F5 – Performance Management
ACCAPAPER F5
PERFORMANCE MANAGEMENTJUNE 2011 REVISION CLASS
ACCAPAPER F5
PERFORMANCE MANAGEMENTJUNE 2011 REVISION CLASS
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JUNE 2011 REVISION CLASSJUNE 2011 REVISION CLASS
Prepared by
Gbenga Okubadejo
AMG
PROFESSIONALS
Gbenga Okubadejo
F5 - Management accounting 2
F5 – Performance Management
� To provide a revision tool to students writing paper F5
� To provide exam focus study that saves time
Presentation Objective
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F5 – Performance Management
Outline
� F2 revision
� Modern management accounting
� Cost volume profit (CVP) analysis
� The Concept of limiting factor analysis
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� Pricing decisions
� Short-term decisions
� Risk and uncertainty
� Budget and budgetary control
� Quantitative analysis in budgeting
� Standard costing and variance analysis
� Performance measurement
F5 – Performance Management
1 F2 – Management accounting revisionF2 – Management accounting revision
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F5 – Performance Management
Introduction to Management accounting
Costing is the process of determining the cost of products, services or activities. Methods
include absorption costing and process costing.
Direct cost = D.M + D.L + D. EXP
All direct production costs are referred to as PRIME COSTS.
F2 – Management Accounting gave the background to paper f5. It is better you’re confident with the concepts and techniques learnt at the lower level.
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Addition of all indirect costs = Overheads.
Direct + indirect = Total factor cost.
Absorption costing is a method of sharing out overheads incurred amongst units produced. It
follows three processes:
�Allocation
�Apportionment
�Absorption: may lead to under/over absorbed overhead
F5 – Performance Management
F2 revision
�When sales fluctuate because of seasonality in sales demand but production is held constant, absorption costing avoids large fluctuations in profit.
For absorptionFor absorption
�It shows how an organisation's cash flows and profits are affected by changes in sales volumes since contribution varies in direct proportion to units sold.� By using absorption costing
For marginal costingFor marginal costing1 2
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fluctuations in profit.� Prices based on marginal cost (minimum prices) does not guarantee profit.�Absorption recognisesthat all costs are variable in the long run.�It is the method allowed by accounting standards.
� By using absorption costing and setting a production level greater than sales demand, profits can be manipulated.�Total costs need separation for decision making� For short-run decisions in which fixed costs do not change, fixed costs are irrelevant.
F5 – Performance Management
2 Modern management accounting techniquesModern management accounting techniques
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Activity based costing (ABC)
Target costing
Life cycle costing
Throughput accounting
Environmental accounting
F5 – Performance Management
Activity based costing (ABC)
Steps to follow in ABC1Identify major activities.
2 Identify cost drivers (factors which determine thesize of an activity/cause the costs of an activity).
3 Collect costs associated with each activity intocost pools.4 Charge costs to products on the basis of thenumber of an activity’s cost driver they generate.
Cost drivers
Why ACT is not enough
�One basis of absorption – volume
�Companies now produce variety
of Products
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Cost drivers•Volume related (eg labour hrs) for costs that vary
with production volume in the short term (eg power
costs)
• Transactions in support departments for other costs
(eg No of visit for site supervisor costs)
of Products
�May hide inefficiency.
�Allocate more ohds to
volume-based product
F5 – Performance ManagementTarget costing
�Involves setting a target cost by subtracting adesired profit margin from a competitive marketprice� The target cost may be less that the initialproduct cost but it is expected to be achievedby the time the product reaches maturity�There is a focus on price-led costing, customer
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�There is a focus on price-led costing, customerrequirements and designSteps in target costiing1. Do market research to obtain a competitive price2. Determine the required magin3. Cal. target cost = estimated SP – req’d margin4. Compare the estimated costs with the target5. Cost gap exists if estimated > target.
F5 – Performance Management
Life cycle costing
This method tracks and accumulates costs
and revenues over a product’s entire life. This cycle include
1. Development 2. Introduction 3. Growth 4.Maturity 5. Decline
1. Design costs out of products
Maximising returns over the product life cycle
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1. Design costs out of products
2. Minimise the time to market
3. Minimise breakeven time
4. Maximise the length of the life span
5. Minimise product proliferation
6. Manage the product’s cashflows
F5 – Performance Management
Life cycle costing
Sales
Sales Volume
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Introduction Growth Maturity Decline
Profit
Time
F5 – Performance Management
Throughput accounting
� In the short run, all costs except materials are fixed
� In a JIT environment, the ideal inventory level is zero. So unavoidable, idle
capacity in some operations must be accepted
� The factory spends money when goods are produced and a product makes money
when it sold. Overall profitability is determined by how fast the product makes money
compare to how the factory spends.
