costing

For marginal costingFor marginal costing1 2

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fluctuations in profit.� Prices based on marginal cost (minimum prices) does not guarantee profit.�Absorption recognisesthat all costs are variable in the long run.�It is the method allowed by accounting standards.

� By using absorption costing and setting a production level greater than sales demand, profits can be manipulated.�Total costs need separation for decision making� For short-run decisions in which fixed costs do not change, fixed costs are irrelevant.


2 Modern management accounting techniquesModern management accounting techniques

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Activity based costing (ABC)

Target costing

Life cycle costing

Throughput accounting

Environmental accounting


Activity based costing (ABC)

Steps to follow in ABC1Identify major activities.

2 Identify cost drivers (factors which determine thesize of an activity/cause the costs of an activity).

3 Collect costs associated with each activity intocost pools.4 Charge costs to products on the basis of thenumber of an activity’s cost driver they generate.

Cost drivers

Why ACT is not enough

�One basis of absorption – volume

�Companies now produce variety

of Products

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Cost drivers•Volume related (eg labour hrs) for costs that vary

with production volume in the short term (eg power

costs)

• Transactions in support departments for other costs

(eg No of visit for site supervisor costs)

of Products

�May hide inefficiency.

�Allocate more ohds to

volume-based product

F5 – Performance ManagementTarget costing

�Involves setting a target cost by subtracting adesired profit margin from a competitive marketprice� The target cost may be less that the initialproduct cost but it is expected to be achievedby the time the product reaches maturity�There is a focus on price-led costing, customer

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�There is a focus on price-led costing, customerrequirements and designSteps in target costiing1. Do market research to obtain a competitive price2. Determine the required magin3. Cal. target cost = estimated SP – req’d margin4. Compare the estimated costs with the target5. Cost gap exists if estimated > target.


Life cycle costing

This method tracks and accumulates costs

and revenues over a product’s entire life. This cycle include

1. Development 2. Introduction 3. Growth 4.Maturity 5. Decline

1. Design costs out of products

Maximising returns over the product life cycle

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1. Design costs out of products

2. Minimise the time to market

3. Minimise breakeven time

4. Maximise the length of the life span

5. Minimise product proliferation

6. Manage the product’s cashflows


Life cycle costing

Sales

Sales Volume

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Introduction Growth Maturity Decline

Profit

Time


Throughput accounting

� In the short run, all costs except materials are fixed

� In a JIT environment, the ideal inventory level is zero. So unavoidable, idle

capacity in some operations must be accepted

� The factory spends money when goods are produced and a product makes money

when it sold. Overall profitability is determined by how fast the product makes money

compare to how the factory spends.

Throughput accounting ratio

Basic concept of throughput

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Throughput accounting ratio= Return per factory hour

Total conversion cost per factory hour

TPAR > 1 = Continue Product

TPAR < 1 = Cease Product

Before cessation, consider other qualitative factors. Or consider working on the

product for TPAR to > 1.


Environmental management accounting (EMA)

The generation and analysis of both financial and

non-financial information in order to support

environmental management processes.

Definition

Typical environmental costs

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Typical environmental costs

�Consumables and raw materials�Transport and travel�Waste and effluent disposal�Water consumption�Energy

Importance

�Identifying environmental costs associated

with individual products and services can

�assist with pricing decisions

� Ensuring compliance with regulatory

standards

� Potential for cost savings


Cost volume profit (CVP analysis)

How to calculate a multi-product breakeven point

1. Calculate the contribution per unit.

2. Calculate the contribution per mix.

3. Calculate the breakeven point in number of mixes.

4. Calculate the breakeven point in units and revenue.

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

Calculation of breakeven sales:Calculation of breakeven sales:

1. Calculate the revenue per mix.


3. Calculate the average C/S ratio.

4. Calculate the total breakeven point.

5. Calculate the revenue ratio per mix.

6. Calculate the breakeven sales.

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

F5 – Performance ManagementCost volume profit (CVP analysis)

Target profits


2. Calculate the required number of mixes.

3. Calculate the required number of units and

4. sales revenue of each product.

