MALec Batch 4
MALec Batch 4
MALec Batch 4
Management Accounting
Lecture Notes
Lecture 16
Topics Covered
Budgeting 2
298
Fixed Versus Flexible Budgets
A fixed budget is a planning budget and is used to set the target performance.
Flexible Budgets
A flexible budget recognises how variable cost changes as activity levels changes.
The flexible budget is prepared for the level of activity actually achieved.
At the end of the actual budget period, actual results should be compared to flexible
budgets for variance analysis as part of performance measurement.
Step 2 - Break up semi- variable cost into fixed & variable cost if necessary
using the high-low method
Step 3 - Flex the variable cost. Do not flex the fixed cost.
299
Why prepare a flexible budget?
The adverse variance means here means that the production manager has due to
inability to control cost caused the actual profit to be lower than the budgeted profit by
$35,000.
But this is obviously not the case here as the budget is only for 10,000 units of
production when 20,000 units were actually produced. Hence, the comparison of the
cost is not logical as you not comparing “apples to apples”. We cannot expect the
production manager to produce 20,000 units using the variable cost resources for
10,000 units. Its simply not possible to do this. You can’t produce 20,000 cars with
10,000 engines!
The production budget above is actually a fixed budget as the volume(units) is not the
same as the actual units produced. It should only be used at the planning stage (before
the year starts) to communicate the expected level of performance. In this case, based
on the demand expected, the company planned to produce 10,000 units this was the
forecast demand. But it seems like the actual demand was much higher at 20,000 units
and hence the production manager has done well as he did produce the expected
demand and satisfied the customer’s requirement.
Hence, to judge his ability to control cost, a flexible budget should be used to compute
controllable variances. The variable cost in the budget should be doubled to $60,000 to
reflect that 20,000 units were actually produced. No change to the total fixed cost as
total fixed cost is constant over the relevant range.
Performance Report – Production Manager
This is a more meaningful
Flexible Actual Variance
comparison of “apples to
Budget
apples”
Units 20,000 20,000
Total Cost $ $ Do not change the actual
Variable cost 60,000 60,000 0 amounts the actual
Fixed cost 50,000 55,000 5,000(A) amounts are based on
Total 110,000 115,000 5,000(A) actual transactions300
Don’t flex the total fixed cost already incurred.
Preparing a flexible budget
Remember, when you flex the budget you only making changes in the total variable cost
and the total sales amounts, no change to total fixed cost. Total sales and total variable
cost are linear functions, with a constant gradient or slope.
Total sales Total variable cost
Total sales
Total variable cost
Hence, the total variable cost and the total sales amounts in the flexible budget is only a
“change in proportion” as compared to the fixed budget. No need to compute the selling
price per unit or the variable cost per unit to compute the flexible budget amounts.
Example, assume the following information. Compute the total variable cost, total fixed
cost and the total sales amount for 60% capacity.
Capacity Total sales Total variable cost Total fixed cost
$ $ $
40% 140,000 60,000 100,000
60%
Total sales
$140,000
40% 60%
301
Lecture Illustration 1
The Noble restaurant that is only open in the evenings, on six days of the week.
It has eight restaurant and kitchen staff, each paid a wage of $8 per hour on the
basis of hours actually worked. It also has a restaurant manager and a head
chef, each of whom is paid a monthly salary of $4,300. Noble’s budget and actual
figures for the month of May was as follows:
Budget Actual
Variable costs:
Staff wages 9,216 13,248
Food costs 6,000 7,180
Drink costs 2,400 5,280
Energy costs 3,387 3,500
(21,003) (29,208)
Contribution 38,997 43,332
Fixed costs:
Manager’s and chef’s pay 8,600 8,600
Rent, rates and depreciation 4,500 4,500
(13,100) (13,100)
Operating profit 25,897 30,232
1) The restaurant is only open six days a week and there are four weeks in a
month. The average number of orders each day is 50 and demand is evenly
spread across all the days in the month.
2) The restaurant offers two meals: Meal A, which costs $35 per meal and Meal
B, which costs $45 per meal. In addition to this, irrespective of which meal the
customer orders, the average customer consumes four drinks each at $2·50 per
drink. Therefore, the average spend per customer is either $45 or $55 including
drinks, depending on the type of meal selected. The May budget is based on
50% of customers ordering Meal A and 50% of customers ordering Meal B.
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5) When the number of orders per day does not exceed 50, each member of
hourly paid staff is required to work exactly six hours per day. For every
incremental increase of five in the average number of orders per day, each
member of staff has to work 0·5 hours of overtime for which they are paid at the
increased rate of $12 per hour. You should assume that all costs for hourly paid
staff are treated wholly as variable costs.