Throughput accounting ratio
Basic concept of throughput
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Throughput accounting ratio= Return per factory hour
Total conversion cost per factory hour
TPAR > 1 = Continue Product
TPAR < 1 = Cease Product
Before cessation, consider other qualitative factors. Or consider working on the
product for TPAR to > 1.
F5 – Performance Management
Environmental management accounting (EMA)
The generation and analysis of both financial and
non-financial information in order to support
environmental management processes.
Definition
Typical environmental costs
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Typical environmental costs
�Consumables and raw materials�Transport and travel�Waste and effluent disposal�Water consumption�Energy
Importance
�Identifying environmental costs associated
with individual products and services can
�assist with pricing decisions
� Ensuring compliance with regulatory
standards
� Potential for cost savings
F5 – Performance Management
Cost volume profit (CVP analysis)
How to calculate a multi-product breakeven point
1. Calculate the contribution per unit.
2. Calculate the contribution per mix.
3. Calculate the breakeven point in number of mixes.
4. Calculate the breakeven point in units and revenue.
How to calculate a multi-product C/S (or profit volume or P/V) ratio
Calculation of breakeven sales:Calculation of breakeven sales:
1. Calculate the revenue per mix.
2. Calculate the contribution per mix.
3. Calculate the average C/S ratio.
4. Calculate the total breakeven point.
5. Calculate the revenue ratio per mix.
6. Calculate the breakeven sales.
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It is vital to remember that formulti-product Breakeven analysis, a constant product sales mix must be assumed.
F5 – Performance ManagementCost volume profit (CVP analysis)
Target profits
1. Calculate the contribution per mix.
2. Calculate the required number of mixes.
3. Calculate the required number of units and
4. sales revenue of each product.
Limitations of CVP analysisLimitations of CVP analysis
� It is assumed that fixed costs are the same in total and variable costs are the same per unit at all levels of output
� It is assumed that sales prices will be constant at all levels of activity
� Production and sales are assumed to be the same
� Uncertainty in estimates of fixed costs and unit variable costs is often ignored
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F5 – Performance ManagementDecision making time
“Decision making is an important aspect of the Paper F5 syllabus, and questions on this topic will be common…….but this article will focus on only one: linear programming.”
“…….The first step in any linear
programming problem is to produce the equations for constraints and the contribution function. This should
Excerpts from technical article by Geoff
Cordwell former examiner for Paper F5.
contribution function. This should not be difficult at this level.”
F5 – Performance ManagementLinear programming
Formulating the problem
Steps in linear programming
1. Define variable
2. Construct objective function
3. Establish constraints
4. Graph
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5. Find the optimal solution
There are two methods of finding the optimal solution:
1. Graphical method
2. Using equations
F5 – Performance ManagementLinear Programming
Shadow price
SurplusSlack
�Occurs when maximum availability of a
resource is not used.
�The resource is not binding at the
optimal solution. Slack is associated with
≤ constraints.
�Occurs when more than a minimum
requirement is used.
�Surplus is associated with ≥ constraints
eg a minimum production requirement
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� It is the increase in contribution created by the availability of an extra unit of a limited resource at its original cost.� It is the maximum premium an organisation should be willing to pay for an extra unit of a resource.�It provides a measure of the sensitivity of the result.�It is only valid for a small range before the constraint becomes non-binding or different resources become critical.
F5 – Performance ManagementPricing decisions
Influence on price
1. Cost
2. Demand
3. Income level
4. Competition
5. Quality perception
6. Market structure
A measure of the extent of change in market demand for a good, in response to a change in its price= change in quantity demanded, as a % of demand ÷ change in price, as a % of price
Price elasticity of demand (η)
Inelastic demand6. Market structure
7. Product life cycle
8. E.c.t.
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Inelastic demand� η < 1
� Demand falls by a smaller % than % rise in price
� Pricing decision: increase prices
Elastic demand� η > 1
� Demand falls by a larger % than % rise in price
� Pricing decision: decide whether change in cost
will be less than change in revenue.
NB: For pricing strategy to be adopted, make
reference to PED.
F5 – Performance ManagementProfit Maximisation
when Profits are maximised when
MC = MR.
