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Mnemonics and Charts Paper F5: Performance Management

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ACCA Paper F5: PERFORMANCE MANAGEMENT

Mnemonics and Charts

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DOWNLOAD SAMPLE Welcome to our download sample of the Tony Surridge +AddVance E-book publication:

ACCA Paper F5 – Performance Management – Mnemonics and Charts Thanks for taking time to review a download extract of this Mnemonics and Charts publication which we have developed specially for the ACCA Paper F5: Performance Management. We hope you like our electronic study material and recognise that at our affordable prices the complete purchased and downloaded version represents true value for money. This is only a small sample, taken directly from the full version. This sample shows our table of contents outlining all the Mnemonics and Charts available in the full version, and a small selection of the types of Mnemonics and Charts you can expect to find within. As a new addition to this particular +AddVance E-book we are also introducing some sample practice Questions and Answers, as well as a Glossary of Terms. Due to the fact that this is only a demonstration, the hyperlinks currently shown here in the table of contents will not be active. All hyperlinks are fully functional only in the full downloaded version when purchased. You may like to learn some details about the full version: (please note these details may vary slightly depending on which updated version you have purchased) Mnemonics: 105 Charts and Diagrams: 133 Complementary Questions and Answers: 31 Total number of pages: 459 It is important for you to know that each Tony Surridge +AddVance E-book can only be used on the computer it is initially downloaded to. The data cannot be transferred to any portable memory or any other computer or electronic device. This condition is enforced to protect our digital rights. If you wish to use the full version of this +AddVance Exam Study Text on two separate computers (such as a desktop and laptop), then you will need to purchase an additional license. Good luck with your studies.

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Main Page ISBN and Copyright statement For the ladies only Why study from a computer screen? Memorising: Tips and techniques Writing or saying things over and over again …. Vocalising Initial letters and making phrases The use of mnemonics The use of jingles Word association Visualising Link/story technique Do I need to memorise all your mnemonics? Disguise your use of mnemonics in the exam Charts Colour codes Electronic links within the database

Syllabus Study Guide The structure of the syllabus A Specialist cost and management accounting techniques Intellectual levels B Decision-making techniques Learning hours C Budgeting Guide to exam structure D Standard costing and variance analysis Guide to examination assessment E Performance measurement and control Aim Main capabilities Relational diagram of main capabilities Rationale Detailed syllabus Approach to examining the syllabus

Sections Combined Charts and Mnemonics. Click below. Specialist cost and management accounting techniques Decision-making techniques Budgeting Standard costing and variance analysis Performance measurement and control Contents page Questions and Answers Formulae sheet

ACCA Paper F5 Performance Management

Mnemonics and Charts

“Where shall I begin, please your majesty?” he asked. “Begin at the beginning,” the king said gravely, “and go on till you come to the end: then stop.” Lewis Carroll Through the Looking-Glass

Only part of this section

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6

Specialist cost and management accounting

techniques

ACCA Paper F5 Performance Management





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Fact Sheet: Modern industry – 1 of 2

'Modern industry' and 'world class manufacturing' are convenient labels given to a series of fundamental changes introduced by many manufacturing (and service-providing) companies over the last few decades. It is beneficial for our study of management accounting and performance management, to consider the concepts of modern industry before looking further at the work of modern management accounting and performance reporting. The modern business environment The following points briefly summarise the main characteristics of modern business: (a) Complex and dynamic environments Although not relevant to all organisations, most business concerns face difficult environments which relate to: (i) open-systems characteristics and associated uncertainty, (ii) the need for equal-finality (organisations with similar objectives achieved by pursuing different strategies), (iii) dependency on the ecosystem, (iv) the need for organisational integration as well as differentiation (a 'quilt-work' of vertical and horizontal separation of responsibilities and work but achieving common goals). (b) Difficult business environments Most organisations now face very competitive business environments. Furthermore, customer empowerment and fragmented (and yet further fragmenting) markets require companies to be competent in: flexibility (quick response to change), versatility (multi-need capacity), quality and innovation. These needs have resulted in the development and use of advanced manufacturing technologies (AMT), which place particular demands on management information systems.

During your studies of Paper F5 bear in mind the role of a management accountant. A management accountant supports managers, by way of information and advice, and managers themselves make decisions and take control actions in an extremely tough and demanding ‘modern industry’. These facts set the scene for what you study, how you study and the way you answer exam questions.

Please go to the next screen





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Fact Sheet: Modern industry – 2 of 2

(c) High overhead costs In modern industry (and with the view that labour cost is largely fixed) the majority of costs are overheads. In manufacturing concerns overhead costs have risen to as much as 80 per cent of the total cost, and in service-providing organisations can exceed 90 per cent. (d) The impact of 'modern industry' on the management accountant Although management accounting practices and techniques were developed in the days of what is often called 'traditional industry' many of them are still relevant and used in today's industrial environment. However, the demands of modern industry on the information and support which managers now depend upon has led to the development and application of new and additional management accounting techniques, a number of which are included in the Paper F5 syllabus.

The Intel 8088 microprocessor was a variant of the Intel 8086 and was introduced on July 1, 1979. It had an 8-bit external data bus instead of the 16-bit bus of the 8086. The 16-bit registers and the one megabyte address range were unchanged, however. The original IBM PC was based on the 8088.

It is difficult to exactly define the term ‘Modern industry’. Some commentators suggest that it started in the early 1980s with the introduction of Intel’s 8088 microprocssor. Moore's law describes a long-term trend in the history of computing hardware. Since the invention of the integrated circuit, the number of transistors that can be placed inexpensively on an integrated circuit has increased exponentially, doubling approximately every two years. This has had an enormous impact on industry and society in general. Management accounting methods and techniques have developed to meet the exacting demand of modern industry For our purposes we can assume that ‘traditional industry’ started in the 1920s with the beginnings of what are now huge corporate concerns. Traditional management accounting techniques were developed or refined from this time. Some of these techniques are still used by organisations.

Practice question which makes reference to modern industry: Linacra Co Page 138.



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Fact Sheet: Traditional versus modern Industry

‘Traditional’ Industry

- Mainly manufacturing based - Mass production (single high-volume product focus) - Dedicated machinery - Semi-skilled direct labour - A high proportion of manual work - High direct costs (materials and labour) - Feedback systems of control (based on ‘correction’) - Low production overhead costs

Main performance measurement focus: - Responsibility accounting: investment/profit/cost and revenue centres. - Standard costing - Variance analysis - Linear programming - Extrapolation-based forecasting techniques

Modern Business

Environment

- Competitive (hostile) - Fragmented markets - Dynamic change - Environmental complexity - Environmental uncertainty - Customer empowerment

Impact on Business Practice

- Emphasis on ‘world class manufacturing’ - Use of advanced manufacturing technologies (AMT) - JIT orientation/systems - Focus on quality (TQM) - Systems that are flexible and versatile - Small production runs - Increase in production overhead costs (engineering support, set-ups, ‘first-piece’ inspection’ etc.)

Important objectives of modern management: - competitiveness - quality - flexibility - innovation - resource utilisation

Management Accounting Response

- Quality management and performance measurement - Just-in-Time (JIT): cost tracking and performance measurement - Target costing (use of ‘drifting’ instead of ‘standard’ costs’)* - Activity-based Costing* - Feed forward cybernetic control systems (as well as the use of sophisticated feedback systems) - Customer profitability Analysis (CPA) as well as Product Profitability Analysis (PPA)* - Activity-based budgeting - ‘Balanced scorecard’ performance indicators* - Back-flush accounting systems* - Throughput accounting* - Life-cycle costing*

* covered by the ACCA Paper F5 syllabus

- Design and use of ‘Executive Support Systems (ESS), Expert systems, Decision Support Systems (DSS), Data warehousing and data mining systems - Competitive analysis and appraisal - Environmental scanning and analysis - Strategic benchmarking - Non-financial key performance indicators, linked to ‘critical success factors’* (Knowledge of information technology (IT) systems not specifically covered on the Paper F5 syllabus but the role of IT in modern management accounting should always be considered.)

