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F5 Performance Management

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Page 1: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

F5Performance Management

F5Performance Management

Page 2: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

The examThe exam

• Five compulsory questions: 20 marks each

• Time allowed: 3hours plus 15 minutes reading time

• Balance typically 50:50 between calculations and discussion aspects

Page 3: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

The examiner’s key concernsThe examiner’s key concerns

• Students need to be able to interpret any numbers they calculate and see the limitations of their financial analysis.

• In particular financial performance indicators may give a limited perspective and NFPIs are often needed to see the full picture.

• Questions will be practical and realistic, so will not dwell on unnecessary academic complications.

• Many questions will be designed so discussion aspects can be attempted even if students have struggled with calculation aspects.

Page 4: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

1. Advanced costing methods1. Advanced costing methods

• ABC.

• Target costing.

• Lifecycle costing.

• Throughput accounting.

• Environmental Accounting

Page 5: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Activity Based Costing (ABC)Activity Based Costing (ABC)

Steps

1.Identify major activities.

2.Identify appropriate cost drivers (note: you may have to justify your choice here in the exam).

3.Collect costs into pools based upon the activities.

4.Charge costs to units of production based on cost driver volume.

Page 6: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Activity Based Costing (ABC)Activity Based Costing (ABC)

Cost driver rate = total driver pool cost

cost driver volume

Page 7: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Advantages of ABCAdvantages of ABC

• More realistic costs.• Better insight into cost drivers, resulting in

better cost control.• Particularly useful where overhead costs

are a significant proportion of total costs.• ABC recognises that overhead costs are

not all related to production and sales volume.

• ABC can be applied to all overhead costs, not just production overheads.

• ABC can be used just as easily in service costing as in product costing.

Page 8: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Criticisms of ABCCriticisms of ABC

• It is impossible to allocate all overhead costs to specific activities.

• The choice of both activities and cost drivers might be inappropriate.

• ABC can be more complex to explain to the stakeholders of the costing exercise.

• The benefits obtained from ABC might not justify the costs.

Page 9: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Implications of ABCImplications of ABC

• Pricing - more realistic costs improve cost-plus pricing.

• Sales strategy - more realistic margins can help focus sales strategy.

• Decision making – for example, research and development can be directed at products with better margins.

Page 10: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Target CostingTarget Costing

Steps

1.Estimate a market driven selling price for a new product. (E.g. to capture a required market share).

2.Reduce this figure by the firm’s required level of profit. (E.g. based on target ROI).

3.Produce a target cost figure for product designers to meet.

4.Reduce costs to provide a product that meets that target cost.

Page 11: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Closing the target cost gapClosing the target cost gap

• Value analysis

• Focus is on reducing cost without compromising perceived value.

• Can labour savings be made?

• Can productivity be improved?

• What production volume is needed to achieve economies of scale?

Page 12: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Closing the target cost gap – cont.

Closing the target cost gap – cont.

• Could cost savings be made by reviewing the supply chain?

• Can any materials be eliminated?

• Can a cheaper material be substituted without affecting quality?

• Can part-assembled components be bought in to save on assembly time?

• Can the incidence of the cost drivers be reduced?

Page 13: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Implications of target costing

Implications of target costing

• Pricing – might identify sufficient cost savings to reduce the target price.

• Cost control – target cost motivates managers to find new ways of saving costs.

Page 14: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Lifecycle costingLifecycle costing

Life cycle costing

• Is the profiling of cost over a product’s life, including the pre-production stage.

• Tracks and accumulates the actual costs and revenues attributable to each product from inception to abandonment.

• Enables a product’s true profitability to be determined at the end of its economic life.

Page 15: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Implications of lifecycle costingImplications of lifecycle costing

• Pricing decisions can be based on total lifecycle costs rather than simply the costs for the current period.

• Decision making - a timetable of life cycle costs helps show what costs need to be recovered.

• Control - Lifecycle costing reinforces the importance of tight control over locked-in costs, such as R&D.

• Performance reporting - Life cycle costing costs to products over their entire life cycles, to aid comparison with product revenues generated in later periods.

Page 16: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

ThroughputThroughput

Background

• Application of key factor analysis to production bottlenecks.

