ACCA – PM: PERFORMANCE MANAGEMENT 1

ACCA

PM:
PERFORMANCE MANAGEMENT

REVISION NOTES

By: Noor Liza Ali

By : Noor Liza Ali
 ACCA – PM: PERFORMANCE MANAGEMENT 2

1.0 PERFORMANCE MANAGEMENT INFORMATION SYSTEM (MAIS)

MIS
o A management information system (MIS) provides information that organizations need to
manage themselves efficiently and effectively.

o Management information systems are typically computer systems used for managing five primary
components: hardware, software,data (information for decision making), procedures
(design,development and documentation), people (individuals, groups, or organizations),.

o Management information systems are distinct from other information systems, in that they are
used to analyze and facilitate strategic and operational activities.

Levels of management

There are three levels of management in an organization.

Strategic Executive Information System (EIS)

management
Management Information System (MIS)
Tactical
management
Operational Transaction Processing System (TPS)

ERP (Enterprise Resources Planning System)

1.1 Management accounting and management accounting
information
Management accounting (MA) management accounting information (MAI)
o Need more information to help them o To measure performance and put
to run the business. value to inventories.
o Need forward looking for planning o To plan for the future.

o Analyse data to suit specific o To control the business (control

requirement. resources)
o To make decision

1.2 Open and closed system

Open system Closed system

Open system is connected to and interacts Closed system is isolated and shut off form
with the environment and is influence by it. the environment and cannot influence by
the environment.
Accept inputs from surroundings

By : Noor Liza Ali

 ACCA – PM: PERFORMANCE MANAGEMENT 3

1.3 Enterprise Resource Planning system (ERPS)

o ERPS are software system designed to support and automate the business process of medium and
large enterprise.
o ERPS handle many aspects of operations including manufacturing, distribution, inventory, invoicing
and supply chain management. Also cover human resources management and marketing.
o All system integrated between department.
o Support performance measures such as balanced scorecard and strategic planning.

SOURCES OF MANAGEMENT INFORMATION

INTERNAL SOURCES EXTERNAL SOURCES

Include the financial accounting and other More relevant to strategic and tactical
systems decision
Sources Formal collection of data:
o Financial accounting records o Tax agent
o Payroll/HR o Company secretary
o Production (capacity) o R&D agent / consultant
o Supplier
o Customer
o Government agencies

2.1 Information for control purposes

o Control is achieved through feedback.

o Primary data - collected directly from first-hand experience.
o Secondary data - Published data and the data collected in the past or other parties

2.2 Cost of information

Cost related to internal information:
o Direct data captured – eg -
o use of bar coding and scanners
o Time spend to key-in data

o Processing
o time spend to processing and analyzing data

o Inefficient use of information

o Information overload
o Information stored long/ outdated
o Duplication

By : Noor Liza Ali

 ACCA – PM: PERFORMANCE MANAGEMENT 4

Cost related to external information

- Direct search cost
o Marketing research/survey
o Subscription to online database/magazines
o Download fees

- Indirect access cost

o Management and employee time spend finding useful information
o Wasted management time on excessive time

- Management cost
o Recording, processing and dissemination cost of external information
o Wasted time due to information overload/ excessive processing

- Infrastructure cost
o Installation hardware and software

- Time-theft
o Using office equipment and time for private use
o Cost monitoring and disciplinary procedures.

2.3 Benefits and limitations of external data

Benefits Limitations
- Quality of decisions that the The quality of data is questionable
data has influenced due to:
- Risk/uncertainty avoided by - The procedures of the
having data data
- Improve performance from the - Collection method
available information - Group/samples

2.4 External information and management accounting system

Value of external data depends to planning, decision making and control
Management function Type of information Accounting process
Planning - Demand estimates Sales budget
- Market research
Decision making - Demand estimates - Breakeven analysis
- Market research - Competitor cost
- Competitor research
Control - Demand estimates - Sales variances
- Price variances - Benchmarking

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 ACCA – PM: PERFORMANCE MANAGEMENT 5

MANAGEMENT REPORTS

- Reporting internal information – qualitative and quantitative information

- Control need to be in place over the generation of internal information (ad-hock and routine)
o Carry out cost/benefit analysis
o Prepared prototype/ consistent format
o Characteristics
▪ Relevance
▪ Accuracy
▪ Usefulness
▪ Timeliness
▪ Completeness

- Controls over distributing internal information: a procedural manual set out controls over
distributing internal information
o Procedural manual (for standard report)
▪ Indicates standard report to be issued
▪ Set out format for standard report
▪ Clearly states the preparer and to whom to prepare report
▪ Indicates classification – general / confidential
▪ Makes clear what information should be regarded as highly confidential

o Other control
▪ Computer should be protected password
▪ An appropriate e-mail policy should be set-up
▪ A firewall to restrict access to a network
▪ If information is held on server – control over viruses and hacking; audit trail; access
level.

o A number of procedures to ensure the security of highly confidential information that is not
for external consumption :
▪ Passwords
▪ Logical access system (physical control – door, locks. Eg: payroll, server area,
accounting dept)
▪ Database control (access to the system – modify/alteration of program)
▪ Firewalls – prevent unauthorized access to the system
▪ Antivirus and anti-spyware software

By : Noor Liza Ali

 ACCA – PM: PERFORMANCE MANAGEMENT 6

2.0: ACTIVITY BASED COSTING (ABC)

• Activity-Based Costing (ABC) is a costing model that identifies activities in an organization and assigns
the cost of each activity resource to all products and services according to the consumption by each: it
assigns more indirect costs (overhead) into direct costs.

• Reasons for development of ABC

i. Diverse product range.
ii. Overheads are high fraction of total cost.
iii. Different product have different diversification & complexity.

→ ABC can overcome limitation of traditional costing.

• Outline of ABC system

i. Identify orgn’s major activities.
ii. Cost pool – Group overheads into different activities.
iii. Cost driver - Factors that causes the a change in the cost of activities (eg: no. of orders, productions)
iv. Calculate cost per driver.
v. Charge cost to products

• Cost driver
o Cost driver – what causes cost to increase.
o Cost that vary with production volume should be traced to volume-cost driver ( eg. Power cost →
machine hours)
o Cost that is not vary with production should be traced to transaction-cost driver (eg. No of
production, order etc)

o Examples of cost and cost driver:

Cost Cost driver

1. Setup cost No. of setup
2. handling raw-material cost No. of order
3. inspection costs No of inspections
4. Scheduling cost No of production runs
5. Short run variable cost Machine hours

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 ACCA – PM: PERFORMANCE MANAGEMENT 7

Merits Critism

1. Can cater > complexity of Time consuming and costly - Cost of implementing
manufacturing process, > product range ABC can exceed the benefit of improved accuracy.
& product cycle (ABC recognised the
complexity with multiple cost drivers)

2. Product profitability can be accurately Limited benefit if product have similar cost
measured ( ABC facilitate good structure.
understanding of overhead cost drivers)

3. Cost control – remove non value added 3. Implementing ABC – problematic

activities
• To determine cost driver
• To understand the technique
• Lack of correct data
• Incorrect belief that ABC can solve all
orgn’s problem

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 ACCA – PM: PERFORMANCE MANAGEMENT 8

3.0 TARGET COSTING

• Target costing – involves setting a target cost by subtracting desired profit margin from
product/service’s market price.

• Implementing target costing

1. Determine product specification.

2. Set selling price
3. Estimate required profit
4. Calculate target cost.
Target cost = estimated selling price – target profit
5. Estimate cost for production based on anticipated specification and current cost level.
6. Calculate target cost gap (design out cost prior to production)
Cost gap = Estimated cost – target cost
7. Identify ways to reduce gap.

Example:
SE decide to produce brand new product that can be sold at $150.

The company requires 10% profit margin.

The cost needed in producing the product is $140 (based on list of design, materials & manufacturing cost
prepared by Engineering department).

Calculate the target cost and cost gap for the product.