5) Energy costs are deemed to be related to the total number of hours worked by
each of the hourly paid staff and are absorbed at the rate of $2·94 per hour
worked by each of the eight staff.
Required:
Prepare a flexed budget for the month of May. What is the % increase
Flexible Budget - May in the number of meals?
_______________.
No of Meals 1,560
$
As long as you use the
Revenue: Food right technique, you can
actually ignore the
Drink information given in
item 2) above
Total Revenue 78,000
Variable Cost
Food Cost
Drinks Cost
Energy Cost
Salary
Rent, Depreciation
Operating Profit
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Exam Tip
Adopting the right technique is important in the preparation
of the flexible budget.
304
Working
305
Lecture Illustration
Blue Skies Promotions Ltd organises trade exhibitions around the UK. It
concentrates on medium sized cities providing medium sized exhibition facilities.
Typically, a location provides 1,000 square metres of ‘stand’ space which Blue
Skies offers to exhibitors as ‘small’ stands of 4 square metres or ‘large’ stands of
6 square metres. Companies needing even larger stands can take up multiples of
either. For a normal two day exhibition the list price for 2020 is £1,200 for a small
stand and £1,680 for a large stand. Discounts are offered to companies which
book early, or take larger stands. If an exhibition runs for 3 or 4 days a pro-rata
daily rate of £600 for a small stand and £840 for a large stand applies.
Each location provides the exhibition hall, heating and lighting, cleaning, car
parking and catering facilities, etc. Blue Skies handles planning, advertising and
publicity, exhibition preparation, liaison with exhibitors and the running of the
exhibition.
Blue Skies plan to run one 2-day exhibition each week. From January 1st 2020
the management is establishing a budgeting system for the exhibition activities.
Shown below is the standard revenue and cost sheet for a 2-day exhibition:
Per Exhibition
£ £
Revenue
Small ( 4 metres) Stand
100X £1,200 X 0.90 X0.85 91,800
Lage (6 metres) Stand
100 X £1,680 X 0.9 X 0.85 128,520
Total Revenue 220,320
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Lots of details here but
mostly not required to
prepare the required
The above standard was prepared using the following assumptions: budgets
• Blue Skies will be able to let 90% of the available stand space and early
booking discounts, etc., will be 15% of the full list price.
Blue Skies is now embarking on a detailed analysis of the most recent quarter’s
(January-March 2020) activities. During that quarter it actually ran eight 2-day
exhibitions, plus one of 3 days and one of 4 days. The analysis reveals:
Direct exhibition expenditure was: The actual cost given here not relevant to
the preparation of the required budgets
• Hall hire £870,000.
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Exam Tip:
For the exam, always assume that there are 52
weeks in a year, unless mentioned otherwise.
Required:
Prepare a table (down to company operating profit) showing: Fixed budge
Small
Large
Less: Cost
Hall Hire
Advertising
Exhibitor
Visitors
Setup
Administration
Allocated HQ Cost
Division Profit
Note:
This question is not as difficult as it seems as long as you
adopt the right technique.
308
This is a Japanese budgeting concept.Good
Kaizen budgeting for 5 marks question in Section B of exam.
Kaizen budgeting is a budgetary process that explicitly incorporates
continuous improvement during the budget period.
This should be done by comparing the actual results to the flexible budgets
instead of the fixed budgets as the fixed budgets do not reflect the different
volumes achieved.
309
A responsibility centre is a decentralised subunit of an organization whose
manager is accountable for a specified set of activities.
2) Revenue centre, in which the manager is accountable only for revenues only.
For example the sales department could be a revenue centre because the
sales manager is responsible primarily for revenue.
3) Profit centre, in which the manager is accountable for revenues and costs.
For example, the shoe department in a department store may be accounted
for as a profit centre
310
The following table highlights the differences between cost centre, profit centre
and investment centre.
311
Examples
How the choice of the responsibility centre effect the manager’s behaviour
The choice of the type of responsibility centre determines what the manager is
accountable for and thereby affects the manager’s behaviour. For example, if a
revenue centre is chosen, the manager will focus on revenues, not on costs.
Behaviour
Cost centre The manager will focus only on Wrong behaviour
cost control, ignoring revenue
generation.
Revenue Centre The manager will focus only on Wrong behaviour
revenue generation, ignoring
cost control.
