p5 - final

Final Assessment

KAPLAN PUBLISHING of 9

ACCA FINAL ASSESSMENT

Advanced Performance Management

QUESTION PAPER Time allowed Reading time: 15 minutes Writing time: 3 hours This paper is divided into two sections Section A BOTH questions are compulsory and MUST be

answered Section B TWO questions ONLY to be answered Do not open this paper until instructed by the supervisor This question paper must not be removed from the examination hall

JUNE 2009

Kaplan Publishing/Kaplan Financial

ACCA P5 Advanced Performance Management

© Kaplan Financial Limited, 2008 All rights reserved. No part of this examination may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without prior permission from Kaplan Publishing.

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Final Assessment

SECTION A

BOTH questions are compulsory and MUST be answered QUESTION 1 John Wizard has recently won a contract to act as a financial consultant to Sportstown, a publicly owned organisation that provides a range of community services to its inhabitants. Wizard’s first brief is to prepare a report on the ‘Operating Efficiency and Financial Performance’ of the leisure centre that is owned and managed by the public body. The governing body of Sportstown has become increasingly concerned by the growing financial subsidy that it has to provide to its leisure centre. Sportstown originally owned and operated two identical leisure centres, but sold one of them in 20X0 to a private leisure company, Totaleisure, who continue to manage a successful leisure business. Totaleisure have kindly provided Wizard with recent operating and financial data to permit a comparative study to be undertaken. The two leisure centres both offer the same four activities: Squash, Swimming, Gym and Badminton. The following data and information is available for the Sportstown leisure centre and for Totaleisure: Data categorised by leisure activity for 20X6

Squash Swimming Gym Badminton

*S *T *S *T *S *T *S *T

Number of hours per day that the facility is open 12 13 10 15 12 15 6 8

% utilisation of facility + − daytime 50 20 70 40 15 25 50 40 − evening 80 85 70 80 50 85 50 60 The average number of people attending per hour who pay

6 n/a 29 n/a 20 n/a 6 n/a

Price per person per hour $4 n/a $2 n/a $3 n/a $4 n/a Annual cost savings if activity is discontinued ($000) 21 25 120 105 51 60 60 52

*S = Sportstown *T = Totaleisure + = Includes free access customers

Cost data ($000) Actual

Budget

20X5 20X6 20X6 *S *T *S *T *S *T

Salaries 450 350 500 400 550 350 Maintenance contract 150 75 200 100 200 90 Depreciation 25 50 25 50 25 50 Other costs 125 100 75 25 125 150 Loan interest None 200 None 125 None 200

*S = Sportstown *T = Totaleisure



Additional information: (1) Both leisure centres are open for 350 days per year. (2) The income of Totaleisure is derived from an annual membership fee of $500 per

person in both 20X5 and 20X6. No additional charges are made for using the facilities. (3) The membership of Totaleisure has risen from 1,700 to 2,000 between 20X5 and

20X6. The management had budgeted for membership to rise from 1,700 to 1,900 during this period.

(4) Sportstown compels its centre to offer free access of all facilities to local schools to

encourage sports development and those over 60 years of age to promote healthy living styles. It is estimated that 60% of those provided with free access would continue to use the facilities if they had to pay the standard charges to use the facilities. The remaining 40% would not use the facilities if free access were to be withdrawn. The free access users comprise 30%.

(5) Although both centres are identical in terms of the capacity, range and quality of

facilities provided, the Sportstown building is five years older than the Totaleisure premises. The realisable values of both buildings are equal to their market values which are:

20X5 20X6

Sportstown Centre $400,000 $375,000 Totaleisure $800,000 $750,000

(6) The annual subsidy to the Sportstown centre equals its financial deficit (loss) for the

year. (7) The Sportstown opening hours and hourly charges remained the same during 20X5

and 20X6. (8) The average hourly attendance during 20X5 and budgeted attendance for 20X6 for

the Sportstown centre was as follows:

20X5 Budgeted (20X6)

Squash 9 8 Swimming 31 37 Gym 23 25 Badminton 5 10

(9) With the exception of the avoidable costs identified i.e. the annual cost savings if an

activity is discontinued, all costs are generally fixed overheads. (10) The Sportstown centre had all its long-term debt repaid in full by the local authority in

19W8. It has no outstanding debts.