$
1. Sales price 150
2. Target profit 15
3. Target cost 135
4. Estimated cost 140
5. Cost gap 5

• Closing the target cost gap

1. Reduce no. of components

2. Use standard components
3. Staff training.
4. Choice of materials.
5. Use cheaper staff.
6. Acquire efficient technology.
7. Cut non-value-added technology

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 ACCA – PM: PERFORMANCE MANAGEMENT 9

Target costing focus on:

Price-led
costing Design

Customers

Customer
Cost
requirements

Quality
7

• Target costing – difficult to be used for

service industries due to its characteristics.
No transfer of ownership Intangibility
• no substantial material

Characteristics
Of service

Perishability Inseparability

• naturally not lasting • Service are created at

Variability the same time as they
consume (eg. Dental
service)
Need
quantitative & • Service have prob. of
Qualitative maintaining consistency
information in standard output
8

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 ACCA – PM: PERFORMANCE MANAGEMENT 10

4.0 LIFECYCLE COSTING

• Lifecycle cost – accumulates cost over a product’s life (not for limited period) & determine
profitability for whole product cycle.

20
PRODUCT LIFE-CYCLE

15

10

5 Sales

0 profit
0 1 2 3 4 5 6 7

-5

Product Introduction Growth Maturity Decline

Development
-10

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 ACCA – PM: PERFORMANCE MANAGEMENT 11

COST: RELEVANT TO STAGES

Declining stage
Retirement & disposal cost

Introduction, growth and

maturity stage
Production cost
Development stage Distribution cost
Research & development Marketing cost
(design, testing & Inventory cost (holding cost)
production process)
After sales & service
Purchase of technical
data
Training cost

• Benefit of lifecycle costing

– Total production cost for whole lifecycle compared to revenues generated in the future.
– Individual product profitability can be easily understood.
– More accurate feedback information can be generated for:-
• Pricing
• Performance management
• Decision making

By : Noor Liza Ali

 ACCA – PM: PERFORMANCE MANAGEMENT 12

5.0 THROUGHPUT ACCOUNTING

➢ Throughput Accounting is not costing method and it does not allocate costs to products and
services.

➢ It can be viewed as business intelligence for profit maximization.

➢ TA seeks to increase the speed at which products move through an organization by eliminating
bottlenecks within the organization.

➢ TA – management accounting in JIT environment

The concept of throughput accounting

➢ The goal for a profit maximizing firm is easily stated, to increase profit.

➢ Obj. of orgn is to maximize throughput by identifying & eliminating bottlenecks.

Throughput = Sales – direct material cost

➢ Theory of constrain (TOC)

o TOC is an approach to production management which aims to maximized sales revenue less
material cost.
o It focus on bottlenecks which act as constrain to maximization.
o Bottlenecks / limiting factors are:
▪ Sales demand
▪ Production constrain
• Labor
• Materials
• Manufacturing capacity

HOW TO ELIMINATE BOTTLENECKS → ➢ Advert/promo

➢ Overtime
➢ Product changes
➢ Process alteration
➢ Lower setup & waiting time

TA are based on 3 concepts:

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 ACCA – PM: PERFORMANCE MANAGEMENT 13

1. Costs (except direct material) are fixed.

2. Inventory should be maintained at zero level. Product only made based on order. WIP valued at
material cost only, until sold.
3. Profitability determine by ‘money’ (when sales are made).

Performance measures:-

TPAR Throughput Sales – Direct Material

Limiting Factor Limiting Factor
Factory Cost Labour + Overhead cost
Limiting Factor Limiting Factor

Ideal situation : TPAR > 1

If TPAR < 1 : this indicates that this product should not be continued with
production, as it will generate throughput (Sales – d. material) less than fixed cost.

By : Noor Liza Ali

 ACCA – PM: PERFORMANCE MANAGEMENT 14

6.0 ENVIRONMENTAL MANAGEMENT ACCOUNTING

Requirement for PM:

• discuss the issues businesses face in the management of environmental costs
• describe the different methods a business may use to account for its environmental costs.

Defining Environmental cost:

1. The International Federation of Accountants (IFAC) originally defined environmental management

accounting as:

‘The management of environmental and economic performance through the development and
implementation of appropriate environment-related accounting systems and practices. While this
may include reporting and auditing in some companies, environmental management accounting
typically involves lifecycle costing, full cost accounting, benefits assessment, and strategic planning
for environmental management.’

2. US Environmental Protection Agency in 1998.

the definition of environmental costs depended on how an organization intended on using the
information. A distinction between four types of costs:
» Conventional costs: raw material and energy costs having environmental relevance
» Potentially hidden costs: costs captured by accounting systems but then losing their identity in
‘general overheads’
» Contingent costs: costs to be incurred at a future date, eg clean up costs
» Image and relationship costs: costs that, by their nature, are intangible, for example, the costs of
preparing environmental reports.

3. The UNDSD, environmental costs are:-

» costs incurred to protect the environment, eg measures taken to
prevent pollution and
» costs of wasted material, capital and labour, ie inefficiencies in the
production process.

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 ACCA – PM: PERFORMANCE MANAGEMENT 15

4. Hansen and Mendoza (1999)

The categories of cost:

i. Environmental prevention costs: the costs of activities undertaken to prevent the production of
waste.

ii. Environmental detection costs: costs incurred to ensure that the organisation complies with
regulations and voluntary standards.

iii. Environmental internal failure costs: costs incurred from performing activities that have produced
contaminants and waste that have not been discharged into the environment.

iv. Environmental external failure costs: costs incurred on activities performed after discharging
waste into the environment.

The needs of environmental management accounting / more important

1. Society become more environmentally aware

2. Environmental cost are becoming huge for some companies.
3. Regulation is increasing worldwide.

Environmental costs are important for:

• Pricing decision – identify environmental cost for individual products

• Compliance with regulatory
• Cost savings

IDENTIFYING ENVIRONMENTAL COSTS

Classification of Identifying cost and Cost control

Environmental costs
waste and effluent » There are lots of environmental costs associated with waste.
disposal
» For example,the costs of unused raw materials and disposal;
taxes for landfill; fines forcompliance failures such as pollution.
It is possible to identify how much material is wasted in
production by using the ‘mass balance’ approach, whereby the
weight of materials bought is compared to the product yield.

» In addition to these monetary costs to the organisation, waste

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 ACCA – PM: PERFORMANCE MANAGEMENT 16

Classification of Identifying cost and Cost control

Environmental costs
has environmental costs in terms of lost land resources
(because waste has been buried) and the generation of
greenhouse gases in the form of methane.

» From this process, potential cost savings may be identified.

water consumption » You have probably never thought about it but businesses
actually pay for water twice – first, to buy it and second, to
dispose of it.

» If savings are to be made in terms of reduced water bills, it is

important for organisations to identify where water is used and
how consumption can be decreased.

energy » Energy costs can be reduced significantly at very little cost.

» Environmental management accounts may help to identify

inefficiencies and wasteful practices and, therefore,
opportunities for cost savings.

transport and travel » environmental management accounting can often help to

identify savings in terms of business travel and transport of
goods and materials. At a simple level, a business can invest in
more fuel-efficient vehicles.

consumables and raw » These costs are usually easy to identify and discussions with
materials. senior managers may help to identify where savings can be
made. For example, toner cartridges for printers could be
refilled rather than replaced.

» This should produce a saving both in terms of the financial cost

for the organisation and a waste saving for the environment
(toner cartridges are difficult to dispose of and less waste is
created this way).

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 ACCA – PM: PERFORMANCE MANAGEMENT 17

ACCOUNTING FOR ENVIRONMENTAL COST

Management accounting techniques for identification and allocation of environmental cost:-

Accounting Description
techniques
Input/output Analysis This technique records material inflows and balances this with
outflows on the basis that, what comes in, must go out.

Finish Product
60 kg (60%)

Input Scrap to sold

15 kg (15%)
100kg
Waste 10 kg (10%)

Not accounted
15 kg (15%)

» Must accounted Qty(units) & value (monetary)

» businesses are forced to focus on

environmental costs.

Flow cost Accounting » This technique uses not only material flows but also the
organizational structure.

» It makes material flows transparent by looking at

» the physical quantities involved,
» their costs and

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 ACCA – PM: PERFORMANCE MANAGEMENT 18

Accounting Description
techniques
» their value.

» It divides the material flows into three categories:

» material,
» system
» delivery
» disposal.

» The values and costs of each of these three flows are then
calculated.

» The aim of flow cost accounting is to reduce the quantity of

materials which, as well as having a positive effect on the
environment, should have a positive effect on a business’ total
costs in the long run.

Activity-based costing In an environmental accounting context, it distinguishes between

environment-related costs, which can be attributed to joint cost
centres, and environment‑driven costs, which tend to be hidden on
general overheads.