Profit Centre The manager will focus on Right behaviour
revenue generation and cost
control as this will maxmise 312
profit
The type of responsibility centre also depends on the organisational structure.
Such work units are either profit centres or investment centres as they
operate autonomously with minimal interference by head-office.
313
Example: Business work units
Refer to the above chart and designate the divisions as appropriate responsibility
centres.
314
Choice of types of responsibility centres depends on:
• size of organisation
• nature of organisation
• organisational structure.
Functional work units tend to be cost or revenue centres, for example production
and sales departments.
315
Homework Questions - Lecture 16
Question 1
Whitewater Promotions Ltd organises trade exhibitions around the UK. It
concentrates on medium sized cities and uses medium sized exhibition facilities.
Each location provides the exhibition hall, heating and lighting, cleaning, car
parking catering facilities, etc. Whitewater handles planning, advertising,
publicity, exhibition preparation, liaison with exhibitors and the running of the
exhibition.
Whitewater plan to run one 2-day exhibition each week. From January 1st 2009
the management is establishing a budgeting system for the exhibition activities.
Shown below is the standard revenue and cost sheet for a 2 day exhibition:
Per Exhibition
Revenue £ £
Small (4 sq metres) stands
100 x £1,000 x 0.90 x 0.85 76,500
Large (6 sq metres) stands
100 x £1,400 x 0.90 x 0.85 107,100
Standard Revenue 183,600
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The above standard is prepared using the following assumptions:
• Whitewater will be able to let 90% of the available stand space and early
booking discounts, etc. will be 15% of the full list price.
• There will be an equal number of large and small stands.
• Hall hire will average £32,500 per day.
• Advertising directed at exhibitors is incurred for each exhibition and is
not dependent on the length of the event. However advertising directed
at visitors varies with the number of days of each event.
• 10 freelance fitters and electricians take a total of 3 working days each to
set up the exhibition and dismantle the stands after the event. They are
paid £100 each per day and their travelling, subsistence, etc. averages
£30 each per day.
• While the exhibition is running Whitewater provides an organiser’s office
to monitor admissions, etc. This requires 8 staff each paid an average of
£80 for each day of the exhibition. Since several exhibitions are open in
the evening, travelling, subsistence and hotel expenses average £60
each per day.
• Whitewater’s Head Office budget for 2009 is £360,000.
(c) Discuss the significance of the variances you have calculated. What further
information would be useful and are there any further variances which could be
calculated?
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(5 marks) – UOL adapted Zone B 2009 Question 3
Question 2
A Charity is extending its budgetary control and responsibility accounting systems
to all departments. One such department concerned with public health and welfare
is called “Elderly”. The department consists of staff who visit elderly “clients” in
their homes to support them with their basic medical and welfare needs.
Shown below is the first months’ cost control report for the Homecare department.
Cost Control Report - Elderly Department
Month ending May 2012
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is a central administration overhead charge over all departments. Consumables
consist of materials which are used by staff to care for clients. Administration and
telephone costs are costs of keeping in touch with the staff who often operate from
their own homes.
As a result of the report, the Director sent a memo to the manager of the Elderly
department pointing out that the department must spend within its funding
allocation and that any spending more than 5% above budget on any item would
not be tolerated. The Director refused an immediate explanation for the serious
overspend.
Required:
Develop and explain the issues concerning the budgetary control and
responsibility accounting system which are likely to be raised by the
management accountant. You should refer to the way the budget was prepared,
the implications of a 20% increase in the number of visits, the extent of
controllability of costs, the implications of the funding allocation, social aspects
and any other points you think appropriate. You may include numerical
illustrations and comment on specific costs, but you are not required to produce
the cost control report.
Question 3
(a) Draw a diagram to show the separate budgets necessary to produce
complete operating budgets and financial budgets for a manufacturing
organisation. You should indicate the inter-relationships between budgets, where
appropriate. (10 marks)
Question 4
Explain how the choice of the type of responsibility centre affects behavior.
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University Of London
Management Accounting
Lecture Notes
Lecture 17 & 18
Topics Covered
Lecture 17 & 18
The first part is a review of standard costing variances as done in POA as its
important to be familiar with the basic variances before being able to understand
the advanced variances.
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Standard Costing Defined
Purpose:
5) Standard costs are predicted future cost which can be used to support
decision making, for example, in making pricing decisions.
Generally, standard cost system not
Usefulness of Standard Costing Systems useful for service industries
Standard Costing systems are the most useful in mass production (for example
process costing) or repetitive assembly line work and less suited for specific
order costing environment such as job costing.
Differences:
1) Standard is unit concept, applied to a product or to individual operations.
