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1 | P a g e © Mahmood Reza on behalf of Knowledge Grab

ACCA P5 TUITION & EXAM SUPPORT NOTES

Mahmood RezaFRSA, MCMI, ATT, FCCA, DMS, PGCE, BSc (Hons)

www.knowledgegrab.com www.facebook.com/KnowledgeGrab

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ACCA P5 EXAM SUPPORT NOTES: CONTENTS PAGEPage Number

Introduction 3

ACCA P5 exam pass rates 4

Examiners guidance, approach, syllabus change& exam 4

Exam structure 4

Strategic planning and control 5

Purpose of strategy and types 5

Overview of planning 8

Mission 11

Aims and Objectives 12

SWOT 14

Product portfolios 14

BCG Matrix 15

Ansoff Matrix 16

Stakeholder analysis 17

Benchmarking 18

Government intervention and regulation 19Risk and uncertainty 21

PESTLE 21

Porter: industry analysis - the five forces 22

Budgeting 27 ABC, ABB, 32

BPR 34

Responsibility Accounting Systems 32

Human resource management 33o Vrooms Expectancy Theory

o Agency theory

Financial performance indicators 35o Net present value 38o Internal rate of return 38o EPS 39

Divisionalisation and transfer pricing 44

Performance measures

o Return on investment (ROI) 45


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o Residual income 46o Economic value added 49

Activity one: risk 32

Pricing 21

Corporate Failure 52

Establishing a performance Management System 55

Criteria for designing performance indicators 57

Types of performance measures 58

Performance models 60

Performance Pyramid, Lynch and Cross (1991) 60

Balanced scorecard

62

Table of potential scorecard measures 64

Performance Prism 65

Fitzgerald & Moon Building Block 66

Target costing 70

Total Quality Management (TQM) 72

Activity three: performance measures 39

Performance management & evaluation 42

LIST OF RELEVANT ACCA ARTICLES 74 · Activity one: solution 75· Activity two: solution 76· Activity three: solution 78


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INTRODUCTIONThese ACCA P5 exam support notes are based on my experience, not only in respect ofteaching ACCA P5 since its introduction, but over 30 years of teaching business andmanagement. These notes are not meant to be a comprehensive overview of the syllabus butfocus on selected parts

The notes are provided to supplement existing texts and focus on areas that, in my experience,students find more challenging. Any feedback regarding the notes (positive or negative) wouldbe greatly welcomed.

ACCA P5, in common with the other option papers does not enjoy significantly high pass rates.However, people do pass the exam; a structured and focused approach to studying is highlyrecommended, as well reading around the subject.

It is worth remembering that are an abundant level of support resources available to assistyou in passing your exams. However, unless you have a photographic memory you will needto apply conventional techniques to passing your exams, e.g. question practice, questionpractice, question practice you get the picture.

These notes are to aid and assist your study programme and to reflect student requirements,any suggestions for future improvements are greatly welcomed.

The strategic planning process was examined in detail in the P3 paper. InP5 the focus is moreon the performance management aspects of strategic planning and the role of strategicmanagement accounting.


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EXAMINER'S GUIDANCE AND REPORTSThere was a change of examiner for the exam diet in December 2010; the examiner haswritten a number of articles in Student Accountant explaining his approach, and with the slightchange in exam format for the June 2013 exam an updated article was published.

This article is available, with many other useful resources on the ACCA website, link beinghttp://www.accaglobal.com/gb/en/student/acca-qual-student-journey/qual-resource/acca-qualification.html

The examiner felt that it would be helpful to try to give candidates a consolidated article on hisapproach to the exam, the style of questions and the skills that will be tested in PaperP5, Advanced Performance Management . The new exam format was illustrated with a newPilot Paper to give students a feel for what to expect. Older questions are still relevant as thesyllabus topics are not altering materially.

The article considered the syllabus and overall aims of the paper, how it relates to previouspapers and the format of the exam. It then summarised his advice about his approach to thepaper using suitable example questions from recent exams to illustrate points.

The current ACCA Qualification syllabus was first examined in December 2007; a review ofthe pass rates since the new examiner is shown below.

Dec 10 Jun 11 Dec 11 Jun 12 Dec 12 Jun 13 Dec 13 Jun 14 Dec 14 35 35 29 35 33 31 30 29 ?

The ACCA Professional syllabuses were updated with effect from June 2011, these notes arebased on that syllabus and study guide for the June 2011 exam diet.

STRUCTURE OF THE EXAM PAPERThe exam comprises two sections. Section A includes one compulsory question worth 50marks in total. As Section A is compulsory, candidates must not only attempt it in the exam,but must also allocate an appropriate amount of time.

Section B contains three optional questions worth 25 marks each; candidates are required toanswer two of these questions.

EXAMINERS COMMENTSThis provides a useful insight into the general problems that students encounter and extractshave been reproduced below. The original reports are freely available on ACCAs website.


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Strategy An effective competitive strategy takes offensive or defensive action in order to create adefendable position against the myriad of forces. There are a number of possible approaches:

· Positioning the firm so that its capabilities provide the best defence against the existingarray of competitive forces.

· Influencing the balance of forces through strategic moves so as to improve the firm srelative position

· If factors underlying the forces are going to change, selecting a strategy appropriate tothe new circumstances before rivals recognise the situation.

Generic Competitive Strategies Porter identified three generic competitive strategies:

1. Overall Cost leadership

2. Differentiation

3. Focus

Cost Leader

You must be the cost leader. Being a cost leader is not enough.

You must achieve proximity in the bases of differentiation.

Differentiation

To be unique along some dimensions that are widely valued by buyers.

Price premium > Costs of differentiation

There can be more than one successful differentiation strategy in an industry

Focus

There must be a difference between the focus target market segment and the market.

The segment must be structurally attractive.

Three main strategies

i. Focus on short runs by investing in technology or methods that givecheaper or quicker turnaround.

ii. Cost focus because the broadly targeted differentiator may be over-performing I.e. costs are too high.

iii. Differentiate focus because the broadly targeted competitors may notbe meeting the needs of the segment.

Generic Strategy & Value DriversThe value drivers of shareholder value consist of six drivers. They are:

1. Sales Growth

2. Pretax profit margin

3. Tax rate

4. Incremental investment in working capital

5. Incremental investment in fixed assets


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6. The firm s cost of capital

The three related to operations and their implementations in the business are as follows:The two drivers not, in the first place, related to operations are:

Making Choices· Having chosen a generic strategy it is vital to stick to it:· Failing to choose between generic strategies - getting stuck in the middle.· Cost reduction is not the same as cost advantage. Following a differentiation strategy

does not mean maintaining non-value-added costs.

Being both the cost leader and following a differentiation is possible if:

i. Competition is stuck in the middle.ii. The firm has pioneered an important innovation

iii. Cost leadership is heavily affected by market share.

Competitive Advantage A competitive advantage is the ability of an organisation to be better at some action, or havesome asset, necessary for being more successful than the other participants in a market place.

· Low unit cost.· Branded products.·

Scale of Investment· Technology· Patents· Economies of scale.· Licence protection· Great knowledge, experience and competence.· Legal constraints.

Value Driver Cost Leadership Strategy Differentiation Strategy

Sales Growth Competitive pricingExpand market share

Premium pricingSegment markets and growshare

Operating Profit Margin Achieve cost of scale for allactivities

Improve rate of learning

JIT supply chain

Cut non-value adding costs

Activities chosen to createmost cost-effectivedifferentiation

Eliminate costs that do notcontribute to customer needs

Working Capital investment Minimise cash balance

Minimise A/R

Minimise inventory

Minimise cash balances

Link working capital policiesto differentiation


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· A strategic asset such as the ownership of a majority of the landing rights at a major hubairport.

· Rates of innovation greater than the competition.