Lifecycle costing Within the context of environmental accounting, lifecycle costing is a

technique which requires the full environmental on sequences, and,
therefore, costs, arising from production of a product to be taken
account across its whole lifecycle, literally ‘from cradle to grave’.

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 ACCA – PM: PERFORMANCE MANAGEMENT 19

7.0 RELEVANT COST ANALYSIS

a. Relevant cost – future cash flow arising as a direct consequence of a decision.

Include Exclude

• Incremental cost • Depreciation

• Opportunity cost • Sunk cost
• Incremental fixed overhead • Unavoidable cost
• Future cost • Contracted cost (committed cost)
• Cash flow • Apportioned fixed overhead
• Financing cash flow (e.g interest)

b. Opportunity cost:

 The value of sacrificed when one course of action is chosen in preference to an alternative.
 The cost of passing up the next best choice when making a decision.
 For example, if an asset such as capital is used for one purpose, the opportunity cost is the
value of the next best purpose the asset could have been used for.

c. Controllable cost / uncontrollable.

Controllable cost – cost arising by decision made by the manager, in short-term.

Uncontrollable cost – not relates to decision by respective managers, but at a higher level.
Eg. Investment in plant that effected long term depreciation expenses.

d. Sunk cost
Cost already incurred which cannot be recovered regardless of future events.

e. Incremental cost
The cost associated with one additional unit of production. also called marginal cost.
Relevant cost : Material

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 ACCA – PM: PERFORMANCE MANAGEMENT 20

Material in
stock/contracted No RC = Future / current purchase cost
purchase O

YES

Material are No Material have No RC = Disposable

regularly used& alternative use O value/
O
replace with stock- Scrap value C
run out

YES
YES
RC = Higher value of
Rc = future / current
• Other use <or>
purchase cost • Disposable value/ Scrap
value

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 ACCA – PM: PERFORMANCE MANAGEMENT 21

Relevant cost : Assets

Lower of

Replacement cost Higher of

Net realizable value / Expected revenue /

scrap proceeds future revenue to be
generated

Relevant cost : Labour

YES
Spare Zero, unless overtime work or extra labour hired
O
capacity

NO

Extra YES
employee be O Cost of hiring
hired

Loss of contribution from alternative products that

NO abandoned to create spare capacity.

[Loss of contribution implies loss of revenue but

savings of material and labour cost. If labour not saved
(redeployed) add back labour cost per hour which is not
saved]

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 ACCA – PM: PERFORMANCE MANAGEMENT 22

8.0 Cost volume profit (CVP)

CVP helps to make decision:

• how much do we need to sell in order to break‑even?’ By ‘break‑even’ we mean simply covering all
our costs without making a profit.

CVP analysis can be executed using three approaches as follows:

1. Equation approach
2. Contribution Margin approach (C/S method)
3. Graphical approach

1. Equation approach to CVP analysis

Profits = (Total revenue – Variable expenses) – Fixed Expenses

P = ((U.S.P x Q) – (U.V.C x Q)) - FC

• Contribution Margin approach has two key equations. At the break-even point, contribution margin
must equal total fixed costs.

Break-even Point (Units) = Fixed expenses

CM per unit

BEP ; P= 0, calculate Q
Solution - if company produce < Q; it will make loss

2. Contribution Margin approach (C/S method)

Break-even Point in ($) = Fixed expenses

C/S ratio

C/S ratio = Contribution / Sales x 100

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 ACCA – PM: PERFORMANCE MANAGEMENT 23

✓ The margin of safety (MOS) is the excess of budgeted (or actual) sales over the break-even volume
of sales.

✓ MOS – how much sales can be decrease before loss occurs.

Margin of Safety (RM) = Total Sales (RM) – BEP Sales (RM)

Margin of Safety (%) = Margin of Safety (RM)

Total Sales (RM)

3. GRAPHICAL APPROACH

8-11

Cost-Volume-Profit Graph
450,000

400,000 Break-even Total sales

350,000
point

300,000

250,000 Total expenses

200,000

150,000 Fixed expenses

100,000

50,000

-
- 100 200 300 400 500 600 700 800

McGraw-Hill/Irwin Units Sold

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 ACCA – PM: PERFORMANCE MANAGEMENT 24

8-12

Profit-Volume Graph
$100,000

$80,000

$60,000

$40,000

$20,000

$-
$- $50 $100 $150 $200 $250 $300 $350 $400
$(20,000)

$(40,000)

$(60,000) Break-even
point
$(80,000)

$(100,000) 1 2 3 4 5 6 7 8
Units sold (00s)
McGraw-Hill/Irwin

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 ACCA – PM: PERFORMANCE MANAGEMENT 25

Multi Product Analysis

1. Weighted Average C/S Ratio

Weighted Average C/S ratio = Total contribution

Total sales

2. Multi-product Profit-volume chart (using profit volume graph)

Steps :

i. Calculate C/S ratio for every product

ii. Determine highest profitable product (highest C/S ratio) and rank the product (most
profitable to less profitable)
iii. Calculate cumulative profit / loss
iv. Calculate cumulative revenue
v. Draw graph → x = cumulative Revenue
y = cumulative profit / loss
vi. Draw bow-shape line and straight line
vii. Calculate BEP(constant mix) =
Fixed costs Fixed cost

Weighted Average contribution per unit Total contribution

Total unit

profit / loss Multi-product PV chart

Cummulative
BEP Revenue

X - most profitable; followed by Y

and Z

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 ACCA – PM: PERFORMANCE MANAGEMENT 26

Limitation of CVP analysis

➔ CVP is meaningless for organization that have changes in either/and sales price, cost or sales
volume. [assumption CVP; single product; multiple product with constant mix.]

➔ Variables remain constant (selling price, cost) except volume; this in fact does not hold true.
Eg: Bulk purchase → cost will reduce
Sales price reduce; sales volume will increase
So, CVP not accurate/reflect true value.

➔ Total cost & total revenue is linear (it is short-term)

➔ Take to consideration variable cost and fixed cost; semi-fixed is ignored

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 ACCA – PM: PERFORMANCE MANAGEMENT 27

9.0 LIMITING FACTOR

▪ Buss problems – to decide how co. should divide its production among various types of products to
obtain maximum profits

▪ Limitation on demand & resources – Labor, material & production.

▪ Linear programming – technique for solving problems of profit maximization / cost minimization &
resource allocation.

▪ A typical example would be taking the limitations of materials and labor, and then determining the
"best" production levels for maximal profits under those conditions.

▪ Steps to prepare/calculate optimal production plan are as follows;

1. Define variables

2 . Establish constrains

3. Construct obj. function

4. Graph

5. Establish feasible area

6.Iso/ contribution line

7. Determine optimal solution

▪ The general process for solving linear-programming exercises is to graph the inequalities (called the
"constraints") to form a feasible area on the x,y-plane (called the "feasibility region").

▪ Then you figure out the coordinates of the corners of this feasibility region (that is, you find the
intersection points of the various pairs of lines), and test these corner points in the formula (called
the "optimization equation") for which you're trying to find the highest or lowest value.

▪ Slack - occurs when maximum availability of resources not used. (< = Constrain)

▪ Surplus – occurs when more than a min requirement used (> = Constrain)

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 ACCA – PM: PERFORMANCE MANAGEMENT 28

▪ When produced at full capacity → binding constrain

▪ Shadow price / dual price → Is the increase in value which would be created by having 1 additional
unit of the limiting factor at original cost.

Example & extract of examiner’s article by: Geoff Cordwell (March 2008 student accountant)

A profit-seeking firm has two constraints: labour, limited to 16,000 hours, and materials,
limited to 15,000kg.

The firm manufactures and sells two products, X and Y.

To make X, the firm uses 3kg of material and four hours of labour, whereas to make Y, the
firm uses 5kg of material and four hours of labour.

The contributions made by each product are $30 for X and $40 for Y.

The cost of materials is normally $8 per kg, and the labour rate is $10 per hour.

Solutions:
1. Variables; x = prod x; y = product y

2. Produce the equations for constraints and the contribution function,

materials → 3X + 5Y ≤ 15,000,
labour → 4X + 4Y ≤ 16,000
non-negativity constraint, X,Y ≥ 0.

