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ACCA Paper P5

Advanced Performance Management

Class Notes

June 2011

2

© The Accountancy College Ltd, January 2011

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 The Accountancy College Ltd.

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Contents PAGE

INTRODUCTION TO THE PAPER 5

FORMULAE & TABLES PROVIDED IN THE EXAMINATION PAPER 9

CHAPTER 1: STRATEGY 13

CHAPTER 2: STRATEGIC MANAGEMENT ACCOUNTING 27

CHAPTER 3: DIVISIONAL PERFORMANCE INDICATORS 39

CHAPTER 4: TRANSFER PRICING 51

CHAPTER 5: DESIGN OF PERFORMANCE MANAGEMENT SYSTEMS 59

CHAPTER 6: DECISION - MAKING 71

CHAPTER 7: NON-FINANCIAL PERFORMANCE INDICATORS 81

CHAPTER 8: BUDGETING 93

CHAPTER 9: MANAGEMENT INFORMATION SYSTEMS 103

CHAPTER 10: STRATEGIC OPTIONS 115

APPENDIX – ANSWERS TO QUESTIONS & EXAMPLES 123

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Introduction to the

paper

INTRODUCTION TO THE PAPER

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AIM OF THE PAPER

The aim of the paper is to apply relevant knowledge, skills, and exercise

professional judgement in selecting and applying strategic management accounting

techniques in different business contexts and to contribute to the evaluation of an

organisation and its strategic development.

OUTLINE OF THE SYLLABUS

1. Strategic planning and control

2. Economic, fiscal, market and environmental factors

3. Performance measurement systems and design

4. Strategic performance measurement

5. Performance evaluation and corporate failure

6. Current developments and emerging issues in management accounting and

performance management

FORMAT OF THE EXAM PAPER

The syllabus is assessed by a three hour paper-based examination.

The examination consists of:

● Section A – two compulsory questions totalling 60 marks between them

● Section B – two out of three questions (one of which is entirely discursive)

FAQS

How do I get the most from my course?

● Try and be seated and pick up your handout by the start of the lecture. This

will ensure we have the maximum lecture time. Your course notes will be in

divided into chapters, please make sure you bring the relevant chapters with

you to class.

● Manage your time effectively. If you have a busy work schedule use your

study planner to catch up. Do not allow yourself to fall behind.

● If you have any difficulties or questions please do not hesitate to contact me

either before the lecture or during the break as most students are in a

desperate hurry to leave at the end of the lecture. Alternatively, you can

always email me or phone me through our helpline.

● In the event of an emergency you can come for the same lecture on a

corresponding part-time course as all the courses run parallel to each other.

It is crucially important that you attend the full course of lectures.

● Try to read the business section of a decent newspaper at least once a week

to get an idea of what is going on in the business world and the difficulties

faced by organisations.


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● Make sure you read and understand the supplementary material at the end of

the chapters. The Examiner often asks theoretical questions on these areas

My email is [email protected]

If you email, please give me a couple of days to respond.


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WWW.STUDYINTERACTIVE.ORG 9

Formulae & tables

provided in the examination paper

FORMULAE & TABLES PROVIDED IN THE EXAMINATION PAPER

10

Present value table

Present value of 1 i.e. (1 + r)-n

Where r = discount rate n = number of periods until payment

Discount rate (r)

Periods

(n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%

________________________________________________________________________________

1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909 1 2 0.980 0.961 0.943 0.925 0.907 0.890 0.873 0.857 0.842 0.826 2 3 0.971 0.942 0.915 0.889 0.864 0.840 0.816 0.794 0.772 0.751 3 4 0.961 0.924 0.888 0.855 0.823 0.792 0.763 0.735 0.708 0.683 4 5 0.951 0.906 0.863 0.822 0.784 0.747 0.713 0.681 0.650 0.621 5

6 0.942 0.888 0.837 0.790 0.746 0.705 0.666 0.630 0.596 0.564 6 7 0.933 0.871 0.813 0.760 0.711 0.665 0.623 0.583 0.547 0.513 7 8 0.923 0.853 0.789 0.731 0.677 0.627 0.582 0.540 0.502 0.467 8 9 0.914 0.837 0.766 0.703 0.645 0.592 0.544 0.500 0.460 0.424 9 10 0.905 0.820 0.744 0.676 0.614 0.558 0.508 0.463 0.422 0.386 10

11 0.896 0.804 0.722 0.650 0.585 0.527 0.475 0.429 0.388 0.350 11 12 0.887 0.788 0.701 0.625 0.557 0.497 0.444 0.397 0.356 0.319 12 13 0.879 0.773 0.681 0.601 0.530 0.469 0.415 0.368 0.326 0.290 13 14 0.870 0.758 0.661 0.577 0.505 0.442 0.388 0.340 0.299 0.263 14 15 0.861 0.743 0.642 0.555 0.481 0.417 0.362 0.315 0.275 0.239 15

________________________________________________________________________________

(n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%

________________________________________________________________________________

1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833 1 2 0.812 0.797 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.694 2 3 0.731 0.712 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.579 3 4 0.659 0.636 0.613 0.592 0.572 0.552 0.534 0.516 0.499 0.482 4 5 0.593 0.567 0.543 0.519 0.497 0.476 0.456 0.437 0.419 0.402 5

6 0.535 0.507 0.480 0.456 0.432 0.410 0.390 0.370 0.352 0.335 6 7 0.482 0.452 0.425 0.400 0.376 0.354 0.333 0.314 0.296 0.279 7 8 0.434 0.404 0.376 0.351 0.327 0.305 0.285 0.266 0.249 0.233 8 9 0.391 0.361 0.333 0.308 0.284 0.263 0.243 0.225 0.209 0.194 9 10 0.352 0.322 0.295 0.270 0.247 0.227 0.208 0.191 0.176 0.162 10

11 0.317 0.287 0.261 0.237 0.215 0.195 0.178 0.162 0.148 0.135 11 12 0.286 0.257 0.231 0.208 0.187 0.168 0.152 0.137 0.124 0.112 12 13 0.258 0.229 0.204 0.182 0.163 0.145 0.130 0.116 0.104 0.093 13 14 0.232 0.205 0.181 0.160 0.141 0.125 0.111 0.099 0.088 0.078 14 15 0.209 0.183 0.160 0.140 0.123 0.108 0.095 0.084 0.074 0.065 15


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Annuity table

Present value of an annuity of 1 i.e. r

r) + (1 - 1 -n

Where r = discount rate

n = number of periods

Discount rate (r)

Periods

(n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%

________________________________________________________________________________

1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909 1 2 1.970 1.942 1.913 1.886 1.859 1.833 1.808 1.783 1.759 1.736 2 3 2.941 2.884 2.829 2.775 2.723 2.673 2.624 2.577 2.531 2.487 3 4 3.902 3.808 3.717 3.630 3.546 3.465 3.387 3.312 3.240 3.170 4 5 4.853 4.713 4.580 4.452 4.329 4.212 4.100 3.993 3.890 3.791 5

6 5.795 5.601 5.417 5.242 5.076 4.917 4.767 4.623 4.486 4.355 6 7 6.728 6.472 6.230 6.002 5.786 5.582 5.389 5.206 5.033 4.868 7 8 7.652 7.325 7.020 6.733 6.463 6.210 5.971 5.747 5.535 5.335 8 9 8.566 8.162 7.786 7.435 7.108 6.802 6.515 6.247 5.995 5.759 9 10 9.471 8.983 8.530 8.111 7.722 7.360 7.024 6.710 6.418 6.145 10

11 10.37 9.787 9.253 8.760 8.306 7.887 7.499 7.139 6.805 6.495 11 12 11.26 10.58 9.954 9.385 8.863 8.384 7.943 7.536 7.161 6.814 12 13 12.13 11.35 10.63 9.986 9.394 8.853 8.358 7.904 7.487 7.103 13 14 13.00 12.11 11.30 10.56 9.899 9.295 8.745 8.244 7.786 7.367 14 15 13.87 12.85 11.94 11.12 10.38 9.712 9.108 8.559 8.061 7.606 15 ________________________________________________________________________________

(n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%

________________________________________________________________________________

1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833 1 2 1.713 1.690 1.668 1.647 1.626 1.605 1.585 1.566 1.547 1.528 2 3 2.444 2.402 2.361 2.322 2.283 2.246 2.210 2.174 2.140 2.106 3 4 3.102 3.037 2.974 2.914 2.855 2.798 2.743 2.690 2.639 2.589 4 5 3.696 3.605 3.517 3.433 3.352 3.274 3.199 3.127 3.058 2.991 5

6 4.231 4.111 3.998 3.889 3.784 3.685 3.589 3.498 3.410 3.326 6 7 4.712 4.564 4.423 4.288 4.160 4.039 3.922 3.812 3.706 3.605 7 8 5.146 4.968 4.799 4.639 4.487 4.344 4.207 4.078 3.954 3.837 8 9 5.537 5.328 5.132 4.946 4.772 4.607 4.451 4.303 4.163 4.031 9 10 5.889 5.650 5.426 5.216 5.019 4.833 4.659 4.494 4.339 4.192 10

11 6.207 5.938 5.687 5.453 5.234 5.029 4.836 4.656 4.486 4.327 11 12 6.492 6.194 5.918 5.660 5.421 5.197 4.988 4.793 4.611 4.439 12 13 6.750 6.424 6.122 5.842 5.583 5.342 5.118 4.910 4.715 4.533 13 14 6.982 6.628 6.302 6.002 5.724 5.468 5.229 5.008 4.802 4.611 14 15 7.191 6.811 6.462 6.142 5.847 5.575 5.324 5.092 4.876 4.675 15


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Chapter 1

Strategy

CHAPTER CONTENTS

PAST EXAM REQUIREMENTS -------------------------------------------- 14

WHAT IS STRATEGY? ---------------------------------------------------- 16

WHAT STAGES DOES AN ORGANISATION GO THROUGH WHEN SETTING ITS STRATEGY? ----------------------------------------------- 18

WHAT TYPES OF STRATEGY ARE THERE? ----------------------------- 19

WHO ARE STAKEHOLDERS? -------------------------------------------- 20

HOW CAN THE MACRO ENVIRONMENT BE ANALYSED? -------------- 21

WHAT IS THE SIGNIFICANCE OF PORTER’S FIVE FORCES? --------- 22

WHAT IS MEANT BY THE VISION OF A COMPANY? ------------------ 24

SUPPLEMENTARY MATERIAL ------------------------------------------- 25

THE STRATEGIC PLANNING MODEL 25

THE STAGES OF STRATEGIC ANALYSIS 25

MODELS USED IN THIS CHAPTER -------------------------------------- 26

CHAPTER 1 – STRATEGY

14

PAST EXAM REQUIREMENTS

Dec 2009

Q4 (a) Evaluate the financial performance of CAP. 6 marks

(b) Discuss the principal financial, economic and social

considerations that should be considered by Jody Cundy prior to

a decision to proceed with the proposed expansion into Robland.

14 marks

Dec 2009

Q5 (a) (i) Discuss the purpose, potential benefits and potential

problems of mission statements. 8 marks

(ii) Advise the directors of CFD regarding the appropriateness

of its mission statement. 3 marks

(b) Explain the term critical success factor and discuss THREE critical

success factors for CFD clearly highlighting a key performance

indicator for each critical success factor. 6 marks

(c) Excluding the number of complaints by clients, identify and

briefly explain THREE quantitative non-financial performance

measures that could be used to assess the “quality of service”

provided by CFD. 3 marks

Dec 2008

Q2 (c) Explain the reasons for the concerns of the government of

Happyland with companies such as TMC and advise the directors

of a strategy which might be considered in order to avoid being

subject to any forthcoming legislation concerning the

environment. 5 marks

(d) Evaluate the circumstances in which a government can act as an

aid to business performance. 5 marks

June 2008

Q3 (a) Discuss the strategic and economic factors which should be

considered before a decision is made to build the hotel. 14 marks

Dec 2007

Q1 (a) Prepare a report on the operating performance of GBC and TTC

for the years ended 30 November 20X6 and 20X7. As part of


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your report, you should include an appendix showing detailed

workings of how each of the six figures marked with an asterisk

(*) in Note 1 has been calculated. 23 marks

Note: 6 marks are available in respect of the six figures marked with an

asterisk (*). 17 marks are available for other calculations and discussion.

Pilot paper

Prepare an analysis (both quantitative and discursive) of the ‘gold

standard’ proposal for the period 20X7 to 20X9. You should use the

information in the question, together with the Data in Schedule 1 below.

Your analysis should include the following:

(i) A definition of corporate ‘vision or mission’ and consideration of

how the proposal may be seen as identifying and illustrating a

specific sub-set of this ‘vision or mission’. 5 marks


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WHAT IS STRATEGY?

1.1 Strategy can be defined as

‘the direction and scope of an organisation over the long-term, which achieves

advantage in a changing environment through its configuration of resources

and competences with the aim of fulfilling stakeholder expectations’.

1.2 The above simply means that strategy is how an organisation attempts to

meet its objectives.

Example 1 – Bridgewater Co (Jun 2008 F5 Question)

Bridgewater Co provides training courses for many of the mainstream software

packages on the market.

The business has many divisions within Waterland, the one country in which it

operates. The senior managers of Bridgewater Co have very clear objectives for

the divisions and these are communicated to divisional managers on appointment

and subsequently in quarterly and annual reviews. These are:

1 Each quarter, sales should grow and annual sales should exceed budget

2 Trainer (lecture staff) costs should not exceed $180 per teaching day

3 Room hire costs should not exceed $90 per teaching day

4 Each division should meet its budgeted profit per quarter and annually.

It is known that managers will be promoted on their ability to meet these targets.

A member of the senior management is to retire after quarter 2 of the current

financial year, which has just begun. The divisional managers anticipate that one

of them may be prompted at the beginning of quarter 3 if their performance is good

enough.

The manager of the Northwest division is concerned that his chances of promotion

could be damaged by the expected performance of his division. He is a firm

believer in quality and thinks that if a business gets this right, growth and success

will follow.

The current quarterly forecasts, along with the original budgeted profit for the

Northwest division are as follows:

Q1

$’000

Q2

$’000

Q3

$’000

Q4

$’000

Total

$’000 Sales 40.0 36.0 50.0 60.0 186.0 Less Trainers 8.0 7.2 10.0 12.0 37.2

Room hire 4.0 3.6 5.0 6.0 18.6 Staff training 1.0 1.0 1.0 1.0 4.0 Other costs 3.0 1.7 6.0 7.0 17.7

Forecast net profit 24.0 22.5 28.0 34.0 108.3 Original budgeted profit 25.0 26.0 27.0 28.0 106.0

Annual sales budget 180.0 Teaching days 40 36 50 60


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(a) Assess the financial performance of the Northwest division against its

targets and reach a conclusion about the promotion prospects of the

divisional manager. (8 marks)

The manager of the Northwest division has been considering a few steps to improve

the performance of his division.