Having one or other of these attributes does not turn it into a competitive advantage unless itis used to create better value for the customer than the competition can produce.

Moreover these advantages have a habit of disappearing unless they are tended. Patentshave a fixed life and unless money is allocated to R & D to create new ones the advantagewill disappear. Low cost products may be superseded by technology and so on. For thisreason the strategic information provided must be forward looking rather than back wardlooking.

Competitive advantage then results from how successfully the firm implements its chosengeneric strategy and how, as a result, it creates value for its buyers. Value is what buyers arewilling to pay and superior value stems from offering lower prices than competitors forequivalent benefits or for offering unique benefits that more than offset the higher price.

The fundamental basis of above-average performance in the long-run is sustainablecompetitive advantage.

Anthony Levels of Control & Hierarchy

Overview of planningPlanning is to a large extent a continual activity; it should not be confused with the enddocument(s) produced such as a strategic or business plan, budget or cash flow, thesedocuments are merely capturing in words and numbers the results of some clear thinking andlikely outcomes of an organisations business journey.

One of the primary purposes of planning is to demonstrate that we have considered and havetried to understand the risks involved in our organisational journey, and that we haveconsidered how we may deal with those risks all with the primary objective of realising andultimately achieving our aspirations.


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Planning has to be based on solid foundations, solidity starts with our mission statement,which helps our raison d être, our calling card to the outside world. The mission statementtells the world what are our aspirations are, how we hope to achieve them, and who will bebenefit from this. A mission statement is not a bland promotional tool; it needs to be simple,concise and memorable. Shared mission, value & vision are the bedrock of arts organisations,work/business cultures create the environment in which behaviour dysfunctional orotherwise is created. Organisations are just another example of the family that we see &experience in our personal lives

Mission statements help generate critical success factors (CSFs), CSFs are the cause of oursuccess, those areas in which we need to perform best if we are to achieve overall successand ultimately achieve our objectives. For example, CSFs for a theatre company wouldtypically be audience numbers, audience satisfaction, effective marketing to attract audiencesand cost control. CSFs help us generate measures to monitor and manage the achievementof those CSFs; these measures are also referred to as Key Performance Indicators(KPIs). KPIs should normally be a blend of numbers (quantitative) and non-numbers(qualitative). Targets can be set for these KPIs, and progress measured against these targets,any variations against these targets prompts investigation and ultimately action taken to rectifythe situation.

There is a general rule of management that you cannot manage what you cannot measure;we need clues/milestones to identify if we are progressing on our journey. Take the exampleof an individual who decides that their aspiration (mission) is to lead a healthier life style; oneidentified objective is to reduce their blood pressure to a certain level; a CSF is change of diet;a KPI to monitor this is blood pressure. If we measure blood pressure against a pre-set targetand required blood pressure is not achieved then we can have a closer look at (say) life styleand then hopefully put this right.

In the example of the retailer quoted above, appropriate KPIs may be levels of occupancy,ticket sales, customer feedback, repeat visits and spend against budget.

Within the planning process we need to consider the resources, both physical (tangible) andnon-physical (intangible). The ability of any business to perform effectively is determined bythe adequacy and suitability of those resources, whether those resources are physical,intangible, financial or intellectual. A resource analysis needs to consider how resources aremanaged, deployed and used. For example, the impact of an organisation having a goodreputation is minimised if it lacks the skills and expertise to exploit them effectively.

The primary aim of the SWOT analysis is to identify the extent to which the current strengthsand weaknesses are relevant to and capable of dealing with the changes taking place in thebusiness environment. If the strategic capability of an organisation is to be understood theSWOT analysis is only considered useful if it is comparative, and not absolute to itscompetitors or other organisations, i.e. examining strengths, weaknesses, opportunities and

threats relative to competitors.

The expressions Vision and Mission are used to describe aspects of organisational purpose.They serve to explain the concept of organisational purpose in order that managers may betterunderstand and be able to apply it.

MISSION A mission statement is a statement of the overriding direction and purpose of an organisation.It is the foundation for any strategic plan and expresses its reason for being . A missionstatement is the foundation for the entire strategic planning process. It sets the standard to


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which the organisation aspires, now and in the future, and forces the Board members and staffto align themselves around a specific agenda.

VISION A statement of what the organisation will be , or be perceived to be. It often includes referencesto products and services, customers, markets, employees, new technology and socialresponsibility.

The term vision statement is used by some organisations instead as mission statement, visionand/or value statements may also be developed alongside the mission statement.

AIMSThese normally flow from the mission statement and are subsequently used to developsuitable organisational objectives. Organisational and strategic aims represent the linkbetween mission and objectives and act as a statement of intention. They tend to be positivein nature and unquantifiable, unlike objectives.

OBJECTIVESObjectives are statements of specific outcomes that are to be achieved, from the strategic to

operational levels. Objectives are developed and extended from an organisations missionstatement and goals; they can be stated in financial and non-financial terms. Conventionalwisdom is that unless objectives are SMART (Specific Measurable Attainable Relevant TimeBound) then they are not helpful, however, some organisational objectives are important butdifficult to quantify or convert into measurable terms, such as to be the leader in ones field.Milestones and indicators of achievements are essential to monitor progress of all objectives.

Rewards What we can expect as a result of our efforts. Rewards can be either financial or non-financial.In most instances a mix of both and non-financial rewards will be expected.

ValuesThose things that we believe to be important, and if they were not met, or respected, would

cause us to be unhappy.

The Strategic Triangle


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Mission statement

A mission statement is a statement of the overriding direction and purpose of an organisation.It is the foundation for any strategic plan and expresses its reason for being . A missionstatement is the foundation for the entire strategic planning process. It sets the standard towhich the organisation aspires, now and in the future, and forces the Board members and staffto align them around a specific agenda.

The term vision statements are used by some organisations instead as mission statements,vision and/or value statements may also be developed alongside the mission statement.

AimsThese normally flow from the mission statement and are subsequently used to developsuitable organisational objectives. Organisational and strategic aims represent the linkbetween mission and objectives and act as a statement of intention. They tend to be positivein nature and unquantifiable, unlike objectives.

Objectives

Objectives underpin all planning and strategic activities, and serve as the basis forcreating business policy and performance evaluation.

Organisations have objectives for the following reasons:

1. Objectives provide a direction for members of the organisation. Employees should knowwhat their organisation is aiming for so that their efforts can be in line with it.

2. Objectives provide a standard for performance. People know what is expected of themand what standards they need to achieve in their own work.

3. Objectives provide a basis for planning and control for managers. Managers cannot makeany plans without objectives. If the organisation is not going anywhere in particular then thereis no need to control the activities of the employees. The organisation will become more of acommunity and drop-in centre than a company which provides a product or services.

4. Objectives reduce uncertainty in decision making. It is very difficult for managers to takedecisions if they are not sure where the organisation is heading. If they understand that costsare to be kept low as part of a short term goal, this will help them to decide on such mattersas how to respond to a supplier increasing their prices.

5. Objectives help to develop commitment among employees to the activities of theorganisation. Employees often do not fully understand what is happening in their organisationor why it is happening. Making the organisation objectives clear to all employees helps themfeel part of the organisation.

6. Objectives provide a basis from which to monitor achievements. When an organisationhas objectives, the members of the organisation have a direction to head for and they canmeasure whether they have arrived, or how far yet they have to go.


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SMART objectives

Many writers have argued that objectives are not worthwhile unless they are capable of beingmeasured and achieved. This is the thinking behind the development of the SMART acronymwhich argues that an objective is only genuine if i t is Specific, Measurable, Attainable, Realistic

and Time-bounded.

To enable an organisation to fulfil its mission, the mission must be translated into long-term,medium-term and detailed short-term objectives. Ultimately each individual or departmentneeds to know what is expected of him or it in the coming days and weeks ahead. Suchmedium- and shorter-term targets need to be smart .