3. contribution function is 30X + 40Y = C

4. (4,5,6,7) Draw graph

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 ACCA – PM: PERFORMANCE MANAGEMENT 29

5. The optimal point is at point B, which is at the

intersection of:
3X + 5Y = 15,000 and
4X + 4Y = 16,000

Multiplying the first equation by four and the

second by three we get:
12X + 20Y = 60,000
12X + 12Y = 48,000

The difference in the two equations is:

8Y = 12,000, or Y = 1,500
Substituting Y = 1,500 in any of the above
equations will give us the X value:

3X + 5 (1,500) = 15,000
3X = 7,500
X = 2,500
The contribution gained is (2,500 x 30) +
(1,500 x 40) = $135,000

6. The point of this calculation is to provide management with a target production plan in
order to maximise contribution and therefore profit.

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 ACCA – PM: PERFORMANCE MANAGEMENT 30

Shadow price of materials

To find this we relax the material constraint by 1kg and resolve as follows:
3X + 5Y = 15,001 and
4X + 4Y = 16,000

Again, multiplying by four for the first equation

and by three for the second produces:
12X + 20Y = 60,004
12X + 12Y = 48,000
8Y = 12,004
Y = 1,500.5

Substituting Y = 1,500.5 in any of the above

equations will give us X:
3X + 5 (1,500.5) = 15,001
3X = 7,498.5
X = 2,499.5

The new level of contribution is:

(2,499.5 x 30) + (1,500 x 40) = $135,005

The increase in contribution from the original optimal is the shadow price: 142,505 - 142,500 = $5
per kg.

The shadow price of materials is $5 per kg ; if management is offered more materials it should be
prepared to pay no more than $5 per kg over the normal price.

Paying less than $13 ($5 + $8) per kg to obtain more materials will make the firm better off
financially.

Paying more than $13 per kg would render it worse off in terms of contribution gained.

Management needs to understand this. There may, of course, be a good reason to buy ‘expensive’
extra materials (those costing more than $13 per kg).

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 ACCA – PM: PERFORMANCE MANAGEMENT 31

10.0 PRICING DECISION

• Pricing decision is a decision to fix the selling price.

• Factors to be considered :-
✓ Cost
✓ Competitors
✓ Cutomers/ demand
✓ Quality
✓ Government regulation

• Market in which the organization operates:-

i. Perfect competition – many buyers & sellers , same product
ii. Monopoly – one seller dominates many buyers (eg TNB-electricity supply)
iii. Monopolistic competition – large number of suppliers offer similar(non identical) products.
iv. Oligopoly – Relatively few competitive companies dominates market.

Pricing strategies

1. Cost-plus pricing

• Steps
o Estimate total cost per unit
o Add % of mark-up

• Advantage
o Quick, simple & cheap method
o Full cost are being taken into consideration; plus % profit, so the price will surely cover the
cost, plus desired profit.

• Disadvantage
o Not taken into consideration the demand & competitors price.
o If >1 product, difficult allocate absorption basis.

2. Marginal cost-plus

• Steps
o Estimate marginal cost (variable / incremental) per unit
o Add % of mark-up

• Advantage
o Quick, simple & cheap method
o Mark-up % can be varied & adjustable to reflect demand.

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• Disadvantage
o Not taken into consideration the demand & competitors price.
o Ignores fixed overhead.

3. Market skimming pricing

- Charging high price when product first launched; to maximized short-term profit.

4. Market penetration pricing

- Charging low price when product first launched ; to obtain penetration in market.

5. Complementary pricing

- Complementary product are sold separately, but connected and dependent to each other.

6. Volume discounting

- Reduction in price for larger purchase.

7. Price discrimination

- Charging different price for same product to different customers:

* By market segment ( Air tickets to kids / adults / elderly)
* By place ( Cinema – front / middle / back)
* By time (Hotel rate – peak seasons / week end / weekday)

Price Elasticity of Demand

• PED – measure size of effect on demand of change in selling price.

• Price elastic demand (PED) = % change in demand
% change in price
• Perfectly elastic demand (PED = ∞ )
• Perfectly inelastic (PED = 0)
• High PED – demand is very sensitive to price (elastic → η>1 )
• Low PED – demand is nor sensitive to price (inelastic → η<1)

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A set of graphs shows the

relationship between
demand and total revenue
(TR) for a linear demand
curve. As price decreases in
the elastic range, TR
increases, but in the inelastic
range, TR decreases. TR is
maximised at the quantity
where PED = 1.

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 ACCA – PM: PERFORMANCE MANAGEMENT 34

Price demand equation

• Demand is linear equation:

P = a – bQ

P – the price
Q – quantity demand
b – change in price/change in quantity
a – Price when demand is nil

MR = MC; MR = a-2bQ

Determining profit-maximising selling price

Profit are maximized when MR = 0

profit-maximization chart

• Steps to calculate Price:

1. Calculate b
2. Calculate a
3. Identify Variable cost
4. Calculate Q (use MR=MC)
5. Calculate P

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 ACCA – PM: PERFORMANCE MANAGEMENT 35

11.0 MAKE OR BUY AND OTHER SHORT TERM DECISIONS

• Identify relevant cost

• Make or buy decision

o Mnfct co – whether to manufacture components or buy from vendor

o Construction co – whether to do work using own workers or to appoint sub-contractors

o Service – should be carried out internally or appoint external agent/orgn

o Shut down decision

• Joint product – further processing decision

--------------------------------------------------------------------------------------------------------------------------

i. Relevant cost (refer to 1.0 page1)

ii. Learning curves

Learning Curve Theory

• Concerned with the idea that when a new job, process or activity commences for the first time it is
likely that the workforce involved will not achieve maximum efficiency immediately.
• Repetition of the task is likely to make the people more confident and knowledgeable and will
eventually result in a more efficient and rapid operation, hence reduce time spent.

The primary reason for why experience and learning curve effects apply.

• Labour efficiency - Workers become physically expert.

• Standardization, specialization, and methods improvements - As processes, parts, and products

become more standardized, efficiency tends to increase.

• Technology-Driven Learning/ better use of equipment - Automated production technology and

information technology can introduce efficiencies as they are implemented and people learn how to
use them efficiently and effectively.

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Areas of consequence:

• To set standard labour times after the learning curve had reached a plateau.
o To calculate budget for labour cost
o To set the selling price / contract price

Limitations:

• The stable conditions necessary for the learning curve to take place may not be present – unplanned
changes inproduction techniques or labour turnover will cause problems and affect the learning rate.

• The employees need to be motivated, agree to the plan and keep to the learning schedule these
assumptions may not hold.

• Accurate and appropriate learning curve data may be difficult to estimate.

• Inaccuracy in estimating the initial labour requirement for the first unit.

• Inaccuracy in estimating the output required before reaching a ‘steady state’ time rate.

• It assumes a constant rate learning factor.

Calculation Of Learning Rate

Eg: time spend for first 4 units of production are as follows:
Unit Time spend (hours)
1 200
2 120
3 106
4 86

A B C= B/A LR (r ) = n√(Cumm Avg per unit/1st unit hour)

Total Total time for all units Cumm. = √ (128/200)^2
cumm. Average = 80%
units time per
unit
1 200 200
2 320 160 r
4 512 128 r

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It can be graphed as follows:

Calculation of hours spend

Example – learning rate

Estimated direct labour hours for the 1st unit of production are 200 hours.

80% learning rate is expected.

Calculate;
a. hours spend for 2nd unit.
b. average hours for 3rd and 4th units.
c. All 8 units of productions.

Table format Formula

b
Y = ax
Where y = average cost per batch
a = cost of first batch
x = total number of batches produced
b = learning factor (log LR/log 2)
LR = the learning rate as a decimal

LR = 80%; b=-0.32193
A B C=A+B D=C2-C1 E=D/unit
Total Cumm. Total Incremental Average a. 200 x .8 = 160 hours
cumm. Average time time for time for
units time for all additional additional
b. Average for 4 units x 4
per unit units unit unit → (200 x 4^-0.32193) x 4 = 512
1 200 200 200 -
2 160 320 120 120 Average for 1st 2 units x 2
(200 x (120/1)
80%)
→ (200 x 2^-0.32193) x 2 = 320
4 128 512 192 96 (192/2) 192 hrs
(160 x
80%)
c. Average for 8 units x 8
8 102.4 819.2 307.2 76(307.2/4)
(128 x → (200 x 8^-0.32193) x 8 = 819.2 hrs
80%)

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 ACCA – PM: PERFORMANCE MANAGEMENT 38

a . 160 hours

b. 192 hours

c. 819.2 hours

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 ACCA – PM: PERFORMANCE MANAGEMENT 39

iii. Make or buy decision

• Make or buy decisions : Buy / outsource

– Look at future incremental CFs.
– Watch for opportunity cost
✓ Co. have spare capacity / not
✓ Co have limiting factors / not ( limited resources)

• What? : Use external supplier for internal activities (contract mnfct/ sub-contract).