IMPACT OF MODERN INDUSTRY ON THE MANAGEMENT ACCOUNTANT

CHANGES

A ‘HOSTILE BUSINESS WORLD’





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Modern industry

The characteristics of modern industry that would influence and affect the work of a strategic management accountant are:

H Hostile (in other words, very competitive) business environments.

O Overhead costs are now very significant, particularly fixed overhead costs.

S Splintered, or fragmented markets with small but varied market segmentation.

T Technological sophistication (for even small companies) including the uses of ‘Advanced Manufacturing Technologies (AMT)’.

I Impact of information technology (IT) in all areas – communication, product/service design/production, marketing, etc. is pervasive.

L Legal complexity and rapid change, including the impact of international conflicts of legislation.

E Empowered customers – with resultant rapid change of needs and market competitiveness.

W World-wide competition leading to global and international strategy.

O Organisational delayering and decentralisation of decision making.

R Rapid change in market structures – for instance the recent growth in the economies of Brazil, China and India.

L ‘Large company’ growth – acquisitions creating large corporate bodies.

D Dynamic (change which causes more change) business environments generally.

Memory jog: Remember the business environment of ‘Modern Industry’ is a ‘HOSTILE WORLD’.

If two line on a graph cross, it must be important. Ernest F.Cooke University of Baltimore Remark to a student, February 1985





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Modern organisation structures Hostile, dynamic and complex business environments, including the development of advanced manufacturing technologies and information technology and the impact of global competitive forces, has led organisations to review and usually change from the traditional hierarchically-based line-and-staff structure to other structures and mechanisms that are more suitable. The following approaches influence organisational structuring in modern industry.

A Activity-based management. Many organisations are now restructuring around activities (‘Activity Based Management’ (AMB)) which is often linked to re-engineering activities on the ‘value chain’.

M Matrix-based teamwork. Matrix-based organisations are the use of multi-disciplinary teams involved in creativity, innovation, project development, market creation, etc.

O Outsourcing. The employment of external organisations to take over functions which they can perform more effectively than the organisation outsourcing the work, or which releases assets and resources the organisation can use more effectively.

D Delayering. This results from a reduction in the number of levels in the management hierarchy, usually by removing middle level (‘mid-line) management. One reason, is that the development of modern information technology (IT) has given senior managers direct lines of communication and control with work at the operating level, thus making much of the role of middle-level managers superfluous.

E Employment of core-based management teams. A modern approach is to build a small core of specialist competent full-time and permanent staff alongside a periphery of temporary part-timers or contract workers. This provides the organisation with ability to be versatile, flexible and responsive to short-term events.

R Reconstructing as ‘small within big’. Another way of attempting to achieve versatility, flexibility and responsiveness is to re-structure the organisation on the basis of small ‘strategic business units’ which will be flat, and organic but at the same centralising strategic services (to achieve big-spend

economies). N Networking. Networking involves franchising, other forms of collaborative ventures, product-market partnerships and other forms of strategic alliances.

Memory jog: in an attempt to deal with dynamic, hostile and complex business environments, and to meet world-class standards, ’A MODERN’ organisation structure evolves.





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Fact Sheet: Modern industry: some effects of market fragmentation

Customer choice and empowerment generally has had wide implications on manufacturing concerns.

CUSTOMER EMPOWERMENT

WHY?

WIDE CHOICE OF SUPPLIERS

AND PRODUCTS

DEMANDS FOR PRECISE

NEEDS

INCREASE IN TYPES AND

VARIETIES OF PRO0DUCTS

MARKET FRAGMENTATION

SMALL PRODUCTION

RUNS (BATCHES)

IMPLICATIONS - Wide range of materials required (inventory problems). - Need for product flexibility and versatility and the development of ‘Advanced Manufacturing Technology (AMT)’. - Increase in production services. - Complexity of production scheduling, control and logistics. - Need for product-market synchronisation. - Need for multi-skilled and empowered labour. - Increase in use of ‘general purpose technology’ and engineering ‘set ups’. ALL OF WHICH MEANS AN INCREASE IN OVERHEAD COSTS!

Market fragmentation results from the management process of market segmentation.





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Fact Sheet: Management accounting versus financial accounting

The diagram on the next screen helps us distinguish the role of management accountancy from the role of financial accountancy. Consider also the table below.

Financial accounting Management accounting 1

Provides information for external users

Provides information for internal users

2

Is often a legal requirement

Is not a legal requirement

3

Is subject to GAAP and accounting standards

Is not subject to GAAP or accounting standards

4

Must generate accurate and timely data

Emphasises relevance and flexibility of data

5

Records historical facts

Has more emphasis on future events and decisions

6

Looks at the business as a whole

Focuses on parts (such as individual contracts) as well as the whole of a business

7

Primarily it stands by itself

Draws heavily from other disciplines such as finance, economics and operational research

8

Is an end in itself

Is a means to an end

The main differences between financial accounting and management accounting





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Management Accounting Information System/ Strategic Management Accounting System Incorporates FAIS and also encompasses: - External data - Predictions - Non-financial data - Segmental reporting

Operates within ‘modern industry’ Use of modern MAIS and SMAIS* techniques and practices Designed to produce management information and support

Performance analysis in terms of: - Competitiveness - Quality - Flexibility - Innovation - Resource utilisation

FINANCIAL ACCOUNTING INFORMATION SYSTEM

(FAIS) Main focus: - Historical (results) - Financial values - Internal - Mainly holistic

Is of limited use for managers

- Based on Accounting and Financial Standards (GAAP) - Designed for external users: - Shareholders: - existing - potential investors - The loan group: - bankers - creditors - suppliers - Business advisors (those people advising others on how to invest) - Employees: - present - potential recruits - past (if receiving a pension from the company) - Government agencies, such as - the Inland Revenue - the Customers and Excise (re VAT) - Other interested parties

MAIS/SMAIS

Fully supported by information systems and information technology and purpose designed systems Main focus on ‘continuous improvement’

Use of sophisticated forecasting methods:

Environmental analysis: - Social factors - Legal factors - Economic factors - Political factors - Technological factors - Competitive analysis - Customer/consumer (market) research

* Note: SMAIS is ‘Strategic Management Accounting Information

System’

Financial Accounting Information System (FAIS)

Management Accounting Information System (MAIS)

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Fact Sheet: Modern Management Accounting Information Systems (MAIS)

Information designed for: - Strategic management - Tactical (‘executive’) management - Operational (‘action’) management





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Weaknesses of traditional management accounting information systems (MAISs)

Orthodox (traditional or conventional) MAIS have failed to remain relevant in the face of changing business environments and management needs. Weaknesses include the following:

D Delays in the production of reports. The system is based on ‘periodical’ (e.g. monthly) or ‘batch’ reports.

A Aggregated information is reported, i.e. totals. This can be misleading for managers. What is the difference, say, between a $5,000(A) variance in one month and a $5,200 (A) in the next month, as far as the manager is concerned?

T Timeframe of reports is mainly historical (results based). Not much business ‘intelligence’ gathering is facilitated.

A Attention is placed on ‘What?’ and much less focus placed on the important questions of ‘How?’ and ‘Why?’.

F Financial orientation. The translation of events into money surrogates causes delays, inaccuracies and misinterpretation.

A Attention placed on feedback control (reactive management) – little focus is placed on feedforward needs (proactive management).

I Inflexibility – systems relate to ‘programmed decisions’ and the production of structured/routine reports.

L Lack of attention is placed on what causes overhead costs – thus resulting in the reporting of misleading information concerning this significant (and rising) cost.

U Unhelpful variances reported in cybernetic control systems, e.g. traditional standard costing variances which are inappropriate.

R Reports and information are mainly designed for operational managers – little attention is placed on the needs of strategic management.