Limitations of CVP analysisLimitations of CVP analysis

� It is assumed that fixed costs are the same in total and variable costs are the same per unit at all levels of output

� It is assumed that sales prices will be constant at all levels of activity

� Production and sales are assumed to be the same

� Uncertainty in estimates of fixed costs and unit variable costs is often ignored

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F5 – Performance ManagementDecision making time

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

“…….The first step in any linear

programming problem is to produce the equations for constraints and the contribution function. This should

Excerpts from technical article by Geoff

Cordwell former examiner for Paper F5.

contribution function. This should not be difficult at this level.”

F5 – Performance ManagementLinear programming

Formulating the problem

Steps in linear programming

1. Define variable

2. Construct objective function

3. Establish constraints

4. Graph

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5. Find the optimal solution

There are two methods of finding the optimal solution:

1. Graphical method

2. Using equations

F5 – Performance ManagementLinear Programming

Shadow price

SurplusSlack

�Occurs when maximum availability of a

resource is not used.

�The resource is not binding at the

optimal solution. Slack is associated with

≤ constraints.

�Occurs when more than a minimum

requirement is used.

�Surplus is associated with ≥ constraints

eg a minimum production requirement

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

F5 – Performance ManagementPricing decisions

Influence on price

1. Cost

2. Demand

3. Income level

4. Competition

5. Quality perception

6. Market structure

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

Price elasticity of demand (η)

Inelastic demand6. Market structure

7. Product life cycle

8. E.c.t.

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Inelastic demand� η < 1

� Demand falls by a smaller % than % rise in price

� Pricing decision: increase prices

Elastic demand� η > 1

� Demand falls by a larger % than % rise in price

� Pricing decision: decide whether change in cost

will be less than change in revenue.

NB: For pricing strategy to be adopted, make

reference to PED.

F5 – Performance ManagementProfit Maximisation

when Profits are maximised when

MC = MR.

Determining the profit-maximisingselling price/output level

Full cost plusAdvantages�Quick, simple, cheap method�Ensures company covers fixed costs.Disadvantages�Penetrating pricing

Other Pricing strategy

Pricing strategy

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Disadvantages�Doesn’t recognise profit maximising price and output�Budgeted output needs to beestablished�Suitable basis for overheadabsorption needed

�Penetrating pricing

�Skimming pricing

�Product-line pricing

�Complimentary pricing

F5 – Performance ManagementShort-term decisions

� Future e.g sunk not relevant

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

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

N.B:

�Compare internal

differential production

costs with supplier’s

quotation.

�Consider other

qualitative factors

before sub-contracting

Relevant costs are Make or Buy

N.B:

1. Useful for one-off contract

2. Minimum pricing

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

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before sub-contracting

or outsourcing

F5 – Performance ManagementShort-term decision

Further processing decision

�Determine the contribution earned on the current operation.�Calculate incremental costs and revenue�Compare the results and act accordingly.�Bear in mind that some fixed costs may Any short-term decision

Shut down decision

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

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

F5 – Performance ManagementRisk and uncertainty

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

Attitude to risk

� Risk seeker A decision maker interested in the best outcomes no matter how small the chance that they may occuroccur

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

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

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F5 – Performance ManagementMethods of dealing with risk and uncertainty

Methods of dealing with risk and uncertainty

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

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� Expected values (EV) - indicate what an outcome is likely to

be in the long term with repetition. The expected value will

never actually occur. EV = PR * OUTCOME� Decision rule: This involves calculation of 1. Maximax2. Maximin3. Minimax regret rule� Sensitivity analysis� Simulation� Brainstorming or scenario building

F5 – Performance ManagementBudgeting and budgetary control

� Ensure the organisation’sobjectives are achieved

� Compel planning

� Communicate ideas and plans

� Co-ordinate activities

� Provide a framework for

Objectives of a budgetary planning and control system

At the planning stage– Managers may fail to co-ordinate

plans with those of other budget

centres.

– They may build slack into expenditure

estimates.

When putting plans into action

Negative effects of budgets include

� Provide a framework for responsibility accounting

� Establish a system of control

� Motivate employees to improve their performance

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– Minimal co-operation and

communication between managers.

– Managers might try to achieve targets

but not beat them.

Using control information– Resentment, managers seeing the

information as part of a system of trying

to find fault with their work.

– Scepticism of the value of information

if it is inaccurate, too late or not

understood.

F5 – Performance ManagementBudgetary systems

Traditional budgetary systems

This involves adding a certain percentage to last

year’s budget to allow for growth and inflation. It

encourages slack and wasteful spending to creep

into budgets.