Determining the profit-maximisingselling price/output level
Full cost plusAdvantages�Quick, simple, cheap method�Ensures company covers fixed costs.Disadvantages�Penetrating pricing
Other Pricing strategy
Pricing strategy
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Disadvantages�Doesn’t recognise profit maximising price and output�Budgeted output needs to beestablished�Suitable basis for overheadabsorption needed
�Penetrating pricing
�Skimming pricing
�Product-line pricing
�Complimentary pricing
F5 – Performance ManagementShort-term decisions
� Future e.g sunk not relevant
� Incremental e.g the amount by which fixed cost steps up
� Cash flows e.g provisions, notional costs, absorbed overheads not relevant.
N.B:
�Compare internal
differential production
costs with supplier’s
quotation.
�Consider other
qualitative factors
before sub-contracting
Relevant costs are Make or Buy
N.B:
1. Useful for one-off contract
2. Minimum pricing
3. The key note is “I don’t want to be worse off”. if I can’t make money then I don’t wanna loose any!
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before sub-contracting
or outsourcing
F5 – Performance ManagementShort-term decision
Further processing decision
�Determine the contribution earned on the current operation.�Calculate incremental costs and revenue�Compare the results and act accordingly.�Bear in mind that some fixed costs may Any short-term decision
Shut down decision
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�Bear in mind that some fixed costs may no longer be incurred if the decision is to shut down and they are therefore relevant to the decision.�Consider the size of the incremental contribution that would be earn.�Lastly, consider other qualitative factors e.g current brand loyalty, legal implication, social effect, accuracy of data available.
Any short-term decision must consider qualitativefactors related to the impact on employees, customers, competitors and suppliers
F5 – Performance ManagementRisk and uncertainty
The technique that a decision maker will use in dealing with risk and uncertainty will be dependent on his risk attitude.
Attitude to risk
� Risk seeker A decision maker interested in the best outcomes no matter how small the chance that they may occuroccur
� Risk neutral A decision maker concerned with what will be the most likely outcome
� Risk averse A decision maker who acts on the assumption that the worst outcome might occur
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F5 – Performance ManagementMethods of dealing with risk and uncertainty
Methods of dealing with risk and uncertainty
� Market research: Primary & secondary� Expected values (EV) - indicate what an outcome is likely to
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� Expected values (EV) - indicate what an outcome is likely to
be in the long term with repetition. The expected value will
never actually occur. EV = PR * OUTCOME� Decision rule: This involves calculation of 1. Maximax2. Maximin3. Minimax regret rule� Sensitivity analysis� Simulation� Brainstorming or scenario building
F5 – Performance ManagementBudgeting and budgetary control
� Ensure the organisation’sobjectives are achieved
� Compel planning
� Communicate ideas and plans
� Co-ordinate activities
� Provide a framework for
Objectives of a budgetary planning and control system
At the planning stage– Managers may fail to co-ordinate
plans with those of other budget
centres.
– They may build slack into expenditure
estimates.
When putting plans into action
Negative effects of budgets include
� Provide a framework for responsibility accounting
� Establish a system of control
� Motivate employees to improve their performance
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– Minimal co-operation and
communication between managers.
– Managers might try to achieve targets
but not beat them.
Using control information– Resentment, managers seeing the
information as part of a system of trying
to find fault with their work.
– Scepticism of the value of information
if it is inaccurate, too late or not
understood.
F5 – Performance ManagementBudgetary systems
Traditional budgetary systems
This involves adding a certain percentage to last
year’s budget to allow for growth and inflation. It
encourages slack and wasteful spending to creep
into budgets.
Incremental budgeting
�These are budgets which, by
recognising different cost
behaviour patterns, change as
activity levels change.
Flexible budget
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These are prepared on the basis of an estimated
volume of production and an estimated volume of
sales. No changes are made to the budgets and
are not adjusted (in retrospect) to
reflect actual activity levels.
Fixed budget
activity levels change.
� At the planning stage, flexible
budgets can be drawn up to show
the effect of the actual volumes of
output and sales differing from
budgeted volumes.
� At the end of a period, actual
results can be compared to a
flexed budget (what results should
have been at actual output and
sales volumes) as a control
procedure.
F5 – Performance Management
Zero-based budgeting
This approach treats the preparation of the budget for each period as an independent planning exercise: the initial budget is zero and every item of expenditure has to be justified in its entirety to be included. It is usually developed as a package.