Groups and teams within organisations should have clearly defined and well communicatedobjectives. Plans should be developed for the achievement of the objectives and the workshould be monitored to ascertain how far the objectives have been achieved. When changesneed to be made, all the team should be informed of the reasons and the nature of the change.

The objectives of every group or team in the organisation should be very clearly linked to theorganisation's mission. Once long and short term objectives have been decided upon, planswill be drawn up for achieving them. These plans will include all functions or departments inthe organisation and the groups within them. For example:

Short term organisational goal – to increase attendance by 5 per cent in 2014· Marketing team's goal – to devise advertisements and sales promotions for each

production to create greater awareness· Production team's goal – to show 3 new productions each year


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Other departments and teams will follow similar patterns of activity to enable them to meet theshort term goal. If one department or group does not pursue their goal, the organisational goalwill fail. The production department may not wish to work more hours which will be needed ifthe new shows are to be successful, all the sales promotions and advertising campaigns willhave been a waste of money and effort.

Resource analysis

Strategic capability is the ability, or otherwise, of the organisation to pursue its chosenstrategy. The are a range of models and techniques used, all of which involve an examinationof the resources and internal features of the organisation.

The first technique used is a Resource Audit. It involves analysing the resources of theorganisation in the following categories:

• Physical Assets - buildings, plant and equipment, vehicles

• Financial Resources - funds available to the organisation

• Human Resources - number of staff available

• Intangibles - skills, know-how, relationships, reputation

Value Chain analysis

The next stage is to examine how effectively these resources are being used. This involvesusing another analytical model developed by Porter, the Value Chain. The Value Chainidentifies how the activities of the organisation are co-ordinated to support i ts chosen basis forcompetitive advantage. Value Chain Analysis consists of breaking the activities oforganisation down into the following categories:

Value Chain Analysis also forms the basis for identifying Core Competences. From theactivities identified above, management can determine what the organisation does better thanother organisations.

The issues raised by these analyses are carried forward to the SWOT analysis.


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SWOTThis is a strategic planning tool which summarises the key issues from the businessenvironment and the strategic capability of an organisation most likely to impact on strategydevelopment. This can be used as a basis against which to generate strategic options andassess future courses of action.

· STRENGTHS : What we are good at· WEAKNESSES : What we are not so good at· OPPORTUNITIES : Favourable events trends· THREATS : Unfavourable events trends

The primary aim is to identify the extent to which the current strengths and weaknesses arerelevant to and capable of dealing with the changes taking place in the businessenvironment. If the strategic capability of an organisation is to be understood the SWOTanalysis is only considered useful if it is comparative, and not absolute to its competitors orother organisations, i.e. examining strengths, weaknesses, opportunities and threats relativeto competitors.

A SWOT analysis should help focus discussion on future choices and the extent to which an

organisation is capable of supporting these strategies. An effective SWOT should be limitedto four to five factors, focus on major and not marginal areas, be open and honest and have apriority and emphasis

RATIONALE AND APPLICATION:This is a strategic planning tool which summarises the key issues from the businessenvironment and the strategic capability of an organisation most likely to impact on strategydevelopment. This can be used as a basis against which to generate strategic options andassess future courses of action.

The primary aim is to identify the extent to which the current strengths and weaknesses arerelevant to and capable of dealing with the changes taking place in the business environment.If the strategic capability of an organisation is to be understood the SWOT analysis is only

considered useful if it is comparative, and not absolute to its competitors or otherorganisations, i.e. examining strengths, weaknesses, opportunities and threats relative tocompetitors.

A SWOT analysis should help focus discussion on future choices and the extent to which anorganisation is capable of supporting these strategies.

LIMITATIONS AND ERRORS OF APPLICATION· Beginning SWOT without defining a desired objective· Generating long lists of factors rather than considering what is necessary in achieving· Objectives· Confusing opportunities (external) with strengths (internal)· Confusing SWOT with potential strategies. SWOT describes conditions, strategies· define actions· Lack of prioritisation, focus and critical appraisal· Generalisation

EXAMPLESStrengths and weaknesses

· Resources: Physical and intangible· Customer care· Staff


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· Quality· Brand strength· Range of cultural excellence music, theatre, heritage, crafts, etc· Good facilities

Opportunities and threats·

Funding opportunities for participatory arts from Arts Council, Heritage Council· Market trends· Reputation declining· Promote, export and import excellence in culture· Celebration of minority cultures (travellers, asylum seekers, etc)· No National Cultural Strategy or Task Force· Local government and the public sector may not take up the new opportunities to· promote/advance culture in the county· Decline in volunteers· Focus of funding will remain on bricks and mortar rather than on the use of facilities· Lifestyle changes· Technology· Duplication of provision and competitor actions

PRODUCT PORTFOLIOSBecause of the inevitability of the eventual decline of all products and services, businessesseek to reduce their exposure to the risk of a product decline by maintaining a portfolio ofproducts.

A balanced portfolio will contain products at various stages of the product life cycle.Conglomerates will seek to minimise the risks found in individual industries by holdinginvestments in a range of industries.

There are various tools and techniques for analysing a product or Business Unit investment,portfolio. The most widely used of these is the Boston Consulting Group Matrix, often referredto either as the Boston Box or the BCG Matrix. This framework allows the product portfolio to

be identified in terms of market share and market growth. Products/ services are placed inthe matrix and identified as question marks, stars, cash cows and dogs.


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BCG MATRIX

ANSOFF PRODUCT MATRIX Apart from competitive advantage and entry barriers the company strategy will also include itsdecisions on which products to sell in which markets- the so-called product/market decision.This decision is often illustrated by the Ansoff matrix, called after Igor Ansoff who originated itin the 1960s. The matrix plots markets against products giving in each cell the type of strategicdecision.

A market penetration strategy is one where the company strategy is to increase its marketshare in an existing market with current products. This is particularly successful at developingsuper-profits when the market is growing strongly. The key strategic information required isthat on the market, its volumes and prices, by customer segment.

A market development strategy is one where the company seeks to increase its profitabilityby selling its existing products to new customers (markets) it has never sold in before. This ismost successful when it is based on the most profitable existing products. The strategicinformation required here is the direct profit contribution by unit and an investment strategybased on incremental/opportunity costing based on future outcomes.

A product development strategy is based on selling new products to existing customers.Clearly the strategy is most successful when the customers who are approached are those

Existing Markets New Markets

Existing Products

New Products

MarketPenetration

Exisitingcustomer strategy

Existing productled strategy

Diversification

Market Growth

High

Low

Stars QuestionMarks

Cash Cows Dogs

High Low

Market Share (Relative to biggest competitor)


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that are the most profitable to the firm. This will require a soundly based customer profitabilityinformation system.

The diversification strategy requires the company to sell new products to new customers. Herethe management accounting system must be able to clearly identify the competitive advantageby which the company is going to create its super-profit. Sadly the evidence is that this is notonly the most risky strategy but also one which is frequently fails.

STAKEHOLDER ANALYSISStakeholders are normally seen as individuals or groups that are affected by organisationsactivities, these consisting of providers of finance, managers, employees, competitors,government, clients and suppliers.

It is important to conduct a Stakeholder Analysis, as the most powerful stakeholders are theones who ultimately determine the purpose and direction of the organisation. It may be easyto assume that the owners of an organisation as the most powerful stakeholders, however,this is often not the case and so the leader in an organisation should have a clear view ofwhere the most powerful influences are likely to come from.

Stakeholder Analysis is a process that involves the following stages:

· Identify - who are the stakeholders?· Assess and rank - which stakeholders have the most power or influence over the

organisation?· Decide criteria - what are the stakeholders expectations?· Decide actions - are we meeting the stakeholders expectations? If not, what should

we do?· Assess performance - are our actions on generating the appropriate outcomes, or

should we change?