• The only totally variable costs are the purchase cost of raw materials / components

• Direct labour costs are not wholly variable.

Page 17: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

ThroughputThroughput

Multi-product decisions

• Rank products by looking at the throughput per hour of bottleneck resource time

• Throughput = Revenue – Raw Material Costs

Page 18: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

ThroughputThroughput

Throughput accounting ratio (TPAR)

Throughput per hour of bottleneck resource

Operating expenses per hour of bottleneck resource

Page 19: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

ThroughputThroughput

How to improve the TPAR

• Increase the sales price to increase the throughput per unit.

• Reduce total operating expenses, to reduce the cost per hour.

• Improve productivity, reducing the time required to make each unit of product.

Page 20: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

ACCOUNTING FOR ENVIRONMENTAL COSTS

Page 21: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Management Accounting Techniques

Management Accounting Techniques

Page 22: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Break-even analysisBreak-even analysis

The Break-even chart

£

Output (units)

Fixed Costs

Breakeven

PointSales R

evenue

Total Costs

Breakeven point: The point where total costs = total

sales revenueand

Where there is neither a profit or

loss

B/E Point (units) = Fixed Costs

Contribution per Unit

Chapter 4

Page 23: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

The Margin of SafetyThe Margin of Safety

£

Fixed Costs

Total Costs

Breakeven Output

Budgeted Output

Margin of safety

The Margin of Safety represents the level by which output can fall before the organisation makes a loss

Margin of Safety = Budgeted Output – Breakeven Output

Budgeted Output

X 100%

Chapter 4

Page 24: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Contribution to Sales ratioContribution to Sales ratio

Chapter 4

Contribution to Sales Ratio (C/S ratio)=

(Contribution per unit) / Unit Sales Price

Breakeven Point in Sales Value=

Fixed Costs / C/S ratio

Sales for a certain level of profit = Fixed Costs + Required Profit

Contribution per Unit

Page 25: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Basic Breakeven chartBasic Breakeven chart

Chapter 4

0

Sales Revenue

10

20

30

Fixed Costs

40

Breakeven point

Loss

Loss

Profit

Profit

20 30 40 50 60 70 Number of units

£’000

Total Costs

Page 26: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Contribution Breakeven chartContribution Breakeven chart

Sales Revenue

10

Total Costs

Variable Costs

Breakeven point

Loss

Loss

20 30 40 50 60 70 Number of units

£’000

Profit

Profit Fixed Costs

Contribution

Chapter 4

Page 27: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

The Profit-Volume ChartThe Profit-Volume Chart

The profit-volume chart presents information in a way that clearly shows the change in the level of profit – using data from the previous data table:

0

+£5000

-£10000

1000 1500

Profit

Output

Page 30

Chapter 4

Page 28: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Contribution = Sales Value – All Variable Costs

Units 0 100 500 1000 1500

Contribution(£) 0 1000 5000 10000 15000

Fixed Costs(£) (10000) (10000) (10000) (10000) (10000)

Profit(£) (10000) (9000) (5000) 0 5000

Profit = (Contribution per unit x units) - Fixed Costs

A product has a sales price of £20 and a variable cost of £10 per unit

Contribution per unit 10 10 10 10

Profit per unit 0 (90) (10) 50

2. CVP Analysis2. CVP Analysis

Page 29: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

C/S RatioBE Point (Revenue)

=Fixed Costs

Required Revenue

=Fixed Costs = Required profit

Weighted Average C/S Ratio

Weighted Average C/S Ratio

Multi-product breakeven analysis

Multi-product breakeven analysis

Page 30: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Limitations/Assumptions of CVP

Limitations/Assumptions of CVP

Costs behaviour is assumed to be linear Revenue is assumed to be linear Volume Produced = Volume Sold Ignores inflation Assumes a constant sales mix

Chapter 4

Page 31: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

3. Planning with limited factors3. Planning with limited factors

• Key factor analysis – one resource in short supply

• Linear Programming – two or more scarce resources

Page 32: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Key factor analysisKey factor analysis

1. Calculate contribution per unit.

2. Calculate contribution per unit of the limiting factor.

3. Rank in order.

4. Allocate resources – make first up to max demand, then second,...

Page 33: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Linear programmingLinear programming

1. Define variables

2. Define the objective

3. Set out constraints

4. Draw graph showing constraints and identify the feasible region

5. Identify optimal point

6. Solve for optimal solution

7. Answer the question

Page 34: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Linear programmingLinear programming

Assumptions

• A single quantifiable objective.