E External (environmental) factors, such as customers [market] and competitors are given low priority. The main concentration is on internal performance reports based on internal data sources.

Memory jog: Remember the problem with using traditional management accounting systems and techniques is that they often result in a ‘DATA FAILURE’.





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Fact Sheet: Finance function within a large company/group

BOARD OF DIRECTORS CHAIRMAN CHIEF EXECUTIVE

OPERATIONS DIRECTOR

DIRECTOR OF FINANCE

MARKETING DIRECTOR

FINANCIAL CONTROLLER

FINANCIAL ACCOUNTING

MANAGEMENT ACCOUNTING

PAYROLL AND TAXES

INFORMATION PROCESSING

INTERNAL AUDIT AND REVIEW

TREASURER

FINANCIAL PLANNING AND FUND-RAISING MANAGER

CASH MANAGER

CAPITAL EXPENDITURE MANAGER

CREDIT MANAGER

PORTFOLIO MANAGER

TAX MANAGER

Notice the two main divisions within the finance department of a large organisation. Management accountants normally report to the ‘Financial Controller’ of the department.





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Business environment

COST ACCOUNTING

SYSTEM

Often maintained as a integral apart of the Financial

Accounting System

MANAGEMENT ACCOUNTING INFORMATION

SYSTEM

Specialist software

Tactical

Operational

Strategic

Decision making Control of decisions Analytical

Interpretation

Routine (periodic) reports

Special (ad hoc) reports

Cost data

Costing methods Costing techniques

Inventory account

Wages account

Work-in-progress account

Overhead account

Finished Goods

account

Cost of Goods Sold

account

Operating Profit/Loss

account

Conventional accounts Responsibility of management accountants

Other internal data

External data

Control systems

Performance appraisal Internal audit

Risk appraisal and

management

Main responsibilities of management accountants

Source Documents

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Fact Sheet: Management Accounting Information System (MAIS)

Management accountants usually maintain their own accounts within a computer-based accounting system that also contains the necessary financial accounts. Traditionally, this was referred to as ‘Cost accounting’





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COST DATA

JOB PRODUCTION JOB COSTING

BATCH PRODUCTION BATCH COSTING

CONTRACT PRODUCTION

CONTRACT COSTING

NON-MANUFACTURING

CONCERN

NON-MANUFACTURING

COSTING

PROCESS PRODUCTION

PROCESS COSTING

JOINT AND BY-PRODUCT

PRODUCTION

JOINT AND BY-PRODUCT COSTING

MANAGEMENT DECISIONS

MANAGEMENT CONTROL

- Single identifiable unit. - General purpose machinery (machine set-ups etc.). - More ‘craft skill’ required. - Complex production planning and control. - Complex production logistics. - Separate identifiable group of similar units. - Maintains a separate identity throughout the different production processes. - General purpose machinery (machine set-ups between batches). - Similar to ‘job’ but often takes more than one year to complete. - Usually the work is performed away from the company’s premises. - Many cost items normally classified as overhead are treated as ‘direct’ costs. - Price of contract is agreed in advance. - Contract provides for ‘stage-payments’. - There may be penalties for over-run. - Mining - Farming - Merchandising - Service provision. - Continuous nature of the production process – oil refining, manufacture of soap, paper, foods, drinks, chemicals, etc. - Two or more products output from the same processing operation which are indistinguishable up to their point of separation.

Specific Order Costing

Continuous Operation Costing

The aim is to identify the average cost of a series of similar cost objects (units) over a period of time of

This method involves specific orders by ‘external’ customers, OR jobs, batches, etc. identified ‘internally’ (usually products made for finished goods inventory)

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Note that a type of costing system is contingent on the method or mode of production.

Fact Sheet: Modes of production and associated methods of management accounting





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The elements of management: Planning Controlling Organising Motivating Decision making

Planning and

decision making

Managers need to be aware of their objectives which may be short-term and/or long term be aware of the problems they face and their significance and consequence consider optional courses of action evaluate the options to decide which is best make a decision

Strategic management

Tactical (executive) management

Operational management

Levels of decision making

Controlling

Controls are based on plans/decisions Results are monitored (recorded) Periodically, often monthly, results are compared with the objectives of the plans/decisions Variances (the difference between the objectives and results) are calculated The variances are investigated for cause, significance, future consequence and to identify potential remedy Corrective (control) action is planned: - to change the plan or objective, or - bring the activity into line with the plan/objective

Organising

Managers: need to plan their objectives and decide the work required to achieve them decide what decisions will need to be taken in the work need to break the work into manageable tasks link people with tasks, which might require recruitment issue ‘Terms of Reference’ (job descriptions, procedure instructions, etc). train the people involved, as required plan to coordinate the different activities

Motivating

Managers will try to motivate individuals to work hard towards achieving their personal objectives and work assignments motivate groups/teams of people

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Paper 5 is concerned with management accounting’ – so we ought to remember the responsibilities of the managers who are supported by the management accountants!

Fact Sheet: Main roles of the manager





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CORPORATE STRATEGY

TACTICAL PLANS

OPERATIONAL PLANS

ORGANISATION

DECISION FRAMEWORK

Corporate strategy concerns: - Decisions made by senior management. - Product-market portfolio - Major tactical manoeuvres, such as ‘green field’, acquisition, forming business alliances. - Major marketing decisions. One member of the Board is usually the Finance Director.

Tactical decisions are the responsibility of different functional (departmental) executives aimed at achieving the intended business strategies. One such functional area is the Finance Department and the Treasury Manager would be an example of an executive working in the Finance Department. Operational decisions regulate day-to-day activities designed to implement corporate policy and tactical plans. In the Finance Department, operational decisions are concerned with ledger accounting, payroll, credit control, cash management and the like.

FINANCIAL MANAGEMENT

- Strategic investment decisions (SIDs) - Capital structure - Dividend policy - Long-term financing - Portfolio management - Risk reduction

- Medium- and short-term financing - Short-term financial decision making, including - budgetary control - project planning and control - Foreign exchange management - Financing working capital investment - Budgetary control, standard costing and variance analysis - Cash management - Working capital management

Eureaka! (I’ve got it!) Archimedes 287 – 212 B.C. Vitruvius Pollio, De Architectura, ix. 215

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Fact Sheet: Strategic, tactical and operational financial management

It is useful to see how financial strategy, tactics and day-to-day operations link to management decision-making.





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The role of ‘Strategic Management Accounting’

A strategic management accounting information system (SMAIS) should provide information to senior management at all stages of the strategic management process – strategic review, identifying and evaluating optional plans, setting goals, monitoring results and adapting plans. The SMAIS would involve the following:

S Strategic decisions.

T Timely and external data.

A Appropriate internal performance measures.

M Monitoring systems.

P Prediction systems.

O Objectives based on broad goals.

F Feedback and feed-forward based on internal performances and external events.

Memory jog: an effective SMAIS will put a ‘STAMP OF’ value on the information provided to senior (strategic) management.

“Far too many managers have lost sight of the basics, in our opinion: quick action, service to customers, practical innovation, and the fact that you can’t get any of these without virtually everyone’s commitment.”





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Direct materials Variable with ‘object’ (e.g. product) Direct labour Variable with ‘object’ (e.g. product) Direct expenses Variable with ‘object’ (e.g. product) Variable production overhead Variable with ‘object’ (e.g. product)

Variable costs are incremental, thus they are MARGINAL

Production overhead costs

TOTAL PRODUCTION

COSTS

Direct costs

Fixed production overhead

Fixed in the period concerned. (All fixed costs are period costs: rent, rates, insurance, depreciation, etc.)