There is often a conflict between differing stakeholder requirements and aspirations; part ofthe planning process involves the consideration of stakeholder requirements, power, influence

and ambition. One way to help manage stakeholders is by the use of Mendelow s Matrix.

Stakeholder power Low A B

High C D

A. Minimal effort;

B. Keep informed;

C. Keep satisfied;

D. Key players.

Low High

Probability of exercisingpower/level of interest

Mapping of stakeholders emphasisesHow each stakeholder group wishes to 'force' their expectations on the organisations goals

and selection of strategiesWhether stakeholders have the power and influence to do so


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LIMITATIONS AND ERRORS OF APPLICATIONUnderestimating the level of interest of a stakeholder group, who may frustrate the strategySelecting strategies skewed to one stakeholder groupGeneric description of stakeholder groupsThe concept of power being misunderstood: power is where stakeholder expectations

dominate and/or compromise strategic developmentIdeally, a Stakeholder Analysis should be performed regularly or even continuously, since

the relevant stakeholders, their power and relationships may quickly changeThe lack of constructive co operation and dialogue with stakeholder

BENCHMARKINGBenchmarking is the practice of measuring an organisations products or services against bestpractice ; the primary objective is to improve processes or activities. Through benchmarking,organisations learn about their own practices and procedures, and the best practices of others.Benchmarking enables them to identify where they fall short of current best practice anddetermine action programmes to help then match and surpass it.

Benchmarking originated in the USA in the 1970s, pioneered by Rank Xerox and wasexported to Europe and the UK in the 1980s. A number of commercial, public sector and notfor profit organisations have successfully embraced the technique, and it is a popular andeffective management process.

Any activity that can be measured can also be benchmarked. However this is neither feasiblenor practical. The starting point for any benchmarking exercise is to determine the keyperformance areas; those are the areas that are critical to the organisation, operationally andstrategically. They should focus on those areas that (a) tie up most of the resources; (b)significantly improve the relationship with their client groups; (c) impact on the viability of theorganisation. For example a charitable organisation that relies on grant aid as its main sourceof income might benchmark fund raising activities.

Once the key performance areas have been decided upon an organisation must then set thekey standards and variables to measure, these are commonly known as key performance

indicators (KPIs). Having defined the benchmarks the hunt is on for information to establishthe benchmark performance. There are four types of benchmarking· Internal : this is done within an organisation arid generally between closely related

divisions, plants or operations. This is an easy way to start benchmarking, but is limitedto internal criteria only

· Functional : this is a comparison of performance and procedures between similarfunctions, but in different organisations and industries. It is more likely than internalbenchmarking to generate benefits to the specific function, but it is unlikely to give widebenefits throughout the organisation

· Competitive: thisfocuses on direct competitors within the same industry and withspecific comparable business operations, or on indirect competitors in relatedindustries with complementary business operations. There can be practical difficultiesin achieving this.

· Generic: thisis undertaken with external companies in different industries thatrepresent the "best-in-class" for particular aspects of the selected business operations.

Organisations then need to specify programmes and actions to close the gap. Havingmeasured one s actual performance and compared it with some form of target, benchmarkingmoves from simple measurement through to performance improvements. Many organisationsforget this stage and therefore miss the real benefit of benchmarking. It is essential thatprogrammes and actions are implemented and that ongoing performance is monitored.


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Successful and effective benchmarking requires commitment and support from the board andsenior management. Managers need to be as specific as possible when identifying areas tobenchmark. For example, a company that wishes to benchmark customer service needs todecide what specific aspect of customer service needs to be examined. Customer serviceencompasses a diverse range of activities, such as dealing with enquiries, handlingdisappointed customers, issuing refunds and taking payments. Each of these activities isdifferent, each with its own thought processes, techniques and controls.

Once the best practices have been identified, the benchmarking team collects the data,analyses it, and then plots their performance against best practice to help identify improvementopportunities.

Finally the team decides what is needed to adapt the best practices to suit their own particularcircumstances, this will a re-evaluation and re-design of existing procedures and approaches.

A cost-benefit exercise will usually be carried out and an implementation timetable withpriorities is established.

Government intervention and regulation

Introduction

The government can also take specific measures to regulate businesses through competitionpolicies, ecological policies and business assistance policies.

Competition Policies

Competition policies ensure that market failures are avoided. Government particularly seek toregulate private markets . Competition policies are introduced to:

· Reduce company domination (Monopolies)· Control prices and profits·

Investigate mergers (Against the public interest)· Investigate restrictive practices (Prevent development of anti-competitive practices)

Green Policies

Green (Ecological) policies may not directly benefit the organisation but rather the environmentand society. They include external environmental costs occurringfrom production or consumption . The Government policies include:

· Polluter pays principle (Tax on environmental damaging practices)· Subsidies (Encourage reducing pollution)· Legislation (Regulation governing waste disposal and emissions)

Business Assistance Policies

The Government also has aid policies to assist businesses in the economy in particular smallbusinesses. These include:

· Grants for depressed areas /official aid schemes· Enterprise initiatives


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RISK AND UNCERTAINTYRisk management is the process of managing your organisation's exposure to potentialliabilities. It gives managers, staff, clients, the board and other stakeholders the confidence topursue their mission without the fear of legal action or harm, and approaches risk in astructured and calculated manner, rather than being haphazard.

Risk consists of three elements, namely choice , likelihood and consequence. Some choiceis needed in the situation, if there is no choice, a manager does not have a risky situation arather a bounded one beyond the manager's control; Likelihood for some level of uncertainty;and some unwanted consequence must exist in one or more of the choices available to themanager.

Decisions under uncertainty are effectively where· Outcomes are known· Associated probabilities are unknown

Decisions under risk are effectively where· Outcomes are known· Associated probabilities are known

A number of techniques exist for decision making under uncertainty, the more popular beingcontingency tables and its associated interpretation:

Contingency TableThis is used for decisions made under uncertainty; it identifies & records all payoffs whereaction affects outcomes.

MaximinThis maximises the smallest pay-off, it is indicative of a pessimistic and Risk-avertingapproach

Maximax

This has the highest maximum pay-off, it is indicative of an optimistic approach, albeit with therisk of loss to low returns

Minimax regretThis minimises the maximum possible regret and limits the potential opportunity loss. Regretis seen as the pay-off lost v. not pursuing optimal action

Expected Values (EV)This is used where decisions subject to risk

EV = Total of probabilities of outcome × returns

ACTIVITY ONE A retailer needs to decide how many kilos of fruit he needs to buy from the market and hasassessed the possible daily demand as 60, 100, 125 or 175 kg

He can buy quantities of 50, 100, 150 or 200 kg at a price of $4 per 10 kg. The selling priceis $1 per kg with any unsold apples being scrapped.

Required

a) Construct a contingency table


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b) How many kilos should be bought if the following approach were adopted?v Maximinv Maximaxv Regret

c) Calculate expected contribution (EV)

PESTELOne of the key features that differentiated strategic management accounting from traditionalmanagement accounting is the external focus. By looking at the organisation s competitiveposition we will be concentrating on this external focus

The business environment can be thought of as comprising the wider macro-environment andthe competitive (operating) environment

YourOrganisation

Suppliers

Substitutes

Competitors

Customers

Political

Economic

Social

Technological

Stakeholders

MacroEnvironment

CompetitiveEnvironment

Entrants

PESTEL ANALYSIS (MACRO ENVIRONMENT)The figure above shows the range of environmental influences. It is useful to identify whatmacro environmental factors are affecting an organisation and then to consider which of theseare most important (a) at present, (b) in the future. This is known as a PESTEL analysis, i.e.an assessment of how Political, Economic, Social, Technological, Ecological and Legal factorsimpact, or are likely to impact, on your company.