Final Assessment

Required: (a) Compare the operational and financial performance of the Sportstown centre and

Totaleisure. (18 marks) (b) Assess the validity of appraising their relative performance from the data made

available to you. (5 marks) (c) Make any necessary adjustments to the data used to appraise performance above in

section (a) to develop an alternative and more appropriate comparison of their financial performance. (6 marks)

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

comprehensive comparison of the financial performance of the two centres? (4 marks) (e) Traditional financial measures of performance have been criticised for not providing a

broad enough basis for the assessment of organisational performance. Identify a range of appropriate Non-Financial Performance Indicators for the leisure

centres which, when taken in conjunction with traditional financial indicators, would provide a comprehensive assessment of performance. (7 marks)

(Total: 40 marks) QUESTION 2 (a) Spiro Division is part of a vertically-integrated group of divisions all located in one

country. All divisions sell externally, and also transfer goods to other divisions within the group. Spiro Division’s performance is measured using profit before tax as a performance measure.

Required:

(i) Prepare an outline statement which shows the costs and revenue elements which should be included in the calculation of divisional profit before tax.

(5 marks)

(ii) The degree of autonomy which is allowed to divisions may affect the absolute value of profit reported.

Discuss this statement in relation to Spiro Division. (8 marks) (b) Division A makes a component, Y, which it currently transfers to division B. The

following information is available:

• Division A can sell Y externally for $25 • Division A’s variable cost of producing Y is $18 • Division A has no spare capacity • Division B can purchase component Y externally for $22.

Discuss the pricing basis on which divisions should offer to transfer goods in order that corporate profit-maximising decisions can take place. (7 marks)

(Total: 20 marks)



SECTION B

TWO questions ONLY to be answered QUESTION 3 Over the past few years, there have been a number of high profile financial scandals surrounding the reporting of company performance, and the associated role of accountants. As a consequence, organisations have been urged to consider future practice carefully. Some feel that an over-emphasis by a company on market expectations and profitability may be detrimental to its long term well-being. Such thinking has implications for the objectives of a company and the range of performance measures used both externally and internally. Required: (a) Discuss the functions that organisational objectives should fulfil strategically and the

main disadvantages of using only profit-related performance measures. (10 marks) (b) The balanced scorecard approach has been described as relating an assessment of

performance to choice of strategy through four categories of measurement. It is used by many organisations in monitoring performance. Evaluate the use of the balanced scorecard in meeting stakeholder needs and determining objectives. (10 marks)

(Total: 20 marks)


Final Assessment

QUESTION 4 Ochilpark plc has identified and defined a market in which it wishes to operate. This will provide a ‘millennium’ focus for an existing product range. Ochilpark plc has identified a number of key competitors and intends to focus on close co-operation with its customers in providing products to meet their specific design and quality requirements. Efforts will be made to improve the effectiveness of all aspects of the cycle, from product design to after-sales service to customers. This will require inputs from a number of departments in the achievement of the specific goals of the ‘millennium’ product range. Efforts will be made to improve productivity in conjunction with increased flexibility of methods. An analysis of financial and non-financial data relating to the ‘millennium’ proposal is shown in Schedule 2.1. Required: (a) (i) Prepare a table ($m) of the total costs for the ‘millennium’ proposal for each of

years 20X0, 20X1 and 20X2 (as shown in Schedule 2.1), detailing target costs, internal and external failure costs, appraisal costs and prevention costs. The following information should be used in the preparation of the analysis:

20X0 20X1 20X2

Target costs – variable (as % of sales) 40% 40% 40% – fixed (total) $2m $2m $2.5m

Internal failure costs (% of total target cost) 20% 10% 5%

External failure costs (% of total target cost) 25% 12% 5%

Appraisal costs $0.5m $0.5m $0.5m

Prevention costs $2.0m $1.0m $0.5m

(4 marks)

(ii) Explain the meaning of each of the cost classifications in (i) above and comment on their trend and inter-relationship. You should provide examples of each classification. (8 marks)

(b) Prepare an analysis (both discursive and quantitative) of the ‘millennium’ proposal for

the period 20X0 to 20X2. The analysis should use the information provided in the question, together with the data in Schedule 2.1. The analysis should contain the following:

(i) Discussion of the external effectiveness of the proposal in the context of ways

in which (1) Quality and (2) Delivery are expected to affect customer satisfaction and hence the marketing of the product. (4 marks)

(ii) Discussion of the internal efficiency of the proposal in the context of ways in

which the management of (1) Cycle time and (2) Waste are expected to affect productivity and hence the financial aspects of the proposal. (4 marks)



Schedule 2.1

‘Millennium’ proposal – estimated statistics

20X0 20X1 20X2

Total market size ($m) 120 125 130

Ochilpark plc sales ($m) 15 18 20

Ochilpark plc total costs ($m) 14.1 12.72 12.55

Ochilpark plc sundry statistics:

Production achieving design quality standards (%) 95% 97% 98%

Returns from customers as unsuitable (% of deliveries) 3.0% 1.5% 0.5%

Cost of after-sales service ($m) 1.5 1.25 1.0

Sales meeting planned delivery dates (%) 90% 95% 99%

Average cycle time (customer enquiry to delivery) (weeks) 6 5.5 5

Components scrapped in production (%) 7.5% 5.0% 2.5%

Idle machine capacity (%) 10% 6% 2%

(Total: 20 marks)


Final Assessment

QUESTION 5 SCOS Limited intends to launch a commemorative product in the UK market for the next soccer World Cup. The proposed launch date is 1 April 20X7, with an 18-month product lifecycle. Required: (a) Explain the procedures that may be followed in setting a selling price for the product

where a total cost plus profit mark-up approach is used. (6 marks) (b) Demand for the commemorative product is expected to be price dependent for the

first six months after the launch date. Thereafter, the entry of competitors into the market will lead to an agreed market price emerging, with SCOS Limited obtaining a fixed share of the market that may be above or below its production capacity. SCOS Limited intends to produce at maximum production capacity during the first six months, and thereafter produce at a level to enable demand to be satisfied with stock being run down to zero if possible.

Comment on the impact of each of the following factors when setting a launch price for the commemorative product, where profit maximisation over the life of the product is desired.

(i) Price/demand relationship. (ii) Market share. (iii) Opportunity cost/shadow price of stock. (8 marks)

(c) Comment on the relevant costs and revenues to be considered by SCOS Limited

after the World Cup has taken place if it contemplates selling residual stocks of the commemorative product after the World Cup. (6 marks)

(Total: 20 marks)


Final Assessment

KAPLAN PUBLISHING Page 1 of 18

ACCA

Paper P5

Advanced Performance Management June 2009

Final Assessment – Answers

To gain maximum benefit, do not refer to these answers until you have completed the final assessment questions and submitted them for marking.


Page 2 of 18 KAPLAN PUBLISHING

© Kaplan Financial Limited, 2008 All rights reserved. No part of this examination may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without prior permission from Kaplan Publishing.

Final Assessment


ANSWER 1 Key answer tips: Note (a) requires both operational and financial performance. Before writing your answers, plan and organise carefully. Try to group performance indicators together by main headings. One major point arising in this question is that the two companies are likely to have completely different objectives and benchmarks reflecting the fact that one is in the public sector and the other in the private sector. (a) (i) Operational performance

The longer opening hours of Totaleisure, varying from an additional 8% for Squash to 50% for swimming, provides greater access to customers and extends the potential utilisation of the facilities. The Sportstown centre generally has a higher level of facility utilisation during the day, while Totaleisure has a better utilisation during the evening. If an equal weighting is given to all activities irrespective of daytime or evening sessions, both centres have an identical utilisation ratio of 54.4%. Sportstown

54.4%8

50)507080501570(50 =+++++++

Totaleisure

54.4%8

60)858085402540(20 =+++++++

The Sportstown centre has a more balanced usage, day 46% and evening 63%, compared with Totaleisure with 31% during the day and a very high 78% in the evening. A more balanced usage is preferable in terms of the ease in managing resources and the greater probability of customer complaints arising in Totaleisure over very high usage during the evenings. The more balanced usage at the other centre is probably the consequence of the free access being mainly taken up by day users i.e. during the school day.

(ii) Financial performance

Totaleisure ($000) Sportstown ($000) 20X5 20X6 Budget 20X5 20X6 Budget

(20X6) (20X6)

Revenues 850 1,000 950 700 606.2 792.4 Less: Costs Depreciation 50 50 50 25 25 25 Salaries 350 400 350 450 500 550 Maintenance 75 100 90 150 200 200 Other costs 100 150 150 125 75 125 Loan interest 200 200 200 - - - Profit/(loss) 75 100 110 (50) (193.8) (107.6)Assets (nbv) 800 750 750 400 375 375 Profit/assets (%) 9.4 13.3 14.7 (12.5) (51.7) (28.7)Profit/sales (%) 8.8 10.0 11.7 (7.1) (32.0) (13.6)



Workings

Revenues for Totaleisure: 1,700 × 500 = $850,000 2,000 × 500 = $1,000,000 1,900 × 500 = $950,000

Revenues for Sportstown – sample calculation for 20X6 actual:

Squash 12 (opening hours)

×

6 (paying

attendance)

× 4 (price)

× 350 (days)