Voucher scheme

As a sales promotion, vouchers will be sold for $125 each, a substantial discount on

normal prices. These vouchers will entitle the holder to attend four training

sessions on software of their choice. They can attend when they want to, but are

advised that one training session per quarter is sensible. The manager is confident

that if the promotion took place immediately, he could sell 80 vouchers and that

customers will follow the advice given to attend one session per quarter. All

voucher holders would attend planned existing courses and would be new

customers.

Software upgrade

A new important software programme has recently been launched for which there

would be a market for training courses. Demonstration programs can be bought for

$1,800 in quarter 1. Staff training would be needed, costing $500 in each of

quarters 1 and 2, but in quarters 3 and 4 extra courses could be offered selling this

training. Assuming similar class sizes and the usual sales prices, extra sales

revenue amounting to 20% of the normal sales revenue are expected. (measured

before the voucher scheme mentioned above). The manager is keen to run these

courses at the same tutorial and room standards he normally provides. Software

expenditure is written off in the income statement as incurred.

Delaying payments to trainers

The manager is considering delaying payment to trainers. He thinks that, since his

commitment to quality could cause him to miss out on a well deserved promotion,

the trainers owe him a favour. He intends to delay payment on 50% of all invoices

received from the trainers in the first two quarters, paying them one month later

than is usual.

(b) Revise the forecasts to take account of all three of the proposed

changes. (7 marks)

(c) Comment on each of the proposed steps and reach a conclusion as to

whether, if all the proposals were taken together, the manager will

improve his chances of promotion. (6 marks)

(d) Suggest two improvements to the performance measurement system

used by Bridgewater Co that would encourage a longer term view

being taken by managers. (4 marks)

(25 marks)


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WHAT STAGES DOES AN ORGANISATION GO THROUGH

WHEN SETTING ITS STRATEGY?

2.1 There are a number of stages. Each of these will be discussed in more detail

later in the notes.

2.2 A summary is

Stage 1 – Strategic Position

1. Identify key stakeholders and their expectations

2. Develop long-term objectives to satisfy these stakeholder

expectations

3. Calculate financial and non-financial ratios to show position of

organisation

4. Identify core resources and competences within the organisation

5. Identify key factors changing the environment outside the

organisation

6. Use SWOT analysis to develop strategic position.

Stage 2 – Strategic Choices

1. Consider possible exit from existing industries

2. Consider diversification into new industries

3. Consider how to turnaround underperforming existing competitive

advantage

4. Consider how to extend existing successful competitive advantages

5. Consider entry into new markets

6. Consider development of new products

7. Consider developing new competitive advantages.

Stage 3 – Strategy into Action

1. Evaluate above options and choose strategy to be followed

2. Implement any necessary changes in the organisation.


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WHAT TYPES OF STRATEGY ARE THERE?

MODEL Johnson and Scholes - Three levels of strategy

3.1 Corporate Strategy

This looks at the industries in which the organisation operates. This may

mean deciding to leave existing areas or enter new ones. This is particularly

true if the organisation has a number of divisions

In the P5 exam, you as the management accountant, might be asked to

prepare information to assist in a decision such as whether to leave or to join

an industry.

3.2 Business Strategy

This looks at how the organisation (or subsidiary / division) competes. This

tends to be mean either:

● The division is trying to win customers by being better than rivals in

some way

● The subsidiary is trying to win customers by being cheaper than rivals.

In the P5 exam, you as the management accountant, might be asked to

prepare information to assist in an analysis comparing the organisation with a

similar one in the same industry.

3.3 Operational Strategy

This looks at how resources are used to carry out the strategies noted above.

In the P5 exam, you, as the management accountant, might be asked to

prepare information to assist in deciding whether a particular style of

management accounting might be beneficial to the business.


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WHO ARE STAKEHOLDERS?

4.1 Stakeholders are those parties interested in the decisions made by an

organisation.

4.2 Stakeholders can be:

● Internal – employees and managers

● External – shareholders

● Connected – customers and suppliers.

4.3 MODEL – Mendelow - stakeholder mapping

Stakeholders can be divided into those with:

● High Interest with High Power = Key players

● Low Interest with High Power = Keep satisfied

● High Interest with Low Power = Keep informed

● Low Interest with Low Power = Minimal Effort.

There will always be a conflict of interest between what different groups want. For

example giving employees better pay levels reduces the profit available for

shareholders.

4.4 Stakeholders matter because objectives should be geared towards the needs

of those with high power.

4.5 Stakeholders matter because any strategy followed will need to be acceptable

to the key players.

4.6 In the P5 exam, you will usually have to consider the shareholders first. You

might have to prepare information to show how your company is doing

relative to others (this is known as benchmarking).

4.7 The P5 Examiner might also give you information about possible future

projects, if they are profitable they are likely to appeal to shareholders.

4.8 Stakeholders can be:

● Internal e.g. managers, employees

● Connected e.g. Shareholders, banks, customers, suppliers

● External e.g. Government.


21

HOW CAN THE MACRO ENVIRONMENT BE ANALYSED?

The macro-environment includes all the things that affect an entire industry.

5.1 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.

5.2 With PESTEL the key things to consider are:

Is the current environment making it easier or harder for the organisation? In

the exam things are usually getting harder, look for the financial indicators to

be getting worse because of this.

If the environment is making conditions harder, what can the organisation do

about it. Remember that the macro – environment will effect an entire

industry the same way. This means all the organisation’s rivals will also be

affected.

If the company is going to move into a new industry what will the conditions

be like (different industries will be effected in different ways.

5.3 It is important to remember that legal and economic factors are specifically

mentioned in the P5 syllabus. This is particularly true of global economic

factors that affect multinationals as well as companies setting up in new

countries.

5.4 Governments may act in the ‘public interest’ through regulations to

● Promote competition

● Protect customer welfare

● Reduce public spending

● Ensure subsidies are spent wisely

● Attract private financing to achieve quality standards.


22

WHAT IS THE SIGNIFICANCE OF PORTER’S FIVE

FORCES?

6.1 MODEL – Porter’s 5 forces

Porter’s 5 forces model looks at why some industries might be more profitable than

others. In general the more of the forces that are favourable within an industry the

more profits will be earned. Unfortunately if the industry becomes more attractive

then more rivals will want to enter it.

The 5 forces are:

● Competitors (new)

● Competitors (existing)

● Customers

● Suppliers

● Substitutes.

6.2 Competitors (new)

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

● Switching costs

● Access to distribution channels.

6.3 Competitors (existing)

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:

● Market growth is slow

● If capacity can only be increased in large amounts

● If it is difficult to exit the industry.

6.4 Customers

Powerful customers prevent companies from putting prices up or

implementing other changes.

Customers will be powerful if:

● There is standardisation within the industry

● The customer makes low profits

● Product quality is not particularly important.


23

6.5 Suppliers

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

company.

Suppliers will be powerful if:

● There are high switching costs

● Where the suppliers’ product is necessary to the business and is

differentiated from other suppliers.

6.6 Substitutes

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

prices.

There are three main kinds of substitute:

● Direct - where the customer buys the same product from a different

manufacturer

● Indirect - where the customer buys a product from a different industry

to meet the same need

● Monetary – where different industries are competing for the same part

of a customer’s income.

6.7 Some of the above might apply to an entire industry, some might apply to

one company. For example when looking at how powerful suppliers are in the

airline industry:

● Oil companies are powerful suppliers for all airlines since all airlines use

a lot of fuel

● Staff are more powerful in airlines such as British Airways than in

Ryanair (since British Airways is more heavily unionised).

6.8 Strategic management accounting is much more focussed on external events

and information than the management accounting you encountered at F5.


24

WHAT IS MEANT BY THE VISION OF A COMPANY?

7.1 Shareholders are a key stakeholder in any company. They buy shares in the

hope that a company makes a profit in the future in order to deliver:

● Dividends

● Capital growth.

7.2 Most shareholders want to invest in a company for a lengthy period of time to

allow the value of the shares to grow. The shareholder may be aware of the

company’s plans for the current six months, maybe even a year but it is

unlikely the company has told them much more.

7.3 The shareholder will be more likely to invest in companies which have a

‘vision’ (also known as a ‘mission’). This is the long-term aims of the

company. It may be very vague and simply say what kinds of market the

company wants to operate in and how it hopes to attract customers.

7.4 This vision will need to be turned into annual objectives that the company

aims at throughout the year. One of the key areas in P5, is knowing what will

be useful for the company to measure.


25

SUPPLEMENTARY MATERIAL

The strategic planning model

An organisation must decide:

● What are its strengths (benchmarking helps here)

● How the market might change (PEST, Porter’s 5 forces help here)

● How customer satisfaction can be delivered

● What might prevent the plan from working (Threats)

● What should be done to minimise risk (see sensitivity analysis)

● What actions should be taken (see strategic options).

The stages of strategic analysis

● Vision (also known as mission) gets turned into

● Goals (to satisfy key stakeholders) which are turned into numbers

● Objectives which are compared with current performance to produce

● Gap analysis (difference between what we expect to achieve and what

stakeholders require).

To close this gap:

● Come up with new options (see Ansoff) which can be evaluated using

● Suitability, Feasibility, Acceptability (again sensitivity analysis) which allows

● Strategies to be chosen.


26

MODELS USED IN THIS CHAPTER

Johnson and Scholes three levels of strategy

● Corporate strategy

● Business Strategy

● Operational Strategy

MODEL – Mendelow - stakeholder mapping

Stakeholders can be divided into those with

● High Interest with High Power = Key players

● Low Interest with High Power = Keep satisfied

● High Interest with Low Power = Keep informed

● Low Interest with Low Power = Minimal Effort

Porter’s 5 forces

The 5 forces are:

● Competitors (new)

● Competitors (existing)

● Customers

● Suppliers

● Substitutes


Chapter 2

Strategic management accounting

CHAPTER CONTENTS


WHY IS STRATEGIC MANAGEMENT ACCOUNTING NEEDED? -------- 30

WHAT IS STRATEGIC MANAGEMENT ACCOUNTING? ----------------- 31

WHAT IS STRATEGIC CONTROL? --------------------------------------- 33

WHAT IS BENCHMARKING? -------------------------------------------- 34


KEY ASPECTS OF STRATEGIC MANAGEMENT ACCOUNTING 36


CHAPTER 2 –STRATEGIC MANAGEMENT ACCOUNTING

28


Dec 2009

Q1 (ii) Prepare a statement which shows actual and budget income

statements of BEC and JBC in respect of the year ended 30

November 2009 on a comparable basis. 10 marks

June 2009

Q1 (a) Critically assess, on the basis of the above information, the

performance of both hospitals for the year ended 31 May 2009.

You should use the four dimensions to perform your assessment

as per note (6). 20 marks

Dec 2008

Q1 (a) Assess the financial performance of SSH and its operations in

Bonlandia and Karendia during the years ended 30 November

2007 and 2008. 14 marks

Note: you should highlight additional information that would be required in

order to provide a more comprehensive assessment of the financial

performance of each operation.

(b) Discuss the statements of the operational manager of Bonlandia

and assess their implications for SSH. 4 marks

June 2008

Q1 (b) Discuss the problems that the directors of HFG might experience

in their wish to benchmark the performance of HFG with the

performance of SFC, and recommend how such problems might

be successfully addressed. 7 marks

Dec 2007

Q1 (a) Prepare a report on the operating performance and financial

performance of GBC and TTC for the years ended 30 November

20X6 and 20X7. As part of your report, you should include an

appendix showing detailed workings of how each of the six

figures marked with an asterisk (*) in note 1 has been

calculated. 23 marks

Note: 6 marks are available in respect of the six figures marked with an

asterisk (*). 17 marks are available for other calculations and discussion.

CHAPTER 2 – STRATEGIC MANAGEMENT ACCOUNTING

29

June 2005 3.3 (previous syllabus)

Q1 (b) Comment (with relevant calculations) on the performance of the

business of Quicklink and Celer Transport during the year ended

31 May 20X5 and, insofar as the information permits, its

projected performance for the year ending 31 May 20X6. Your

answer should specifically consider:

(i) Revenue generation per vehicle;

(ii) Vehicle utilisation and delivery mix;

(iii) Service quality. 14 marks

Dec 2001 3.3 (previous syllabus)

Q1 (a) Compare the operational and financial performance of the

Sportstown centre with Totaleisure. 18 marks

(b) Assess the validity of appraising their relative performance from

the data made available to you. 5 marks

(d) What additional information would you require to provide a more

appropriate and comprehensive comparison of the financial

performance of the two centres. 4 marks


30

WHY IS STRATEGIC MANAGEMENT ACCOUNTING

NEEDED?

1.1 In earlier management accounting papers you looked at various topics such

as:

● Variances

● Budgeting

● Unit costing.

1.2 These measures have similar characteristics. They tend to be:

● Short-term

● Backwards looking

● Focused at individual departments

● Able to be produced in standard reports

● Able to be produced at regular intervals

● Produced by junior staff for senior staff to review.

Because of this, all of these measures are useful for CONTROL purposes.

1.3 We saw earlier that strategy is concerned with big decisions, such as whether:

● to acquire a new company

● to launch a new product

● to close down a division.

1.4 Traditional management accounting will not help with these decisions.

Instead we need to use strategic management accounting.


31

WHAT IS STRATEGIC MANAGEMENT ACCOUNTING?

2.1 Any strategic decision such as those noted above will need to be justified.

This means the accountant will be involved with preparing information to

support a decision.

2.2 You may remember from Paper P3 that any strategy which is followed will

need to be

● Suitable

● Feasible

● Acceptable.

Strategic management accounting information can assist with all of these.

2.3 The main features of Strategic management accounting are:

● Externally focused

● Forward looking

● Aimed at achieving the goals of the entire organisation

● Produced when needed

● Not in a standard form.

2.4 It is also important to note that this different emphasis means that different

information systems will need to be developed (we will look at this again later

in the course).

2.5 The kind of information that could be provided includes:

● Product profitability – why is one product making more profit than

another

● Customer profitability - why are some customers worth more than

others

● Pricing decisions – including looking at customers and competitors

● Brand values – How much should be invested in a brand

● Shareholder wealth – What choices will increase it

● Possible acquisition targets

● Expected synergistic gains

● Decisions on entering new industries or markets

● Decisions on launching new products

● Decisions on whether to expand certain parts of the business

● Decisions on whether to close or sell-off various parts of the business.