A mere listing of PESTEL influences has little value, it is important to identify the keyopportunities and threats facing the company (a) at present, (b) in the future and how theseare, in effect drivers for change. A PESTEL analysis should also examine the differentialimpact of these macro environmental influences by asking how they affect different companiesdifferently. Some form of impact analysis and scenario planning is especially useful to exploredifferent possible futures. This exercise allows what if questions to be explored.


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PORTER: INDUSTRY ANALYSIS - THE FIVE FORCESThe factors that determine the returns that are possible in an industry are known as the FiveForces. This approach to analysis was developed by Prof. Michael Porter (CompetitiveStrategy, 1980) initially as an investor s tool. An industry is a group of firms producing productsthat are close substitutes for each other. According to Porter five forces determine industrystructure:

1. Buyer Power2. Threat of substitutes3. Supplier Power4. Rivalry5. Barriers to Exit and Entry.

Competition in an industry continually works to drive down the rate of return towards thecompetitive floor rate of return.

Buyer PowerBuyer power is the ability of the buyer to determine the price at which they will buy irrespectiveof the decisions of the firm.

· A group of buyers is powerful if for example a buyer purchases large amounts relativeto the seller s total sales.

· If the product bought represents a significant portion of the buyers total purchases thebuyer will tend to shop around for lower prices.

· If the products are standard and undifferentiated the buyer will have more power overprices.

· If the buyer has few switching costs it will not be locked into a particular seller.· If the buyer has low profitability it will have to press for low prices.· If the product is unimportant to the quality of the buyers products or services.


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· If the buyer can exercise significant power over which products its customers purchaseas in large retail stores.

Substitute ProductsFirms in one industry are also competing with firms in another that produce substituteproducts. Substitutes limit returns in an industry by setting a ceiling on the prices the industrycan charge. The more attractive the price-performance of alternatives the firmer the lid is onindustry pricing.

Substitute products that need to be closely watched are those with improving price-performance ratios where the industry that produces them is more profitable than yours.

Supplier PowerProfitable suppliers can squeeze profitability out of an industry if that industry cannot recoupthe cost of higher priced supplies in prices of its own products. The conditions makingsuppliers powerful are:

· It is concentrated with few firms· It does not have to contend with other substitute products for sale to the industry.· The industry is not an important customer.· The suppliers product is an important input to the industry.· The supplier group as built up switching costs

RivalryRivalry takes the form of price competition, advertising battles, product introductions,increased customer service, improvements to warranties and so on. Price competition canleave the whole industry worse off while advertising battles may increase demand and hencewealth of firms. Intense rivalry is the result of a number of factors:

· Numerous or equally balanced competitors.· Slow industry growth· High fixed or storage costs. The significant cost here is fixed cost relative to value-

added.·

Lack of differentiation or switching costs.· Capacity augmented in large increments· Diverse competitors· High strategic stakes· High barriers to exit. Exit barriers can be economic, strategic and emotional. They

consist of specialised assets, fixed costs of exit, strategic interrelationships,identification with the business, loyalty to the workforce, fear for one s own career,government denial or discouragement of exit and so on.

Threats of EntryNew entrants to an industry bring new capacity, the need to gain market share and they canbring substantial resources. The threat of entry depends on the strength of the barriers toentry:

· Economies of scale. If these are large then the new entrant has to come in on a largescale. However these economies of scale must be real. If they are not, as Xeroxdiscovered when Japanese entrants started following the expiry of patents, the newentrant may enter at a lower price than the incumbents are manufacturing for. Scaleeconomies can vary by function, such as selling, or by operation. For example thereare large economies of scale in manufacturing television colour tubes but not in cabinetmaking or assembly.

· Product differentiation leads to brand identities and customer loyalties.· Capital requirements


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· Switching costs.· Access to distribution channels which may be difficult if they are controlled by the

industry.· Cost disadvantages to the entrant, not brought about by scale, as a result of proprietary

technology, favourable access to materials, favourable locations, experience curveeffects

·

Expected retaliations· The entrant will have costs of entry and if the industry price is insufficient to allow himto recoup these - on other words it is below the Entry Deterring Price - he will notenter. Where however the industry price is significantly above these then new entrantswill tend to bring the price down to it.


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BUDGETINGBudgets have multiple functions, namelyPlanning

· Management produce detailed plans for implementation· Coordination· Actions of different parts of organisation are brought together·

Communication· Everyone is informed of the plans and policies; top management communicates tolower level management

· Motivation· This influences managerial behaviour, individuals motivated to perform in line with

objectives. This can encourage inefficiency and conflict between managers· Control· Assists managers in controlling activities with management s attention concentrated

on deviations from a pre-set planPerformance Evaluation

· Measuring success of achieving the budget, rewards like bonuses are given in somecompanies and is meant to iinfluence human behaviour

Incremental budgetingIndirect cost and support activities are prepared incrementally, say 5% on last year.

Zero based budgeting Activities are justified & prioritised before decisions are taken. The approach is that budgetedexpenditure starts from base zero and description of each activity is included in a decisionpackage, they are evaluated, ranked and resources allocated.The benefits are that the deficiencies of traditional budgeting are avoided, resources areallocated by need or benefit; a questioning attitude is created and the focus is on attention onoutputs in relation to value for money

Anthony (1965) categorised control into three main types:

Strategic Control· The setting of corporate strategy and long term objectives for the organisation.

Operational Control· Operational control is ensuring that specific tasks are carried out. This is primarily

concerned with the processing of inputs and raw materials to get outputs.

Management Control· Management control is the coordination of the day to day activities in an organisation

to ensure that inputs and raw materials are used efficiently and effectively towardsachieving long term goals. Management control, therefore, links strategic control andoperational control.

Management control utilises regular feedback reporting systems so that corrective action cantaken where variances from plan are identified. The budget plays an important role here inproviding controls to aid management control.

The systematic comparison of planned inputs to actual results made using the budget,followed by corrective action where deviations from plan exist, is known as a control system .The system providing the reports for this control system is known as responsibilityaccounting . This will be discussed in more detail later in the notes.


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Feedback and Feed-forward Controls · Feedback control - occurs where actual outputs are monitored against desired

outputs and corrective action is taken where there is a variance between the two.· Feed-forward control predictions are made about future outputs and compared to

desired outputs and action is taken where there is a difference between the two.

So, with feed-forward controls any likely errors can be foreseen and actions taken to avoidthem, whereas, with feedback control actual errors against the plan are identified andcorrective actions taken to achieve the remainder of the plan.

The budgeting process is an example of both a feed-forward and feedback control system.

Budgets as feed-forward controlIn putting budgets together, and submitting them to the budget committee, they are comparedagainst the future expectations of the organisation as outlined in the long term plan. If thebudget falls short of these expectations then it may be adjusted and alternatives considered.This process may continue until a budget is agreed that will meet long term expectations.

Budgets as feedback control

During the budget period actual results are compared to the budget and any deviations frombudget identified. Corrective actions are then taken to ensure that future results are in line withthe budget.

BEYOND BUDGETING

During recent years the business environment has become far more complex,dynamic, turbulent and uncertain. Shorter product lifecycles coupled withtechnological advancement has focused greater attention on innovation as adeterminant of corporate success. Although organisations need to be as adaptive tochange as possible, the rigidity of the budget serves only to stifle innovation andresponsiveness to change. The need to comply with a fixed plan, and to manage with

resources which may have been allocated more than one year earlier, act asimpediments that prevent managers from responding quickly to changes in today'sbusiness environment.

The weaknesses of traditional budgeting processes have been the subject of muchattention and many commentators. Such weaknesses include the following:

· Budgets prepared under traditional processes add little value and require fartoo much valuable management time which would be better spent elsewhere.