321
Flexible Budget Variances
A variance is the difference between the budgeted amount and the actual
amounts.
Variance formula
322
This illustration is a review of the basic variance analysis that
was done for POA.
It is important to understand the basic variance computation
Lecture Illustration before proceeding to the advanced variance analysis.
Bench Ltd makes quality wooden benches for both indoor and outdoor use.
Overheads are absorbed using labour hours and the company uses an
absorption costing system. There were no inventory at the beginning of the
month. Inventory is valued at standard cost.
Required:
Calculate all possible variances and reconcile the actual profit with the
budgeted profit using absorption costing.
Note:
There are many methods to compute these variances and
you can use any method as long as you show your working
and get the right answers.
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Cost Variance
D. Material
Price Variance =
Usage Variance
SQ for Actual Production units
Usage Variance =
D. Labour
Rate (Price) Variance =
Efficiency Variance
SQ for actual production units =
Efficiency Variance =
Variable Overhead
Price (Spending) Variance
=
=
=
Efficiency Variance
=
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Fixed Overhead
Spending Variance
Efficiency Variance
Capacity Variance
Interpretation
Sales Variance
Price Variance =
AC Volume Var =
MC Volume Var =
The two difference between the Absorption costing (AC) and Marginal
costing (MC) approach are:
1) MC does not involve the absorption of fixed production overheads
into products, hence there is no capacity and efficiency variance,
only spending variance for fixed overhead.
325
Reconciliation of Budgeted Profit and Actual Profit (Absorption costing)
£ £
Budgeted Profit (Fixed Budget)
4,000 units @£28 per unit 112,000
Variable Overhead
Spending Variance 12,000(F)
Efficiency Variance 14,400(A)
Total Variable overhead variance (2,400) (A)
Fixed Overhead
Spending Variance 60,000(F)
Efficiency Variance 57,600(A)
Capacity Variance 32,000(F)
Total Fixed overhead variance 34,400 (F)
Actual Profit 134,800
Reconciliation (Rule)
(F) Var = Add
(A) Var = Deduct
326
Exam Tip
Advanced Variance Analysis This area on advance variance are most likely to
Material Usage Variance be tested in the exam.
(Standard usage for actual production Less Actual Usage) X Standard Price per Kg
The material usage variance can be subdivided into a material mix variance
and a material yield variance when more than one material used in the
production process.
Note the mix and yield variance only
relevant when more than one type
DIRECT MATERIAL USAGE VARIANCE of materials are used in the
production process. One material
used, no mix and yield variance.
A mix variance occurs when the actual mix differs from the standard mix.
A yield variance is the difference between the standard usage that should
have been used for the output achieved and the actual usage.
(Standard cost per unit@ standard mix Less Standard cost per unit@ actual mix) X Actual
Total Usage
Yield Variance =
(Actual total Usage Less Standard Total Usage) X Standard cost per unit@ standard mix
Question
Which the 2 process have a better yield?
Process 1 Process 2
Total Input 110KG 150KG
Answer:_________________________________________________
________________________________________________________
________________________________________________________
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Lecture Illustration
In the period, the actual output was 93.1 tonnes and the inputs were as follows:
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Answer:
Mix Variance
Step 1 Compute the two average standard cost
______________________________________________________________
Answer:_______________________________________________________
Mix Variance =
______________________________________________________________
Note:
Variance
1)Standard cost per tonne @actual mix < Standard cost per tonne @standard mix (F)
2)Standard cost per tonne @actual mix > Standard cost per tonne @standard mix (A)
329
Yield variance
Therefore, use the % above to compute the tonnes you should have
used to produce 93.1 tonnes of output
Answer:____________________________________________________
Yield Variance =
__________________________________________________________
Note:
Variance Note:
1)Actual Total Usage < Standard total usage (F) If use less total material compared
to standard = Good(F)
2)Actual Total Usage > Standard total usage (A) Use more total material compared to
standard = No good(A)
330
This can be confirmed as correct by computing the sum individual usage
variance for the three ingredients.
Note: You don’t need to do this in exam, just add Mix + Yield = Usage
variance
331
Interpretation of the above variances:
Because the average standard cost per tonne at actual mix ($23.91) lower
than the average standard cost per tonne at standard mix ($24.20).
Since the average standard cost per tonne at actual mix is lower
compared to average standard cost per tonne at standard mix, it implies
that proportionately more of the cheaper material P & N were used (92%)
in the actual production process as compared to only 90%( standard mix)
that was supposed to be used in the standard production process.