= $100,800

Swimming 10 × 29 × 2 × 350 = $203,000 Gym 12 × 20 × 3 × 350 = $252,000 Badminton 6 × 6 × 4 × 350 = $50,400 ________ $606,200

Totaleisure is a profitable business with both sales and profit growth. The profit ratios improved between 20X5 and 20X6 although they did not achieve those budgeted. The increase in salaries appears to be the cause of the shortfall from the budget. In contrast, the performance of Sportstown was poor and deteriorated between 20X5 and 20X6. It exceeded the budgeted deficit and experienced a decline in revenues (a shortfall of 23.5% of budget), and when allied to budget overspends in salaries and other costs, has created a cause for concern for the authority having to finance the deficit. The financial performance of Badminton at the Sportstown centre may require a more detailed analysis and an explanation as to why the revenues it generated during 20X5 and 20X6 were insufficient to recover the cost savings from discontinuing the activity i.e. the loss would be reduced if the facility were to be withdrawn.

(b) Validity of comparison

Their relative performance is difficult to assess because they operate in differing financial environments and with different constraints and obligations. Performance needs to be assessed in relation to more specific objectives of the two centres – but what are they? How are they measured? The available data is insufficient to appraise their relative performance in a detailed and satisfactory manner. We know that Totaleisure is a private company seeking profits, Sportstown wishes to reduce its financial deficit and meet a social need, and both of them can compare budgeted figures with actuals. What about the NFI’s such as customer satisfaction reports, safety standards, adherence to equal opportunity legislation, staff turnover, location and accessibility of facilities, etc?

A direct financial comparison is difficult owing to the following issues: Totaleisure have:

• higher asset value resulting in larger depreciation charges • significant interest repayments on debt • their daytime utilisation levels do not benefit the uplift provided from

subsidised asset schemes.

Final Assessment


Sportstown have:

• higher maintenance charges possibly because of older premises • the free access provision denies them income • the continuation of the badminton facility (negative contribution) would not be

sustained in a private sector business – there may be a requirement to provide a range of services although some are uneconomic.

To summarise, a valid comparison of their relative overall performance requires extensive additional information, especially in terms of NFI’s and adjustments to the available financial information.

(c) Adjustments

Totaleisure Sportstown 20X5 20X6 Budget 20X5 20X6 Budget

Original profit (loss) 75 100 110 (50) (193.8) (107.6)

Attributable income (1) − − − 180 155.9 203.8

Interest adjustment 200 200 200 − − −

Discontinuing

Uneconomic facilities (2) − − − 18 9.6 −

Operating profit after adjustments 275 300 310 148 (28.3) 96.2

(1) Estimates of attributable income from free access usage = 3/7 × 3/5 = 9/35

20X5 700 × 9/35 = 180 20X6 Actual 606.2 × 9/35 = 155.9 20X6 Budget 792.4 × 9/35 = 203.8

(2) Badminton

Income Cost Negative contribution

20X6 50,400 – 60,000 = (9,600) 20X5 42,000 – 60,000 = (18,000) Budget 84,000 – 60,000 = 24,000

Note: The individual revenues generated from the remaining three activities all exceed their respective avoidable costs (see workings from (a) and compare with avoidable costs).



(d) Further information

• Further comparative data from other centres. • Why the disparities in salary costs; efficiency differentials, staffing levels? • Is Sportstown charging market prices, or are they compelled to control price

levels by the authority? • The all-inclusive fee for Totaleisure makes it difficult to assess the financial

performance of individual facilities – can revenues be apportioned? • Revenue per employee per square foot of premises.

(e) (i) Non-financial indicators could be categorised into two groups:

Quantifiable and common • The safety and accident records. • The quality of the facilities offered e.g. cleanliness and ventilation

standards. • The accessibility of the facilities e.g. the duration of the opening

hours. • System down time e.g. the length of time to repair faulty gym

equipment. • The number of complaints. • Response times e.g. how many rings before the telephone is

answered. • Innovation and development of new activities.

(ii) Specific to the organisation and difficult to quantify:

• The centre’s contribution towards sports development in the area e.g. the achievement record of members in national and regional competitions.

• The contribution to the health of the community e.g. the participation rate by the over 50s.

• The utilisation of the centre for regional, national and international events.

• The extent of innovation and development of new activities.

Note: Other relevant comments would be accepted.