Absorption costing

Marginal costing

Fixed production overhead costs are absorbed into ‘cost objects’ (e.g. products), and thus inventory. Adjustment is made for over- or under-absorption (recovery)

Fixed production overhead costs are treated as a period costs. Costs are NOT absorbed into ‘cost objects’ (e.g. products) but instead the FULL fixed production overhead costs are charged to the period’s costing profit and loss account

For control purposes variable production overhead costs can be regarded as 1. variable with time (such as extra lighting costs caused by overtime) so ultimately it varies with the level of production (the overtime is used to produce products) 2. variable with output of cost objects’ (e.g. products) such as oil used in multi-functional equipment

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Fact Sheet: Accounting for fixed production overhead costs

Remember, there are TWO main ways of accounting for fixed overheads: (i) absorption costing, and (ii) marginal costing. There are two main types of absorption costing: (i) traditional absorption (ii) activity based costing (ABC)





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1. Identify the area of work from which costs need to be absorbed.

2. Identify each of the separate activities on which the overhead costs are incurred.

3. Each activity is termed a ‘Cost Pool’. 4. Trace the costs of overheads to the

activities. (Because it is the activities which cause the costs, such costs should be direct with the minimum of apportionment

being necessary). 5. For each activity it is necessary to

identify one cost driver. (The cost driver is what causes the overhead cost to increase or reduce, and there should only be one cost driver per activity).

6. Determine the number of cost driver transactions for the period under review, either on a historic basis (unusual) or on a budget (future plan) basis (common).

7. Calculate the cost per ‘cost driver’ (by dividing the result of Stage 4 by the results of Stage 6).

8. Absorb overhead costs into the jobs/ products on the basis of the use of the cost driver transactions of each.

Fact Sheet: Activity Based Techniques

ACTIVITY BASED

COSTING (ABC)

ACTIVITY BASED BUDGETING

(ABB)

ACTIVITY BASED MANAGEMENT

(ABM)

ACTIVITY BASED PERFORMANCE

INDICATORS

ACTIVITY ANALYSIS

AREA OF WORK (ACTIVITY)

Cost control focus 1. Establish size and growth of the cost. 2. Consider the competitiveness of

methods (for which cost is attributed). 3. Analyse cost behaviour in respect of: - costs drivers - economies or diseconomies - learning (or spillover) from one industry to another) - the pattern of capacity utilisation as it affects fixed costs.

Types of activity 1. CORE or PRIMARY ACTIVITY is one that adds value to a product/service. 2. SECONDARY ACTIVITY is one that supports a core activity. 3. DIVERSIONARY ACTIVITIES do not add failure and are symptoms of failure within the organisation.

Remember the significance of overhead in modern industry – so frequent questions on ABC can be expected.





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Fact Sheet: The Activity Based Costing (ABC) system - Overview

A modern approach for calculating product costs is activity based costing which emphasises the need to obtain a better understanding of the behaviour of overhead costs and in doing so ascertains what causes cost. ABC is an accounting method that allows businesses to gather data about their operating costs. Costs are assigned to specific activities - such as planning, engineering, or manufacturing - and then the activities are associated with different products or services. In this way, the ABC method enables a business to decide which products, services and resources are increasing their profitability, and which are contributing to losses. Managers are then able to generate data to create a better budget and gain a greater overall understanding of the expenses that are required to keep the company running smoothly. Activity-based costing first gained prominence in the 1980s. It emerged as a logical alternative to traditional cost management systems that tended to produce insufficient results when it came to allocating costs. Harvard Business School Professor Robert Kaplan was an early advocator of the ABC system. While mainly used for private businesses, ABC has also been used in public forums, such as those that measure government efficiency. Assumptions underlying ABC The assumptions underlying ABC are: (a) activities consume resources; (b) the consumption of resources drives cost; (c) products, services and other cost objects use activities; (d) although some overhead costs are variable in the short term, in the long-run, all overhead costs are variable; however, many overhead costs do not necessarily vary with production volume or service level.

Definition: Activity based costing (ABC) An approach to costing and monitoring of activities which involves tracing resource consumption and costing final outputs. Resources are assigned to activities and activities to cost objects based on consumption estimates. The latter utilise cost drivers to attach End of definition

Example A 'set up' is the work needed at the end of one job or batch of work to get the production process ready for the next job or batch. An example would be the need to change the colour of paint in a paint machine between the manufacture of one batch of products and a batch of different products. The paint machine would need to be closed down, stripped, cleaned and then the new (required) paint put into the machine before the new production starts. It is obvious that the overhead cost involved (including the machine downtime cost) would be the same regardless of the number (volume) of products involved in the new batch. End of Example





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There are four main steps in establishing and implementing a system of activity-based costing: Step 1 Identify the major activities in the organisation. Examples include machine-related activities (such as machining cost centres), direct labour-related activities (like assembly departments) and various support activities such as ordering, receiving, materials handling, parts administration, production scheduling, packing and dispatching. Step 2 Identify factors which influence the cost of a particular activity. The term 'cost driver' is used to describe the events or forces that are the significant determinants of the cost of the activities. For example, if a production scheduling cost is caused by the number of production runs each product generates, the number of set-ups would represent the cost driver for production scheduling. (i) Cost behaviour must be understood ABC recognises that cost behaviour is dictated by cost drivers and therefore the tracing of overhead costs to products requires that cost behaviour must be understood to identify appropriate cost drivers. Examples of some of the cost drivers used by ABC systems include: - the number of receiving orders for the receiving department, - the number of production runs undertaken for scheduling and set-up costs, - the number of purchase orders for the cost of operating the purchasing department, and - the number of dispatch orders for the dispatch department. (ii) Volume related cost drivers are appropriate in some cases For those costs which are purely variable with output in the short term, ABC systems use volume-related cost drivers such as direct labour hours or machine hours. An example is power costs charged to products using machine hours as the cost driver; it is the machine hours that drive the consumption of power. If production volume increased by 10%, the consumption cost and the number of machine hours would also increase by 10%. Step 3 A cost pool is created for each activity, e.g. total cost of all set ups might constitute one cost pool for all costs related to the set-ups. Step 4 The cost of each activity is traced to products according to the product's usage of these activities during the production process (using cost drivers as a measure of demand). This is measured by the number of cost-driver transactions which the product uses.

Definitions Activity cost pool. A grouping of all cost elements associated with an activity. Activity driver. A measure of the frequency and intensity of the demands placed on activities by cost objects. For example, the number of customer orders measures the consumption of order entry activities by each customer. Activity driver analysis. The identification and evaluation of the activity drivers used to trace the cost of activities to cost objects. It may also involve selecting activity drivers with potential to contribute to the management accounting function with particular reference to cost reduction. Cost driver. Any factor which causes a change in the cost of an activity, e.g. the quality of parts received by an activity is a determining factor in the work required by that activity and therefore affects the resources required. An activity may have multiple cost drivers associated with it. End of Definitions

Fact Sheet: The steps in Activity Based Costing (ABC)





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Benefits of using activity based costing (ABC) The use of ABC methods offers a number of benefits:

Q Quality management is aided. One important aspect of quality is to remove waste (non-value- adding activity) from processes. With ABC, waste, such as idle time can be identified as an activity, highlighted, costed and efforts be made to reduce it.

U Understanding of cost by managers is improved. By using ABC managers are made aware of how the overhead is spent. Questions are prompted: How can this cost be reduced? What has been the growth of this costs and why? And so on.

E Efficient cost control. The essence of effective control rests on ‘controllability’. The concept of overhead cost drivers more precisely defines a manager’s authority and thus responsibility for the cost. (With orthodox systems ‘fixed overhead’ is regarded as being ‘uncontrollable’ by individual managers.)

S Support activities (which comprise a significant part of fixed overhead cost) are identified and better controlled.

T Takes account of fixed overhead costs into the calculation of ‘profitability’ (the ‘cost-volume- profit’ algorithm). Traditionally profitability has been measured by ‘contribution’ and fixed costs (which can represent 80% - 90% of the total cost) has been ignored (as ‘not relevant’).