• Each product always uses the same quantity of the scarce resources per unit.

• The contribution per unit is constant.

• Products are independent – e.g. sell A not B.

• The scenario is short term.

Page 35: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Linear programmingLinear programming

Slack

• Slack is the amount by which a resource is under utilized. It will occur when the optimum point does not fall on the given resource line.

Page 36: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Linear programmingLinear programming

Shadow (or dual) prices• The extra contribution that results from

having one extra unit of a scarce resource.

• The max premium (i.e. over the normal cost) that the firm should be willing to pay for one extra unit of each constraint.

• Non-critical constraints will have zero shadow prices as slack exists already.

Page 37: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Linear programmingLinear programming

Calculating dual prices

1.Add one unit to the constraint concerned, while leaving the other critical constraint unchanged.

2.Solve the revised equations to derive a new optimal solution.

3.Calculate the revised optimal contribution. The increase is the shadow price

Page 38: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Linear programmingLinear programming

Range of applicability of dual prices

• The dual price only applies as long as extra resources improve the optimal solution

• i.e. the constraint line concerned moves out increasing the size of the feasible region and moving the optimal point.

• Eventually other constraints become critical.

Page 39: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

4. Pricing4. Pricing

• Factors to consider when pricing.

• Calculation aspects.• Pricing approaches.

Page 40: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Factors to consider when pricingFactors to consider when pricing

• Costs

• Competitors

• Corporate objectives

• Customers

Page 41: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Calculation aspectsCalculation aspects

Price elasticity of demand (PED)

• PED = % change in demand / % change in price.

• PED >1 (elastic) revenue increases if the price is cut.

• PED <1 (inelastic) revenue increases if the price is raised.

Page 42: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Calculation aspectsCalculation aspects

Equation of a straight line demand curve

• P = a – bQ

• “a” = the price at which demand would fall to zero

• “b” = gradient = change in price/change in demand

• Calculate “b” first

Page 43: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Calculation aspectsCalculation aspects

Equation of a cost curve

• C = F + vQ

• Volume based discounts

Page 44: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Pricing approachesPricing approaches

• Cost plus pricing

• Price skimming

• Penetration pricing

• Linking pricing decisions for different products

• Volume discounts

• Price discrimination

• Relevant cost pricing

Page 45: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Cost plus pricingCost plus pricing

• Establish cost per unit – options include MC, TAC, prime cost

• Calculate price using target mark-up or margin

• Often used as a starting point even when using other methods

Page 46: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Cost plus pricingCost plus pricing

Advantages

• Widely used and accepted.

• Simple to calculate if costs are known.

• Selling price decision may be delegated to junior management.

• Justification for price increases.

• May encourage price stability.

Page 47: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Cost plus pricingCost plus pricing

Disadvantages

• Ignores link between price and demand.

• No attempt to establish optimum price.

• Which absorption method?

• Does not guarantee profit

• Which cost?

• Inflexibility in pricing.

• Circular reasoning.

Page 48: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Price skimmingPrice skimming

• Set a high initial price to ‘skim off’ customers who are willing to pay extra.

• Prices fall over time.

• Suitability?

Page 49: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Penetration pricingPenetration pricing

• Set a low initial price to gain market share

• If a high volume is achieved, the low price could be sustainable.

• Suitability?

Page 50: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Linking pricing decisions for different products

Linking pricing decisions for different products

• Basic idea: product A is cheap to attract customers who then also buy the higher margin product B.

• Key issue is the extent to which customer must buy the other products.

• Suitability?

Page 51: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Volume discountsVolume discounts

• Discount for individual large order.

• Cumulative quantity discounts.

• Suitability?

Page 52: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Price discriminationPrice discrimination

• Have different prices in different markets for the same product.

• Suitability?

Page 53: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Relevant cost pricingRelevant cost pricing

• Price = net incremental cash flow.