• Why?? : Co to concentrate on the core competence & turn other function over to specialized
contractors.

• Relevant cost = different between (i)cost to perform the service/prod <or> (ii) Cost to use external
resources.

• Benefits:-
– Special contractors can offer at better quality & efficient (better skill & expertise)
– Less capital invested for R&D & prod planning.
– Contractors have capacity & flexibility to start very quickly.

• Benefits of ‘in-house’ production/ things to consider b4 outsourcing:-

– Give more direct control.
– Will create space capacity
– Hidden benefits of outsourcing.
– The reliability of delivery time & quality

iv. Further processing and shutdown decision

• Shutdown decisions
– Whether to close prod line / activities.
– Whether to close permanent or temporary
– Relevant cost:
– Future incremental CFs
– Include only specific incremental cost (Apportion overhead – not relevant).
– Closure cost .eg penalties, redundancy cost.
– Alternative use of resources.

• Joint product – further processing decision

– A decision whether to sell each joint product at the split-off point or after processing.
– Look at future incremental cash flows: sell at split off <or> process further and then sell.
– Pre-separation (joint) cost not relevant. Only include post-split-off costs.

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 ACCA – PM: PERFORMANCE MANAGEMENT 40

12.0 DEALING WITH RISK AND UNCERTAINTY

• Risk – Involve situation /event which may or may not occur, probability of occurrence can be calculated
statistically & occurrence predicted from past record.

• Uncertainty – outcome cannot be predicted

• Elements of a Decision
There are three components to any decision-making situation:

⚫ The available choices (alternatives or acts).

⚫ The states of nature, which are not under the control of the decision maker - uncontrollable
future events.

⚫ The payoffs - needed for each combination of decision alternative and state of nature.

Payoff Table and Expected Payoff

• A Payoff Table is a listing of all possible combinations of decision alternatives (Activities/Decision)

and states of nature (circumstances).
• The Expected Payoff or the Expected Monetary Value (EMV) is the expected value for each decision.
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Example

Bob Hill, a small investor, has $1,100 to invest. He has studied several common stocks and narrowed his
choices to three, namely, Kayser Chemicals(KC), Rim Homes(RM), and Texas Electronics(TE).

He estimated that, if his $1,100 were invested in Kayser Chemicals and a strong bull market developed by
the end of the year (that is, stock prices increased drastically), the value of his Kayser stock would more than
double, to $2,400. However, if there were a bear market (i.e., stock prices declined), the value of his Kayser
stock could conceivably drop to $1,000 by the end of the year.

His predictions regarding the value of his $1,100 investment for the three stocks for a bull market and for a
bear market are shown below.

A study of historical records revealed that during the past 10 years stock market prices increased six times
and declined only four times. According to this information, the probability of a market rise is .60 and the
probability of a market decline is .40.

Solution:-

KC (A1) RM(A2) TE(A3)

Bull Market S1 2,400 2200 1900
(0.60)
Bear Market S2 1000 1100 1150
(0.40)

Expected Payoff 1,800 1760 1,600

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Expected Monetary Values (EMV)

Advantages Disadvantages

• Recognised several possible • Probability used are subjective.

outcomes (probabilities)
• The EMV suitable to guide repeated
• Leads directly to simple decision decision making, not useful for one-off
rule. decisions.

• Calculation are simple • Ignore the attitude toward risk.

Opportunity Loss

• Opportunity Loss or Regret is the loss because the exact state of nature is not known at the time a
decision is made.

• The opportunity loss is computed by taking the difference between the optimal decision for each
state of nature and the other decision alternatives.
Eg:Payoff Table

KC (A1) RM(A2) TE(A3)

Bull Market S1 2,400 2200 1900
(0.60)
Bear Market S2 1000 1100 1150
(0.40)

Opportunity Loss

KC (A1) RM(A2) TE(A3)

Bull Market S1 0 200 500
(0.60)
Bear Market S2 150 50 0
(0.40)

Opportunity Loss when market rises: Opportunity Loss when market declines:
KC: 2,400 – 2400 = 0 KC: 1,150 – 1000 = 150
RM: 2,400 – 2200 = 200 RM: 1,150 – 1100 = 50
TE: 2,400 – 1900 = 500 TE: 1,150 – 1150 = 0

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 ACCA – PM: PERFORMANCE MANAGEMENT 43

Maximin, Maximax and Minimax Regret Strategies

Payoff Table

KC (A1) RM(A2) TE(A3)

Bull Market S1 2,400 2200 1900
(0.60)
Bear Market S2 1000 1100 1150
(0.40)

MAXIMIN 1,000 1100 1,150

MAXIMAX 2,400 2200 1900

Regret Table

KC (A1) RM(A2) TE(A3)

Bull Market S1 0 200 500
(0.60)
Bear Market S2 150 50 0
(0.40)

Minimax Regret 150 200 500

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 ACCA – PM: PERFORMANCE MANAGEMENT 44

Maximin (Risk Averse) Maximax (Risk Takers) Minimax regrets (risk Averse)

1. Identify min. value 1. Identify max. 1. Identify max. circumstances.

of the action. value of the 2. Calculate regret = max
action. circumstances – profit /
2. For decision 2. For decision contribution of circumstances
making, select the making, select the
max. value out of max. value out of 3. Chose the max. value of every
min. action. max. action. action.

4. For decision making, select

the lowest regret.

Decision Tree

A decision tree is a picture of all the possible courses of action and the consequent possible outcomes.

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Preparation of decision tree :-

i. Start from left to right

ii. Label decision point

iii. Add branch at each option / alternative

iv. If the outcome is uncertain (<100%) add an outcome point

v. For each of possible outcome, add branch with relevant probabilities to the outcome
point

vi. Decision: work from right to left; and calculate the EV of revenue/ cost/ contribution/
profit of each outcome point (rollback analysis)

Expected Value of Perfect Information

• Companies are trying to improve the probability assessment for the states of nature prior to the
decision making. The conventional approach for determining of the potential value of this
information is to conduct a marketing research and analysis.

• The assumption is that the study could provide perfect information regarding the state of nature,
that is, as a result from the marketing research and analysis the decision maker could determine with
certainty, prior to making the decision, which state of nature is going to occur.

• Based on this perfect information the decision maker is developing a decision strategy (or a decision
rule) that his/her company should follow once it knows which state of nature will occur. The decision
rule specifies which decision alternative to select after new information (from the marketing
research and analysis) becomes available.

Perfect Information: is guaranteed to predict the future with 100% accuracy

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 ACCA – PM: PERFORMANCE MANAGEMENT 46

Imperfect Information: is better than no information at all but could be wrong in its prediction of the future.

Expected Value With Perfect Information: The decision maker knows for sure that one or several states of
nature will occur, selects the decision alternative for each of these states of nature, and based on known
subjectively selected probabilities for the states of nature is computing the expected value of the decision
strategy with perfect information.

The expected value of perfect information is computed as follows:

EVPI = |EVwPI − EVwoPI|
where:
EVPI = expected value of perfect information
EVwPI = expected value with perfect information about the states of nature
EVwoPI = expected value without perfect information about the states of nature

Example:
N Investment and co is considering two mutually exclusive projects, Project A and B. The expected profits
are as follows:
Project A Project B Probability
Profit under good economic condition $1,000 $2,000 0.7
Profit under bad economic condition $5,000 $1,500 0.3
Cost to obtain the information is $300.
Required:
Calculate the value of perfect information.