M Make or buy decisions rest on a comparison of ‘relevant costs’. With ABC it is argued that fixed overhead costs are relevant because the decision may cause a change in the overhead cost, certainly in the medium term.

A Accountability of managers becomes defined. When managers make decisions that affect the use of cost drivers they become responsible for their actions and can thus be held accountable.

D Design of products/services can be done in ways that ‘design out’ the higher costs caused by the use of cost drivers.

E Effective product pricing, when price is set on the basis of ‘full cost plus mark-up’. It is argued, that by burdening the product with fixed cost on the basis of cost-diver usage, the ABC system more accurately traces fixed costs to products.

Memory jog: Remember by using ABC a ‘QUEST’ is ‘MADE’ to improve decisions and reduce and control costs.

Practice question on ABC related topics: Spring Company Page 313.





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In a business organisation, the ABC methodology assigns an organisation's resource costs through activities to the products and services provided to its customers. It is generally used as a tool for understanding product and customer cost and profitability. As such, ABC has predominantly been used to support strategic decisions such as pricing, outsourcing and identification and measurement of process improvement initiatives. However there are people who argue against the use of ABC. For example, in 1998, Kaplan stated that ‘ABC has stagnated over the last five to seven years’. The main criticisms directed against introducing an ABC system are listed below.

M Many overheads are not suitable for ABC. Some people have questioned the fundamental assumption that activity causes cost, suggesting that it could be argued that decisions cause cost, or the passage of time causes cost, or that there may be no one clear cause of cost.

A Arbitrary cost apportionment may still be necessary. Even in activity-based costing, some overhead costs are difficult to assign to products and customers, for example the chief executive's salary. These costs are termed 'business sustaining' and are not assigned to products and customers because there is no meaningful method. This lump of unallocated overhead costs must nevertheless be met by contributions from each of the products, but it is not as large as the overhead costs before ABC is employed. Although some may argue that costs untraceable to activities should be "arbitrarily allocated" to products, it is important to realise that the only purpose of ABC is to provide information to management. Therefore, there is no reason to assign any cost in an arbitrary manner.

N No one clear cause of cost can be identified. Many overheads relate neither to volume or to complexity and diversity. The ability of a single cost driver to fully explain the cost behaviour of all items in its associated pool is questionable.

I Information required. One of the principal problems of ABC is that it may be difficult to collect the information required to enable ABC to be introduced. The various activities within the organisation need to be established (possibly by using observation and employee interviews) and cost drivers identified. A database of activities, their occurrence, their cost and cost drivers needs to be set up. This is a huge wealth of information which may not have been recorded before. Information collection and retrieval systems may therefore need to be expanded and improved.

C Costs involved. Although developments in information technology and software allow for more sophisticated information systems, the cost of the required changes and improvements may outweigh the anticipated benefits of ABC and make its introduction unsuitable. ABC has been found to be a very high-cost accounting technology. Installing an ABC system is technically complex, requiring talented personnel and a considerable amount of time and money , and whether it is good value is questioned. Lean accounting methods have been developed in recent years to provide relevant and thorough accounting, control, and measurement systems without the complex and highly wasteful methods of ABC. Lean Accounting takes an opposite direction from ABC by working to eliminate cost allocations rather than find complicated methods of allocation. While lean accounting is primarily used within lean manufacturing, the approach has proven useful in many other areas including healthcare, construction, financial services, government, and other industries.

Criticisms of introducing an activity based costing (ABC) system

Memory jog: companies should not be too ‘MANIC’ in their enthusiasm to introduce an ABC system





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When is activity based costing relevant? Activity-based costing could provide more meaningful information about product costs and profits when:

C Complex products or services are involved.

O Overhead costs are related to products/customers, not volume;

S Some products or services are sold in large numbers but others are sold in small numbers.

T Tailored made products. Where products or services are tailored to product/service specifications, as in the case of job costing.

S Significant service overhead costs exist which are not easily assigned to individual products. In such cases, ABC will usually result in significantly different product or service overhead charges, compared with traditional absorption costing.

Memory jog: ABC is a method of sharing overhead ‘COSTS’ between products or services.

How often have I said to you that when you have eliminated the impossible, whatever remains, however improbable, must be the truth. Sherlock Holmes Arthur Conan Doyle, 1859 - 1930





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Fact Sheet: Lean Accounting

Lean Accounting is not specifically mentioned in the syllabus – although the presence of back-flush accounting, life-cycle accounting and throughput accounting infer that it is being questioned. Anyway, it is not a bad idea to mention it in the exam simply to communicate to the examiner that you are interested in the subject and are up-to-date with your knowledge.

What is Lean Accounting? Lean accounting is accounting for the lean enterprise. It seeks to move from traditional cost accounting to a system that measures and motivates good business practices in the lean enterprise. Why is Lean Accounting Needed? Everybody working seriously on the lean transformation of their company eventually bumps up against their accounting systems. It soon becomes clear that traditional accounting systems are actively anti-lean: • They are large, complex, and wasteful processes requiring huge amounts of non-value work. • They provide measurements and reports like labour efficiency and overhead absorption that motivate large batch production and high inventory levels; the opposite of lean-goals. • The traditional accounting systems have no good way to identify the financial impact of the lean improvements taking place throughout the company. On the contrary, the financial reports will often show that bad things are happening when very good lean change is being made . • Very few people in the company understand the reports that emanate from the accounting systems, and yet they are used to make important and far-reaching decisions. • They use standard product costs which are misleading when making decisions related to quoting, profitability, make/buy, sourcing, product rationalisation, and so forth. The Vision for Lean Accounting 1. Provide accurate, timely and understandable information to motivate the lean transformation throughout the organization, and for decision-making leading to increased customer value, growth, profitability, and cash flow. 2. Use lean tools to eliminate waste from the accounting processes while maintaining thorough financial control. 3. Fully comply with generally accepted accounting principles (GAAP), external reporting regulations, and internal reporting requirements. 4. Support the lean culture by motivating investment in people, providing information that is relevant and actionable, and empowers continuous improvement at every level of the organisation.





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A "cost driver" is the unit of an activity that causes the change of an activity cost. A cost driver is any activity that causes a cost to be incurred. The Activity Based Costing (ABC) approach relates indirect cost to the activities that drive them to be incurred. In traditional costing the cost driver to allocate indirect cost to cost objects was volume of output. With the change in business structures, technology and thereby cost structures it was found that the volume of output was not the only cost driver. Advocates of activity-based techniques have also suggested three ways of classifying cost drivers.

D Duration drivers. In this case, the cost of the activity is not so much affected by the number of times the action is undertaken as by the length of time that it takes to perform the action, e.g. set- up costs may not be related to the number of set-ups so much as to the set-up time, because some products involve more complicated and time consuming set-ups than others.

I Transaction drivers. Here, the cost of an activity is affected by the number of times a particular action is undertaken. Examples would include the number of set-ups, number of power drill operations, number of batches of material received, number of purchase orders, etc.

T Intensity drivers. In this case, efforts would be directed at determining what resources were used in the making of a product or service, e.g. rather than charging all purchase orders with the same cost per order, we might determine that overseas orders involve more work than home orders and apply a weighting to the overseas orders to reflect the extra work.

Cost drivers used in activity based costing

Memory jog: ‘DIT’ is not a difficult word to remember – it is almost poetical! (One meaning of DIT is ‘a poem, or words of a song’ – Chambers 20th Century Dictionary.)