• Suitability?

Page 54: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

5. Make v buy and other shortterm decisions

5. Make v buy and other shortterm decisions

• Relevant costing principles.

• Make v buy decisions.

• Shut down decisions.

• Joint products – the further processing decision.

Page 55: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Relevant costing principlesRelevant costing principles

• Include – Future incremental cash flows.– Opportunity costs

• Exclude– Depreciation.– Sunk costs.– Unavoidable costs.– Apportioned fixed overheads.– Financing cash flows (e.g. interest).

Page 56: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Make v buyMake v buy

Decision

• Look at future incremental cash flows.

• Watch out for opportunity costs –especially whether or not spare capacity exists and alternative uses for capacity.

• Practical factors?

Page 57: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Shut down decisionsShut down decisions

Decision

• Look at future incremental cash flows.– Apportioned overheads not relevant – Closure costs – e.g. redundancies.– Alternative uses for resources?

• Practical factors?

Page 58: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Joint productsJoint products

The further processing decision

• Look at future incremental cash flows:– sell at split off v process further and then

sell.

• Pre-separation (“joint”) costs not relevant– only include post split-off aspects.

Page 59: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

6. Risk and uncertainty6. Risk and uncertainty

• Basic concepts.

• Research techniques.

• Scenario planning.

• Simulation.

• Expected values.

• Sensitivity.

• Payoff tables.

Page 60: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Basic conceptsBasic concepts

• Risk = variability in future returns.

• Investors’ risk aversion

• Upside v downside

• Risk v uncertainty

• Risk = probability x impact

Page 61: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Research techniquesResearch techniques

• Desk research– Company records.– General economic intelligence.– Specific market data.

• Field research– Opinion v motivation v measurement– Questionnaires, experiments, observation.– Group interviews, triad testing, focus

groups.

Page 62: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Scenario planningScenario planning

1 Identify high-impact, high-uncertainty factors.

2 Identify different possible futures.

3 Identify consistent future scenarios.

4 “Write the scenario”.

5 For each scenario identify and assess possible courses of action for the firm.

6 Monitor reality.

7 Revise scenarios and strategic options

Page 63: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

SimulationSimulation

1 Apply probabilities to key factors in scenario analysis.

2 Use random numbers to select a particular scenario and calculate outcome.

3 Repeat until build up a picture of possible outcomes

4 Make decision based on risk aversion.

Page 64: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Expected valuesExpected values

• EV = Σ outcome × probability.

• Make decision based on best EV.

Page 65: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Expected valuesExpected values

Advantages

• Recognises that there are several possible outcomes.

• Enables the probability of the different outcomes to be taken into account.

• Leads directly to a simple optimising decision rule.

• Calculations are relatively simple.

Page 66: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Expected valuesExpected values

Disadvantages

• probabilities used are subjective.

• EV is the average payoff. Not useful for one-off decisions.

• EV gives no indication of risk

• Ignores the investor’s attitude to risk.

Page 67: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

SensitivitySensitivity

• Identify key variables by calculating how much an estimate can change before the decision reverses.

• Can only vary one estimate at a time.

Page 68: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Payoff tablesPayoff tables

• Prepare table of profits based on different decision choices and different possible scenarios.

• Four different ways of making a decision.– 1 Expected values– 2 Maximax– 3 Maximin– 4 Minimax regret

Page 69: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Decision TreesDecision Trees

A diagrammatic representation of a multi-decision problem, where all possible courses of action are represented, and every possible outcome of each course of action is shown.

Decision trees should be used where a problem involves a series of decisions being made and several outcomes arise during the decision-making process.

Decision trees force the decision maker to consider the logical sequence of events. A complex problem is broken down into smaller, easier to handle sections.

The financial outcomes and probabilities are shown separately, and the decision tree is ‘rolled back’ by calculating expected values and making decisions.

Page 70: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

7. Budgeting I7. Budgeting I

• The purposes of budgeting.

• Budgets and performance management.

• The behavioural aspects of budgeting.

• Conflicting objectives.