Answer:
Step 1: EV of imperfect information (EVwoPI)
Project A($) Project B($)
Profit under good economic condition 700 w1 1,400
Profit under bad economic condition 1,500 450

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2,200 1,850
w1: (1,000 x 0.7)
*Project A will be selected with EV $2,200

Step 2: EV with perfect information (EVwPI)

Project EV ($)
Profit under good economic condition Project B 1,400
Profit under bad economic condition Project A 1,500
2,900
Step 3: EV of perfect information (EVPI)
EVPI = |EVwPI − EVwoPI| = |$2,900 − $2,200| = $700

$2000
good
$2900

1 $5000
Obtain info bad
($300)
$2200 good $1000
No info (Proj A)
$2,600
2
$5000
bad

$1850 good $2000

No info (Proj B)
3
$1500
bad

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13.0 BUDGETARY SYSTEM AND TYPES OF BUDGET

Budget
➢ generally refers to a list of all planned expenses and revenues.
➢ Is quantified plan of action for next accounting period
Aims / Objective Of Budget
- Forecasting - Planning
- Control - Communication – ideas & plans
- Coordinate activities - Evaluate performance
- Motivation – employee to improve performance
- Authorisation & delegation

Participation In Budgeting

Top-down (Imposed budgeting) Bottom-up (Participative budget)

Effective in the following situation
o Newly form business o Well-establish organization
o Small business o Large business
o During economic downturn o During economic wealth
o When units require coordination o Units & managers are independent &
have budgeting skills
Advantages:
o Strategic plan are incorporated o Increase motivation & morale
o Coordinate plan & objective among o Better information from e’yee
units (familiar with unit)
o Use senior management expertise & o More realistic.
knowledge of target & resources o Increase operational manager’s
o Decrease input by inexperience & commitment.
uninformed e’yees. o Senior managers concentrate on
o Decrease period of time taken. strategy.

Disadvantages:
o Dissatisfaction & demotivating; and no o Time consuming
team spirit. o Managers can introduce ‘budgetary
o Acceptance of goal & objective may be slack’
limited. o Bad decision/ input from inexperience
operation managers.
o Budgets may not be in-line with
corporate objectives

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Types of budget:-

a. Incremental budget:

• a budget prepared using a previous period’s budget or actual

• Allocation of resources is based upon allocations from the previous period.
• Suitable for stable business where cost are not expected to change significantly.

Advantages of incremental budgeting

✓ simple to use and easy to understand
✓ Managers can operate their departments on a consistent basis.
✓ Conflicts should be avoided if departments can be seen to be treated
similarly.
✓ Co-ordination between budgets is easier to achieve.

Disadvantages of incremental Budgeting

✓ not incentive for employees to develop new ideas/ to innovate.
✓ Not encourage to reduce cost, as employees will spend up to the budget
so that the budget is maintained next year.
✓ the budget may become out of date and no longer relate to the level of
activity or type of work being carried out. (inefficiencies)
✓ Budgetary slack and nor responsive to change

b. ZBB
Preparing budget from zero base, 3 steps approach

» Define the » Evaluate & rank » Allocate resources

decision package a decision (according to rank and
available funds)

Advantages of ZBB
✓ Identifies and removes inefficiency
✓ Provide physical force to employee to avoid wasteful expenditure
✓ Leads to a more efficient allocation of resources

Disadvantages of ZBB
✓ Time consuming & costly By : Noor Liza Ali
✓ Short term focus
✓ Ranking is difficult and can be wrong decision
✓ Lead to loss of continuity of action in short-term
 ACCA – PM: PERFORMANCE MANAGEMENT 50

c. ABB
Use ABC for budgeting purposes; 3 steps
➢ Identify cost pools and cost drivers
➢ Calculate a budgeted cost driver rate based on budgeted activity
➢ Produce a budget for each department/product by multiplying the budgeted cost driver rate
by the expected usage.

Advantages ABB
✓ Greater focus on understanding overhead
✓ Greater control on overhead.
✓ Allocate resources efficiently

Disadvantages ABB
✓ Time consuming & costly
✓ Identify cost pool and cost driver is challenging
✓ Too onward focus

d. Continuous / rolling budget

o Revised at regular interval or continuously updated by adding a new budget period to full budget.
o Eg : budget for quarter 1 of year 2 been added to quarter 4 of year 1; will continue to look one year
forward.
o
o
o Advantages Rolling
o ✓ Responsive to change
o ✓ Forward looking
o ✓ Accurate budget, reduce uncertainty
o
o
o Disadvantages Rolling
o ✓ Time consuming & costly
o ✓ Demotivating and confusing - target constantly change
✓ Staff resistance
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Other types of Budget

Budget remains unchanged irrespective of the level of activity
Fixed budget actually attained.

Prepared based only on one level of output. Therefore, if the level

of output actually achieved differs considerably from that
budgeted, large variances will arise.

Used in service industry, with high level of fixed cost.

Budget set for several activity level.
Flexible budget
Eg: 100%, 80%, 60%

The budget recognizes the difference in cost behavior namely fixed

and variable costs in relations to fluctuations in output or turnover.
The budget is designed to change appropriately with such
fluctuation.
Restate budget based on actual volumes
Flex budget
Useful for control

Meaningful for variances

Feed-forward control

➢ Feed forward control is define as the forecasting of differences between actual and planned
outcomes and the implementation of actions before the event, to avoid such differences.

➢ Eg: using the cash-flow budget to forecast a funding problem and as a result arranging a
finance solution of the problems(s/term loan or Overdraft)

. Advantages Feed-Forward Control

✓ Inform the management of what likely to happen, unless preventive action
as taken.
✓ Encourage managers to be pro-active

Disadvantages Feed-Forward Control

✓ Time consuming and costly – report must be produce regularly.
✓ Require sophisticated forecasting system.

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14.0 BASIC VARIANCE

Sales margin price variance

P Total sales
margin variance
(AP-SP) AQ sold

Sales margin volume variance

r (AQ – BQ) Std Margin

o Material price variance

(AP-SP) AQ
f Total direct
material variance
i Material usage variance
(AQ – BQ) SP

t Labour rate variance

(AR-SR) AH

Total direct labour Idle time variance

Total production variance (AHr-AHw)SR
variance
Labour efficiency variance
(SH-AHw)SR
0)
V
Variable expenditure variance
a Total variable
overhead variance
(SR x AHw) – Actual cost

Variable efficiency variance

r (SH – Ahw) x SR

i Fixed ovh expenditure variance

a Fixed overhead
(Budgeted exp – Actual cost)

variance Fixed ovh volume variance

n [(SR-BH)SR] <or> [(AQ-BQ)Std CPU]

c
Volume capacity Volume efficiency
e variance variance
(AHw – BH) SR (SH – Ahw)SR
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 ACCA – PM: PERFORMANCE MANAGEMENT 53

BASIC VARIANCE – POSSIBLE REASONS

1. SALES VARIANCES
Price Variance Volume variance
1. Higher or lower discounts offered to 1. Changes in customers buying habits.
customer than expected . 2. Successful or unsuccessful marketing
2. A greater or lesser proportion of higher campaigns.
priced products sold than expected. 3. Higher demand as result of price cuts or
3. More or less price competition from vice versa. i.e volume variance linked to
competitors. price variance.

2. MATERIAL VARIANCES
Price Variance Usage variance
1. Wrong budgeting. 1. Wrong budgeting
2. Lower/ higher quality material used. 2. Lower/ higher quality of material i.e
3. Good / poor purchasing possibly linked to price variance.
4. External factor (inflation, exchange rate) 3. Lower / higher quality of labor.
5. Change supplier 4. Theft
5. Change in product specification.

a. LABOR VARIANCES
Rate Variance Efficiency variance
1.Wrong budgeting 1. Wrong Budgeting
2. Wage inflation 2. Learning curved – not identified,.
3. Lower/higher skilled employees 3. Lower/higher morale
4. Unplanned OT/Bones 4. Lower/ higher skilled employees
5. Lower/ higher quality of material.
6. Idle time

INTERRELATED VARIANCES

Interrelated variances
Material Price &  Cheaper material purchased (favorable price variances) , material wastage might
Usage be higher (Adverse usage variance)
 Cheaper material more difficult to handle; adverse labor efficiency variance.
 If expensive material purchased, price variance will Adverse, but usage variance
may favorable.

Labor rate &  If higher rate paid for experience & skill e’yee; lead to Adverse rate variance&
efficiency Favorable efficiency variance (efficient staff less likely to waste material..
Selling price and  Reduction in selling price might stimulate bigger sales demand, so Adverse selling
sales volume price variance might be counterbalance by favourable Sales volume variance

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 ACCA – PM: PERFORMANCE MANAGEMENT 54

15.0 Material Mix and Yield variances

The materials mix variance focuses on inputs, irrespective of outputs.

The materials yield variance, focuses on outputs, taking into account inputs.