Be proud of everything that is unique about you. Remember …. “Every bee’s honey is sweet.” French proverb





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Linacre Co operates an activity-based costing system and has forecast the following information for next year. Cost Pool Cost Cost Driver Number of Drivers Production set-ups $105,000 Set-ups 300 Product testing $300,000 Tests 1,500 Component supply and storage $25,000 Component orders 500 Customer orders and delivery $112,500 Customer orders 1,000 General fixed overheads such as lighting and heating, which cannot be linked to any specific activity, are expected to be $900,000 and these overheads are absorbed on a direct labour hour basis. Total direct labour hours for next year are expected to be 300,000 hours. Linacre Co expects orders for Product ZT3 next year to be 100 orders of 60 units per order and 60 orders of 50 units per order. The company holds no inventories of Product ZT3 and will need to produce the order requirement in production runs of 900 units. One order for components is placed prior to each production run. Four tests are made during each production run to ensure that quality standards are maintained. The following additional cost and profit information relates to product ZT3: Component cost: $1·00 per unit Direct labour: 10 minutes per unit at $7·80 per hour Profit mark up: 40% of total unit cost Required: (a) Calculate the activity-based recovery rates for each cost pool. (3 marks) (b) Calculate the total unit cost and selling price of Product ZT3. (8 marks) (c) Discuss the reasons why activity-based costing may be preferred to traditional absorption costing in the modern manufacturing environment. (9 marks) (20 marks)

Linacre Co: Question - 1 of 1 A question covering activity based costing

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(a) Activity-based recovery rates are found by dividing the expected cost in each cost pool by the number of cost driver transactions expected during the coming year. Cost Pool Cost Number of Drivers ABC Recovery Rate Production set-ups $105,000 300 set-ups $350·00 per set-up Product testing $300,000 1,500 tests $200·00 per test Component supply/storage $25,000 500 component orders $50·00 per order Customer orders/delivery $112,500 1,000 customer orders $112·50 per order (b) Production of product ZT3 = (100 x 60) + (60 x 50) = 9,000 units per year Number of production runs = number of set-ups = 9,000/900 = 10 set-ups Number of product tests = 10 x 4 = 40 tests Number of component orders = number of production runs = 10 orders Number of customer orders = 100 + 60 = 160 orders General overheads absorption rate = 900,000/300,000 = $3·00 per direct labour hour Annual direct labour hours for Product ZT3 = 9,000 x 10/60 = 1,500 hours Activity ABC recovery rate Number of Drivers Annual cost ($) Setting up $350·00 per set-up 10 set-ups 3,500 Product testing $200·00 per test 40 tests 8,000 Component supply $50·00 per order 10 orders 500 Customer supply $112·50 per order 160 orders 18,000 30,000 General overheads = 1,500 x $3·00 per hour = 4,500 Total annual overhead cost 34,500 Total unit cost $ Components 1·00 Direct labour = 7·80 x 10/60 = 1·30 Overheads = 34,500/9,000 = 3·83 6·13 Profit mark up 2·45 Selling price 8·58 (c) Traditional absorption costing allocates a proportion of fixed overheads (indirect costs) to product cost through an overhead absorption rate, usually based on labour hours, machine hours, or some other volume-related measure of activity. These overhead absorption rates may be factory-wide absorption rates (blanket rates) or, for increased accuracy in determining product cost, departmental absorption rates. In the traditional manufacturing environment, indirect costs constituted a relatively small proportion of total product cost compared to direct costs such as direct material cost, direct labour cost and direct expenses (collectively referred to as prime cost).

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Linacre Co: Answer - 1 of 2 A question covering activity based costing

(For our Fact Sheet on ABC Page 47.)

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Q ©Tony Surridge Online Limited, 2012




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The modern manufacturing environment In the modern manufacturing environment, indirect costs constitute a relatively high proportion of total product cost. There are several reasons for this. Modern manufacturing is characterised by shorter and more frequent production runs rather than continuous or high volume production runs. This increases the frequency of production line set-ups and therefore the total cost arising from set-up activity. Widespread use of computer control and automation has decreased the importance and use of direct labour. Direct labour cost as a proportion of total cost has therefore declined. This decline has been accelerated by the use of salaried employees rather than staff whose wages depend on production output, transferring labour costs from a direct cost to an indirect cost. Increased use of just-in-time production methods and customer-led manufacture has led to quality control costs and production planning costs forming a higher proportion of total cost. These costs relate to particular production runs rather than to manufacture as a whole. (For our Fact Sheet: Modern Industry - Page 30.) Activities and costs Traditional absorption costing, by employing volume-related overhead absorption rates, failed to take account of the relationship between costs, activities and products. The insight at the heart of activity-based costing is that it is activities that incur costs and products that consume activities. Analysis of the way in which products consume activities allows the overhead costs incurred by those activities to be related to product cost using cost drivers derived from those activities rather than using production volume-related overhead absorption rates. For example, set-up costs under traditional absorption costing could have been allocated to product cost using an overhead absorption rate based on machine hours. This would transfer a disproportionate amount of set-up costs to high volume products, which in fact gave rise to fewer set-ups because of their longer production runs. If set-up costs were transferred using number of set-ups as the cost driver, a fairer allocation of set-up costs would be achieved and products with longer production runs would not be penalised with a disproportionate share of their indirect costs. Improved cost control Activity-based costing can lead to more detailed product cost information because a larger number of ABC cost drivers are likely to be identified in a given manufacturing organisation. An average of fifteen ABC cost drivers tends to be used, compared with one or two overhead absorption rates in traditional absorption costing. This more detailed product cost information can lead to improved cost control, since managers can seek to control costs by controlling the activities that cause the costs to be incurred. Production scheduling, for example, can optimise the number of production runs in order to minimise set-up costs. Better information on product profitability Since product cost information is more accurate, managers have more accurate information on the relative profitability of individual products. This can lead to better decisions on product promotion and pricing, since managers can promote higher margin products while seeking to improve margins on products where margins are lower. Activity-based budgeting Budget planning and formulation can use an activity-based approach to determining the required level of support activities, rather than an incremental approach based on prior year figures. With activity-based budgeting, the required level of production is used to determine the required number of cost driver transactions (e.g. number of set-ups), which in turn are used to determine the level of support activity that must be budgeted for (e.g. number of set-up engineers). In this way managers can seek to identify and eliminate any unnecessary slack in support activities, thereby improving efficiency and profitability. 33

Linacre Co: Answer - 2 of 2 A question covering activity based costing Q

Q ©Tony Surridge Online Limited, 2012




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Note: some pages notated as ‘Chart’ consist of discussion sheets.

Title Page SPECIALIST COST AND MANAGEMENT ACCOUNTING TECHNIQUES 29

Chart Modern industry 30 Chart Traditional versus modern Industry 32

Mnemonic Modern industry 33 Mnemonic Modern organisation structures 34

Chart Modern industry: some effects of market fragmentation 35 Chart Management accounting versus financial accounting 36 Chart Modern Management Accounting Information Systems

(MAIS) 37

Mnemonic Weaknesses of traditional MAISs 38 Chart Finance function within a large company/group 39 Chart Management Accounting Information System (MAIS) 40 Chart Modes of production and associated methods of

management accounting 41

Chart Main roles of the manager 42 Mnemonic The role of ‘Strategic Management Accounting’ 44

Chart Accounting for fixed production overhead costs 45 Chart Activity based techniques 46 Chart The Activity Based Costing (ABC) system – Overview 47

Mnemonic Benefits of using activity based costing (ABC) 49 Mnemonic Criticisms of introducing an ABC system 50 Mnemonic When is activity based costing relevant? 51

Chart Lean Accounting 52 Mnemonic Cost drivers used in activity based costing 53

Chart Target costing – Overview 54 Chart Traditional cost management versus target cost

management 56

Mnemonic The underlying philosophy of target costing 57 Chart Case study: Target costing 58 Chart Target costing – new product 61 Chart New-product target costing 62

Mnemonic The ‘cost reduction’ management approach 63 Mnemonic Cost reduction techniques 64

Chart Life Cycle Costing (LCC) – Overview 65 Chart Life-Cycle Costing (LCC) 66 Chart Costs and expenditures of the product-life cycle 67

Mnemonic Benefits of using Life Cycle Costing (LCC) 68 Chart Throughput Accounting (TA): Overview 69 Chart The concepts of throughput accounting 70 Chart Throughput accounting: A summary 71 Chart Example of a bottleneck constraint in a factory 72 Chart Theory Of Constraints (TOC) and the use of the Five Focusing