Page 71: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

The purpose of budgetsThe purpose of budgets

• Forecasting

• Planning

• Control

• Communication

• Co-ordination

• Evaluation

• Motivation

• Authorisation and delegation

Page 72: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Budgets and performancemanagement

Budgets and performancemanagement

Responsibility accounting

• Responsibility accounting divides the organisation into budget centres, each of which has a manager who is responsible for its performance.

• The budget is the target against which the performance of the budget centre or the manager is measured.

Page 73: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Management by exceptionManagement by exception

1 Set up standard costs, prepare budgets and set targets.

2 Measure actual.

3 Compare actual to budget (e.g. via variances).

4 Investigate reasons for differences and take action.

Page 74: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Behavioural aspects of budgetingBehavioural aspects of budgeting

Key issues– Dysfunctional behaviour – want goal

congruence.– Budgetary slack.

Management styles (Hopwood)– Budget constrained– Profit conscious – Non-accounting

Page 75: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Target setting and motivationTarget setting and motivation

• Expectations v aspirations

• Ideal target?

• Targets should be:– communicated in advance– dependent on controllable factors – based on quantifiable factors– linked to appropriate rewards – chosen to ensure goal congruence.

Page 76: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Participation Participation

Advantages of participative budgets

• Increased motivation

• Should contain better information,

• Increases managers’ understanding and commitment

• Better communication

• Senior managers can concentrate on strategy.

Page 77: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

ParticipationParticipation

Disadvantages of participative budgets

• Loss of control

• Inexperienced managers

• Budgets not in line with objectives

• Budget preparation slower and disputes can arise

• Budgetary slack

• Certain environments may preclude participation

Page 78: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Conflicting objectivesConflicting objectives

• Company v division

• Division v division

• Short-termism

• Individualism

Page 79: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

8. Budgeting II8. Budgeting II

• Rolling v periodic.

• Incremental budgeting.

• Zero based budgeting (ZBB).

• Activity based budgeting (ABB).

• Feedforward control.

• Flexible budgeting.

• Selecting a budgetary system.

• Dealing with uncertainty.

• Use of spreadsheets.

Page 80: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Rolling v periodic budgetingRolling v periodic budgeting

Periodic budgets

• The budget is prepared for typically one year at a time. No alterations once the budget has been set.

• Suitable for stable businesses where forecasting is easy and where tight control is not necessary.

Page 81: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Rolling v periodic budgetingRolling v periodic budgeting

Rolling (continuous) budgets

• A budget kept continuously up to date by adding another accounting period when the earliest period has expired.

• Aim: to keep tight control and always have an accurate budget for the next 12 months.

• Suitable if accurate forecasts cannot be made, or if need tight control.

Page 82: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Incremental budgetingIncremental budgeting

• Start with the previous period’s budget or actual results and add (or subtract) an incremental amount to cover inflation and other known changes.

• Suitable for stable businesses where costs are not expected to change significantly. There should be good cost control and limited discretionary costs.

Page 83: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Zero based budgetingZero based budgeting

Preparing a budget from a zero base, justifying all expenditure.

1 Identify all possible services and then cost each service (decision packages)

2 Rank the decision packages

3 Identify the level of funding that will be allocated to the department.

4 Use up the funds in order of the ranking until exhausted.

Page 84: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Activity based budgetingActivity based budgeting

• Use ABC for budgeting purposes:1 Identify cost pools and cost drivers.

2 Calculate a budgeted cost driver rate

3 Produce a budget for each department or product by multiplying the budgeted cost driver rate by the expected usage.

Page 85: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Feed forward controlFeed forward control

• Feed-forward control is defined as the ‘forecasting of differences between actual and planned outcomes and the implementation of actions before the event, to avoid such differences.

• E.g. using a cash-flow budget to forecast a funding problem and as a result arranging a higher overdraft well in advance of the problem.

Page 86: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Flexible budgetingFlexible budgeting

• Fixed Budgets

• Flexible Budgets

• Flexed Budgets

Page 87: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Selecting a budgetary systemSelecting a budgetary system

Determinants

• Type of organisation.

• Type of industry.

• Type of product and product range.

• Culture of the organisation.

Page 88: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Changing a budgetary systemChanging a budgetary system

Factors to consider

• Time consuming

• Are suitably trained staff are available to implement the change successfully?