1)Well, that is obvious as the actual loss was higher than the standard
loss.
If the actual loss is higher, it also implies that the actual yield was lower.
The actual yield was 93.1% whereas the standard yield should be higher
at 95%. (100 – 5% Loss)
Favourable variance arises when you use less total material input
(compared to the standard input) to produce the actual output.
Adverse variance arises when you use more total material input
(compared to the standard input) to produce the actual output.
Hence the yield variance is adverse as you used a total 100 tonnes
instead of 98 tonnes to produce the actual total output of 93.1 tonnes.
332
Lecture Illustration
Best Cakes make cakes, which are sold directly to the public. The new
production manager wants to use only high quality materials in cake production.
Standard cost card for one cake (not adjusted for the high quality ingredients
change)
Ingredients Kg $
Flour 0·10 0.12 per
kg
Eggs 0·10 0·70 per
kg
Butter 0·10 1·70 per
kg
Sugar 0·10 0·50 per
kg
Total input 0·40
Normal loss (10%) (0·04)
Standard weight of a cake 0·36
Standard sales price of a cake 0·85
Standard contribution per cake after all variable 0·35
costs
The budget for production and sales in April was 50,000 cakes. Actual
production and sales was 60,000 cakes in the month, during which the following
occurred:
Ingredients Kg $
Flour 5,700 $741
Eggs 6,600 $5,610
Butter 6,600 $11,880
Sugar 4,578 $2,747
Total input 23,478 $20,978
Actual loss (1,878)
Actual output of cake mixture 21,600
Actual sales price of a cake $0.99
Required:
Calculate the material usage, mix and yield variances.
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Answer:
Mix Variance
Step 1 Compute the two average standard cost
______________________________________________________________
Answer:_______________________________________________________
Mix Variance =
______________________________________________________________
Yield Variance
Step 1 Compute the Standard Total Usage:
Answer:____________________________________________________
Yield Variance =
__________________________________________________________
334
Interrelationship between the mix, yield variance and other variances
A change in the mix of materials, for example using relatively cheaper materials
may cause adverse yield variance as actual losses may increase due to the
cheaper (lower quality) material used.
Also, using cheaper materials may compromise the overall quality of the
product, thus having an adverse effect on sales variances. This will have
implications on the performance of the sales manager, even though the
decision to use cheaper material was taken (controllable) by the production
manager.
(Budgeted sales units Less Actual sales units) X Standard margin per unit
The sales margin volume variance can be subdivided into a mix variance and
a quantity variance where multiple products are sold.
Indicates the effect on budgeted profit of changing the mix of actual sales from
the standard mix.
335
Formulas:
Mix Variance =
(Standard margin per unit@ standard mix Less Standard margin per unit@ actual mix) X
Actual total units sold
Note:
Variance
1)Standard margin per unit @actual mix < Standard margin per unit @standard mix (A)
2)Standard margin per unit @actual mix > Standard margin per unit@ standard mix (F)
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Quantity Variance =
(Actual total units sold Less Budgeted Total Usage sold) X Standard margin per unit@
standard mix
Note:
Variance Logic:
1)Actual total units sold < Budgeted total units (A) If sell more compared to budget =
Good (F)
2)Actual total units sold > Standard total units (F) If sell less more compared to budget
= No good (A)
337
Lecture Illustration
Budgeted
Actual
338
Answer:
Mix Variance
______________________________________________________________
Answer:_______________________________________________________
Mix Variance =
______________________________________________________________
Quantity Variance
Step 1 Identify the actual total quantity and the budgeted total
Quantity sold
Quantity variance =
__________________________________________________________
339
Lecture Illustration
A company makes 2 different products A and B. During the period the budgeted
and actual results are as follows:
Budgeted
Actual
Product Volume Margin
W 50 21
X 550 2.50
Calculate the sales volume variance including the mix and quantity variance
340
Recall that the basic principle in responsibility accounting is that a manager
cannot be held responsible for any activity that he/she cannot control.
Hence, if a variance is due to uncontrollable factors, he/she cannot be held
responsible for that variance.
In line with responsibility accounting, the total variance may be subdivided into
planning and operational variance to account for any uncontrollable factors.
Planning variance compares the original standard with the revised standard
that should have been used if planners had known in advance what was going
to happen.
An operational variance compares the actual result with the revised, more
realistic standards. These variances are controllable and therefore can be used
to evaluate performance.
341
Lecture Illustration
The following relates to Shea Company for April when 2000 units of Ceramics
were produced.