2.6 The last two points are particularly important. Senior management will need

to identify which parts of the business are performing well and which are

under-performing.


32

2.7 To do this senior management will need to introduce a set of performance

measures which can be used to summarise the performance of the business.

2.8 Much of the P5 exam will be concerned with:

● What the business is trying to achieve

● What performance measures would be useful

● How these measures can be calculated

● What the results might mean

● The effect of these measures on the behaviour of departmental

managers.

2.9 A past Examiner (George Brown) wrote ‘The achievement of long-term goals

will require strategic planning which is linked to short-term operational

planning.... If there is no link between strategic planning and operational

planning the result is likely to be unrealistic plans, inconsistent goals, poor

communication and inadequate performance measurement.’


33

WHAT IS STRATEGIC CONTROL?

3.1 Strategic control means discovering if the organisation is going to meet the

objectives it has set out (to keep the stakeholders happy). If the answer is no

– some kind of corrective action will need to take place (we will see this in gap

analysis later).

3.2 When we looked at stakeholders we saw that they wanted different things.

The decisions made by the company will involve a complicated series of trade-

offs between meeting the demands of different groups of stakeholders

(particularly those inside the organisation).

3.3 Model - Porter’s generic strategies

You may also remember from P3 that business strategy is concerned with ways of

being successful. One of the most basic ideas is that to be successful companies

need to be either:

● Cost leaders or

● Product differentiators.

A company will need to measure how good its performance is to make sure it is not

losing its competitive advantage.

Example 1

You have recently been appointed the finance manager for a small / medium sized

engineering company that makes components for the shipping industry. The

company experience rapid growth in turnover and profits until the last three years.

Since then its profits and turnover have slumped. It has relied on a loyal but slowly

contracting client base and has never concerned itself with exploring new markets

or products. The company’s management spends most of its time on day to day

operational issues with limited consideration given to the analysis if strategic

issues.

Required:

Write a memo to the managing director discussing the concentration on operational

matters to the exclusion of strategic planning and management.

10 marks


34

WHAT IS BENCHMARKING?

4.1 We saw in the previous section that a company needs to measure its

performance. Of course on its own this is not particularly helpful, the

company will then need to compare its performance with others. The idea of

comparing performance is called benchmarking.

4.2 There are a number of types of benchmarking.

● Internal

● Functional

● Competitive

● Strategic.

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

performance measures.

4.3 Benchmarking can benefit the organisation by

● 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.

4.4 The disadvantages of benchmarking include:

● 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.


35

4.5 In the exam, the simplest benchmarks will be financial ratios that you have

seen at F3 and F7. Look to calculate measures of:

Profitability

● Return on Capital Employed

● Gross Profit Margin

● Asset Turnover

Liquidity

● Current ratio

● Acid ratio

● Inventory days

● Receivables days

● Payables days

Gearing

● Debt / Equity ratio

4.6 As far as the exam is concerned there are a number of points that come up

frequently

● The Examiner will ask you to compare two different organisations in part

a)

● In parts b) / c) he will then ask

o Why it is difficult to compare the two

o What additional information is required

It is worth noting that

● The answer to b) / c) will be in the question

● You can score marks quickly on this part (as opposed to a) which will be

hard-going.


36


Key aspects of strategic management accounting

Strategic management accounting:

● Focuses on customers, competitors and suppliers (i.e. stakeholders)

● Is looking at making decisions about the future

● Often focuses on relevant costs (rather than historical ones).

In addition strategic management accounting aims towards goal congruence by:

● Relating business operations to financial performance

● Allowing the effect of past strategies to be compared.


37


Porter’s generic strategies

To be successful companies need to be either:

● Cost leaders; or

● Product differentiators.


38


Chapter 3

Divisional performance indicators

CHAPTER CONTENTS


WHAT IS DIVISIONALISATION? --------------------------------------- 42

WHAT MEASURES CAN BE USED TO ASSESS DIVISIONS IN THE SHORT-TERM? ------------------------------------------------------------ 44

RETURN ON INVESTMENT 44

RESIDUAL INCOME? 45

WHAT MEASURES CAN BE USED TO ASSESS DIVISIONS IN THE LONG-TERM? ------------------------------------------------------------- 46

ANNUITY DEPRECIATION 46

WHAT IS MEANT BY ECONOMIC VALUE ADDED? --------------------- 47


EBITDA 49

NPV 49


CHAPTER 3 – DIVISIONAL PERFORMANCE INDICATORS

40


Dec 2010

Q3 (b) Perform an assessment of the performance of LOL using EVA and

evaluate your results compared with those of earnings per share

growth and share price performance. 12 marks

June 2008

Q1 (a) (i) The directors of HFG have asked you, as management

accountant, to prepare a report providing them with

explanations as to the following:

Which of the three centres is the most ‘successful’? Your

report should include a commentary on return on

investment (ROI), residual income (RI), and economic

value added (EVA) as measures of financial performance.

Detailed calculations regarding each of these three

measures must be included as part of your report; 14 marks

Note a maximum of 7 marks is available for detailed calculations

Dec 2007

Q2 (a) (i) Calculate the residual income of the proposed investment

and comment briefly (using ONLY the above information) on

the values obtained in reconciling the short-term and long-

term decision views likely to be adopted by divisional

management regarding the viability of the proposed

investment. 6 marks

(b) (i) Stating clearly any assumptions that you make, estimate

the Economic Value Added (EVA) of the Gamma Group for

both 20X6 and 20X7 and comment briefly on the

performance of the group. 8 marks

(b) (ii) Briefly discuss THREE disadvantages of using EVA in the

measurement of financial performance. 3 marks


41

June 2004 (Paper 3.3 previous syllabus)

Q1 (a) (i) Prepare a statement of the budgeted profit in respect of

Division O for the year ending May 20X5. 7 marks

Your answer should show the annual budgeted contribution

of each branded and unbranded product. Calculate BOTH

the Residual Income and return on Investment for Division

O.

(a) (iii) Suggest three reasons why the management of NAW Group

may have chosen to use Residual Income in addition to

Return on Investment ROI in order to assess divisional

performance. 3 marks


42

WHAT IS DIVISIONALISATION?

1.1 Understanding the performance of a small company should be very easy. The

management accountant can produce monthly accounts which would include:

● Income statement

● Balance sheet.

1.2 Based on this the accountant can assess the company’s profitability by

calculating measures seen earlier such as:

● Return on Capital Employed

● Gross Profit Margin

● Asset Turnover.

1.3 As the business grows it will start offering more products and services and

may move into new industries. At this point it would be sensible to split the

company into a number of divisions – each dealing with a separate part of the

business.

1.4 It is possible for the company to remain centralised. This would mean that all

decisions for each division (products offered, prices charged etc.) would be

made by Head Office (i.e. the centre).

1.5 Usually divisionalisation is accompanied by decentralisation. This means that

each of the divisions will be run by a divisional manager.

1.6 Reasons for divisionalisation and decentralisation include:

● Greater speed of decision-making by divisional managers

● Divisional managers have a greater understanding of their own markets

● Senior managers (in the centre) are freed up to concentrate on strategic

issues rather than operational ones

● Less experienced staff can be put in charge of small divisions and

allowed to gain experience

● The divisional managers should be motivated to perform better

(particularly if divisions are encouraged to compete with each other).

1.7 Problems with divisionalisation and decentralisation include:

● Duplication of functions

● Senior managers may not have all the information to make decisions

● Competing with each other might lead divisions to make decisions which

are good for them but not for the company as a whole (this is known as

dysfunctional decision-making)

● Senior management may lose track of what is actually happening in

each division.


43

1.8 The big issue for P5 is what indicators should be calculated to measure the

performance of each division. These measures will be calculated regularly

and passed to senior management to make strategic decisions such as should

the division be expanded or closed.

1.9 From the above there are a number of considerations when considering what

measures to use:

● Senior management will base their decisions on these measures - if they

do not accurately reflect what the division is doing then the wrong

decisions will be made.

● Measures should motivate division managers – if they do a better job

then this will be good for the entire company and its shareholders.

● Division managers will be rewarded based on their performance against

these measures - they will make decisions that make their own

performance look better (even if these are decisions are bad for the

entire company).


44

WHAT MEASURES CAN BE USED TO ASSESS DIVISIONS

IN THE SHORT-TERM?

2.1 As noted earlier, divisions can be judged on their financial ratios such as profit

margins etc.

2.2 In the P5 exam, there are three key divisional ratios that the Examiner

frequently looks for:

● Return on Investment

● Residual Income

● Economic Value Added.

Return on investment

2.3 Return on Investment is calculated in exactly the same way as Return on

Capital Employed.

The main benefits of ROI are that:

● It allows divisions of different sizes to be compared (since the answer is

given as a percentage)

● The percentage calculated can be compared with the return required by

investors (you may remember cost of equity from F9)

● The performance of a division can be tracked over time (again since a

percentage is calculated).

Example 1 – Divisions X and Y

Division X Division Y

Forecast 20X7 Actual 20X6 Forecast 20X7 Actual 20X6

Profits 120 110 4000 2880

Investment 1000 800 20000 18000

Calculate the ROI for each Division forecast for 20X7 and actual for 20X6.


45

2.4 The problem with ROI is that it is not necessarily good for decision-making.

Example 2 – Division X and Y new projects

At the start of 20X7 the marketing department of the company presented each of

the managers of Division X and Y with a proposal for a new product

Division X Division Y

Profit 13 360

Investment 100 2000

The Company requires a return on capital employed of 15% to satisfy its

shareholders.

Calculate the Return on Investment of each project and the Return on

Investment of each Division in 20X7 if it undertakes the project.

State whether the manager of each division will take on the proposed

project.

Residual income

2.5 Residual income is calculated as

The main benefits of RI are;

● More useful in decision-making since more likely to give goal congruence

● Allows for different risks by using different costs of capital when

calculating imputed interest

Profit

Less imputed interest Investment x required return

Equals Residual income

Example 3 – Divisions X and Y Residual income

For each division - calculate the:

i) Residual income originally forecast for 20X7 (before the proposed investment)

ii) Residual income of the new project on its own

iii) Residual income for 20X7 with the new project included.

State whether the manager of each division will take on the new project.


46

WHAT MEASURES CAN BE USED TO ASSESS DIVISIONS

IN THE LONG-TERM?

3.1 Both RI and ROI have problems when being used to evaluate long-term

decisions. This problem arises because of the way in which depreciation is

calculated.

3.2 This is potentially a very big problem with using them since most projects

undertaken by managers are for the long-term.

Annuity depreciation

3.3 The way round this problem is to use a technique called annuity depreciation.

3.4 A big clue that the Examiner is looking at this area of the syllabus is if he

includes a note in the question stating that mangers are moved around inside

the organisation regularly. This means that the manager will only be

interested in the impact of the decision on the division for the short-term

whereas the company is interested in the long-term.

Example 4 – Easterpark (Extract from old P9 Q)

A company is looking to invest in a new project. The initial cost will be £6,000,000

and will generate a contribution of £1,672,000 per year for each of the five years

the project is expected to last.

The company’s cost of capital is 10%

(a) Discuss the acceptability of the project. You should take into account a range

of performance measures and the likelihood that management would tend to

take a short-term view because of a group policy of rapid management

turnover at each division as part of a career development programme.

10 marks

(b) (i) Calculate and present the year 1 and year 2 figures from Table 1 where

annuity depreciation is used, based on a cost of capital of 10%.

8 marks

(ii) Comment on the acceptability of the revised figures produced in (b) (i)

and their impact on management decision-making in relation to the

investment proposal.

4 marks

Note that discount factors for a 10% cost of capital are as follows:

Yr 1 0.909

Yr 2 0.826

Yr 3 0.751

Yr 4 0.683

Yr 5 0.621


47

WHAT IS MEANT BY ECONOMIC VALUE ADDED?

4.1 EVA is very similar to Residual Income, in fact the calculations look almost

identical.

Economic profit

Less imputed

interest

Net Assets x weighted average

cost of capital

Equals EVA

4.2 The difference between EVA and RI lies in what is included in economic profit

and what is included in net assets. EVA treats items such as research as an

investment rather than a cost (so they are treated as an increase in net

assets instead of a reduction in profit).

4.3 The advantages of EVA include:

● Less distortion by accounting policies since the measure is closer to

cashflows

● An absolute value which can easily be understood

● Increasing EVA should result in increase of real wealth for shareholders

● Encouraging expenditure on costs which build up the business by

treating them as an investment rather than an expense.

4.4 Disadvantages include:

● Focus on short-term performance

● Focus on part performance

● Potentially a large number of adjustments need to be made, making it

difficult to compare different investment centres.


48

Illustration 5

Turnover £4,000,000

Cost of sales £3,200,000

Research costs £250,000

Net Assets £5,000,000

Cost of capital 10%

RI EVA

£ £ £ £

Turnover 4,000,000 4,000,000

Cost of

Sales

3,200,000 3,200,000

Research

costs

250,000 Ignored

Profit 550,000 550,000 Economic

profit 800,000

Net Assets 5,000,000 5,000,000

Add back

development 250,000

Economic

value of

assets

5,250,000

X Cost of

capital

10% 500,000 525,000

RI 50,000 EVA 275,000


49


EBITDA

Earnings Before Interest Tax and Depreciation is used because

● It is a good approximation to cashflow

● Is easy to calculate and understand

● Can be used to assess the performance of a manager who has no control over

acquisitions or financing (since depreciation and interest are both ignored)

● Good for divisions with a high capital expenditure (since EBITDA ignores

depreciation as well as the interest cost on the debt taken on to purchase the

assets).

NPV

In the exam companies generally use NPV to assess whether a project is worth

pursuing or not. NPV obviously focuses on cash flows

● Cash is less subject to manipulation than profit

● NPV considers the opportunity cost of not holding money

● Risk can be included by adjusting the cost of capital.

However a number of assumptions need to be included such as:

● The duration and timing of cash flows

● What cost of capital to use.


50


Financial models have included:

● ROI

● RI

● EVA.