Step 1: choose the best mix ( contribute to highest profit)

Mix 1 : 10 litres of A and 10 litres of B will yield 18 litres of C; and
Std Mix 2 : 8 litres of A and 12 litres of B will yield 19 litres of C.

standard cost Contribution:

Chemical A $20 per litre Mix 1: (18 x $30) - (10 x $20) - (10 x 25) =$90
Chemical B $25 per litre Mix 2: (19 x $30) - (8 x $20) - (12 x $25) $110
C has a standard selling price of $30 per litre.

The standard cost per unit of C is (8 x $20)/19 + (12 x $25)/19 = $24.

Step 2: Calculate material mix variance (input)

1. Identify standard Mix (SM)
2. Calculate Actual Quantity in standard Mix (AQSM)
3. Compare to Actual Quantity Actual Mix (AQAM)
4. Calculate Mix variance

Step 3: Calculate material yield variance (output)

Tabular format 1.AQSM
2.Compare to BQSM
3.Calculate Yield variance
Schedule format:
Actual input → did yield
Should yield
X std cost per unit of output

Sales Mix and Quantity Variances

If company sells more than one product, it is possible to analyse sales mix variance.
i. Sales mix variance
→ Actual sales (std mix) x Std profit
→Standard sales (std mix) x Std profit
Sales mix variance occur when proportion of various products sold are different from budget.

ii. Sales quantity variance

→ ‘should mix (AQ (std mix) x std margin)
→”did’ mix (AQ(actual mix) x std margin)
Sales quantity variance shows the different in contribution/ profit because change in sales
volume from budgeted volume of sales.

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 ACCA – PM: PERFORMANCE MANAGEMENT 55

16.0 Planning and Operational Variances

PLANNING AND OPERATIONAL VARIANCES

Original standard / budget Revised standard / budget Actual results

Planning variance Operating variance

(uncontrollable by operation (controllable by operational
mngr but by senior mngmt) mngr)

Arise due to inaccurate Caused by

planning and faulty favourable/adverse
standards operational performance

ADVANTAGES & DISADVANTAGES OF PLANNING & OPERATIONAL VARIANCES

ADVANTAGES DISADVANTAGES
• Variance are more relevant. • Establishment of budgeted and revised
• Operational variance provide ‘fair’ std , figure is difficult and time consuming.
with reflection of actual results.
• Analysis highlight controllable • Managers with poor performance
(operational) & non-controllable unlikely to accept them.
(planning) variance.
• Lead to mngrs acceptance as • Poor performance normally been
performance measurement and be excused of poorly set budget.
motivated to reduce cost for favorable
(F) operational variance. • Frequent demand for revision may
• Should improve planning & std-setting resulted in bias.
processes.

REASONS TO REVISE STANDARDS

• A change in one of main materials used to make the product.
• An unexpected increase in price of materials due to increase in world market prices.
• A change in working method that alters the labor time.
• Unexpected change in labor

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 ACCA – PM: PERFORMANCE MANAGEMENT 56

17.0 PERFORMANCE ANALYSIS IN PRIVATE SECTOR ORGANISATION

FINANCIAL PERFORMANCE INDICATORS

1.1 PROFITABILITY ANALYSIS

→ to test the profitability of the business.
→ to assess a business's ability to generate earnings
→ profits on its ordinary activities.
Purpose Comparison/ description
ROCE indicates the efficiency and • ROCE should always be higher
profitability of a company's than the rate at which the
[PBIT/Total long capital investments. company borrows, otherwise any
term capital] increase in borrowing will reduce
shareholders' earnings.
<or> • Compare against trend / several
years
PBIT/[Capital + • 2 factors that effect ROCE
reserves + long i. Profit margin ( high profit
term liabilities] margin, high ROCE)
ii. Assets turnover ( high assets;
high ROCE)

G.P margin used to assess a firm's • Compare with co. in the same
financial health by revealing industry.
=GP/Revenues the proportion of money left • Lower sales margin, shows that orgn.
over from revenues after Has not control its cost (Action :
accounting for the cost of increase sales price, control cost)
goods sold.

Measure level of fixed cost.

(If cost is high, G.P margin is
low)

EPS The portion of a company's • Compare over several

profit allocated to each share years/trends
of common stock. • Co have to sustain % / level of
EPS.
Shows how well the
shareholders doing (profit
attributable to shareholders.)

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1.2 GEARING ANALYSIS

Purpose Comparison/ description

GEARING Measure financial risk. • Highly geared company, financial
risk is high
=Long-term • Difficult to get loan,
liabilities/ • Creditors loss confident
shareholders • Investors refuse to invest
fund • Vulnerable to downturn/
capital reconstruction.
• Compare with the same company
in the industry.
• If > 50% - highly geared.

1.3 LIQUIDITY RATIO

Purpose Comparison/ description

Current ratio / determine a company's • Liquidity funds – cash; short term
quick ratio ability to pay off its short- investment; quoted investment;
terms debts obligations. fixed deposits; trade receivables &
CR = curr bills of exchange.
assets/curr
liability • Current ratio > 1 (the greater the
better)
QR = [Curr assets
– inventory]/ • Inventories; liquidity is
curr liability questionable; since its cannot
simply be convert to cash.

• Quick ratio; at least =1

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BALANCED SCORECARD

The balanced scorecard is a strategic management technique for communicating and evaluating the
achievement of the strategy and mission of an organisation.

It comprises an integrated framework of financial and non-financial performance measures that aim to
clarify, communicate and manage strategy implementation.

It translates an organisation’s strategy into objectives and performance measurements for the following four
perspectives:

Objectives, measures, target & initiatives

• Objectives – what strategy is to achieve
• Measures – how the progress of the objectives be measured.
• Target – the target value for each measure
• Initiatives – what will be done to facilitate the reaching of the target.

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Learning And Growth

Obj. Measures
Mnfct learning Process time to maturity
Product focus % of product representing % of sales
Time to market New product introduction v competitors

Internal
Obj. Measures
Mnfctg excellent Cycle time, unit cost, yield
Increase design productivity Engineering efficiency
New product launching Actual launch v plan
Staff retention/ staff turnover

Financial
Obj. Measures
Growth Revenue growth
Profitability ROE
Cost leadership Unit cost

Customer
Obj. Measures

New products % sales from new products

Responsive supply Ontime delivery

To be preferred suppliers Share of key acc.

Market share

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 ACCA – PM: PERFORMANCE MANAGEMENT 60

Finance Non-financial (learning and growth)

- Return on capital - employee turnover
- Net operating margin - employee satisfaction
- Gross to net ratio - Training and learning opportunities
- Introduction on new medical technologies

Balanced Scorecard -
Hospitals

Internal External (customer)

- Bed occupancy / OT room utilisation - Inpatient satisfaction
-Average length of stay - Outpatient satisfaction
- Doctors hours to attend to Patient - Market share
- Number of specialist to patient - Unattended patient

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 ACCA – PM: PERFORMANCE MANAGEMENT 61

BUILDING BLOCK MODEL

• Fitzgerald et al (1993) and Fitzgerald & Moon (1996) consider performance measurement in service
businesses.

• There are particular characteristics of service businesses which will affect performance and its
measurement. These are:

– Inseparability (production and consumption of the service coinciding);

– Perishability (the inability to store the service);

– Heterogeneity (variability in the standard of performance of the provision of the service);

– Intangibility (of what is provided to and valued by individual customers)

– No transfer of ownership

Building Block Model

• Ownership •E’yee need to participate in std setting & budget
•E’yee likely to accept std & > motivated & higher morale.
• Achievability Mngmt to find balance between orgn’s perceived & e’yee perceived as
achievable std.
• Equity Performance measurement of diff. Buss. Units should not be measured
against other units

STANDARD •Competitive Performance

•Financial Performance
• Quality of Service
•Flexibility
•Resource Utilization
REWARD DIMENSION •Innovation

(towards std)
Clarity • every e’yee need to understand e
performance being appraised & what goal to
achieve
Motivation Participation of e’yee towards orgn’s obj.
Controllability Mngrs should have certain level of control 10

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 ACCA – PM: PERFORMANCE MANAGEMENT 62

Competitive
Performance

Financial
Innovation
Performance

DIMENSION

Resource Quality of
Utilization Service

Flexibility

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18.0 DIVISIONAL PERFORMANCE AND TRANSFER PRICING

TRANSFER PRICING ISSUES

– definition - ‘Price of which goods/services are transferred from one department to another’

- Purpose - promoting divisional autonomy, without discouraging overall corporate maximization.