· Too heavy a reliance on the 'agreed' budget has an adverse impact onmanagement behaviour, which can become dysfunctional with regard to theobjectives of the organisation as a whole.

· The use of budgeting as a base for communicating corporate goals - settingobjectives, continuous improvement etc. - is seen as contrary to the originalpurpose of budgeting as a financial control mechanism.

· Most budgets are not based on a rational, causal model of resourceconsumption, but are often the result of protracted internal bargainingprocesses.

· Conformance to budget is not seen as compatible with a drive towardscontinuous improvement.

· Traditional budgeting processes have insufficient external focus.


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Rolling, or perhaps monthly, budgets focus management attention on current andlikely future realities within the organisational context. This is not seen as managingchange, as this is outside the control of the organisation. Rather it is seen as anattempt to keep ahead of change or, strictly speaking, to be more in control of theresponse to the challenges facing the organisation. This importance may beemphasised in the knowledge-based economies that have developed in the western

world.

Knowledge-based companies face competition which may seriously undermine anyinnovation. This is particularly the case as product lifecycles become shorter.Invariably, price levels are falling while the demand for increased product/servicequality is rising. Organisations need to be operating at the excellent end of the qualityspectrum if they are to continue to flourish and remain close to their customers. It isarguable that talented managers who seek freedom, challenge and responsibility arealso in short supply. Such individuals often find traditional time-consuming and'legalistic' budget processes off-putting. The rapid production of new solutions andstrategies also depends on attracting and retaining such individuals.

In this view of the world, the traditional budget is seen as the fixed plan in accordancewith which all management processes are based and aligned. This determines howmanagers behave and the activities and objectives on which they focus. Annualbudgeting is seen as absorbing considerable management time and the monthlycomparisons of actual and budgeted performance are primarily concerned with controlissues. Managers will not exceed their budgets by perhaps spending necessaryresources outside the planned budget cycle to react to events because their bonusesor even their jobs may be put in jeopardy.

A major problem lies in the fact that circumstances will be different when the budgetwas set and when subsequent comparisons are made and management decisionsrequired. An increasingly competitive global arena further accentuates the problem.Inflexibility is thus seen as the key failing of traditional budgeting, and companies arebeing urged to move towards continuous rolling forecasting to enable speedy andcoordinated adaptations to actual and anticipated changes in the businessenvironment.

Traditional budgets show the costs of functions and departments (eg staff costs andestablishment costs) instead of the costs of those activities that are performed bypeople (e.g. receipt of goods, processing and dispatch of orders).

Thus managers have no visibility of the real 'cost drivers' of their business. In addition,

it is probable that a traditional budget contains a significant amount of non-value-added costs that are not visible to managers.

The annual budget also tends to fix the capacity for the forthcoming budget period,thereby undermining the potential of activity-based management (ABM) analysis todetermine required capacity from a customer-demand perspective.


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Those experienced in the use of ABM techniques will be familiar with such problems.However, their tasks would be much easier to perform, and their results more reliable,if such problems were removed.

THE 'BEYOND BUDGETING' MODEL - PRIVATE SECTOR

In the private sector, managers are forced to consider current and future opportunitiesand threats, particularly where rolling monthly forecasts of financial performanceoperate together with a focus on other non-financial 'value drivers'.

In essence, the 'beyond budgeting' model entails devolved managerial responsibilitywhere power and responsibility go hand in hand. The view held by proponents of thebeyond budgeting model is that the following benefits may accrue as a result of itssuccessful application by management:

· It creates and fosters a performance climate based on competitive success.Goals are agreed via reference to external benchmarks as opposed tointernally-negotiated fixed targets. Managerial focus shifts from beating othermanagers for a slice of resources to beating the competition.

· It motivates people by giving them challenges, responsibilities and clear valuesas guidelines. Rewards are team-based, in recognition of the fact that no singleperson can act alone to achieve goals.

· It devolves performance responsibilities to operational management who arecloser to the 'action'. This uses the 'know-how' of individuals and teamsinterfacing with the customer, which in turn enables a far more rapid adaptationto changing market needs.

· It empowers operational managers to act by removing resource constraints.Key ratios are set, rather than detailed line-by-line budgets. For example,gearing and liquidity ratios may be used to show there is enough cash in thebank to meet liabilities. Local access to resources is thus based on agreedparameters rather than line-by-line budget authorisations. This is aimed atspeeding up the response to environmental threats and enabling quickexploitation of new opportunities.

· It establishes customer-orientated teams that are accountable for profitablecustomer outcomes. These teams agree resource and service-levelrequirements with service departments via the establishment of service levelagreements.

· It creates transparent and open information systems throughout theorganisation, which should provide fast, open and distributed information tofacilitate control at all levels. The IT system is crucial in flexing the keyperformance indicators as part of the rolling forecast process.

THE PUBLIC SECTOR

The legal framework of public sector organisations would probably prevent such asystem being introduced. As with all alternatives, the success of a particular processdepends on the needs of the individual organisation. The alternative of the beyondbudgeting model places considerable emphasis on the need for organisational,managerial and cultural changes in order that it may be successfully applied byorganisations.


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This will present considerable behavioural challenges and individual managers mightbecome overwhelmed by the complexity of decision-making in such an unregulateddecision-making environment.

In the public sector, the budget process inevitably has considerable influence onorganisational processes, and represents the financial expression of policies resulting

from politically motivated goals and objectives.

Yet the reality of life for many public sector managers is an increased pressure toperform in a resource-constrained environment, while also being subjected to growingcompetition.

In essence, a public sector budget:

· establishes the level of income and expenditure· authorises that expenditure, once agreed, out of the planned income· acts as a control on expenditure and income· communicates policies and plans· focuses attention on the future· motivates managers and staff.

While these issues may be common with the private sector, a number of issues arisewhich are specific to the public sector. For example, UK local authorities are preventedby law from borrowing funds for revenue purposes or budgeting for a deficit. If thebeyond budgeting model is to allow greater freedom for managers then it will take aconsiderable change of mindset in the public sector to achieve the flexible agendaenvisaged, especially where such flexibility would involve considerable and increaseddelegation to managers.

Are managers capable of making this change, as it would entail the adoption of aradically different approach?

Local authority financial regulations also tend to prevent the transfer of funds from onebudget head to another (otherwise known as virement) without compliance withvarious rules and regulations. These rules (expressed in the financial regulations ofpublic sector organisations) will be consistent with the policies of the organisation andare designed to prevent expenditure on items such as permanent staff where suchcosts would go beyond the budget year and represent a commitment of futureresources.

Budgets in the public sector tend to concentrate on planning for one financial year

ahead. Attempts are being made by UK central government, through thecomprehensive spending review, to place an emphasis on the longer-term. However,considerable difficulties exist within the individual organisations that make up thepublic sector when creating a budget system that reflects longer-term objectives andgoes beyond the annual cycle. It also remains to be seen how the relatively newsystem of resource accounting in central government will fit into the budgetingframework.


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Traditional methods of budgeting in the public sector centre on the bid system andincremental budgeting. These approaches focus on changes at the margin andgenerally reflect acceptance of the budget base from the previous year. This is partlya reflection of the size and complexity of public sector organisations, but also theinternal political power of large departments, which protect their positions through theirrelative strength. Bid systems also minimise conflict, as debate and power struggles

are only concerned with the 'incremental' items.

More advanced approaches are represented within financial planning systems, andinclude such concepts as zero-based budgeting and planned programme budgetingsystems with a timeframe greater than one year.