Chapter 4

Transfer pricing

CHAPTER CONTENTS


WHY IS TRANSFER PRICING NEEDED? -------------------------------- 54

WHAT OTHER METHODS OF TRANSFER PRICING ARE USED? ------- 57

MARKET PRICE 57

ADJUSTED MARKET PRICE 57

MARGINAL COST PLUS 57

DUAL PRICING 57

WHAT IS DIFFERENT FOR TRANSFER PRICING IN MULTI-NATIONAL COMPANIES? ------------------------------------------------------------- 58


CHAPTER 4 – TRANSFER PRICING

52


Dec 2009

Q3 (a) (i) The management of the SSA Group have asked you to

advise them regarding the appropriateness of the decision

by the management of Division A to use an adjusted market

price as the basis for the preparation of each quotation and

the implications of the likely sourcing decision by the

management of Division B. 8 marks

Your answer should include recommendation of the prices

that should be quoted in respect of quotations 1 and 2.

(ii) Advise the management of Divisions A and B regarding the

basis of transfer pricing which should be employed to

ensure that the profit of the SSA Group is maximised.4 marks

(b) Advise the management of SSA group whether the management

of Division B should be directed to purchase the ankle supports

from Division A, or to purchase a similar product from a local

supplier in Distantland. 8 marks

Dec 2008

Q4 (a) (i) State the price / prices per kg at which division C should

offer to transfer chemical CC to Division B in order that the

maximisation of BAG profit would occur if Division B

management implement rational sourcing decisions based

purely on financial grounds. 6 marks

(ii) For BOTH the current selling price of CC of $105 per kg and

the proposed selling price of $95 per kg, prepare a detailed

analysis of revenue, costs and net profits of BAG. 6 marks

Pilot paper

Q3 (a) Discuss the application and acceptability of each of the following

transfer prices bases at which component A may be offered by

CD to other divisions within the same group of companies:

(i) External selling price and adjusted selling price;

(ii) Marginal cost, marginal cost plus an annual lump sum; and

(iii) Dual pricing. 10 marks

Your answer should incorporate illustrative values ($) for each transfer

price using the data provided above and additional data of your choice.


53


Q1 (b) (i) From the viewpoint of the NAW Group, comment on the

appropriateness of the decision by the management of

Division O to use an adjusted market price as a basis for the

preparation of quotations 1 and 2, and the implications of

the likely decision by the management of Division L. 3 marks

(ii) Recommend the prices that should be quoted by Division O

for Awaysafe, in respect of quotations 1 and 2, which will

ensure that the profitability of the NAW Group as a whole is

not adversely affected by the decision of the management

of Division L. 3 marks

(iii) Discuss the proposition that transfer prices should be based

on opportunity costs. 4 marks

(c) (i) Advise the management of the NAW Group whether the

management of Division L should be directed to purchase

Awaysafe from Division O, or purchase a similar product

from a local supplier. Supporting calculations should be

provided. 6 marks

(ii) Identify and comment on the major issues that can arise

with regard to transfer pricing in a multinational

organisation. 5 marks


54

WHY IS TRANSFER PRICING NEEDED?

1.1 Remember that in previous chapters we looked at how the managers of

divisions will be judged by Head Office.

1.2 The manager of each division knows that:

● if the division’s performance is good they will receive a bonus and their

division might be expanded

● if the division’s performance is poor they will get fired and the division

might be closed down.

1.3 Two common methods of evaluating performance seen earlier include

● ROI

● RI.

Both of these measures include a profit figure, so the manager of each

division will try to:

● Maximise revenue

● Minimise costs.

1.4 Since both divisions are part of X plc, the managers must be persuaded to

make decisions that are good for X plc not just for their own division.

1.5 The idea behind transfer pricing is to promote goal congruence. In other

words, both managers do what is good for X plc because it is also good for

their own division.

Illustration

X plc has a number of divisions including M and A.

Division M manufactures components which are then shipped to Division A who use

them to assemble finished products.

● The variable cost for M of manufacturing each component is $2

● M could also supply an external customer who is willing to pay $5 for each

component. The customer requires 100,000 components per annum

● A could purchase the components from an external supplier for $6. The

external supplier can supply all of 150,000 components that A requires per

annum.

● A sells the components on for $10.


55

Situation 1 No transfer price

● If Division M supplies Division A it receives no revenue. Since it costs $2 to

make each component, M is getting a negative contribution of $2 per

component and performance will be poor.

● So the manager of M would rather sell to the external customer and receive a

positive contribution of $5 - $2= $3.

● Unfortunately this means A will need to purchase the components from the

external supplier at a cost of $6 each.

● From X plc’s viewpoint this is more expensive than paying M $2 to

manufacture them.

● The Manager of M has made the correct decision for Division M (but bad for X

plc).

Situation 2 Transfer price of $10

● The Manager of M decides to add a mark-up of 400% on to the cost of the

components.

● The Manager of A will obviously refuse to purchase from M and will use the

external supplier. This leaves M to sell to the external customer.

● The situation is the same as before, the decision will cost X plc.

Situation 2 occurs frequently in the exam.

You will often need to discuss WHY the decision is wrong (remember the decisions

need to be good for X plc as well as M and A).

You will often also need to advise on a correct transfer price. This will depend on

which of the following two situations is given:

● Situation 3 Division M has spare capacity

● Situation 4 Division M has a capacity constraint.

Situation 3 M has the capacity to manufacture 300,000

components per annum (spare capacity)

● M will be able to supply the external customer and still have enough capacity

to supply all of A’s demand.

● Since it is obviously better for X plc if M makes the components for A rather

than A buying them in, the transfer price should encourage M’s manager to do

this.

● If the transfer price was $1, M would receive less than the variable cost of

manufacture and so would refuse to supply A, again leading to a negative

contribution for X plc.

● The minimum transfer price should be the marginal cost in this case $2.

● The maximum will be the price A would have to pay the external supplier

i.e.$6.

● With a transfer price of e.g. $4 the managers of M and A will both be happy

for the transfer to take place. This also leads to X plc saving $4 per

component (since it costs M $2 to manufacture rather than A buying in for

$6).


56

Situation 4 M has the capacity to manufacture 80,000 components (capacity constraint)

● M’s manager now is in the position where every component that is transferred

to A is one less sale to the external customer.

● Each lost sale means lost contribution of $3. If the components are to be

transferred to A, M will need to receive this contribution as well as the

marginal cost.

● So the minimum transfer price is now $2 + ($5-$2) =$5

MC Lost contribution

● The maximum price is still $6

● So a transfer price of $5.50 would be acceptable to both managers.

● This again leads to X plc saving $4 per component (since it costs M $2 to

manufacture rather than A buying in for $6).

Situation 4a External customer is now willing to pay $8

The Examiner often uses this trick.

Using the same argument as above

● So the minimum transfer price is now $2 +($8-$2) =$8

MC Lost contribution

● The maximum price is still $6

● So whatever transfer price is set, one of the managers will refuse. No

transfer will take place.

● From X plc’s point of view this is the correct decision since

It will cost $6 to purchase the component instead of $2 to manufacture (so $4 extra

cost) BUT

M will now earn $5 extra contribution

So net is $5 - $4 = $1 extra contribution.


57

WHAT OTHER METHODS OF TRANSFER PRICING ARE

USED?

2.1 In the exam you will often end up with a range of transfer prices.

● The lower the transfer price the happier A will be (bigger cost saving)

● The higher the price the happier M will be (bigger contribution)

Remember that from the point of view of X plc the transfer price makes no

difference in the accounts, the revenue in M will cancel out the cost in A.

2.2 In certain cases the company may want to do things slightly differently.

Market price

2.3 If there is one single price that the external customer is willing to pay and

that the external supplier is willing to charge then it makes sense to use this

as the transfer price.

Adjusted market price

2.4 In some cases there will costs that can be avoided if the goods are transferred

internally (e.g. packing costs). It makes sense when calculating the transfer

price to deduct these from the market price used above.

Marginal cost plus

2.5 Division M will have fixed costs in addition to variable ones. If the marginal

cost only is used there is a danger that M will make a loss. The transfer price

might be set as the marginal cost plus an amount towards these (the same as

using a fixed overhead absorption rate).

2.6 Alternatively a lump sum could be paid annually to help pay the fixed costs.

Dual pricing

2.7 This is where different prices are recorded in the books of M and A. For

example A would record a cost of $3 (the marginal cost) in its books but M

would record a sale of $6 in its books.

This would obviously mean an adjustment would need to be carried out at the

end of the year when the consolidated accounts were being prepared.


58

WHAT IS DIFFERENT FOR TRANSFER PRICING IN MULTI-

NATIONAL COMPANIES?

3.1 There are a number of additional issues when the transfer is between

divisions in different countries:

● Exchange rate fluctuation

● Taxation rates

● Import tariffs

● Fund repatriation

● Anti-dumping legislation

Models used in this Chapter

1 Transfer pricing with spare capacity

● Minimum TP = MC

● Maximum TP = Purchase cost from external supplier.

2 transfer pricing with capacity constraints

● Minimum TP = MC + lost contribution

● Maximum TP = Purchase cost from external supplier

Note in the exam, this may give an impossible TP (which means it is better for the

company if transfer does not happen).


Chapter 5

Design of performance management systems

CHAPTER CONTENTS


WHY DOES THE PERFOMANCE MEASUREMENT SYSTEM MATTER? -- 62

WHAT ARE THE BEHAVIOURAL ASPECTS OF PERFORMANCE MEASUREMENT? 62

WHAT IS MEANT BY CONTROLLABILITY? 63

WHAT ARE THE BENEFITS AND PROBLEMS OF A PERFORMANCE MEASUREMENT SYSTEM 63

HOW CAN TARGETS BE SET? ------------------------------------------- 65

WHAT ISSUES ARE THERE WITH INTERPRETING RESULTS? -------- 66


COMPARING PROFIT AND NON-PROFIT MAKING ORGANISATIONS 67

MEASURING PERFORMANCE IN THE PUBLIC SECTOR 67

BENEFITS AND PROBLEMS WITH LINKING REWARD SCHEMES AND PERFORMANCE 67

ACCOUNTABILITY WITHIN THE ORGANISATION 68


CHAPTER 5 – DESIGN OF PERFORMANCE MANAGEMENT SYSTEMS

60


Dec 2009

Q2 (b) (i) Apply the KPI performance appraisal process shown and

explained in Table C, using actual data for 2008 and 2009 in

order to show the bonus (as a % of salary) that would have

been achieved by Alpha Division for the year ending 30

November 2009. 12 marks

(ii) Discuss potential benefits that might be derived from the

application of the KPI appraisal and bonus approach, both

for Alpha Division and throughout the RRR Group. 4 marks

Dec 2009

Q1 (iii) Prepare a discussion of the issues that might restrict the extent

to which a performance measurement system is accepted and

supported by management and employees. 6 marks

June 2009

Q3 (a) Discuss in relation to the lecturing staff each of the following:

(i) The application of agency theory to staff, in their role as

agents and provide examples of the observability of their

role in relation to outcomes and effort;

(ii) The application if Expectancy Theory with specific reference

to the relationship between:

Strength of motivation to do (X)

Strength of preference for Outcome (y)

Expectation that doing (X) will result in (Y). 12 marks

June 2009

Q2 (c) Discuss ways in which reliance solely on financial performance

measures can detract from the effectiveness of the performance

management system within an organisation. 6 marks


61

Dec 2008

Q1 (a) Prepare a report for the Directors of TSC which:

(i) Contains a summary table which shows the points gained

(or forfeited) by each depot. The points table should

facilitate the ranking of each depot against the others for

each of the 12 measures provided in the Appendix. 9 marks

(ii) evaluates the relative performance of the four depots as

indicated by the analysis in the summary table prepared in

(i). 5 marks

(iv) Critiques the performance measurement system at TSC.

5 marks

Note: Requirement a) includes 4 professional marks.

(b) Evaluate the potential benefits and problems associated with the

use of league tables as a means of measuring performance.

6 marks

June 2008

Q1 (b) Provide explanations on the percentage change in revenue, total

costs and net assets during the year ended 31 May 2008 that

would have been required in order to have achieved a target ROI

of 20% by the Beetown centre. Your answer should consider

each of these three variables in isolation. State any assumptions

that you make. 6 marks


62

WHY DOES THE PERFOMANCE MEASUREMENT SYSTEM

MATTER?

1.1 Senior managers and Directors run a company to meet the needs of its

stakeholders. Key amongst these will be the shareholders, who expect:

● Dividends

● Capital gains.

1.2 In order to satisfy these needs the company will need to improve profits

constantly. To do this the company will need to monitor how it is performing

so that it can identify:

● Areas where it is strong

● Areas where it is weak (to try and improve them)

● These should follow on from the mission of the organisation.

1.3 In addition to this, the performance of each division will be measured. This

allows:

● Strongly performing divisions to be expanded through investment

● Average performing divisions to be improved

● Poorly performing divisions to be closed.

As we have seen earlier methods such as ROI are useful in this respect.

1.4 As well as this, managers in each division need to be encouraged to perform

well, i.e. to be motivated.

They will be judged on how well their divisions perform and so will tend to

make decisions that make their own division improve whichever performance

measure is used.

We saw with ROI this can lead to managers making decision that are poor for

the company.

What are the behavioural aspects of performance

measurement?

1.5 The most basic point is that:

● Managers will try and improve whatever is being measured.

● Making these improvements does not always assist with the organisation

meeting its objectives.

● An example of this is price and usage variances.


63

1.6 If performance measurement is used to motivate management a number of

key issues need to be considered:

● Will the measures help the entire organisation achieve its objectives?

● Will the measures promote goal congruence?

● How do we recognise how much of the performance of a division can be

attributed to its manager?

What is meant by controllability?

1.7 This means that managers should only be judged on what they can control.

For example it would be unfair to judge a manager on the amount of fixed

costs the finance department apportioned to their department.

This will be particularly important when departments use each others services

or when costs are imposed from above (such as spending on a marketing

campaign).

1.8 Methods to get around this include:

● Separating variances into planning and operational

● Using flexible budgeting

● Benchmarking.

What are the benefits and problems of a performance

measurement system?

1.9 Berry, Broadbent and Otley claim that performance measures can help an

organisation:

● Clarify its objectives

● Give greater understanding of processes

● Make it easier to compare performance

● Make it easier to set targets

● Increase the accountability of the organisation to its stakeholders.


64

1.10 Unfortunately there are also a number of problems associated with

performance measurement:

● Tunnel vision

● Sub-optimisation

● Misinterpretation

● Myopia

● Measure fixation

● Misrepresentation

● Gaming

● Ossification.


65

HOW CAN TARGETS BE SET?

2.1 Once suitable measures have been decided, the organisation will need to set

targets to motivate the managers.

2.2 The most widely-remembered approach is to aim for targets which are:

S

M

A

R

T

2.3 Fitzgerald and Moon – Building blocks of performance - standards

Fitzgerald and Moon state that all targets should include the following standards.