Steps 73

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Title Page SPECIALIST COST AND MANAGEMENT ACCOUNTING TECHNIQUES 29

Mnemonc Constraints on throughput 74 Mnemonic Assessment of throughput accounting (TA) 75

Chart Distinctions between throughput costing and orthodox cost accounting

76

Mnemonic Environmental accounting: Direct and indirect costs 77 Mnemonic Environmental accounting: Contingent or intangible environment

costs 78

Chart Environmental accounting: Environmental accounting procedures 79 Chart Environmental reports and communications- the two main roles 80

Mnemonic Environmental accounting: Environmental reports and communications

81

Mnemonic Environmental accounting: Objectives of environmental accounting 82 DECISION-MAKING TECHNIQUES 83

Mnemonic Benefits of identifying and understanding costs 84 Mnemonic Classification of costs 85

Chart Function of costs 86 Mnemonic Factors that influence cost behaviour 87 Mnemonic Assumptions underlying breakeven calculations 88 Mnemonics Applications of break-even charts 89

Chart Rules for short-term cost-based decision making 90 Mnemonic Limitations of the linear programming model 91

Chart Pricing strategy: Overview 92 Chart Examples of pricing objectives 93

Mnemonic Factors that influence a company’s pricing strategy 94 Mnemonic Determinants of price elasticity of demand 95

Chart Price elasticity of demand 96 Chart Linear approximation of a curvilinear function 97 Chart Marginal revenue and marginal costs 98

Mnemonic Analysing competitors’ costs, prices and offers 99 Chart Cost-based pricing strategies 100 Chart Cost-based pricing strategies 101

Mnemonic Cost-based pricing strategies: cost variables 104 Chart Demand-based pricing strategies 105 Chart Demand-based pricing strategies 106 Chart Differential calculus 110 Chart The decision cycle 112 Chart Appropriateness of Relevant Costing 113 Chart Relevant costs 114 Chart Relevant costs 115

Mnemonic The qualitative (non-financial) issues surrounding make versus buy decisions

117

Mnemonic The financial issues surrounding make versus but decisions 118 Mnemonic The qualitative (non-financial) issues surrounding the ‘stay

open or close’ decision 119

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Title Page SPECIALIST COST AND MANAGEMENT ACCOUNTING TECHNIQUES 83 Mnemonic The financial (monetary) issues surrounding the ‘stay open

or close’ decision 120

Chart Maximax, maximin and minimax regret techniques 121 Chart Probability and expected values 125

Mnemonic Problems of using expected values in budgeting 131 Chart Using decision tree analysis 132

Mnemonic Benefits of using decision tree analysis 133 Mnemonic Limitations of using decision tree analysis 134

BUDGETING 135 Chart Budgetary control – The main areas of study 136 Chart Budgets and budgetary control 137 Chart Role of the Budget Officer 138 Chart Budgetary control procedures 139 Chart Budgetary control feedback loop 140

Mnemonic Principles of responsibility accounting 141 Chart A structure for ‘Responsibility Accounting’ 142 Chart Terms used in ‘Responsibility Accounting’ and the role of the

management accountant 143

Chart Examples of cost responsibilities 144 Mnemonic Benefits of ‘Responsibility Accounting’ 145 Mnemonic Problems associated with ‘Responsibility Accounting’ 146 Mnemonic Advantages of budgetary control 147 Mnemonic Stages involved in a budgetary control system 148

Chart Cybernetic control systems 149 Chart Cybernetic control: Feedback 152

Mnemonic Problems when using a ‘closed feedback control loop’ 153 Chart Cybernetic control: feed-forward 154

Mnemonic Feed-forward control 155 Chart Top-down and Bottom-up budgeting 156 Chart Bottom-up planning: a caution 157 Chart Example of a bottom-up budgetary control system in a

manufacturing concern 158

Chart Example of an incremental budget plan as part of an incremental budgeting system

165

Mnemonic Justification for using the incremental (periodic) budgeting approach

166

Mnemonic Disadvantages of using the incremental (periodic) budgeting approach

167

Chart Zero-based budgeting (ZBB) 168 Chart Example of a ‘Mutually-exclusive decision package’ as part of

a zero-based budgeting system 171

Mnemonic Justification for using the zero-based budgeting (ZBB) approach

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Title Page BUDGETING 135

Mnemonic Disadvantages associated with the zero-based budgeting (ZBB) approach

176

Chart Activity-based budgeting (ABB) 177 Chart Example of an activity cost matrix for a sales order department

as part of an activity-based budgeting (ABB) system 178

Mnemonic Justification for using the activity-based budgeting (ABB) approach

179

Chart Rolling budgets 180 Mnemonic Justification for using the rolling budgeting approach 181 Mnemonic Disadvantages associated with rolling budgets 182

Chart Overviews of incremental budgeting and zero-based budgeting 183 Chart Overviews of activity-based budgeting and rolling budgets 184

Mnemonic Ways of implementing a change to a company’s budgeting system

185

Mnemonic Difficulties of changing a budget system 186 Mnemonic Constraints and limiting factors in budget planning 187

Chart Chilgrove Co: Opening Financial Position (Balance Sheet) 188 Mnemonic Factors considered in preparing the Sales Budget 189

Chart Chilgrove Co: Sales Budget 190 Chart Production Budget (including Chilgrove Co.) 191 Chart Direct Materials Cost Budget (including Chilgrove Co.) 192 Chart Direct Labour Cost Budget (including Chilgrove Co.) 193 Chart Plant Utilisation Budget 194 Chart Production Overhead Budget (including Chilgrove Co.) 194 Chart Selling and Administration Budget (including Chilgrove Co.) 195 Chart Research and Development Budget 196 Chart Master Budget 197 Chart Cash Budget (including Chilgrove Co.) 198 Chart Budgeted Income Statement (including Chilgrove Co.) 199 Chart Budgeted Financial Position (Balance Sheet) (including Chilgrove) 200

Mnemonic Reasons for having a budgeted financial position (balance sheet) - for closing date - as part of the ‘Master budget’)

201

Chart Problems with budgetary control 202 Chart Quantitative ways of separating fixed and variable costs 203

Mnemonic Problems with using the high-low method of cost estimation 204 Chart Scattergraph: example 205

Mnemonic Flexing a budget 206 Chart Correlation analysis 207 Chart Time-series analysis 210 Chart Forecasting seasons: additive method 211 Chart Forecasting seasons: proportional method 212 Chart The distinction between additive and proportional models 213

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Title Page BUDGETING 135

Chart Learning curve 214 Mnemonic Uses for the learning curve 216 Mnemonic Potential problems associated with the learning curve 217 Mnemonic Difficulties of budget forecasting 218 Mnemonic Assumptions made in the budget planning stage 219 Mnemonic Aides to budget forecasting 220 Mnemonic Factors which affect the degree of forecasting success 221 Mnemonic Evaluation of forecasting techniques 222 Mnemonic Sources and causes of forecasting errors 223 Mnemonic Ways of reducing forecasting errors 224 Mnemonic Behavioural problems of using participation in budgetary control

system 225

Mnemonic Pre-requisites for a successful participatory budgetary control system

226

Mnemonic Resolution of budget conflict 227 Mnemonic Reasons why budget-holders set difficult to achieve budgets 228 Mnemonic Reasons why budget-holders set easy to achieve budgets 229 Mnemonic Ways that budget-centre managers use to ‘hide’ slack in budgets 230 Mnemonic Reasons why ‘budget slack’ should be accepted 231 Mnemonic Problems with accepting ‘budget slack’ 232 Mnemonic ‘ Technical’ problems with budgetary control 233 Mnemonic Difficulties of budget forecasting 234 Mnemonic Benefits of using spreadsheets in budgeting 235 Mnemonic Dangers inherent in using spreadsheets in budgeting 236