Whether the public sector can adapt to the concept of greater flexibility - which lies atthe heart of beyond budgeting - remains a matter of ongoing debate. Such anadaptation would require a mindset which not only moves away from control but alsorequires a reduction in the internal political power of large departments which has beenat the heart of public sector budgeting for many years. The desire to generateimproved performance - essentially considered the driver for the beyond budgetingmodel - is present in the public sector evidenced in initiatives such as key performanceindicators and 'best value' plans.

ACTIVITY BASED COSTING (ABC)Organisations are typically structured hierarchically on a functional basis and costs aretypically reported, and control exercised, under commonly recognised general accountheadings. Within this system, departments are controlled against budget and pastperformance. This is a well tried and well understood approach but it fails due to

1. Senior management focusing effort on corporate strategies but failing to communicatethem down the organisation to the lower levels. Businesses try to meet their corporate

objectives and to meet the needs of their customers. However with each departmenthaving its role to play in a cost budget, the departments often allow budgetary targets todominate. Their contribution to meeting business and customer needs is neglected.

2. Conventional cost management fails to recognise that corporate success depends on theeffectiveness of its key business processes. Such processes frequently crossdepartmental boundaries. Inadequacies, in any department which contributes to abusiness process, can affect the entire organisation which is only as strong as the weakestlink. Traditional management accounting and financial control systems reflect the needsfor a hierarchical function in the organising structure. They do not recognise or supportthe effectiveness of the key business processes.

ABM

The determination of the cost of a product or service is vital at the strategic planning level, asit is at the operational level. For example, organisations may need to evaluate the marketprofitability and should they remain in it?

However the customer will perceive things from his/her own perspective. Essentially this willinvolve making decisions about the value of the service or product to them compared to itscost. Using a customer perspective for managing the business implies that management willhave to concern itself with some or all of the following issues:


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· How does the customer perceive the quality of our product versus that of ourcompetitors?

· How can we continuously improve?· Do the activities undertaken by the company produce the value that the customer

requires - activity analysis?· What are the costs of these activities and are they being carried out efficiently?·

How well are the activities/processes being performed relative to competitors?· What are the important things that we should be controlling?

Because the basis of this concern rests on the activities carried out this is called activity basedmanagement.

In order to determine the cost of each activity it is necessary to determine how time is spentand how costs build up. For example the profitability of a customer will depend not only on theprice and costs of the products purchased, but also on such factors as the number of ordersplaced in a year, the number of calls made on the technical service department and so on.This means that costs will have to be traced to this customer from all over the company, not

just the plant. This is done through cost drivers.

Cost drivers are those elements that give rise to the need for an activity such as the numberof orders for a sales order department, number of complaints for the customer servicedepartment and so on. While there may be many identifiable cost drivers management willneed to identify the minimum set that will allow the costs to be calculated.

Cost drivers apply at different levels:

Unit level· Number of hours required to produce a product

Batch level· These are costs such as machine set-up or inspection, these occur once per batch

Processor product level· These cover such items as engineering change orders which refer to a product or

process.

Organisation level · They are incurred for supporting the continuing level of operations i.e. buildingdepreciation, division managers salary.

Customer ProfitabilityThe needs of customers can vary radically. In their efforts to retain existing customers andattract new ones, companies can be drawn into providing widely different levels of service inrespect of many different service elements such as frequency of delivery, number of orderlines, quantity per order line, customer location, discounts given, salesmen's visits and specialorders.

These have one thing in common, they all have associated costs. Conventional costaccounting techniques rarely recognise them. As a result companies do not know the true

cost of trading with these customers, or even with customer groups. Certain customers mayattract so much cost that they provide no profit contribution at all. In addition, companies maybe unaware of the true value their customers place on the level of service they provide. Undersuch circumstances, companies may be trading at a loss with certain customers, giving thema costly service which they do not actually require.

ABC is one answer in view of the drawbacks of conventional cost management.

The ABC approach recognises the following -


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· The need to generate product costs that more accurately reflect the factors whichdrive them, such as variety and complexity - not just volume.

· The requirement to attribute the cost of differing levels of service to your customersin order to establish true customer profitability.

· The need to be able to measure the cost of failure throughout the organisation,particularly in the overhead functions, so as to focus management attention to themajor opportunities for improvement.

· The need to identify the factors that drive costs and helps guide managers as towhere they can best direct their efforts in order to control costs.

· The crucial importance of the key business processes.

ABBThe idea behind activity based budgeting is to develop an activity model (or series of linkedcost centre activity models) of resource requirements. This model can then be flexed to affectdifferent volume assumptions which may need to be evaluated after the first stage of thebudgeting process (external assessment). It can also be used as a basis for identifying andproducing performance improvement. Once the final budget model has been agreed, it thenforms the basis for management control through variance analysis with a more complete

understanding of the impact of changing volumes on activity resource requirements.In developing the activity based budgeting model it is important to understand and identify:-

· What activities are being/need to be carried out?· How efficiently the activities are being carried out and to what quality and

o Standard.· What is driving the level of resource required to perform this activity (the

o Activity level volume driver).· The relationships between the activity level volume driver and its root cause.· How the root cause may be changed and how this can affect the activity

o Resource required.

Activity based budgeting can take this a stage further by identifying and modelling a cascadeof activity level volume drivers. For example, in order to achieve a target sales volume, anorganisation needs to process so many orders which will result in so many invoices with somany complaints and queries to handle before the transactions can be completed. Each ofthese activity level volume drivers carries with it a unit cost that can be used to calculate thetotal value of the resources required.

Understanding these cost linkages is vital to a good understanding of cost behaviour and thisis at the heart of activity based budgeting. However, this understanding is not fully exploitedunless management can use it to make changes in the way the organisation goes about itsbusiness. The most significant of the cost beneficial changes can only be made if incorporatedinto budgets through discussion and performance reviews.


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RESPONSIBILITY ACCOUNTING SYSTEMS Responsibility accounting systems identify individual areas of responsibility in theorganisations structure. Each area of responsibility is often referred to as a responsibilitycentre . Managers are allocated responsibility centres and held responsible for itsperformance.

There are four types of responsibility centre:

1. Cost Centre managers are responsible and accountable for costs only2. Revenue Centre managers are responsible and accountable for revenue only3. Profit Centre managers are responsible and accountable for both revenues and

costs4. Investment Centre managers are responsible and accountable for revenue, costs

and capital investment decisions

In operating a responsibility accounting system a number of issues have to be considered:

· Controllable and uncontrollable costso Managers should only be judged and measured on costs and revenues that

they control. When a manager is allocated responsibility for uncontrollableitems then no matter what variances occur for that item the manager will not beable to take actions to correct this situation. This only serves to demotivate themanager concerned.

· Problems of dual responsibilityo It may be for some items an element of shared responsibility exists. For

example, direct labour may be the responsibility of the production manager.However, training courses for direct workers, which may require overtimepayments for attendance, may be the responsibility of the human resourcesmanager.

o In these instances a responsibility accounting system should seek to assignand report on cost to the person having primary responsibility.

· Guidelines for reportingo If a manager can control the quantity and price paid for a service or goods then

the manager is responsible for all of the expenditure incurred for that serviceor goods.

o If a manager can control the quantity of the service or goods but not the pricepaid for that service or goods then only the variance in usage should beattributed to that manager.

o If a manager cannot control either the quantity or price paid for a service or

goods then both usage and expenditure are uncontrollable and should not beattributed to the manager.

· Arbitrary costsGenerally costs, such as insurance, heating and rent are apportioned to cost centreson some sort of arbitrary basis, e.g. floor area. For managers operating in aresponsibility accounting system this would render them uncontrollable. Therefore,managers should not be held responsible for them.


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However, if managers do not see these costs then they will not understand the coststhat are incurred to support their business areas. There is an argument, therefore, thatmanagers should be made aware of arbitrary costs. This would prevent the abuse ofservices, such as IT support. It should also be borne in mind that they may have someinfluence on the costs involved.