This means that to be successful targets should be designed so that:

● Managers can take ownership

● Targets should be tough but achievable

● Equity should be seen to occur

2.4 Fitzgerald and Moon – Building blocks of performance -

rewards

Fitzgerald and Moon also state that for targets to motivate staff:

● The objectives of the organisation should be clear

● Individuals should feel motivated

● There should be an element of controllability over decisions.


66

WHAT ISSUES ARE THERE WITH INTERPRETING

RESULTS?

3.1 Even if the correct measures are being used, they will need to be interpreted

correctly by senior management in order to make strategic decisions.

3.2 There are a number of difficulties with comparing different companies/

divisions

This is frequently examined. Look at the text to see what the Examiner tells

you.

Amongst the most common difficulties are:

● Public v private sector company

● New v established company

● Different industries

● One company may just be having an unusually bad / good year

● Companies in different locations

● Industries at different stages of the life-cycle

● Differing objectives of companies

● Amount of capital spending (affects ROI / ROCE).

3.3 Another frequently asked question is:

What additional information would enable you to make a more valid

comparison?

Look to see what the Examiner has given you, one or two of the following will

be missing so suggest they would help:

● Budgets

● More previous years

● Other organisations in a similar sector

● Non Financial Performance Indicators (see late chapter).


67


Comparing profit and non-profit making organisations

If you are asked to benchmark a public sector organisation with a private sector

one, there are some adjustments that might need to be made before a meaningful

comparison can occur.

What would the public sector organisation’s surplus / deficit be if:

● they had to borrow money and pay interest on it?

● they stopped providing services that are uneconomic (i.e. they closed

something)?

● they charged everyone for the service they provide?

Measuring performance in the public sector

This has often presented difficulties due to:

● There is often little if any competition for various public sector bodies

● Different stakeholders have expectations of what the organisation should

achieve (profit is obviously not one of them) – this may make it harder to run

things as efficiently as they should be

● It may be difficult to define performance measures and it may be hard to

actually measure outcomes.

Many public sector organisations are measured on the three E’s:

● Economy – the cost of treating a patient in a hospital

● Efficiency – the time taken to treat the patient

● Effectiveness – the success of the treatment.

There may be a trade off between these three. Benchmarking can be used to

examine performance versus other organisations.

Benefits and problems with linking reward schemes and

performance

Benefits

● There is evidence that linking pay with performance DOES encourage

better performance

● A good scheme attracts the best potential recruits and is better at

retaining them

● It can be made clear what the organisation must be good at to succeed

● The focus becomes continuous improvement

● Long-term decision-making can be encouraged through things such as

share scheme.


68

Problems

● They may encourage dysfunctional decision-making

● Measures to encourage long-term decisions may not motivate

● It is difficult to design a set of performance measures to show exactly

what an employee achieves

● People may not co-operate with each other

● Quality may suffer

● They undervalue intrinsic rewards (such as job satisfaction) by focussing

on extrinsic rewards (i.e. pay).

Factors that should be taken into account when designing the system include:

● Goal congruence should be encouraged

● Who should be offered equity in the business and its likely effect (being

offered shares in a small private company may not motivate since there might

be no market for them)

● Different rewards being offered for different staff

● When the reward scheme should be introduced and what time period should it

relate to (monthly, annually etc.)

● The impact of tax (if an employee is likely to pay a high tax rate on any

incentives then they may not be as motivational)

● The size of rewards relative to performance

● What forms rewards should take (including non-financial).

Accountability within the organisation

There are a number of steps an organisation must go through to ensure that its

performance measurement system will help.

● Choose and publicise accepted performance measures

● Identify the benefits of the measures

● Identify and understand problems in their use

● Consider how to counter perceived problems.

In addition, the organisation must ensure that it has a system of accountability set

up. This covers:

Hard accountability –

● Converting activities into numbers

● Explaining why an outcome occurred

● Being held accountable for the results

Soft accountability –

● The human impact on the system and its role in deciding what to measure

and how high targets should be set.


69


Fitzgerald and Moon Building Blocks

Standards

● Ownership

● Achievability

● Equity

Rewards

● Clarity

● Motivation

● Controllability


70


Chapter 6

Decision-making

CHAPTER CONTENTS


WHAT IS MEANT BY RELEVANT COSTING?---------------------------- 74

WHAT IS MEANT BY SENSITIVITY ANALYSIS? ----------------------- 75

WHAT IS MEANT BY EXPECTED VALUE? ------------------------------- 76

WHAT IS MEANT BY TARGET COSTING? 78

WHAT IS MEANT BY THE LEARNING CURVE? ------------------------- 79

CHAPTER 6 – DECISION - MAKING

72


June 2010

Q5 (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)

June 2010

Q2 (a) Prepare a statement showing the budgeted net profit or loss

during the year ended 31 May 2011. (7 marks)

(b) (i) Prepare a summary table which shows the possible net

profit or loss outcomes, and the combined probability of

each potential outcome for the year ending 31 May 2011.

The table should also show the expected value of the net

profit or loss for the year. (9 marks)

(ii) Comment briefly on the use of expected values by the

management of EMA. (3 marks)

(iii) Suggest three reasons why the government of Hartland

might have decided to open an academy comprising an

equine college and a riding school. (6 marks)

June 2009

Q4 (a) (i) Calculate the profit-maximising fee per double room that

MR should charge per night during the tournament. (6 marks)

(ii) Calculate how much profit would be earned from staging

the tournament as a consequence of charging that fee.

(4 marks)

(b) Advise the management whether, on purely financial grounds,

they should make the proposed changes in operational activities.

(6 marks)

(c) Discuss two initiatives that management might consider in order

to further improve the profit from staging the golf tournament.

(4 marks)

June 2009

Q2 (a) Calculate the NPV of the Dance and Drama franchise proposal

and recommend whether it should be undertaken by F4U.(6 marks)


73

(b) Discuss the elements to be considered as “intellectual capital”

and issues associated with its valuation for inclusion in the initial

investment of $6m. (6 marks)

(d) State the franchise fee pricing strategy which will result from the

operation of each of the following decision rules:

(i) Maximax;

(ii) Maximin;

(iii) Minimax regret. (7 marks)

June 2008

Q5 (a) Prepare an estimate of the financial consequences of each option

and advise the directors of TAW which option should be chosen.

(9 marks)

June 2008

Q4 (a) (i) Prepare a statement of product profitability for each of the

years 2008 and 2009 which also shows the net profit or loss

of CTC. (4 marks)

(ii) Comment on the figures in the statement prepared in (a) (i)

above. (4 marks)

(b) (i) Determine whether the new product is viable purely on

financial grounds. (4 marks)

(ii) Calculate the minimum target contribution to sales ratio

(%) at which “Nellie the Elephant” will be financially viable,

assuming that all other data remain unchanged. (4 marks)

(iii) Identify and discuss an alternative strategy that may assist

in improving the performance of CTC with effect from 1 May

2009 (where only the products in a) and b) above are

available for manufacture). (4 marks)

Pilot paper

Q2

Discuss the impact of the possible changes in the quantity of timber and

number of cuts in the shaping process caused by the re-design of

Component A on the total cost per unit of Component A.

You should incorporate an analysis of statistics from the data-table and

probability information contained in the model into your discussion with

specific reference to the impact of management attitude to risk when

deciding whether or not to change from the existing quantity of timber and

number of cuts for Component A. (10 marks)


74

WHAT IS MEANT BY RELEVANT COSTING?

1.1 You may remember from P3 that there are two different parts to choosing a

strategic option.

Firstly a number of different options need to be generated (using a model

such as Ansoff which will be discussed later).

Then each option must be tested to see if it is

● Suitable

● Feasible

● Acceptable.

1.2 One of the major tests will therefore be – does the option improve

profitability, contribution etc.

A common way to look at this in the exam is to use relevant costs.

1.3 The simplest way to deal with this in the exam is to set up a table with a

column for each option. Remember that one option might be to carry on

doing things the way they are done at the moment.

In each column put in

● Any costs that the option will have – these might include extra fixed

costs or one-off costs

● Any savings that the option will give.

Then simply total each column and go with the best option (remember that if

you just have costs then the lower cost option is best).

1.4 Remember that

● Any sunk costs should be ignored – the money has already been spent.

● Only cashflows should be used (so ignore depreciation).

● There may be opportunity costs involved.

● Only fixed costs that change should be included – general ones such as

rent etc will be unaffected by which option you choose.

1.5 If the strategic option will last for more than one year then use the above in

an NPV calculation.


75

WHAT IS MEANT BY SENSITIVITY ANALYSIS?

2.1 Sensitivity analysis is a term used to describe how sensitive a result is to the

change of one variable.

2.2 For example, the budgeted profit for a company might be $100,000.

However, since this is a budget, the chances are that the profit will not

actually be $100,000. It may be more or it may be less.

2.3 Imagine that the company above knows that it has to deliver profits of at

least $80,000 to satisfy its shareholders. If things turn out as they are in the

budget all will be fine, but what if something goes wrong?

2.4 Sensitivity analysis looks at one variable at a time. So for example if the

number of items sold fell by 15% then the company would only make $80,000

profit. Alternatively if the volume of sales was the same but the variable cost

rose by 6% then profits would only be $80,000.

2.5 The advantage of using sensitivity analysis is that it gives an indication of how

risky something might be. For example, sensitivity analysis might show that

costs can only rise by 1% before a company starts to make losses. In this

case a company knows that there is a very large risk that losses will be made.

2.6 The Examiner will often include sensitivity analysis along with calculating the

budgeted profit on a project.


76

WHAT IS MEANT BY EXPECTED VALUE?

3.1 Calculating an expected values is a technique that can be used to give an

approximation of what might happen when a project is undertaken.

3.2 It is usually used in a situation where there are a range of possible outcomes

which might occur.

3.3 For example, the following are estimates of the revenue and costs of a

particular project.

Revenue Probability Costs Probability

100,000 0.2 80,000 0.5

50,000 0.7 50,000 0.3

20,000 0.1 30,000 0.2

3.4 The first thing to do is to construct a table showing ALL the POSSIBLE

outcomes and the combined probability they will occur. This is done by

MULTIPLYING the probabilities that each event will occur.

The probability that revenue is 100,000 AND that costs are 80,000 is 0.2 x

0.5 =0.10

Revenue Probability Costs Probability Profit Combined

probability

100,000 0.2 80,000 0.5 20,000 0.10

100,000 0.2 50,000 0.3 50,000 0.06

100,000 0.2 30,000 0.2 70,000 0.04

50,000 0.7 80,000 0.5 -30,000 0.35

50,000 0.7 50,000 0.3 0 0.21

50,000 0.7 30,000 0.2 20,000 0.14

20,000 0.1 80,000 0.5 -60,000 0.05

20,000 0.1 50,000 0.3 -30,000 0.03

20,000 0.1 30,000 0.2 -10,000 0.02

1.00


77

3.5 Now take each row and multiply the profit by the combined probability. Add

these together to give the expected value.

In the above the expected value =

20,000 x 0.10

+ 50,000 x 0.06

+ 70,000 x 0.04 etc

This gives an expected value of -4,000

So the project may be unacceptable. One key thing to note is that a loss of

4,000 is not one of the actual possible outcomes.

3.6 There is still a chance that the project makes a profit. To calculate this

probability, add together all the probabilities where the project shows a profit.

In other words there is a 0.10 + 0.06 + 0.04 + 0.14 = 0.34 chance that a

profit is made. Note the probabilities are added since the profit could be

20,000 OR 50,000 OR 70,000 OR 20,000, we do not mind which.


78

What is meant by target costing?

4.6 Target costing is used particularly where there is a lot of competition from

similar products / services. Under these circumstances the organisation will

probably have to charge the same as others (average rate pricing).

● Analyse the external environment to look at competitors / customers etc

● Set a realistic price

● Subtract the required return (probably using a target ROI from the investment

in the project)

● This gives a maximum total cost

● Split this total cost into areas reflecting for example

o Variable manufacturing costs

o Variable distribution costs

o Overheads based on development

o Overheads based on marketing

● Come up with a target for each of these areas and design the product to meet

these targets

● These targets become the standards to be used.


79

WHAT IS MEANT BY THE LEARNING CURVE?

5.1 A learning curve relates to products that are labour intensive to manufacture.

If the manufacturing method is repetitive, then the workers will ‘learn’ how to

manufacture the item more quickly. The production time per unit goes down

as more items are manufactured.

5.2 At some point it will become impossible for the workers to improve their

efficiency any further, this is known as reaching the ‘steady state’. After this

point all units take the same length of time.

5.3 The learning curve formula is y = axb (this will probably be given in the exam

if needed).

In the above y = average length of time for ALL units

a = Time taken for 1st unit

x = TOTAL number of units made

b represents the learning curve value (this will be given in the

exam)

Example 1

A company intends to start manufacturing a product which will be highly labour

intensive. They have already taken four orders for the product. Customer A wants

the first 10 items. Customer B requires the next 50 items. Customer C requires

the next 100 items. Customer D wants the next 20 items

Based on past experience the company expects there to be a 80% learning curve

and that a steady state will be reached after 150 items. The first item took 40

hours to produce.

Calculate how many labour hours will required to fill each customer’s

order.


80

To use the formula;

a = 40

b = -0.3219

Cumulative Units Cumulative

Average Time

Cumulative Total

Time

Incremental Time


Chapter 7

Non-financial performance indicators

CHAPTER CONTENTS


HOW CAN WE ASSESS THE PERFORMANCE OF A DIVISION? ------- 85

WHAT IS THE BALANCED SCORECARD APPROACH? ----------------- 86

WHAT IS THE PERFORMANCE PYRAMID APPROACH?---------------- 87

WHAT IS THE BUILDING BLOCKS APPROACH? ----------------------- 88

WHAT IS THE SIX SIGMA APPROACH? -------------------------------- 89


CHAPTER 7 – NON-FINANCIAL PERFORMANCE INDICATORS

82

PAST EXAM REQUIREMENT

Dec 2010

Q1 (a) Explain the difference between monitoring CSFs and building

CSFs using examples appropriate to FP. (4 marks)

(c) For each of the two critical success factors given in the question,

identify two performance indicators that could support

measurement of their achievement and explain why each is

relevant to the CSF. (10 marks)

Dec 2010

Q4 (a) Perform an analysis of FGH’s business environment to identify

factors which will affect its environmental strategy. For each of

these factors, suggest performance indicators which will allow

FGH to monitor its progress. (8 marks)

(b) Evaluate the data given on carbon dioxide emissions using

suitable indicators. Identify trends from within the data and

comment on whether the company’s behaviour is consistent with

meeting its targets. (9 marks)

(c) Suggest further data that the company could collect in order to

improve its analysis and explain how this data could be used to

measure the effectiveness of the reduction initiatives mentioned.