Actual Direct Materials used 4,400 KG for total cost of $72,600. During the
period, the world prices of the material increased to $16.00.
It was also subsequently discovered that the standard allowance for material at
2 kg per unit did not incorporate a normal loss allowance of 10%.
Actual direct labour hours used was 5,500 hours for a total cost of $60,500. It
was also subsequently discovered that 300 hours used was due to equipment
malfunction that was beyond the control of the production manager.
Note:
1) The increase of world prices to $16 would therefore make the
standard cost of $15 per kg no longer realistic, hence the
benchmark price to compute controllable variance should be
$16, not $15.
2) The material loss allowance & idle time allowance should have
been incorporated into the original standard cost to make the
standard cost more realistic and these are also not controllable
by the production manager.
342
D. Material
Price Planning =
Price Operational =
343
Actual Labour Usage Variance
344
Computing sales planning & operational variance
Lecture Illustration
The following budgeted data for a particular period was available for a
company selling two products:
Sales price Variable cost Sales volume
per unit per unit in units
Product A $24 $8 15,840
Product B $24 $11 10,560
The actual results for the period were as follows:
Sales price Variable cost Sales volume
per unit per unit in units
Product A $22 $8 14,200
Product B $26 $11 12,500
For product A, with the benefit of hindsight, is was realised that the budgeted
sales price of $24 per unit was hopelessly optimistic and a price of $21 was
more realistic.
For product B, it was discovered that the market size had unexpected
increased by 10% and in hindsight, this fact should have been incorporated
into the budget.
Required:
a) Compute the sales price variance for product A and show the
breakdown between the planning and operational variance.
b) Compute the sales volume variance for product B and show the
breakdown between the planning and operational variance.
Notes:
1) The budgeted price of $24 is therefore not realistic and hence
responsibility assigned only to achieve the price of $21.
345
Product A
Actual Price Variance =
+ = $
Product B
Actual Sales Volume Variance
346
Factor to consider in decision to investigate variances
Investigation of variances:
The decision to investigate variances will depend the following factors:
These include:
1) The materiality and the trend of the variance.
Because sometimes variances are favourable but for the wrong reasons.
For example, the material price variance is favourable due to the fact that
the purchasing manager, in order to enhance his own performance
purchased a lower grade of material at a price lower than the standard
price. Even though this will result in some saving buying the materials, the
lower grade materials may cause adverse material usage and adverse
labour efficiency variance as follows:
$
Direct material price variance 100,000 (F)
Problem:
Direct material usage variance 200,000 (A)
Labour efficiency variance 50,000 (A)
Net Loss of profit 150,000___
Hence, the saving from buying the lower grade material resulted in loss of
profit overall.
347
Homework Questions Lecture 17 & 18
Short answer questions
Q1
The standard variable production overhead cost of product is as follows:
4 hours at £1.50 per hour
During the period the production of product Z amounted to 400 units. The
labour force worked 1,600 hours, of which 30 hours were recorded as idle
time. The variable overhead cost incurred was £2,500.
Required:
a) What is the variable overhead expenditure variance?
b) What is the variable overhead efficiency variance?
Q2
A company manufactures a number of products and here is the information:
Budgeted Actual
Sales 25,500 units @ £20 each 24,000 units @ £18 each
Production: 26,000 units 25,000 units
Direct materials 3 kg @ £2 per kg 3.5 kg @ £1.5 per kg
Direct labour 5 hrs @ £1 per hour 4.5 hrs @ £1.5 per hour
Fixed production overhead £104,000 £110,000
Absorbed at direct labour hour
Required
(a) Calculate the selling price variance.
(b) Calculate the direct material price variance.
(c) Calculate the direct labour efficiency variance.
(d) Calculate the fixed production overhead volume variance.
(e) Give two explanations for the direct labour efficiency variance calculated in part
(c).
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Question 1
(a) Outline the uses of standard costing and discuss the reasons why standards
have to be reviewed.
Question 2
Discuss the issues to be considered when setting standard product costs.
Explain the ways in which standards may be affected by changes in
technology. (10 marks)
(UOL adapted 2008 Zone A Question 6a)
Question 3
Williams Soft Drinks Ltd is a small company manufacturing high energy drinks
which are sold to retailers in cases of 100 bottles. The production operates on
a Just In Time system. The company installed a standard absorption costing
system in May 2008.
The performance report for May 2008 has been produced and is being
discussed by the executives:
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The following observations are made:
Managing Director
‘What’s the point of a fixed overhead capacity variance? The overheads are
fixed aren’t they? By the way what were the actual results?’