1.1.1 Method calculating transfer price

Market-based
Adjusted market price (less cost savings)
Marginal cost
Full cost
Cost-plus a mark-up
Negotiated transfer prices

MEASURING DIVISIONAL PERFORMANCE

- To measure manager’s performance & divisions’ – difficult; Introduce transfer pricing

- Goal congruence : motivate div. Mngr to make right decision ( increase profit)& improve orgn profit
as a whole.
- Autonomy : Div have autonomy to make decision
- Minimizing global tax liability.
- to record inter-divisional goods/services provided to another division

PROBLEMS OF TRANSFER PRICING

Divisional Autonomy Divisional profit Corporate profit

(div. to govern itself – maximization maximization
freedom to make decision
without consulting with
higher authority)
- self-interest – a profit- - No profit centre would want - Inter-division should maximize
centre mngr might take to work for another & incur its own profit at same orgn’s
decision for best interest of cost; without paid for it. level of output.
its own dept; against orgn - Transfer price effect - Prob: divisional disagreement
as a whole. behavior & decision by profit about output level & profit
- Head office should have centre mngr. maximizing output.

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 ACCA – PM: PERFORMANCE MANAGEMENT 64

autonomy to
overrule/instruct centre
mngr (to retain goal
congruence)

➢ Transfer price should provide ‘selling price’ to enable divs. to earn return.
➢ Transfer price should be set at fair commercial price.
➢ Transfer price should encourage centre mngrs. To agree on goods/ serc to be transferred &
consistent with orgn’s aim (profit maximization)

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 ACCA – PM: PERFORMANCE MANAGEMENT 65

19.0 DIVISIONAL FINANCIAL PERFORMANCE MEASURES:

RETURN ON INVESTMENT (ROI) & RESIDUAL INCOME (RI)/ ECONOMIC VALUE ADDED
(EVA)

ROI = Profit before tax & Interest x 100% RI = Net Profit after tax - Notional interest on
Capital employed (CE) capital

*Capital employed = (Capital + reserve+ long term

*Notional interest on capital = C.E x cost of capital (COC)
liabilities) * COC = Interest Rate or target ROI
<or> (Total assets – s/term
liabilities)
ROI RI
Definition:
RI is an operating income that an investment
ROI measure of the earning power of assets center is able to earn above some minimum
return on its assets.

Advantages:
i. Measure investment in % : can compare i. Reduce probabilities of rejecting project
with division of different size with ROI greater than group target but less
ii. East to understand than division’s current ROI
iii. Encourage good use of existing capital ii. Use different rate of interest/COC/risk for
resources different types of investment/project.
iii. Cost of financing – division’s managers
decision.

Disadvantages:
i. Difficult accounting policies can lead to i. Show absolute figure, cannot
different result. compare with other division of
ii. May lead to wrong decision making ( eg 2) different size.
iii. ROI increase as assets gets older (if NBVs ii. Behavioral impact; manager will tend
are used), thus giving managers an to reject if the project will reduce RI
incentive to hang on possibly inefficient iii. Expose to manipulation by Managers
obsolete machines. (PBIT and Net Assets)
iv. Expose to manipulation by Managers (PBIT
and Net Assets)

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 ACCA – PM: PERFORMANCE MANAGEMENT 66

20.0 PERFORMANCE MANAGEMENT IN NOT-FOR-PROFIT ORGANISATIONS

What is a not-for-profit (NFP) organisation?

NFP organisations display the following characteristics:

• Most do not have external shareholders and hence the maximisation of shareholder
wealth is not the primary objective.
• Their objectives normally include some social, cultural, philanthropic, welfare or
environmental dimension which would not be readily provided in their absence.

When assessing the performance of NFP organisations it is important to include both

financial and non-financial measures.

Problems associated with performance measurement in NFP organisations include the

following:

Problem 1: Non-quantifiable costs and benefits

This is because:

• No readily available scale exists.

For example, how to measure the impact of a charity providing a help line to people
suffering from depression?

• How to trade off cost and benefits measured in a different way.

For example, suppose funds in a hospital are reallocated to reduce waiting lists (a
benefit) but at the expense of the quality of patient care (a cost). Is the time saved
enough to compensate for any potential additional suffering?

• Time scale problems.

Benefits often accrue over a long time period and therefore become difficult to
estimate reliably. For example, a school may invest in additional sports facilities that
will benefit pupils over many decades.

• Externalities.

Suppose a council decides to grant planning permission for new houses to be built.
The new residents will increase the number of cars on local roads, resulting in
greater congestion and pollution, affecting other residents.

Solution = cost benefit analysis (CBA)

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 ACCA – PM: PERFORMANCE MANAGEMENT 67

Some NFP organisations, particularly in the public sector, attempt to resolve the above
difficulties by quantifying in financial terms all of the costs and benefits associated with a
decision.

Illustration - CBA

Suppose a local government department is considering whether to lower the speed limit for
heavy goods vehicles (HGVs) travelling on a particular road through a residential area. The
affected stakeholders may be identified as follows:

These costs and benefits then need to be quantified financially.

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Once these have been quantified, it is relatively straightforward to compare overall costs
and benefits to see the net impact on society and then make a decision.

Problem 2: Assessing the use of funds

Many NFP organisations, particularly public sector organisations,do not generate revenue
but simply have a fixed budget for spending within which they have to keep. The funding in
public sector organisations tends to come directly from the government.

There are a number of problems associated with this funding:

• The organisation may feel under pressure to hit government targets rather than
focusing on what they would normally consider important.
• There is not necessarily a link between providing more service and obtaining more
funds. Funding tends to be limited and may not be controllable.
• A failure to achieve objectives sometimes leads to higher levels of funding. Fore
example, an ineffective or inefficient police force will not be closed down, but is
likely to justify and obtain additional funding.

Solution = assess value for money

Value for money (VFM) is often quoted as an objective in NFP organisations, i.e. have they
gained the best value from the limited funds available?

VFM can be assessed in a number of ways:

• through benchmarking an activity against similar activities in other organisations

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 ACCA – PM: PERFORMANCE MANAGEMENT 69

• by using performance indicators/ measures

• through conducting VFM studies (possibly in conjunction with other institutions)
• by seeking out and then adopting recognised good practice where this can be
adapted to the institution's circumstances
• through internal VFM audit work
• through retaining both documents that show how an activity has been planned to
build in VFM, and evidence of the good practices adopted
• by examining the results or outcomes of an activity.

The 3Es

Value for money is interpreted as providing an economic, efficient and effective service.

Economy - an input measure. Are the resources the cheapest possible for the quality
desired?

Efficiency - here we link inputs and outputs. Is the maximum output being achieved from
the resources used?

Effectiveness - an output measure looking at whether objectives are being met.

Other methods of evaluating performance

In addition to assessing value for money and the 3Es the following approaches can be used
to assess the performance of NFP organisations:

• The 'goal approach' looks at the ultimate objectives of the organisation, i.e. it looks
at output measures.

For example for a hospital: Have waiting lists been reduced? Have mortality rates
gone down? How many patients have been treated?

• The 'systems resources approach' looks at how well the organisation has obtained
the inputs it needs to function.

For example, did the hospital manage to recruit all the nurses it needed?

• The 'internal processes approach' looks at how well inputs have been used to
achieve outputs - it is a measure of efficiency.

For example, what was the average cost per patient treated?

Problem 3: Multiple and diverse objectives

Diverse objectives

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 ACCA – PM: PERFORMANCE MANAGEMENT 70

As mentioned, NFP organisations are unlikely to have an objective of maximisation of

shareholder wealth. Instead they are seeking to satisfy the particular needs of their
members or sections of society,which they have been set up to benefit.

Diverse objectives in NFP organisations include:

• A hospital's objective is to treat patients.

• A council's objective is care for the local community.
• A charity's objective may be to provide relief for victims of a disaster.

Multiple objectives

Multiple stakeholders in NFP organisations give rise to multiple objectives. This can be
problematic when assessing the performance of these organisations.

Solution

The problem of multiple objectives can be overcome by prioritising objectives or making

compromises between objectives.

Problem 4: The impact of politics on performance measurement

The combination of politics and performance measurement in the public sector may result
in undesirable outcomes.

• The public focus on some sectors, such as health and education, make them a prime
target for political interference.
• Long-term organisational objectives are sacrificed for short-term political gains.

Source: http://kfknowledgebank.kaplan.co.uk/

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