(3 marks)

June 2010

Q5 (b) Assess the forecasted performance of BEG for the period 2011 to

2013 with reference to the application for ‘platinum status’

quality certification under the following headings:

(i) Financial performance and marketing;

(ii) External effectiveness;

(iii) Internal efficiency. (12 marks)


83

June 2010

Q1 Prepare a report which:

(i) Discusses the importance of non-financial performance

indicators (NFPIs) and evaluate, giving examples, how a

balanced scorecard approach may be used to improve

performance within SBC. (13 marks)

(ii) Contains a calculation of the actual average cost per chargeable

consultation for both full-time consultants and separately for

sub-contract consultants in respect of each of the three

categories of consultancy services during the year ended 31 May

2010. (7 marks)

(iii) Suggests reasons for the trends shown by the figures contained

in the appendix. (5 marks)

(iv) Discusses the potential benefits and potential problems which

might arise as a consequence of employing subcontract

consultants within SBC. (6 marks)

Dec 2009

Q1 (ii) Provide an assessment of the performance of BEC and JBC using

both financial and non-financial measures based on the

information contained in the question. You should identify other

measures of performance which you consider relevant to BEC.

(10 marks)

June 2009

Q5 (a) Describe the Six Sigma methodology for the improvement of an

existing process. (8 marks)

(b) Explain how the problems at T4Uc could be analysed and

addressed using the Six Sigma methodology. Your answer

should include suggestions regarding additional activities that

should be undertaken to improve the performance of T4UC.

(12 marks)

June 2009

Q1 (b) Evaluate the balanced scorecard used by the Glasburgh Trust and

provide recommendations which would improve its usefulness as

a performance measurement tool. (11 marks)


84

Dec 2008

Q1 (a) (iii) Assess TSC in terms of financial performance,

competitiveness, service quality, resource utilisation,

flexibility and innovation and discusses the inter-

relationships between these terms incorporating examples

from within TSC. (10 marks)

Dec 2008

Q2 (c) Assess the likely criteria which would need to be satisfied for

software to be regarded as ‘quality software’. (4 marks)

(d) Suggest a set of SIX performance measures which the directors

could use in order to assess the quality of service provided to its

clients. (3 marks)

Dec 2008

Q4 (b) Identify the FOUR sub-categories into which quality costs can be

analysed and five examples (which must relate to Division C) of

each of these four sub-categories of quality cost that can be

investigated in order that overall cost savings might be achieved

and hence the performance improved. (8 marks)

Dec 2007

Q5 (b) Discuss the statement of the managing director of JOL Co and

discuss six performance indicators, other than decreasing

market share, which might indicate that JOL Co might fail as a

corporate entity. (10 marks)

Pilot paper

Q1 (e) Excluding the number of complaints by patients, state FOUR

performance measures that may be used in order to assess the

surgical quality provided by a hospital indicating how each

measure may be assessed. (6 marks)


85

HOW CAN WE ASSESS THE PERFORMANCE OF A

DIVISION?

1.1 In the earlier sections we have looked at assessing the division’s performance

through financial measures. Remember these could include:

● ROCE

● RI

● Financial ratios.

1.2 The major problems with using financial indicators to look at the performance

of a division are:

● They are backwards looking

● It is difficult to explain WHY the performance is improving or getting

worse

● Most staff will not be able to influence directly the financial performance

● The division can lose sight of what the customers want

● By the time a product is delivered it may be too late to control costs

(many of which are built in at the design stage)

● It may be hard to directly compare companies financial performance, it

may be easier to look at areas such as customer satisfaction

● Managers may become obsessed with cutting costs and losing sight of

the company’s overall strategy.

1.3 Because of this, a number of writers have suggested performance

measurement systems that include non-financial performance measures.

1.4 Advantages of using NFPIs

● Can be provided quickly

● Easy to calculate

● Easier for non-financial managers to understand

● Should focus managers on the longer-term

● More suitable in competitive environments.

1.5 Disadvantages of using NFPIs

● Financial aspect cannot be ignored

● Possible information overload

● May lead to managers focussing on their own small part of the business

rather than the overall strategy.


86

WHAT IS THE BALANCED SCORECARD APPROACH?

2.1 Kaplan and Norton devised a range of measures that assist managers to focus

on what affects the performance of a division.

2.2 Model – The balanced scorecard

The four areas to look at are:

● Financial perspective – how does the division create value for the

organisation?

● Customer perspective – what do new and existing customers value the

division for?

● Innovation and learning – how can the division continue to deliver value?

● Internal business – what processes must the division excel at to meet the

objectives of the organisation and the customers?

2.3 Main benefits of using the balanced scorecard include:

● Forcing managers to look at internal and external issues

● Focussing on key elements of a company’s strategy

● Linking non-financial results with financial ones – for example

highlighting the impact on customers if cheaper materials are used).

2.4 Major drawbacks of using the balanced scorecard include:

● Improving in some areas will probably lead to deterioration in others.

● It may be hard to come up with measures in all areas

● It may lead to too many things being measured

● There may be too many measures to interpret easily.


87

WHAT IS THE PERFORMANCE PYRAMID APPROACH?

3.1 Model – The performance pyramid

The idea behind this model is that the entire organisation needs to work together in

order to achieve success. The approach is to try to link the overall strategy of the

company with what is happening on a day-to day level.

Vision

Market satisfaction Financial measures

Customer satisfaction

Flexibility Productivity

Quality Delivery Process Time Cost

Operations

External effectiveness Internal efficiency

Head office sets the overall financial and market objectives.

Each division sets its own targets for:

● Customer satisfaction

● Flexibility

● Productivity.

At a day to day level

o Quality

o Delivery

o Process Time

o Cost

can all be monitored.


88

WHAT IS THE BUILDING BLOCKS APPROACH?

4.1 Fitzgerald and Moon designed a system of non-financial performance

indicators specifically for service industries.

4.2 Model – Fitzgerald and Moon – building blocks

There are three aspects to building a performance measurement system:

Standards – what the company expects:

● Ownership

● Achievability

● Equity.

Rewards – what the manager will receive:

● Clarity

● Motivation

● Controllability.

Dimensions – what will be measured?

● Innovation

● Quality

● Resource utilisation

● Flexibility

● Competitive performance

● Financial performance.

The thinking is that getting the top five correct will lead to a strong financial

performance.


89

WHAT IS THE SIX SIGMA APPROACH?

5.1 Model – Six Sigma

The main theory of quality improvement in Paper P5 is the Six Sigma concept. The

idea is to try and reduce the chance of an item failing to be of a good enough

quality. This does not mean having a single standard, there may be a range of

values which are acceptable.

5.2 This range is known as the tolerance. For example a hamburger chain may

say that as long as a burger is not too hot or too cold it is acceptable. This

would give a range of acceptable temperatures (the tolerance).

5.3 The six sigma approach is about many gradual improvements rather than

occasional large ones.

The stages that six sigma goes through are:

● Defining customer requirements

● Measuring existing performance

● Analysing the existing process

● Improving the process

● Controlling the new process.

5.4 The Examiner may require you to calculate the cost to the company of poor

quality. The main categories are -

Prevention costs - money spent BEFORE products are made to prevent

problems occurring. Examples include staff training, design and process

engineering and machine maintenance

Appraisal costs – money spent AFTER products are made to check quality is

acceptable. Examples include inspection costs

Internal failure costs – money spent repairing a product BEFORE a customer

receives a product that has been found to be faulty. Examples include rework

costs

External failure costs – money spent repairing a product AFTER the customer

has received a faulty product. Examples include meeting warranty costs.

5.5 The above can be used in any situation. Often it is necessary for companies

to appreciate the costs involved with not improving quality before they can

accept the need to improve it.

5.6 In a TQM environment NFPIs should cover

● Measuring quality of supplies

● Measuring quality of work done as it proceeds

● Measuring customer satisfaction.


90


Model – The balanced scorecard

● Financial perspective

● Customer perspective

● Innovation and learning perspective

● Internal business perspective

Model – The performance pyramid

Vision

Market satisfaction Financial measures

Customer satisfaction

Flexibility Productivity

Quality Delivery Process Time Cost

Operations

External effectiveness Internal efficiency

Model – Fitzgerald and Moon – building blocks

Standards – what the company expects

● Ownership

● Achievability

● Equity

Rewards

● Clarity

● Motivation

● Controllability

Dimensions

● Innovation

● Quality

● Resource utilisation

● Flexibility

● Competitive performance

● Financial performance

Model – Six Sigma

The stages that six sigma goes through are:


91

● Defining customer requirements

● Measuring existing performance

● Analysing the existing process

● Improving the process

● Controlling the new process.


92


Chapter 8

Budgeting

CHAPTER CONTENTS


WHAT IS THE PROBLEM WITH THE TRADITIONAL BUDGETING SYSTEM? ------------------------------------------------------------------ 96

WHAT ALTERNATIVE TYPES OF BUDGET ARE THERE? --------------- 97

ZERO BASED BUDGETING 97

ROLLING BUDGETS 97

FLEXED BUDGETS 97

ACTIVITY BASED BUDGETING 98


STRENGTHS AND WEAKNESSES OF VARIOUS BUDGET SYSTEMS 99

BUDGETING IN THE PUBLIC SECTOR 100

MAXIMISING THE BENEFITS OF BUDGETING 100

ACTIVITY BASED MANAGEMENT 100

MODELS USED IN THIS CHAPTER ------------------------------------- 102

CHAPTER 8 – BUDGETING

94


Dec 2010

Q2 (a) Evaluate the current method of costing against an ABC system.

You should provide illustrative calculations using the information

provided on costs for 2010 and order 11784. Briefly state what

action management might take in the light of your results with

respect to this order. (15 marks)

(b) An explanation of the beyond budgeting approach and an

evaluation of the potential of such a change at RL. (10 marks)

June 2010

Q4 (a) (i) Compare the cost figures per unit for Job order 973 and 974

calculated by the management accountant and explain the

reason for, and potential consequences of, the differences

in the job cost estimates produced under the two costing

systems. (8 marks)

(ii) Explain two potential problems that SFS might have

experienced in the successful implementation of an activity-

based costing system using its recently acquired ‘state of

the art’ IT systems. (4 marks)

(b) The application of Activity Based Management (ABM) requires

that the management of SFS focus on each of the following:

(i) Operational ABM;

(ii) Strategic ABM;

(iii) The implicit value of an activity.

Critically appraise the above statement and explain the risks

attaching to the use of ABM. (8 marks)

June 2010

Q3 Prepare a detailed analysis which includes a clear explanation of the

following:

(i) Value for Money (VFM) audit (including references to the roles of

principal and agent). (6 marks)

(ii) Economy, efficiency and effectiveness as part of the VFM audit.

(6 marks)

(iii) The extent (if any) to which each of intangibility, heterogeneity,

simultaneity and perishability may be seen to relate to the

decision concerning the proposal, and any problems that may

occur. (8 marks)


95

Dec 2009

Q2 (a) Evaluate the extent to which the budget of Alpha division for the

year ending 30 November 2010 is achievable and consistent with

the “beyond budgeting” philosophy detailed above. (14 marks)

Dec 2008

Q5 (a) Calculate variable cost per unit of both products using an

activity-based costing approach. (8 marks)

(b) Using the unit cost information available and your calculations in

(a), prepare a financial analysis of the decision strategy which

TOC may implement with regard to the manufacture of each

product. (6 marks)

(c) Critically discuss the adoption of activity-based management

(ABM) in companies such as TOC. (6 marks)

Pilot paper

Q1 (e) Excluding the number of complaints by patients, state FOUR

performance measures that may be used in order to assess the

surgical quality provided by a hospital indicating how each

measure may be assessed. (6 marks)


96

WHAT IS THE PROBLEM WITH THE TRADITIONAL

BUDGETING SYSTEM?

1.1 The annual budget is one of the most fundamental performance measures

used in companies. The staring point is to take last years performance and

then to improve.

The annual budget is designed to:

● Turn business plans into figures

● Allow co-ordination between divisions

● Motivate managers

● Measure performance

1.2 Model – Hope and Fraser

In ‘Beyond Budgeting’ Hope and Fraser argued that budgets:

● Add little value

● Are used excessively in measuring performance

● Are used as a method to communicate the values of the organisation rather

than as a means of financial control

● Are too inwardly focussed

● Are a major barrier to change

1.3 They argue that using rolling budgets and non-financial performance

indicators should:

● Create a culture based on beating the competition (since goals are

related to external benchmarks) rather than simply gaining more

internal resources

● Rewards can be team-based increasing the amount of motivation

● It is easier to judge the performance of people lower down the

organisation (who are closer to the customers)

● It empowers more junior managers meaning they can respond more

quickly to changes in the external environment.


97

WHAT ALTERNATIVE TYPES OF BUDGET ARE THERE?

2.1 There are a number of alternatives to the annual budget that have been

developed.

Zero based budgeting

2.2 A problem with the annual, incremental budget is that departments are given

money each year because they have been given it in the past. Zero based is

designed to eliminate this wastage.

2.3 ZBB starts with the idea that each manager begins with a zero base of

resources. The manager only receives resources if they can be justified.

It would be particularly suitable for a department which pursues different

projects each year (marketing, IT).

2.4 The major objection to ZBB is the time and cost involved in preparing the

budget each year.

Rolling budgets

2.5 A problem with the annual, incremental budget is that it can quickly become

unrealistic. This leads to the targets becoming unreachable and managers

becoming demotivated.

2.6 The rolling budget is regularly updated based on actual performance. This

should lead to more realistic targets.

2.7 The major objection to rolling budgets is the time they take to update and

that they are not particularly useful in a stable environment.

Flexed budgets

2.8 A problem with the annual, incremental budget is that cost centres are given

the same amount of money to spend regardless of activity.

2.9 Flexed budgets adjust the target to reflect the amount of work to be carried

out and can identify if the company is likely to have any spare capacity.

2.10 The major objection to flexed budgets is that it is difficult to motivate

managers to achieve a target if they do not know what the target is until the

end of the period. Flexed budgets also assume that the standard cost per unit

has been calculated correctly.

2.11 A further objection is that if most costs are fixed then they are not particularly

useful.


98

Activity based budgeting

2.12 Activity based budgeting comes from the principles of activity based costing.

The basic ideas are:

● The cost of an activity can be calculated accurately

● This can be compared with the value the activity adds to the customer.