Sales Manager
‘We were badly hit in the final week of this month by a promotion from our
largest competitor. They reduced prices by 20% just for that one week. We
responded with additional point of sale advertising costing an extra £2,000 but
it obviously was not enough. Industry sales were down by 8%.
In the first week, factory machine faults led to slower production, so the
factory provided us with 500 less cases than were budgeted.’
Purchasing Manager
‘The materials price variance is the result of a tax increase of 5%. I managed
to prevent our supplying company from passing on the whole increase
because we are their best customer. I negotiated it down to a 2% increase.
Production Manager
‘I had to pay the employees for the hours they waited while machine faults
were being repaired by the manufacturers.
I don’t know why there is a labour rate variance, we paid employees the
£8.05 per hour which was negotiated on 1st May.
Required:
(a) Calculate the budgeted and actual results for May 2008 and present them
as a profit and loss statement. (8 marks)
(b) Explain how the fixed overhead capacity variance should be interpreted.
(4 marks)
(c) Calculate the financial impact of the reasons given by the sales,
purchasing and production managers and provide a more informed report for
the executives, showing which variances have been explained by their
comments and indicating the unexplained variances. (13 marks)
(UOL adapted 2008 Zone B Question 3, 25 Marks)
350
University Of London
Management
Accounting
Lecture Notes
Lecture 19
Topics Covered
Questions from this lecture can appear in both Section A and B of the
exam. The computation questions in Section A for this lecture are fairly
easy to do in the exam.
Hence decision
making becomes
decentralised and
division managers
will make decisions
about the operations
of the division.
This becomes a
problem if the division
manager do what’s
good for the division
but bad for the
company as
managers tend to act
in self-interest.
Divisions as profit or investment centres
Where the division manager cannot control the investment and is only
responsible for profits obtained from operating the assets assigned to the
division, then that division is a profit centre.
Where the divisional manager is responsible for profits and making capital
investment decisions, then that division is an investment centre, given
responsibility to maximise the Return on Investment.
352
Who will be better able to customize a burger to suit the local taste buds in
Singapore, an American manager located in the USA or the local
Singapore manager?_____________________
___________________________________________________________
_____________________________
3. Increases motivation.
Allowing sub-units managers to exercise initiative is motivational to
them.
353
Different Performance Measures of Divisions
The purpose of the performance measure must distinguish between the overall
performance of a division as an economic unit and the performance of an
individual divisional manager.
For example a good manager may be assign to an ailing division to improve its
performance.
The ailing division may still be unprofitable because of industry factors such as
declining demand which is beyond the control of the division manager
personally.
Hence, even though the future of the division as an economic unit is uncertain,
the division manager may still be promoted as a result of personal outstanding
performance.
Hence, allocation of central (HQ) services cost that are not controllable by the
division manager should not be included in the computation of division profit.
354
1) Return on investment (ROI) is the most popular performance measure.
Conclusion:_____________________________________________________
______________________________________________________
______________________________________________________
To Maximise ROI:
1) Maximise sales
2) Minimise expenses
3) Minimise investment(assets)
Hence, if you can lower the assets used, you can also increase ROI,
without increasing profit.
355
Companies use a variety of definition profit and investment to compute ROI
Definition of Profit
PM = Performance measure
$
Controllable revenue x
Less controllable cost x
1. Controllable Profit x 1. PM of division manager(personal)
Less non-controllable avoidable costs x
2. Divisional Profit contribution x 2. PM of division as sub-unit
Less Allocated corporate expense x
3. Divisional Profit before taxes x 3. PM of division for comparison purpose
There are three alternative profit measures to evaluate the division managers
performance or the performance of the division as an economic unit.
These are:
1)Controllable Profit
Controllable Profit is the most appropriate measure of a divisional manager
personal performance as it represents the contribution made be the division
manager to HQ profit.
This measure would include allocated corporate expenses such as legal and
consulting fees.
356
Definition of Investment (Assets)
2) Current cost
This represents the cost of purchasing the assets today.
Compared to historical cost ROI, current cost ROI better measures the
current economic return of the division.
357
ROI may be decomposed into its two components using the du-pont method
as follows:
Maximise Sales Minimise expense = Maximise Profit
ROI = Asset Turnover X Profit Margin
b) Ratio can be subdivided into a series of explanatory ratio using the du-pont
method for further analysis as stated above.
Disadvantages of ROI
a) The different measure of profit or investment involves elements of
subjectivity and lack of consistency. Also, the use of different measures will
impair the comparability of ROI across sub-units due to the lack of
consistency.