Final Assessment


MARKING GUIDE

Marks

(a) Operational performance calculations – max 4 Comments on utilisation – max 4 Revenue calculations 3 Profit/loss calculations 3 Financial ratio calculations (e.g. return on assets, gross

profit %) 4

Comments on financial performance 4 __

Maximum for part (a) 18 (b) Validity of comparisons – different objectives 2 Specific comments 3 __

5 (c) Adjustments for free usage in Sportstown 2 Interest adjustment in Totaleisure 2 Uneconomic activities 2 Profits after adjustments 2 __

Maximum for part (c) 6 (d) 1 mark per relevant comment, to a maximum of 4 (e) Award marks on merit for any sensible NFPIs. There is no

real need to split them according to the two categories given in the answer. You could use other classifications such as those suggested by Kaplan and Norton, or Fitzgerald and Moon.

Maximum marks available 7 __ Total 40 __ Marks should be awarded on merit for other valid points made.



ANSWER 2 (a) (i) The divisional profit may be calculated as follows:

$

Sales External X Inter-divisional X ___ X ___ Less: Variable costs Cost of goods sold (X) Divisional expenses (X) ___ (X) ___ Controllable contribution X Less: Controllable divisional fixed costs (X) ___ Controllable profit X Less: Head office costs (X) ___ Net profit before tax X ___

(ii) The various aspects of income and expenditure can be controlled by the

divisional management to the extent to which they will be allowed under the level of autonomy given.

• The transfer pricing policy of each division will be determined or

affected by the degree of autonomy allowed. Marginal cost may represent the transfer price under a fully directed central pricing policy.

The Spiro Division’s reported profit will therefore reduce owing to goods being transferred out, but increase owing to goods transferred in from other divisions.

• The Spiro Division may increase reported profit where complete

autonomy is given, by purchasing goods externally at a lower cost than the transfer price available.

This may not be the best action for the group, however, if spare capacity is in existence within the group’s supplying divisions.

• The degree of autonomy allowed will affect reported profit and the

level of costs incurred.

Local purchasing agreements such as a just-in-time policy may reduce costs, which would not be possible if purchasing were arranged on a group basis from head office.

Final Assessment


• The apportionment of overheads will be based upon how the functions are centralised, and this will be influenced by the level of autonomy given.

The reported profit of the Spiro Division will obviously be affected by this.

(b) The transfer pricing general rule is as follows.

Transfer price = Marginal variable cost + Any opportunity costs to the group

Any decisions made in relation to internal or external sales or purchases, when the general rule is applied, should be made from a financial point of view.

Applying this to the scenario given in the question:

In order to maximise corporate profits, Division B should purchase externally and Division A should sell externally.

The opportunity cost to the group, being the contribution of $7, would be forgone if Division A transferred to Division B.

However, what if Division A had spare capacity of component Y?

The transfer price should then be set at the variable cost amount of $18 and the component transferred.

This will maximise group profit, as B will purchase from A at a cost of $18 rather than $22 from an external source.

MARKING GUIDE Marks

(a) (i) Outline divisional profit statement: Separate external and internal sales 1 Controllable contribution 1 Controllable profit 1 Head office costs 1 Divisional profit 1 Layout 1 __

Maximum 5

(ii) Award marks on merit for relevant points made to a maximum of

8

(b) General TP principles 2 Application to Division A 5 __

7 __ Total 20 __



ANSWER 3 (a) Discussion of the functions that organisational objectives should fulfil

strategically

The acronym SMART could be used as this shows how objectives aid the business in following its business strategy, as follows: Specific Measurable Achievable Realistic Time-related

There are five main functions that objectives perform in the strategic functioning of an organisation. Planning – Objectives must be put into tangible terms, meaning that the mission is translated into actionable terms. Providing the objectives are both formal and well explained then they should be capable of measurement.

Responsibility – In order to achieve objectives, tasks should be assigned to individuals, divisions, business units and functional areas. This will mean that these groups know exactly what is expected of them. In this way strategic objectives are converted into operational objectives, offering the opportunity for increased visibility of accountability and control. Integration – Objectives communicate business priorities to managers. Clear objectives will mean that goal congruence is achieved. Motivation – By letting managers participate in the objective setting process and also by making sure the objectives are consistent and worthwhile. Evaluation – Objectives act as a measure of success of a business strategy. This is because shareholders and other stakeholder groups can look at performance reports and form an opinion as to whether the objectives are aiding the achievement of business strategy, by ensuring they are measured, corrected and controlled.

The main disadvantages of using only profit-related performance measures

Often there is an emphasis on the profit figure for private companies; this should mean that profit-based measures are the most useful measures of company performance. An example of this would be when a shareholder reads the annual reports of a plc. However, profit-based measures should only be used alongside other measures, as the use of these measures to run a business on their own has a number of disadvantages, as follows: • They are only a snapshot of a single point in time; as such they ignore trends

and other factors that may be crucial for the business to succeed. • Profit is an accounting measure, which can result in a different decision being

made than if an economic approach were used. For example in the valuation of intangibles.