Incremental budgeting

�These are budgets which, by

recognising different cost

behaviour patterns, change as

activity levels change.

Flexible budget

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These are prepared on the basis of an estimated

volume of production and an estimated volume of

sales. No changes are made to the budgets and

are not adjusted (in retrospect) to

reflect actual activity levels.

Fixed budget

activity levels change.

� At the planning stage, flexible

budgets can be drawn up to show

the effect of the actual volumes of

output and sales differing from

budgeted volumes.

� At the end of a period, actual

results can be compared to a

flexed budget (what results should

have been at actual output and

sales volumes) as a control

procedure.


Zero-based budgeting

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

Zero-based budgeting

�Identifies and

removes inefficient

and/or obsolete

operations

� Provides a

psychological impetus

Merit

usually developed as a package.

Steps in ZBB

1. Define decision packages

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

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

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psychological impetus

to employees to

avoid wasteful

expenditure

� Leads to a more

efficient allocation of

resources

F5 – Performance ManagementStandard costing

� To act as a control device (variance analysis)

� To value inventories and cost production

� To assist in setting budgets and evaluating managerial performance

� To enable the principle of

Types of standardUses of standard costing

IdealPerfect operating conditionsUnfavourable motivational impactAttainableAllowances made for inefficiencies and wastageIncentive to work harder (realistic but

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

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

� To motivate staff and management by providing challenging targets

� To provide guidance on possible ways of improving efficiency

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Incentive to work harder (realistic but challenging)CurrentBased on current working conditionsNo motivational impactBasicUnaltered over a long period of timeUnfavourable impact on performance

F5 – Performance ManagementVariance analysis

A standard cost card will look as follows:

$/unit

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

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

Prime costs 150

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

Total variable cost 250

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

Total factory cost 370

Profit (25% mark-up) 92.50

Selling price 462.50

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F5 – Performance ManagementReasons for variances

Material price (F) – unforeseen discounts received

(A) – price increase, careless purchasing

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

(A) – defective material, waste, theft

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

(A) – rate increase

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

Labour efficiency (F) – better quality materials

(A) – lack of training

Overhead expenditure (F) – cost savings

(A) – excessive use of services

Overhead volume - production greater or less than budgeted

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F5 – Performance ManagementPlanning and operation

Planning variances

�Caused by adverse/favourableoperational performance�Calculated by comparing actual results with a realistic, revised standard/budget

Operational variances

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

Calculated by comparing an

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Calculated by comparing anoriginal standard with a revisedstandard

F5 – Performance ManagementPerformance measurement

Financial performance indicators (FPI)

Non-financial performance indicators (NFPI)

Profitability ratio

� ROCE

� Profit margin

� Sales growth

�Look at a wider range of variables� Provide information on quality and customer satisfaction� Better indicator of future

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� Asset turnover

� Liquidity ratios

� Inventory days

� Receivable days

� etc

� Better indicator of future prospects� Can be provided quickly and tailored to circumstances

F5 – Performance ManagementBalanced Scorecard

Perspective Question Explanation

Customer What do existing and new customers

value from us?

Gives rise to targets that matter to

customers: cost,

quality, delivery, inspection, handling

and so on.

Internal What processes must we excel at to

achieve our financial and customer

objectives?

Aims to improve internal processes

and decision

making.objectives? making.

Innovation andlearning

Can we continue to improve and

create

future value?

Considers the business's capacity to

maintain its competitive position

through the acquisition of new skills

and the development of new

products.

Financial How do we create value for our

shareholders?

Covers traditional measures such as

growth, profitability and shareholder

value but set through talking to the

shareholder or shareholders direct.

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F5 – Performance ManagementNot-for-profit organisations

Problem with performance measurement

� Multiple objectives

� Measuring outputs

� Lack of profit measure

�Judge performance in terms

of inputs

� Use experts’ subjective

judgment

� Use benchmarking

Suggested way out

� Lack of profit measure

� Nature of service provided

� Financial constraints

� Political, social and legal considerations

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� Use benchmarking

� Use unit cost quantitative

measures

F5 – Performance ManagementValue for money

3 E’S

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

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

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

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For further reading: BPP revision kits

acca paper f5 performance management june 2011 revision class

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