If the cost of an activity is larger than its value added, then:

o The cost of the activity could be reduced

o The activity could be stopped /outsourced

o The price to the customer could be increased.

In addition managers can identify if activities in one department are adding to

costs in another (e.g. poor quality products needing to be replaced leading to

more distribution costs).

2.13 The idea behind activity based budgeting is that they focus on critical success

factors and the activities which must be performed well in order to be

successful.

2.14 This means that as a company’s strategy changes the budget will also change.

2.15 Since ABB focuses on the whole activity there is more chance of getting in

right first time (ie it links up with TQM).


99


Strengths and weaknesses of various budget systems

Incremental budgeting

Strength

● Easy to prepare.

Weaknesses

● Does not look for ways to improve

● Is only suitable if current operations are efficient already

● Encourages slack in the budget setting process.

Zero Based Budgeting

Strengths

● Responds to changes in the environment

● Should result in more efficient use of resources.

Weaknesses

● Requires a lot of management time

● Involves participation by managers so needs a suitable culture.

Rolling budgets

Strengths

● Useful in a dynamic environment

● Should be more realistic since includes actual events

● Should be better at motivating.

Weaknesses

● Requires time and effort to keep updating

● Managers may not see value in regular updating.

Flexible budgets

Strength

● Allows planning for potential spare capacity / idle time.

Weaknesses

● Limited usefulness if most costs are fixed

● Little benefit if environment is not dynamic.


100

Activity Based Budgeting

Strengths

● Links budgets in with the overall strategy of the organisation

● Identifies critical success factors

● Concentrates on activities rather than individual cost centres allowing for

the “big picture” to be seen

● Can improve the commitment of managers.

Weakness

● Requires resources and time to prepare.

Budgeting in the public sector

A budget in the public sector:

● Establishes income as well as expenditure

● Authorises expenditure

● Acts as a control on expenditure

● Communicates plans to staff.

There are a number of issues that arise from this:

● Some organisations are legally prevented from borrowing money

● It may be difficult or impossible to move funds from one part of an

organisation’s budget to another v(making them inflexible)

● Most public sector budgets simply focus on the coming fiscal year – rather

than a longer timescale

● Incremental budgeting (with all its inherent problems is still widely used).

Maximising the benefits of budgeting

The problems with budgeting have been noted above. In order to get the most

from the budget process, an organisation should:

● Prepare budgets after the corporate strategy has been set

● Conflicts between departments should be identified and resolved as soon as

possible

● Realistic short-term targets should be set

● Managers should be committed to reaching targets

● Managers should be responsible for expenditure

● Any reports produced by the MIS (see later) should be accurate and timely).

Activity based management

Activity Based Management builds on the principles of Activity Based Costing and

Activity Based Budgeting to improve the profitability of an organisation. It does

this by identifying which activities can be performed more efficiently, which


101

activities can be eliminated entirely, how changing the design of a product can

lower costs and improving relationships with customers and suppliers.


102


Model – Hope and Fraser

Budgets:

● Add little value

● Are used excessively in measuring performance

● Are used as a method to communicate the values of the organisation rather

than as a means of financial control

● Are too inwardly focussed

● Are a major barrier to change.

Types of budget

● Zero-based.

● Rolling.

● Flexed.

● Activity Based.


Chapter 9

Management information systems

CHAPTER CONTENTS

PAST EXAM REQUIREMENTS ------------------------------------------- 104

WHAT IS THE PROBLEM WITH THE TRADITIONAL BUDGETING SYSTEM? ----------------------------------------------------------------- 105

WHAT IS A MANAGEMENT INFORMATION SYSTEM? ---------------- 107

WHAT ARE THE MODERN DEVELOPMENTS IN MANAGEMENT ACCOUNTING? ---------------------------------------------------------- 108

SUPPLEMENTARY MATERIAL ------------------------------------------ 110

MOTIVATION AND THE USE OF CONTROL INFORMATION 110

THE IMPACT OF THE OUTSIDE WORLD ON THE MANAGEMENT ACCOUNTING SYSTEM 110

THE USE OF EXTERNAL DATA 110

ENVIRONMENTAL MANAGEMENT ACCOUNTING 111

LIFE CYCLE COSTING 111

THE PERFORMANCE PRISM 112


CHAPTER 9 – MANAGEMENT INFORMATION SYSTEMS

104


Dec 2010

Q1 (b) Identify information that FP could use to set its CSFs and explain

how it could be used giving two examples that would be

appropriate to FP. (6 marks)

(d) Discuss the implications of your chosen KPIs for the design and

use of the company’s website, its management information

system and its executive information system. (9 marks)


(a) Explain why it is necessary when designing a management accounting

system to consider the behavioural consequences of its application.

(5 marks)

(b) Explain the potential behavioural issues that may arise in the

application of performance monitoring, budgeting and transfer pricing

and suggest how problems may be overcome. (15 marks)

December 2001 (Paper 3.3 previous syllabus)

Recommend the significant changes in the Management Information

System that would probably be required to meet the needs of this new

situation. Explain the reasons for your recommendations. (20 marks)


105

WHAT IS THE PROBLEM WITH TRADITIONAL

MANAGEMENT INFORMATION SYSTEMS?

1.1 Model – The feedback loop

You may remember from your earlier studies that one of the main tasks of the

management accountant is to ‘control’ a business.

This means operating a feedback loop like the one below

1.2 The key with the above diagram is to see that if something is not measured

then no action can be taken to correct any problems (since no-one will know

there is a problem).

1.3 For example, the above diagram illustrates an annual budget with monthly

reporting. Imagine that a department has a monthly budget and that this

month the department has overspent. There are two kinds of action that can

be taken:

● Reduce the spending next month to bring it back in line with the budget

– this is known as ‘single’ feedback.

● Adjust the budget –this is known as ‘double’ feedback.

1.4 Many past exam questions (and much of the notes up until this point) have

looked at this feedback loop. From the notes you should be able to see that

the Examiner will want you to suggest what should be measured.

1.5 A feedback loop is useful for analysing what has happened and taking action

to control events in the future (known as feedforward).


106

1.6 A Management Information System (MIS) is used to assist with the feedback

process. For example, if we are looking at monthly spending by a department

the MIS will need to:

● Collect the relevant information Make sure all spending is

recorded

● Measure performance Code spending to each

department

● Compare performance with budget Prepare variance analysis

● Allow for action Send results to department

managers.

1.7 The MIS providing these will be:

● Inward-focused (using endogenous variables)

● Regular

● Standardised

1.8 The main problem with this kind of report is that it is poor at dealing with

strategic issues.

1.9 For the management accountant to be able to provide useful information.

Contact managers of responsibility centres to see what information they need, how

and when it should be given to them.

The accountant then designs a system to collect, process, and distribute this

information.


107

WHAT IS A MANAGEMENT INFORMATION SYSTEM?

2.1 In the exam an MIS will refer to the system used to collect and provide

information to management.

2.2 As noted earlier the traditional system is inward-focused, regular and

standardised. This makes the system useful for controlling the actions of the

business but makes it poor for the strategic management accounting issues

that this course is about.

2.3 In order to carry out strategic management accounting, information will need

to be collected about the external environment (looked at in an earlier

chapter). Because of this the MIS will need to be

● Externally – focused (using exogenous variables)

● Carried out as needed

● Non-standardised

● Include non-financial performance indicators.

2.4 It is important to remember that the basic function of any MIS is the same.

This is to:

Provide information which is useful

● At an appropriate time

● In an understandable format

● so that a decision can be made.

2.5 The types of MIS you will need to be familiar with are:

● Transaction Processing Systems

● Management Information Systems

● Enterprise Resource Planning Systems

● Executive Information Systems.


108

WHAT ARE THE MODERN DEVELOPMENTS IN

MANAGEMENT ACCOUNTING?

3.1 Management accounting is changing as the needs of modern management

change. Some of the ideas in this course are relatively recent (e.g. the rise of

Non-Financial Performance Indicators).

3.2 In the past management accountants were deliberately kept separate from

the operational side of the business (so they could report on management

without being biased)

3.3 Model Burns and Scapens

There are a number of reasons why management accounting has changed:

● Information needs (on competition, customers etc.) are becoming more

important

● Change of all kinds inside organisations is regarded as helpful

● Technology has allowed more information to be processed in more complex

and flexible ways

● Responsibilities in many organisations have been pushed down to junior

managers resulting in more people having responsibilities, but each being

involved in narrower areas of the business

● The realisation that focussing solely on the bottom line (i.e. financial

accounting) is not particularly helpful.

3.4 There are four techniques specifically mentioned in the syllabus. They are

● Total Quality Management

● Kaizen

● Just In Time

● Target costing (discussed later).

3.5 Model Total Quality Management

Key elements are:

● Acceptance that customers are the most important thing

● Internal customers are just as important as external ones

● Preventing errors is better than detecting them through inspections

● Employees should be held responsible fro quality in their areas

● The only ‘acceptable’ level of quality is 100%

● All departments should aim to get things right first time

● The cost of poor quality should be measured and emphasised.


109

3.6 Model Kaizen

This is often used in conjunction with target costing. The key features are:

● The emphasis is on cost reduction (particularly of standard costs)

● Each year the standard cost of an item should be reduced

● The emphasis is on reduction not control

● Non-value adding activities should be identified and eliminated

● Waste should be eliminated

● Cycle times should be improved

● Costs are controlled by continuous improvement (not through variances)

● Employees are heavily involved in finding ways to reduce costs.

3.7 Model Just in Time

Just in time is a manufacturing technique, the key features from a management

accounting perspective are:

● Since little or no inventory is stored it makes no difference whether FIFO,

LIFO or weighted average costs are used for inventory valuation

● Marginal or absorption costing is used for inventory valuation

● Costs of production downtime (due to suppliers not delivering) will need to be

identified so they can be recharged

● Deliveries on-time will become a key performance indicator

● Features of a JIT system will usually include

o Shorter production runs

o Small batch quantities

o More products in the product range

o More time and money spent on preventative maintenance to ensure no

holdups in production.


110


Motivation and the use of control information

If managers have a poor attitude towards the information they receive then the

information may prove to be less effective than expected:

● Management accounting reports may be viewed as unimportant by the users

● Managers may feel that the reports are criticising the way they run their

departments

● Managers may not understand the information they are being provided with

● Managers may focus on what they want to see, for example if a manager

believes that good customer service is important no matter the cost, then any

adverse expenditure variances will simply be ignored (since the accountants

don’t understand the cost involved with providing the service).

The impact of the outside world on the management accounting system

● The more intense the competition, the more complex the management

accounting system will tend to be.

● The faster the environment changes the more frequently reports will be

needed.

● The larger the number of markets the organisation operates in, the more

decentralised the system will be.

● Accounting systems can be affected by customers / suppliers etc who could

insist on things being done in a particular way e.g. supplying a customer who

operates a JIT system.

The use of external data

External data has costs, benefits and limitations.

Costs include:

● Direct search costs e.g. carrying out market research

● Indirect search costs e.g. wasted time trying to find information

● Management costs e.g. processing and distributing information

● Infrastructure costs e.g. necessary computer hardware.

Benefits include:

● Better quality decisions

● Reduction in risks and uncertainty

● Improved ability to respond to changes in the outside world.


111

Limitations include:

● Accuracy

● Quality e.g. is the information complete

● Bias e.g. was the information used to show a particular point of view

● Motivation and the use of control information

Environmental management accounting

Environmental management accounting looks at the costs to the environment of

decisions.

For example, changing the material that is used to package a product might result

in cost savings for the company, but produce more waste for governments to clean

up.

The idea is to make managers aware of the environmental costs associated with

their decisions. This is becoming increasingly important due to the higher profile

that environmental issues have gained over the last few years.

Life cycle costing

Life cycle costing is a an attempt to track and predict costs over the entire life cycle

of a product.

For example in the introduction stage there may be a lot of fixed costs such as

development, these will have disappeared by the time the product is in the mature

stage.

Similarly at the mature stage economies of scale will be gained which will be lost as

the product goes into decline.

There may be costs associated with ceasing to make the product (scrapping

machinery etc) which need to be considered right from the start of the project.

Doing all the above means that a sensible decision can be made about the product’s

likely profitability over its entire life.


112

The performance prism

The performance prism aims to look at organisational performance from the point

of view of different stakeholders.

The five areas looked at are:

● Stakeholder satisfaction – what do our key stakeholders want?

● Strategies – What strategies will we follow to achieve these goals

● Processes – what processes must we be good at to deliver these strategies

● Capabilities – what will we need to be good at to carry out these processes

● Stakeholder contribution – what do we need our stakeholders to contribute in

order to deliver these capabilities (think managers and employees

particularly). Note that this could form the basis of what we measure and use

to motivate staff.


113


Model Burns and Scapens

There are a number of reasons why management accounting has changed:

● Information needs (on competition, customers etc.) are becoming more

important

● Change of all kinds inside organisations is regarded as helpful

● Technology has allowed more information to be processed in more complex

and flexible ways

● Responsibilities in many organisations have been pushed down to junior

managers resulting in more people having responsibilities, but each being

involved in narrower areas of the business

● The realisation that focussing solely on the bottom line (i.e. financial

accounting) is not particularly helpful.

Model Total Quality Management

Key elements are:

● Acceptance that customers are the most important thing

● Internal customers are just as important as external ones

● Preventing errors is better than detecting them through inspections

● Employees should be held responsible for quality in their areas

● The only ‘acceptable’ level of quality is 100%

● All departments should aim to get things right first time

● The cost of poor quality should be measured and emphasised.

Model Kaizen

The key features are:

● The emphasis is on cost reduction

● Each year the standard cost of an item should be reduced

● The emphasis is on reduction not control

● Non-value adding activities should be identified and eliminated

● Waste should be eliminated

● Cycle times should be improved.


114

Model Just in Time

The key features from a management accounting perspective are:

● Since little or no inventory is stored it makes no difference whether

● FIFO, LIFO or weighted average costs are used for inventory valuation

● Marginal or absorption costing is used for inventory valuation

● Costs of production downtime (due to suppliers not delivering) will need to be

identified so they can be recharged

● Deliveries on-time will become a key performance indicator.


Chapter 10

Strategic options

CHAPTER CONTENTS

PAST EXAM REQUIREMENTS ------------------------------------------- 116

WHAT IS GAP ANALYSIS? --------------------------------------------- 117

HOW CAN WE PREDICT BUSINESS FAILURE? ----------------------- 118

HOW CAN WE ANALYSE OUR CURRENT PRODUCT RANGE? -------- 119

WHAT IS ANSOFF’S GRID? --------------------------------------------- 121


CHAPTER 10 – STRATEGIC OPTIONS

116


Dec 2010

Q5 (a) Discuss the strengths and weaknesses of quantitative and

qualitative models for predicting corporate failure. (6 marks)

(b) Comment on the results in the junior analyst’s spreadsheet.