Final Assessment


• Profit is open to manipulation by creative accounting, and can also be manipulated, for example in the case of profit-related bonuses.

• Profit does not really tie in very well with strategic thinking; longer term strategic thinking should use both financial and non-financial performance measures.

• They encourage short-term thinking, for example the annual profit figure in the financial reports. For example in training the best long-term policy would be investment but in the short term it costs money so would lower the profit figure.

• The profit measure does not consider the cash position of a business; there have been many instances where profitable companies have failed as a result of not having adequate liquidity.

• Profit-based measures cannot be used in all businesses, for example non-profit making companies.

• To measure the performance of products/services measures like net profit are used; however, these ignore the capital assets used in the production of the goods/service. This means that the net assets are ignored. These should be considered, as there could be opportunity costs if the assets are not being managed properly or could be used better elsewhere. Also they represent cash if they were sold, especially in situations where cash is in short supply.

• Overall objectives will not be aligned. For example, a manager may pursue an increase in profit at the expense of other divisions within the organisation.

• Not all functions within an organisation are financial, for example marketing and HR. Functions such as these are often cost not profit centres, and so the profit measure is of little value to these departments.

• Shareholders are not the only stakeholders in an organisation. These other stakeholders may have little or no use for the profit measures as a measurement of performance.

• A conflict of objectives can occur as the short-term views of shareholders will sometimes conflict with the long-term plans for the company.

(b) Brief description of the balanced scorecard approach

The balanced scorecard approach developed by Kaplan and Norton (1992, 1996) has four categories of measurement, as follows:

1 Financial performance 2 Customer perspective 3 Internal business processes 4 Learning and growth

Customer perspective To achieve our vision,

how should we appear to customers?

Financial perspective To succeed financially,

how should we appear to our shareholders?

Internal business processes To satisfy our

shareholders and customers, what business processes

must we excel at?

Learning and growth To achieve our vision,

how will we sustain our ability to change and

improve?

Vision and

strategy



The balanced scorecard gives an outline to follow and is not intended to be followed exactly; instead prioritisation can be given to additional areas such as environmental and ethical concerns.

Evaluation of how the balanced scorecard meets stakeholder needs

Stakeholders could include shareholders, other investors, management, employees, suppliers and customers. In addition there are many other parties that could be considered as stakeholders. Companies will have a large number of different types of stakeholder, and one of the best ways to ensure that company performance is aligned to the needs of all of these is to use the balanced scorecard approach. Instead of trying to simply prioritise the most important stakeholders, this approach looks at other non-financial performance measures in addition to financial measures. • The balanced scorecard (BSC) encourages communication between

stakeholder groups, as it provides a means for individuals, divisions and groups to get involved in the development of activity measures.

• The BSC gives owners more control through the use of performance targets, which will include both qualitative and quantitative measures, so supporting other performance measures present within the business. This means that through feedback behaviours can be modified in a positive way.

• The BSC acts as a mechanism of converting stakeholder expectations into performance targets, for example converting objectives into measures.

• As the BSC encourages the development of measures relating to corporate goals, this means that communication of corporate strategy occurs both within the company and to external stakeholders.

• When a company uses the BSC it produces something unique to its business, reflecting the needs of its particular stakeholders.

• The BSC encourages stakeholders to focus on the strategy of the organisation; this means that they are in a position to make judgements on the effectiveness of this strategy. This means that stakeholders can form an opinion on the effectiveness of the firm, providing the results are reported externally.

Evaluation of how the balanced scorecard helps in determining objectives When determining objectives the BSC can help in a number of ways:

• It encourages managers to choose relevant measures that tie into their objectives. During the formulation stage many ideas will be made and the most relevant of these can be selected.

• The BSC will provide management with information, which they can use to review objectives, policy formulation and achievements. If used properly it will provide users with objective and unbiased information that can be used to address all relevant areas of performance.

• It forces consideration of the question: What does our strategy mean in practice?

• It means that financial and non-financial objectives can be considered at the same time, as although the non-financial objectives are important in the short term, the financial measures should always be considered, in order to keep stakeholders happy in the long and the short term.

Final Assessment


• It encourages decision makers to think closely about many different areas of the organisation. These could be financial or non-financial, internal and external and short/medium and long term.