Zero-based budgeting
�Identifies and
removes inefficient
and/or obsolete
operations
� Provides a
psychological impetus
Merit
usually developed as a package.
Steps in ZBB
1. Define decision packages
2. Evaluate and rank packages on the basis of their benefit to the organisation.
3. Allocate resources according to the funds available and the ranking of packages.
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psychological impetus
to employees to
avoid wasteful
expenditure
� Leads to a more
efficient allocation of
resources
F5 – Performance ManagementStandard costing
� To act as a control device (variance analysis)
� To value inventories and cost production
� To assist in setting budgets and evaluating managerial performance
� To enable the principle of
Types of standardUses of standard costing
IdealPerfect operating conditionsUnfavourable motivational impactAttainableAllowances made for inefficiencies and wastageIncentive to work harder (realistic but
� To enable the principle of ‘management by exception’ to be practiced
� To provide a prediction of future costs for use in decision-making situations
� To motivate staff and management by providing challenging targets
� To provide guidance on possible ways of improving efficiency
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Incentive to work harder (realistic but challenging)CurrentBased on current working conditionsNo motivational impactBasicUnaltered over a long period of timeUnfavourable impact on performance
F5 – Performance ManagementVariance analysis
A standard cost card will look as follows:
$/unit
Direct material (20kg@$5/kg) 100
Direct labour (10hrs@$5/hr) 50
Prime costs 150
Variable Overheads(10hrs@$10/hr) 100
Total variable cost 250
Fixed cost (10hrs@$12/hr) 120
Total factory cost 370
Profit (25% mark-up) 92.50
Selling price 462.50
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F5 – Performance ManagementReasons for variances
Material price (F) – unforeseen discounts received
(A) – price increase, careless purchasing
Material usage (F) – material used higher quality than standard
(A) – defective material, waste, theft
Labour rate (F) – use of less skilled (lower paid) workers
(A) – rate increase
Idle time (always (A)) – machine breakdown, illness
Labour efficiency (F) – better quality materials
(A) – lack of training
Overhead expenditure (F) – cost savings
(A) – excessive use of services
Overhead volume - production greater or less than budgeted
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F5 – Performance ManagementPlanning and operation
Planning variances
�Caused by adverse/favourableoperational performance�Calculated by comparing actual results with a realistic, revised standard/budget
Operational variances
Arise because of inaccurateplanning/faulty standards and sonot controllable by operationalmanagers but by senior management
Calculated by comparing an
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Calculated by comparing anoriginal standard with a revisedstandard
F5 – Performance ManagementPerformance measurement
Financial performance indicators (FPI)
Non-financial performance indicators (NFPI)
Profitability ratio
� ROCE
� Profit margin
� Sales growth
�Look at a wider range of variables� Provide information on quality and customer satisfaction� Better indicator of future
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� Asset turnover
� Liquidity ratios
� Inventory days
� Receivable days
� etc
� Better indicator of future prospects� Can be provided quickly and tailored to circumstances
F5 – Performance ManagementBalanced Scorecard
Perspective Question Explanation
Customer What do existing and new customers
value from us?
Gives rise to targets that matter to
customers: cost,
quality, delivery, inspection, handling
and so on.
Internal What processes must we excel at to
achieve our financial and customer
objectives?
Aims to improve internal processes
and decision
making.objectives? making.
Innovation andlearning
Can we continue to improve and
create
future value?
Considers the business's capacity to
maintain its competitive position
through the acquisition of new skills
and the development of new
products.
Financial How do we create value for our
shareholders?
Covers traditional measures such as
growth, profitability and shareholder
value but set through talking to the
shareholder or shareholders direct.
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F5 – Performance ManagementNot-for-profit organisations
Problem with performance measurement
� Multiple objectives
� Measuring outputs
� Lack of profit measure
�Judge performance in terms
of inputs
� Use experts’ subjective
judgment
� Use benchmarking
Suggested way out
� Lack of profit measure
� Nature of service provided
� Financial constraints
� Political, social and legal considerations
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� Use benchmarking
� Use unit cost quantitative
measures
F5 – Performance ManagementValue for money
3 E’S
Efficiency: Relationship between inputs and outputs (getting out as much as possible for what goes in)
Effectiveness: Relationship between outputs and objectives (getting done what was supposed to be done)
Economy: Obtaining the right quality and quantity of inputs at lowest cost (being frugal)
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For further reading: BPP revision kits
F5 – Performance Management