STANDARD COSTING AND VARIANCE ANALYSIS 237 Chart Typical standard costing and variance analysis system 238 Chart Example of a ‘unit standard cost’ 239

Mnemonic Classification of standards 240 Mnemonic Purposes of using standard costing and variance analysis 241 Mnemonic Problems associated with conventional standard costing and variance

analysis 242

Chart Basic standard costing variances 243 Chart Idle time variance 244 Chart Example of an operating control report (absorption costing) 247 Chart Example of an operating report (including mix and yield

variances) 248

Chart Example of an operating report (marginal costing) 249 Chart Problems with traditional standard costing variances 250

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Title Page STANDARD COSTING AND VARIANCE ANALSYSIS 237

Chart Possible causes of sales and cost variance 251 Chart Possible interrelationships between variances 252

Mnemonic General causes of variances 253 Chart Investigation of variances 254

Mnemonic Policy for investigation of variances 255 Chart Policy for investigation of variances 256 Chart Control chart based on materiality of deviation = 10% of standard 258 Chart Control chart based on materiality of deviation = 10% of standard 259 Chart Control chart based on statistical significance of 95% 260

Mnemonic Ways of improving manufacturing labour efficiency (productivity) 261 Mnemonic Causes for idle time in a manufacturing system 262

Chart Planning and operating variances: Market size and market share variances

263

Chart Steps for producing a performance report using planning and operational variances

265

Chart Example of an operating report (planning/operational variances) 266 PERFORMANCE MEASUREMENT AND CONTROL 267

Chart Performance measurement 268 Chart Hierarchy of objectives 269 Chart Example of Statement for QualTech Design Co. 270 Chart Examples of Goal Statements for QualTech Design Co. 270 Chart Examples of Objective Statements for QualTech Design Co. 271 Chart Examples of Critical Success Factors 272 Chart Examples of Performance Indicators for QualTech Design Co. 273 Chart Performance Pyramid 274

Mnemonic Main financial measures 275 Chart Value for Money 276 Chart Measuring performance in a hospital 277 Chart Benchmarking 278

Mnemonic Benefits of business benchmarking 279 Chart Kaplan and Norton’s ‘Balanced Scorecard’ 280 Chart Two levels of strategic management 281

Mnemonic Role of head office 282 Mnemonic Responsibilities of divisional managers 283

Chart The divisional decision structure 284 Chart Different group structures 285

Mnemonic Concept of ‘Principal-agency Theory’ applied to divisional structures 286

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Title Page PERFORMANCE MEASUREMENT AND CONTROL 267

Mnemonic Criteria used for measuring management performance 287 Mnemonic Problems in trying to achieve goal congruence 288 Mnemonic Performance indicators commonly used for measuring the

performance of divisional management 289

Mnemonic Advantages of the ROI performance measure 290 Mnemonic Limitations of the ROI performance measure 291 Mnemonic Management aspects over which management claim they lack

controllability 292

Mnemonic Putting divisional managers back in control 293 Mnemonic Bases used for comparing performances 294 Mnemonic Critical success factors for achieving customer satisfaction 295 Mnemonic Success factors for a strategic management information system

(SMAIS) 296

Mnemonic The critical success factors for just-in-time (JIT) management 297 Mnemonic The aims of transfer pricing between divisions 298 Mnemonic Main problems with transfer pricing 299

Chart Types of cost-based transfer price 300 Chart Transfer price based on a variable (marginal) cost 301

Mnemonic Problems with market-based transfer prices 302 Mnemonic Problems with selling to the intermediate market 303 Mnemonic Factors related to negotiated transfer prices 304

Chart The basis for negotiating a transfer price 305 Chart Dual transfer pricing 306 Chart Dual transfer pricing: A numerical example 307 Chart The framework for deciding a transfer price 309 Chart The rules of transfer pricing 310

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Complementary Questions and Answers (Note: These Questions and Answers are also hyper-linked from appropriate teaching screens.)

Title Page Question Spring Company

A question covering activity based costing and the use of performance measures

312

Answer Spring company 313 Question Linacre Company

A question covering activity based costing. 317

Answer Linacre Company 318 Question Edward Limited

A question covering Target Costing 320

Answer Edward Limited 322 Question HYC

A question covering throughput accounting. 326

Answer HYC 328 Question Yam Co

A question covering throughput costing. 330

Answer Yam Co 331 Question Wargrin

A question covering life-cycle costing. 333

Answer Wargrin 334 Question JD Company

A question covering limiting factor analysis and the make or buy decision.

337

Answer JD Company 339 Question A divisional decision

A question concerning a close down or stay open decision. 341

Answer A divisional decision 342 Question A company manufacturing agricultural machinery

A question covering product mix decision and make or buy. 344

Answer A company manufacturing agricultural machinery 345 Question A four-product company

A question covering Graphical Linear Programming. 347

Answer A four-product company 348 Question Small service company

A question covering simulation modelling. 354

Answer Small service company 355 Question Union Cars Company

A question covering a decision concerning uncertain outcomes. 356

Answer Union Cars Company 357 Question Knight Rider Manufacturing Company

Decision concerning uncertain outcomes. 359

Answer Knight Rider Manufacturing Company 361

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Complementary Questions and Answers Page 311 (Note: These Questions and Answers are also hyper-linked from appropriate teaching screens.)

Title Page Question Responsibility accounting

A question covering budgetary control and performance analysis. 367

Answer Responsibility accounting 368 Question Sine Company

A question covering the planning of a budget 371

Answer Sine Company 372 Question Spike Company

A question covering budget revisions. 374

Answer Spike Company 376 Question Budgeting systems

A question covering budget theory. 379

Answer Budgeting systems 380 Question Wisko

A question covering flexible budgeting. 383

Answer Wisko 385 Question Mermus Company

A question covering flexible budgeting and budget variances. 386

Answer Mermus Company 387 Question Additiv Company

A question covering moving averages and the Additive and Proportional methods of seasonal adjustment.

389

Answer Additiv Company 390 Question Seabrook Company

A question covering the use of the learning curve to set standard costs

396

Answer Seabrook Company 397 Question Different types of standard

A question covering the theory of standard costing 401

Answer Different types of standard 402 Question Ash Company

A question covering standard costing variances 404

Answer Ash Company 405 Question Vogum Company

A question covering basic variance analysis including mix and yield, which requires operating reports using both absorption and marginal costing

408

Answer Vogum Company 409 Question Alk Company

A question covering planning and operating variance analysis 416

Answer Alk Company 417

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Complementary Questions and Answers (Note: These Questions and Answers are also hyper-linked from appropriate teaching screens.)

Title Page Question Lympne Conglomerates

A question covering market volume and market share variances 423

Answer Lympne Conglomerates 424 Question Woodside Charity

A question covering budget variances for a non-profit making organisation

425

Answer Woodside Charity 426 Question CAS Company

A question covering return on investment (ROI) and residual income (RI) measures

429

Answer CAS Company 430 Question Bridgewater Co

Divisional performance measurement 433

Answer Bridgewater Co 435 Question Ties Only Company

Small company performance measurement 438

Answer Ties Only Company 440 Question MAS Company

A question covering transfer pricing 443

Answer MAS Company 444

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THIS FORMULA SHEET IS PROVIDED IN THE

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Formulae Sheet Learning curve Y = axb Where Y = cumulative average time per unit to produce x units a = the time taken for the first unit of output x = the cumulative number of units b = the index of learning (log LR/log 2) LR = the learning rate as a decimal Regression analysis Demand curve

2bQ - a MR

0 Q when price a

quantityin changepricein change b

bQ - a P

=

==

=

=

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y)( - n)( - xnn

nxb -

ny a

)( - xnn b

bx a y

ΣΣΣΣ

ΣΣ−Σ=

ΣΣ=

ΣΣΣΣ−Σ

=

+=

yxyxxyr

xyxxy





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