• It encourages the consideration of whether the organisational objectives are relevant, as it highlights factors that are crucial for the long-term success of the organisation.

• It can highlight conflicts between stakeholder groups and aids in resolving these differences.

• It encourages an holistic view, by ensuring all objectives and their measures are considered together. This will highlight areas that conflict, for example investment in training will have a short-term, negative effect on cash, but a positive effect in the long term. The BSC will mean these conflicts are highlighted and the correct course of action embarked upon.

MARKING GUIDE

Marks

(a) Strategic functions of objectives – maximum 5 Key areas that should be covered are planning, control,

motivation

Disadvantages of using only profit measures One mark per valid point to a max of 5 __

Total part (a) 10 (b) Description of balanced scorecard categories 3 Application to stakeholder needs, max 5 Determination of objectives, max 5 __

Total part (b), to a maximum of 10 __ Total 20 __ Note that this answer is much longer than students could produce in the time available.



ANSWER 4 (a) (i) Cost analysis – ‘Millennium’ proposal

20X0 20X1 20X2 $m $m $m

Target cost − variable 6.000 7.200 8.000

− fixed 2.000 2.000 2.500

Internal failure cost 1.600 0.920 0.525 External failure cost 2.000 1.104 0.525 Appraisal cost 0.500 0.500 0.500 Prevention cost 2.000 1.000 0.500 Total cost 14.100 12.724 12.550

(ii) Target cost is that which will provide the required return for the ‘millennium’

proposal. In order to achieve the target cost it is likely that Ochilpark plc will have to make some improvements over the current expected level of performance. This will include all areas in the cycle from product design to after-sales service to customers. The target variable cost is stated as 40% of sales.

The target fixed cost rises in 20X2 to $2.5m. This may represent a step-function increase due to increased activity. The cost gap between target cost and current expected cost levels might be analysed into internal and external failure costs. Internal failure costs occur when work fails to meet the design quality standards and the failure is detected before transfer to the customer. Examples will include high levels of production losses or excessive machine idle time. External failure costs occur when the product fails to reach design quality standards and failure is not detected until after transfer to the customer. An example is the free replacement of defective product units returned by the customer. Internal failure costs are expected to fall from 20% of target cost in 20X0 to 5% of target in 20X2. External failure costs are expected to fall from 25% of target cost in 20X0 to 5% in 20X2.

Appraisal and prevention costs are incurred in an effort to reduce the incidence of internal and external failure costs in order that total cost may be brought closer to the target cost. Appraisal costs are those associated with the evaluation of costs and services in the cycle in order to ensure conformance with the agreed specification. Examples include checks on design and quality negotiation procedures with customers and checks that machines are performing to specified efficiency tolerances. Prevention costs are those associated with the implementation of actions to ensure that the company reaches the quality standards for the achievement of target cost. Examples include staff training costs or fees to consultants to improve operating procedures.

Appraisal costs are expected to remain at the level of $0.5m over the three-year period 20X0 to 20X2. Prevention costs are expected to fall from $2m in 20X0 to $0.5m in 20X2. This may indicate, for example, a reduced requirement for staff training or consultancy services as improvements are achieved.

Final Assessment


(b) (i) The marketing success of the proposal is linked to the achievement of customer satisfaction. The success will require an efficient business operating system for all aspects of the cycle from product design to after-sales service to customers. Improved quality and delivery should lead to improved customer satisfaction. Schedule 2.1 shows a number of quantitative measures of the expected measurement of these factors:

Quality is expected to improve. The percentage of production achieving design quality standards is expected to rise from 95% to 98% between 20X0 and 20X2. In the same period, returns from customers for replacement or rectification should fall from 3% to 0.5% and the cost of after-sales service should fall from $1.5m to $1.0m.

Delivery efficiency improvement that is expected may be measured in terms of the increase in the percentage of goods achieving the planned delivery date. This percentage rises from 90% in 20X0 to 99% in 20X2.

(ii) The financial success of the proposal is linked to the achievement of high productivity. This should be helped through reduced cycle time and decreased levels of waste. Once again Schedule 2.1 shows a number of quantitative measures of these factors:

The average total cycle time from customer enquiry to delivery should fall from 6 weeks in 20X0 to 5 weeks in 20X2. This indicates both internal efficiency and external effectiveness.

Waste in the form of idle machine capacity is expected to fall from 10% to 2% between 20X0 and 20X2. Also, component production scrap is expected to fall from 7.5% in 20X0 to 2.5% in 20X2. These are both examples of ways in which improved productivity may be measured. Both will be linked to prevention and appraisal costs, which are intended to reduce the level of internal and external failure costs (as shown in part (a) of the answer).