• Management time

• Training needs.

• Cost v benefits for the new system:

Page 89: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Incorporating risk and uncertaintyIncorporating risk and uncertainty

• Flexible budgeting.

• Rolling budgets.

• Scenario planning.

• Sensitivity analysis.

• “What if” analysis using spreadsheets

Page 90: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

9. Quantitative analysis9. Quantitative analysis

• High-low.

• Regression and correlation.

• Time series analysis.

• Learning curves.

Page 91: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

High-lowHigh-low

1: Select the highest and lowest activity levels, and their costs.

2: Find the variable cost/unit.

3: Find the fixed cost, using either level.Fixed cost = Total cost at activity level – total

variable cost.

Page 92: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Regression and correlationRegression and correlation

y = a + bx

22 x)(-xn

yx-xyn

n

xb

n

y

)y)(-y(n )x)(-xn

yx-xyn2222

r =

Page 93: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Time series analysisTime series analysis

• Four components:1 the trend

2 cyclical variations

3 seasonal variations

4 residual variations.

• Additive modelActual = Trend + Seasonal Variation

• Multiplicative modelActual = Trend x Seasonal Variation

Page 94: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Learning curvesLearning curves

• As cumulative output doubles, the cumulative average time per unit falls to a fixed % (the learning rate) of the previous average.

• Y = axb

 y = average cost per batch

a = cost of first batch

x = total number of batches produced

b = learning factor (log LR/log 2)

Page 95: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

10. Standard costing and basic variances

10. Standard costing and basic variances

• Standard costing.

• Recap of basic variances from F2.

• Labour variances with idle time.

• Variance investigation.

Page 96: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Standard costingStandard costing

• A pre-determination of what a product is expected to cost under specific working conditions.

Page 97: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Standard costingStandard costing

Advantages– Annual detailed examination– Performance appraisal– Management by exception– Simplifies bookkeeping

• Disadvantages / problems– Standards not updated– Cost– Unrealistic standards can demotivate staff

Page 98: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Types of standardTypes of standard

• Attainable

• Ideal

• Basic

• Current

Page 99: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Sales variancesSales variances

Page 100: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Material variancesMaterial variances

Page 101: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Labour variances (basic)Labour variances (basic)

Page 102: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Variable overhead variancesVariable overhead variances

Page 103: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Fixed overhead variancesFixed overhead variances

Page 104: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Labour variances with idle timeLabour variances with idle timeNo idle time budgeted for

Page 105: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Idle time budgeted forIdle time budgeted for

Page 106: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Variance investigationVariance investigation

Page 107: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

11. Advanced variances11. Advanced variances

• Materials mix and yield variances.

• Other targets for controlling production.

• Planning and operational variances.

• Modern manufacturing environments.

Page 108: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Materials mix and yield variancesMaterials mix and yield variances

• Only use where materials can be substituted for each other.

Page 109: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Other targets for controlling production processes

Other targets for controlling production processes

• Detailed timesheets, % idle time.

• Productivity, % yield, % waste.

• Quality measures e.g. reject rate.

• Average cost of inputs, output.

• Average margins.

• % on-time deliveries.

• Customer satisfaction ratings.

Page 110: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Planning and operationalvariances

Planning and operationalvariances

Page 111: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Market size and market shares variances

Market size and market shares variances

Page 112: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Planning and operating cost variances

Planning and operating cost variances

Page 113: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Modern manufacturingenvironments

Modern manufacturingenvironments

Total Quality Management (TQM)

• TQM is the continuous improvement in quality, productivity and effectiveness through a management approach focusing on both process and the product.

Page 114: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Modern manufacturingenvironments

Modern manufacturingenvironments

Just-in–time (JiT)

• JIT is a pull-based system of planning and control.

• Pulling work through the system in response to customer demand.

• Goods are only produced when they are needed.

• This eliminates large inventories of materials and finished goods.

Page 115: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

12. Performance measurement and control

12. Performance measurement and control

• Ratio analysis.

• NFPIs.

• Behavioural considerations.

Page 116: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Ratio analysisRatio analysis

Preliminaries

• Ratios may not be representative of the position throughout a period.

• Need a basis for comparison.