(5 marks)

(c) Identify the qualitative problems that are apparent in the

company’s structure and performance and explain why these are

relevant to possible failure. (5 marks)

(d) Critically assess the results of your analysis in parts (b) and (c)

alongside details of RMB’s recent financial performance and

suggest additional data that should be acquired and how it could

be used to assess RMB’s financial health. (4 marks)

December 2008

Q3 (a) Using the above information, explain the term ‘ planning gap’

and discuss other suitable alternative strategies to closing the

planning gap, which the directors of TMC might have considered

prior to giving consideration to the purchase of CBC. (5 marks)

(b) Analyse THREE potential problems, based solely on the

information provided above, that TMC might encounter in the

acquisition of CBC. (5 marks)


(a) Calculate the ‘profit gap’ that is forecast to exist at 30 November

20X9. (10 marks)

(b) (i) Explain how the use of Ansoff’s product-market matrix might

assist the management of Vision to reduce the profit-gap that is

forecast to exist at 30 November 20X9. (3 marks)

(ii) Explain how the existing product range and the actions of per

Note 3 would feature in Ansoff’s product – market matrix.

(7 marks)


(c) (i) Using ONLY the above information, assess the competitive

position of Diverse Holdings plc. (7 marks)

(ii) Explain THREE strategies which might be adopted in order to

improve the future prospects of Diverse Holdings plc. (6 marks)


117

WHAT IS GAP ANALYSIS?

1.1 Earlier in the course we looked at the idea that an organisation has to meet

the needs of its stakeholders. For the purposes of the P5 exam we are mainly

looking at shareholders. Their needs will be met by increasing profits.

1.2 Model – Gap analysis

Gap analysis looks at:

● What will happen if we carry on as we are in the future and:

● What the shareholders will expect in the future.

There will usually be a gap between these two. Much of P3 and P5 is looking at

how to close this gap.


118

HOW CAN WE PREDICT BUSINESS FAILURE?

2.1 Perhaps the most important thimg in any busimess is to make sure it does not

fail.

Model – Argenti’s A score

Early indicators

● Autocratic Chief Executive (particularly if also Chairman)

● Passive board

● Lack of strong FD

● Poor management team

● No budget control

● No cashflow forecasts

● No costing system

● Poor response to change

Subsequent mistake

● High gearing

● Overtrading

● Failure of a big project

Immediate indicators

● Financial indicators forecasting poor results

● Creative Accounting

● Non-financial signs (e.g. high staff turnover)

Argenti’s model assigns a score to each of the above (the bigger the number, the

more severe the likelihood of failure. The difficulty with this is that it makes the

calculation subjective.


119

HOW CAN WE ANALYSE OUR CURRENT PRODUCT

RANGE?

Model – The BCG matrix

3.1 The BCG matrix attempts to analyse the products that a company currently

offers. The matrix can then be used to suggest what to do with each product.

The model looks at two measurements – market share and market growth

and divides products into four categories. Because the model uses market

growth it can be combined with the life cycle models seen earlier. The

categories are:

● Cash cows Low market growth High market share

● Stars High market growth High market share

● Question marks High market growth Low market share

● Dogs Low market growth Low market share.

In the exam you may have to calculate the market share of a product. If the

information is available it would also be useful to calculate profit margins for

each product.

3.2 High or low market share is calculated by taking OUR market share and

comparing it to the market leader. The closer this is to 1.0 the higher the

market share (a score of 1.0 would mean that WE were the market leader).

3.3 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).

3.4 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.

3.5 Question marks 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.


120

3.6 Dogs have low market share and low growth. They should be closed unless

needed by one of the other products.

3.7 The company should aim to have a balanced portfolio, with cash cows funding

the growth of stars and question marks.

3.8 The BCG model (and the life-cycle model) can also be used to look at the

industries a company operates in. Again, the company should aim to have a

balanced portfolio.


121

WHAT IS ANSOFF’S GRID?

4.1 There are a number of ways in which profits could be increased. These

include:

● Improved cost control (most of F5 is concerned with this)

● Increased divisional performance (much of P5 is concerned with this)

● Doing something different.

4.2 Model – Ansoff’s grid

Igor Ansoff comes up with four possibilities to do something different:

● Market penetration – existing products and existing markets

This might include advertising, driving out competition or getting customers to

buy more products.

● Market development – existing products and a new market

This might include new distribution channels or price discrimination.

● Product development – new products and an existing market

This will probably involve looking at the profits of a new product versus an

existing one.

● Diversification – new products to a new market.

4.3 When anything new is considered it is important to look at the relevant costs.


122


Model – Argenti’s A score

Early indicators

● Autocratic Chief Executive (particularly if also Chairman)

● Passive board

● Lack of strong FD

● Poor management team

● No budget control

● No cashflow forecasts

● No costing system

● Poor response to change

Subsequent mistake

● High gearing

● Overtrading

● Failure of a big project

Immediate indicators

● Financial indicators forecasting poor results

● Creative Accounting

● Non-financial signs (e.g. high staff turnover)

Model – The BCG matrix

● Cash cows Low market growth High market share

● Stars High market growth High market share

● Question marks High market growth Low market share

● Dogs Low market growth Low market share

Ansoff’s grid

● Market penetration – existing products and existing markets

● Market development – existing products and a new market

● Product development – new products and an existing market

● Diversification – new products to a new market.


Appendix – answers to questions & examples

CONTENTS

CHAPTER 1 ANSWERS 124




APPENDIX – ANSWERS TO QUESTIONS AND EXAMPLES

124

CHAPTER 1 ANSWERS

Example 1

This is a good example of where simply reading and then answering the

requirements gives a basis for a good answer.

Remember that all the figures given are FORECASTS, none of them have yet

happened.

(a) There are four targets mentioned so simply look at each one

Target 1 – Sales should grow each quarter and annual sales should be

over budget

Sales dip in Q2 before recovering strongly

Overall sales are forecast to exceed budget

Target 2 – Trainer costs less than $180 per day

In each Q costs are forecast to be $200

Target 3 – Room hire less than $90 per day

In each Q costs are forecast to be $100

Target 4 – meeting budgeted profit each quarter and over the year

Forecast is to miss budgeted profit in Q1 and Q2 before recovering strongly to

exceed annual budget.

Why has the Examiner made the manager fail the two cost targets?

● Because he tells you the manager believes in quality and is therefore

spending extra

Why has the Examiner made the manager fail the sales growth and profit target in

Q2

● Because this is when the promotion is due to take place. Whatever

happens in Q3 and Q4 will not help the manager


125

(b) Revise forecasts

Q1 $ Q2 $ Q3 $ Q4 $ Total $

Voucher

scheme sales (W1)

2,500 2,500 2,500 2,500 10,000

Software

upgrade sales (W4)

10,000 12,000 22,000

Extra

trainers (W5)

(2,000) (2,400) (4,400)

Extra room

hire (W6)

(1,000) (1,200) (2,200)

Extra staff training

(W3)

(500) (500) (1,000)

Extra software

(W2)

(1,800) (1,800)

Net change in profit

200 2,000 9,500 10,900 22,600

Workings

Voucher scheme

W1) This produces 80 x $125 = $10,000 i.e. $2,500 per quarter

Uses existing courses so no impact on costs

Software upgrade

W2) Demo program needs to be bought in Q1

W3) Extra staff training needed in Q1 and Q2

W4) Extra sales will be 20% of existing sales in Q3 and Q4

Q1 No change

Q2 No change

Q3 Additional 20% x $50,000 = $10,000

Q4 Additional 20% x $60,000 = $12,000

W5) Extra trainer costs (since manager wants to maintain standards assume

that 20% extra sales means 20% extra variable costs)

Q3 20% x $10,000 = $2,000

Q4 20% x 12,000 = $2,400

W6) As for W5

Q3 20% x $5,000 = $1,000

Q4 20% x $6,000 = $1,200

Delaying payments to trainers

This is a cashflow issue – not one of profit so it is irrelevant here


126

(c) Comment on whether the above ideas are good and will increase the chances

of promotion

Voucher scheme

Obviously good as long as existing customers (who have paid full price) do

not object)

Software upgrade

Initially this looks good, it brings in a profit of

$22,000 - $4,400 - $2,200 - $1,000 - $1,800 = $12,600

But, look at the timing – the costs go out in Q1 and Q2 – the profits arrive

in Q3 and Q4 (after the promotion has been made). This actually makes the

promotion prospects worse.

Delaying payments

Since the manager believes in quality, this is probably a very bad idea

(d) Since Examiner has talked about quality and performance is judged each

quarter – safe thing to go for in the exam is;

● Include non-financial measures

● Look at longer time periods


127

CHAPTER 2 ANSWERS

Example 1

Operational matters focus on looking at past internal information

● For example performing variance analysis.

The problem for this company is that however efficient they are, they are going out

of business since they will be left with no customers within the industry.

The company should look at possible alternative markets. For example

● Can they manufacture components for other industries (e.g. car /plane

manufacture)?

● Can they manufacture components for ship manufacturers in other countries?

● Can they manufacture something entirely different?

When looking at the above options the company will need to look at things like:

● Prices charged by rivals

● Prices that customers are willing to pay

● Barriers to entry

The three above are eternal and forward facing (i.e. strategic management

accounting).


128

CHAPTER 3 ANSWERS

Example 1

Division X

Division Y

Forecast 20X7

Actual 20X6 Forecast 20X7

Actual 20X6

120 / 1000 110 / 800 4000 / 20000

2880 / 18000

=12% =13.75% =20% =16%

Example 2

Division X

Division Y

Project Forecast

plus project

Project Forecast plus

project 13 / 100 133 / 1100 360 /

2000 4360/

22000 =13% =12.1% =18% =19.8%

The manager of Division X will undertake their project (since it raises ROI for the

division from 12% to 12.1%).

Unfortunately the project fails to meet the 15% required by the company (i.e. a

dysfunctional decision).

The manager of Division Y will NOT undertake their project (since it lowers ROI for

the division from 20% to 19.8%).

Unfortunately the project does meet the 15% required by the company (i.e. a

dysfunctional decision).

Example 3

Division X Original

forecast Project on

its own Forecast plus

project

Profit 120 13 133 Imputed interest

15% x 1000

(150) 15% x

100

(15) 15% x 1100

(165)

RI (30) (2) (32)

Now the manger will reject the project since it lowers the RI (this is now in line

with the company who will also want to reject the project).


129

Division Y

Original forecast

Project on its own

Forecast plus project

Profit 4000 360 4360 Imputed

interest

15% x

20000

(3000) 15%

x 2000

(300) 15% x

22000

(3300)

RI 1000 60 1060

Now the manger will accept the project since it raises the RI (this is now in line

with the company who will also want to accept the project)

Example 4

(a)

Division manager

Easterpark Yr 1 Yr 2 Yr 3 Yr 4 Yr 5

NBV 6,000,000 4,800,000 3,600,000 2,400,000 1,200,000

Contribution 1,672,000 1,672,000 1,672,000 1,672,000 1,672,000

Depn 1,200,000 1,200,000 1,200,000 1,200,000 1,200,000

Profit 472,000 472,000 472,000 472,000 472,000

Imputed 600,000 480,000 360,000 240,000 120,000

RI -128,000 -8,000 112,000 232,000 352,000

ROI 7.9% 9.8% 13.1% 19.7% 39.3%

So manager will reject project since poor in Yrs 1 and 2

Company Yr 0 Yr 1 Yr 2 Yr 3 Yr 4 Yr 5

-6000000 1,672,000 1,672,000 1,672,000 1,672,000 1,672,000

DF 1 0.909091 0.826446 0.751315 0.683013 0.620921

-6,000,000 1,520,000 1,381,818 1,256,198 1,141,998 1,038,180

338,195.5

NPV =338,195.5 so company wants to accept project


130

(b) (i) First calculate annual repayment

= 6,000,000 / 3.790787 (=sum of discount factors) = 1,582,785

Annual repayment 1,582,785

NBV Interest Repay Capital repaid

Yr1 6,000,000 600,000 1,582,785 982,785

Yr2 5,017,215 501,722 1,582,785 1,081,063

Yr3 3,936,152 393,615 1,582,785 1,189,170

Yr4 2,746,982 274,698 1,582,785 1,308,087

Yr5 1,438,895 143,890 1,582,785 1,438,895

(b) (ii)

Easterpark Yr 1 Yr 2 Yr 3 Yr 4 Yr 5

NBV 6,000,000 5,017,215 3,936,152 2,746,982 1,438,895

Contribution 1,672,000 1,672,000 1,672,000 1,672,000 1,672,000

Depn 982,785 1,081,063 1,189,170 1,308,087 1,438,895

Profit 689,215 590,937 482,830 363,913 233,105

Imputed 600,000 501,722 393,615 274,698 143,890

RI 89,215 89,215 89,215 89,215 89,215

ROI 11.5% 11.8% 12.3% 13.2% 16.2%

So accept


131

CHAPTER 6 ANSWERS

Example 1

Cumulative Units Cumulative

Average Time

Cumulative

Total Time

Incremental Time

10 19.062 (w1) 190.616 190.616 Customer A

60 10.707 (w2) 642.428 451.812 Customer B

150 7.972 (w3) 1195.825 553.397 Customer C

149 7.989 (w4) 1190.413 5.412

160 = 10 after

steady state

5.412 54.12 54.12 also Customer C

giving 607.517 in total

180 = 30 after

steady state

5.412 162.36 162.36 Customer D

(w1) Customer A wants first 10 units

y = 40 x 10-0.3219 = 40 x 0.477 = 19.062

(w2) Customer B wants next 50 items (so 10+50 = 60 made altogether

y = 40 x 60-0.3219 = = 40 x 0.268 = 10.707

(w3) Customer C wants 100 items (so 60 + 100 = 160 made altogether)

Since this crosses the steady state calculate in two pieces – up to the steady state

and after it

Steady state arises at 150 units so usual calculation up to that point

y = 40 x 150 – 0.3219 = 40 x 0.199 = 7.972

(w4) All remaining units are at same length of time as the 150th one. To calculate

how long the 150th one took on its own we will need to look at the total time for the

first 149 and compare it with the total for the first 150.

y = 40 x 149 – 0.3219 = 40 x 0.200 = 7.989

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