MARKING GUIDE Marks (a) (i) Target variable cost 1 Internal/external failure cost (2 × ½) 1 Appraisal/prevention cost (2 × ½) 1 Overall layout and total per schedule 2.1 1 __

4 (ii) Cost classification meanings and examples (5 × 1) 5 Trend and inter-relationship 3 __

8 (b) (i) External effectiveness and quality 2 External effectiveness and delivery 2 __

4 (ii) Internal efficiency and cycle time 2 Internal efficiency and waste 2 __

4 __ Total 20 __



ANSWER 5 (a) When setting a selling price for a new product on the basis of total cost plus profit

mark-up, SCOS Limited must consider the level of material, labour and overhead cost per product unit, and the level of profit mark-up which it feels is desirable and appropriate.

A product cost specification should be prepared for the product, detailing the following:

• material input quantities and anticipated scrap/loss levels • labour/machine operations and times for each department or process through

which it will pass • estimates of material prices and labour rates which will apply.

Variable production overhead rates may already be available, and can be applied to the new product.

Where the new product is utilising existing production capacity, fixed production overhead will be absorbed at a rate per unit based on budgeted cost and budgeted activity. Administration, selling and distribution overheads may be absorbed on the basis of a budgeted percentage of production cost. Where it is recognised that the new product will incur specific additional overhead costs (such as an additional production supervisor, specially leased equipment or specific advertising expenditure), the absorption of overhead costs will be at rates different from those used for existing products in order to include these additional costs. The allocation of such additional costs over the life of the product will require an estimate of the total number of units to be produced and sold. The level of profit mark-up to be applied in reaching a selling price must be chosen. It may be that SCOS Limited has a standard mark-up which is applied to all products, having been estimated to provide a satisfactory level of return on capital employed. Alternatively, there may be a range of profit mark-up percentages which are applied, depending on the type of product and the degree of competitiveness which exists in the marketplace.

(b) Where demand is expected to be price dependent, the launch price should be set at a

level which is estimated to maximise net income to SCOS Limited.

This procedure will be more difficult to implement, owing to the change in the state of the market after the first six months. At this point, competition will lead to an agreed market price emerging, with SCOS obtaining a fixed market share which may be above or below its production capacity. We are also told that SCOS Limited intend to produce to maximum capacity during the first six months, and thereafter to produce at a level to satisfy demand.

Final Assessment


The choice of launch price will require an estimate of market share after the first six months, so that the opportunity cost (shadow price) of unsold stock at the end of the first six months may be calculated.

Where the market share after the first six months is expected to exceed production capacity, the opportunity cost (shadow price) of the unsold stock at the end of the first six months is its selling price thereafter. Where the market share is expected to be less than production capacity, the opportunity cost of the unsold stock at the end of the first six months is its variable cost. The forecast launch price at which the overall net margin to SCOS Limited will be maximised will, therefore, be affected by the forecast market share after the first six months. In a situation where some unsold stock is envisaged at the end of the 18-month period because of the level of market share obtained, the price at which such stock may be sold may also influence the initial launch price.

(c) The product was specifically launched as a World Cup commemorative product. It is

implied in the question that after the World Cup the market will collapse, and unsold stock will be difficult to sell.

The costs incurred in producing the product are sunk costs which are irrecoverable if the market has collapsed. SCOS Limited may be able to create a post-World Cup market by altering the unsold stock in some way, or by embarking on a supplementary advertising campaign. In any such exercise, it should focus only on incremental costs and revenues when evaluating the financial viability of any proposed course of action. Incremental costs would include the advertising and product alteration costs mentioned above. A deduction from such costs would be the cost of disposing of the products (e.g. transporting them to a tip) if they cannot be sold. Incremental revenue would be any price which can be obtained for the products.



MARKING GUIDE

Marks

(a) Estimation of direct costs 2 Methods to allocate overheads 2 Impact of product specific costs 2 Mark-up – standard rate or product specific 2 __

Maximum part (a) 6 (b) Award marks on merit for each of the three sections. To

score high marks, answers must recognise the importance of gaining high initial market share in a short-life market.

The problem of having excess stock at the end of the first 6 months must also be explored – this stock will either be very valuable if future demands exceeds supply, or worthless if SCOS has excess capacity.

Maximum part (b) 8 (c) Ignore sunk costs (e.g. production cost) 2 Incremental costs (e.g. advertising, product modification) 2 Incremental revenue 2 __

6 __ Total 20 __ Marks should be awarded on merit for other valid points made.

p5 - final

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