• Ratios can be manipulated

• Ratios indicate areas for further investigation rather than giving answers.

Page 117: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Profitability ratiosProfitability ratios

• ROCE = Operating Profit x 100%

Capital Employed• Gross margin = Gross profit x 100%

Sales• Net margin = Net profit x 100%

Sales• Asset turnover = Sales / capital employed

• ROCE = asset turnover x net margin

Page 118: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Liquidity / working capital ratiosLiquidity / working capital ratios

• Current ratio = current assets / current liabilities

• Quick ratio = quick assets/ current liabilities

Quick assets = current assets – inventory

• Receivables days = receivables / sales x 365• Payables days = payables / purchases x 365• Inventory days = inventory / cost of sales x 365

Page 119: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Ratios to measure riskRatios to measure risk

• Financial gearing = debt/equity• Financial gearing = debt / (debt + equity)

• Dividend cover = PAT / total dividend• Interest cover = PBIT / interest

• Operating gearing = fixed costs / variable costs• Operating gearing = contribution / PBIT

Page 120: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Non-financial performanceindicators

Non-financial performanceindicators

• Financial performance appraisal often reveals the ultimate effects of operational factors and decisions but non-financial indicators are needed to monitor causes.

• Critical success factors often non-financial

• Stakeholder objectives may also be non-financial

Page 121: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

The balanced scorecard(Kaplan and Norton)

The balanced scorecard(Kaplan and Norton)

Page 122: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

The building block model (Fitzgerald et al)

The building block model (Fitzgerald et al)

Page 123: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Behavioural aspectsBehavioural aspects

• Measures designed to assess performance should:– provide incentives to promote goal

congruence.– only incorporate factors for which the

manager can be held responsible.– recognise both financial and non financial

aspects of performance.– recognise longer-term, as well as short

term, objectives.

Page 124: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Behavioural aspectsBehavioural aspects

• Potential problems with inappropriate measures– manipulation of information provided by

managers– demotivation and stress-related conflict– excessive concern for control of short term

costs, possibly at the expense of longer-term profitability.

Page 125: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

• Transfer pricing.

• Divisional performance measurement.

13. Transfer pricing and 13. Transfer pricing and divisional divisional

Performance measurementPerformance measurement

Page 126: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Transfer pricingTransfer pricing

Objectives

• Goal congruence

• Performance measurement.

• Autonomy.

• Minimising global tax liability.

• To record the movement of goods and services.

• Fair split of profit between divisions.

Page 127: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Transfer pricing - Exam questionsTransfer pricing

- Exam questionsWill often be given a TP and asked to

comment. Look at the following.

• Implications for divisional performance – e.g. is a target ROI achieved?

• Resulting manager behaviour - does it give dysfunctional decision making – e.g. will a manager reject a new product that is acceptable to the company as a whole?

Page 128: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Transfer pricing - General rule

Transfer pricing - General rule

• TP = marginal cost + opportunity cost

• In a perfectly competitive market, TP = market price.

• If spare capacity exists,TP = marginal cost.

• With production constraints,TP = marginal cost + opportunity cost of not

using those resources elsewhere.

Page 129: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Practical transfer pricing systems

Practical transfer pricing systems

• Market price• Production cost + mark-up • Negotiation

Page 130: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Divisional performancemeasurement

Divisional performancemeasurement

Key considerations

• Manager or division?

• Type of division.– Cost centre– Profit centre– Investment centre

Page 131: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Return on Investment (ROI)Return on Investment (ROI)

Page 132: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Residual Income (RI)Residual Income (RI)

RI = Pre tax controllable profits – imputed charge for controllable invested capital

Page 133: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

14. Performance measurement in not-for-profit organisations

14. Performance measurement in not-for-profit organisations

• Objectives.

• Performance Measurement.

Page 134: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

ObjectivesObjectives

Planning for NFPs usually more complex.

• Multiple objectives

• Difficult to quantify objectives

• Conflicts between stakeholders

• Difficult to measure performance

• Different ways to achieve the same objective

• Objectives may be politically driven

Page 135: F5 Performance Management. The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50

Performance measurementPerformance measurement

Value for money (VFM)

• Effectiveness

• Efficiency

• Economy