Human resource management (HRM) refers to the 'strategic and coherent approach to themanagement of an organisation's most valued assets: the people working there whoindividually and collectively contribute to the achievement of its objectives for sustainablecompetitive advantage' (Armstrong).

People are of central importance in most organisations and their recruitment, managementand motivation forms part of the human resource management function.

The definition mentions competitive advantage and this reinforces the link between HRM andstrategy.

HRM goals

If HR strategies are to be effective and successful then HRM must be effective across fourmain areas, namely

Commitment : requires good motivation and leadership.Competence : requires good recruitment, assessment, training and staff development. Congruence : requires good job design.Cost-effectiveness : this normally comes from the achievement of the others.

Theories of HRM

The two theories that may be examined are :

· Vrooms expectancy theory; and

· Agency theory

VROOMS EXPECTANCY THEORY

Vrooms theory deals with management and motivation. It assumes that behaviour is causedby a making a conscious choice from a number of alternatives, pleasure being maximised andpain minimised. Vrooms realisation was that an employee s performance is based onindividual factors such as skills, knowledge, personality, experience and abilities.

In essence the theory says individuals have differing goals, and they can be motivated if theyhave certain expectations.

The expectations arising from expectancy theory are that

· Efforts and performance are positively correlated

· Positive performance results in positive rewards


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· Then rewards satisfy an important need

· Desire to satisfy outweighs the effort needed to succeed

The foundation of expectancy theory is based on three main beliefs

Valence: This refers to the emotional orientations that people have regardingrewards/outcomes, management need to discover what people (employees) value;

Expectancy: Employees do not share the same levels of expectations and they have differinglevels of confidence in their own abilities. Management needs to identify and provideemployees with resources, training and support.

Instrumentality: There is a difference between employee s perception of what they actuallydesire and what they actually receive by way of rewards. Management need to ensure thatpromises are honoured and the fulfilment by management of these promises is effectivelycommunicated.

The link between the three beliefs can be stated as:

Motivation = Valence × expectancy

Agency Theory: Agency theory suggests that an organisation can be seen as agreementsbetween resource holders. An agency relationship arises whenever one or more individuals,called principals, hire one or more other individuals, called agents, to perform some serviceand then delegate decision-making authority to the agents.

Two of the primary agency relationships in a commercial organisation are between (1shareholders and managers and (2) between employers and employees. These relationshipsare not necessarily positive; and agency theory deals with these agency conflicts, or conflictsof interest between agents and principals.

This has implications for, among other things, corporate governance and business ethics.When agency exists, agency costs are also incurred, for example offering managementperformance rewards to encourage managers to act in the best interest of shareholders'.

BUSINESS PROCESS REENGINEERINGThis is often referred to by the acronym BPR and one of the ways that organisations aspire tobecome more efficient and effective. Business Process Re-engineering (BPR) is the strategicanalysis of business processes and the planning and implementation of improved businessprocesses.

A key element underlying the BPR philosophy is that one should look at an organisation as aseries of processes, as opposed to functional specialties such as production, and marketing.

The approach advocated by Davenport (1992) is to1. Develop the business vision and process objectives2. Identify the business processes to be redesigned3. Understand and measure the existing processes4. Identify IT levers5. Design and build a prototype of the new process6. Adapt, if appropriate an organisations organisational structure and governance model

BPR is not a universal panacea and criticisms of the approach include


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· Ineffectiveness of processes is what limits an organisations performance, this is notnecessarily true

· The existing way of doing things is disregarded· No real focus is provided for process improvement on organisational constraints· The model (US origin) may be culturally biased towards a US perspective;cultural

differences make it difficult for this approach to be universally applicable.


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Financial Performance Indicators

Ratio Analysis

We understand how financial statements are prepared and the definitions of the terms used. Assuming that this information is available in an accurate and timely manner what does itmean? What is the significance of a particular level of profit or borrowing? How should theinformation in the various financial statements be related to one another?

To a large extent this is done by the use of ratios in effect dividing one number by another.There are a considerable number of ratios that could be calculated from any one set offinancial statements. We will discuss a few of the more common ones.

Ratios are calculated either to examine performance, or to make comparisons, or to decideon risk, or to make forecasting easier. They can be combined, using suitable weights obtainedas a result of statistical studies, to form an index to show company solvency.

With any financial analysis the trend over a number of years is always important since any

number of special factors can distort one year s figures. It is also important to use financialinformation with care. As we have seen many of the numbers in financial statements aresubject to management s interpretation of future events or can be directly manipulated as aresult of fraud. Therefore when analysing statements of companies it is important to be awarealso of the trend in such things as market share, comments of customers and regulatorybodies and other organisations.

All external analyses of this sort when carried out on other companies suffer from the fact thatthe information is not always available until several months after the end of the financial year.

Finally, remember that there are no systems, whether naturally occurring or brought about bythe hand of man, that continue in a straight line or that grow in a compound fashion forever,or that carry no risk. Their performance depends on the time scale over which they are being

examined. In the short term and it may be that they can be considered straight line in the longterm, however performance becomes erratic and cyclical.

Characteristics:Ratios should have a number of characteristics.

· The numerator and the denominator should be linked in some way. The more tenuous thelink, the less useful the ratio. A very common problem in ratio analysis is to find anumerator and denominator, which are strongly linked from the available data.

· The ratio should be measuring something which is important within or about theorganisation.

· The result of the ratio must be able to be influenced in a positive way by the managementof the organisation so that managerial action which changes the numerator or thedenominator may indicate improvements or worsening in the ratio.

· Because ratios are relative measures, they enable performance in different sizedorganisations to be compared

· They also enable performance of a single organisation to be measured and comparedover different time periods


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Operating Ratios:The important ratios are those used to calculate sales, efficiency, risk, profitability and gearing.

Sales Ratios:

For example the ratio of operating profit or gross profit to sales or the ratio of expenses tosales, for example selling expenses to sales. The profit to sales ratio is called Return on Sales(ROS) and is widely used as a measure of how well a company is managed in comparison toother companies in its sector.

With sales ratios it is important to bear in mind that some of the total costs of operations arevariable, some are fixed and some are semi-variable. Their ratios will respond differently todifferent levels of sales.

Efficiency Ratios:There are some ratios where sales is the numerator in the expression. These importantturnover relationships are calculated by dividing sales by the appropriate balance sheet item,for example total inventory or debtors, or by total number of employees.

Receivables collectionYearend receivables divided by sales (credit sales if available) gives the number of times thatthe debtors turned over in a year. Divided by 365 it gives the number of days on average ittakes receivables to pay. An increasing trend in this number is a warning signal, especially ifthe number of days outstanding is significantly higher than the industry average.

Payable PaymentsThis is the relationship between trade payables and cost of sales (or credit purchases ifavailable) multiplied by the number of days in a year (365).

Inventory Turnover Cost of sales divided by average inventory for the year (opening inventory + closing inventory

divided by 2) multiplied by 365 gives the average age of the inventory. As usual an averagecan hide an awful lot of obsolete stock that should have been written off, so comparisons withprior years or with industry averages will aid in deciding whether inventories are too high.Price changes over time can also effect this ratio.

Asset TurnoverThis is generally calculated as sales to capital employed.

Employee ProductivitySales divided by the number of employees gives a useful indicator of productivity in theorganisation when compared with industry averages.

Liquidity ratios:

These ratios are particularly important when deciding to extend credit to a customer or tocontinue existing credit.

The Current ratioThis is the current assets divided by current liabilities or creditors due within one year. It givesthe company s ability to pay in the medium term say 4-9 months in the future. It is veryimportant to know the average for the sector here since different industries have differentoperating characteristics. The large food retailers with their high inventory turnover andvirtually all cash sales are likely to have a ratio less than 1. Heavy manufacturing

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