ROI = Profit/ Assets, hence higher asset amount will lower ROI.
c) The ROI measure only focuses on performance in one year. Managers may
take actions which will improve short-term ROI but impair future performance.
This is particularly likely if a manager receives bonuses based on the annual
division ROI.
We want managers to increase profit by doing the right actions such as eliminating non-value added
activities.
We don’t want managers in increase profit by doing the wrong actions such as
1) Post-pone important Research and development and training
2) Decrease equipment maintenance
Why would a manager do 1) and 2)? Because doing these activities increases annual expense
and reduces the annual profit and hence annual ROI. This means lower bonus.
d) Managers may reject good investment opportunities that would improve the
company’s overall performance but will lower the ROI of the division leading
to sub-optimal decision.
Invest in Finance By
Assets = Liability + Equity
2) Residual Income (RI) ROI Cost of capital
Conclusion:________________________________________________
__________________________________________________________
__________________________________________________________
__________________________________________________________
______________________________________________________
Areas where residual income is an improvement on ROI
______________________________________________________
Residual income uses the same figures as ROI for the computation of profit
and investment. Hence same disadvantages apply to RI as for ROI.
RI makes the cost of capital more visible compared to ROI. ROI tends to
ignore the cost of capital.
359
Residual Income also helps in resolving the problem of managers rejecting
new investment opportunities which have a return that would improve the
company’s overall profit but is lower than the ROI of the division as along as
the RI of a potential investment is positive, the RI of the division will also
increase.
Lecture Illustration
The Bravo division of a company currently has capital employed of $100,000
and earns an annual profit $18,000. The divisional manager is considering an
investment of $10,000 in an asset that will earn a constant annual profit of
$1,600. The company’s cost of capital is 15%.
i. The return on divisional investment, before and after the new investment
ii. The divisional residual income before and after the new investment.
(i)
New Investment ROI =
Profit
Less:Cost of capital
Residual income
360
New investment increases residual income by
iii) Implications
1) If ROI is used to evaluate the performance of the division
manager, the manager will reject the good investment even though
the ROI of 16% greater than the company’s cost of capital of 15%.
15%.
congruent decision.
361
Lecture Illustration 2
Financial data for the three divisions for the year ended 31st March 2014 are
shown below:
362
Exam tip:
Notice in this question that you are essentially repeating the same
calculation 4 times for easy marks. Hence, in the exam do the
computation fast.
Required:
(a) For each of the divisions and the company as a whole calculate:
£’000
Appliance Utensils Crockery Company
ROI
ii) RI £’000
Appliance Utensils Crockery Company
Less:Cost of Capital
363
b) Comments
1) Overall, Crockery division is the best performing division on both
performance measures.
Exam Tip:
Note the presentation of the answer above. The ratios should be well
tabulated in columns so that you can analyse them quickly. This is the
expectation in the exam.
364
Note the 2 ROI above and their respective purpose:
Note:
EVA is a refined version of RI as the formula to compute EVA is
similar to RI, except its more specific. For example, it defines the
cost of capital used as the WACC and the profit should be
adjusted after-tax profit.
365
The adjustments are necessary to recognise value enhancing
expenditure that should not be expensed.
Advantages of EVA
b) Generally, projects with positive EVAs have positive NPVs. The EVA rule is
(usually) consistent with the NPV rule.
c) EVA sends a message to managers that says invest only if the profit from
the project is sufficient to cover the cost of capital.
d)EVA makes the cost of capital visible to operating managers. Managers can
increase EVA either by increasing profits or by reducing capital employed.
Disadvantages of EVA
a) It is based on annual profit and can still result in managers taking decisions
to boost only annual profit at the expense of long term performance.
366
Lecture Illustration
Assume the following information for the two divisions of a company:
The company uses Economic Value Added (EVA) with a capital charge of
12% to appraise divisions and makes the following adjustments to net income:
Required:
Calculate the EVA for 2015 for each division using the EVA method adopted
by the company. (5 marks)
367
£’000 £’000
EVA Motor Products
Adjustment EVA
R & D Capitalise
Launch Market
The three major divisional financial PMs are: ROI, RI, EVA.
1) Laggard(Past)measure of performance.
368
Determining which assets should be included in the investment base
In computing ROI, RI, EVA, the assets to be included in the investment base
must depends on the purpose of the performance measure.
If for some reason, the divisional manager can influence the non-controllable
assets, then these assets should be included in the investment base also. For
example, if the accounts receivable is excluded from the investment base,
then the divisional manager may increase divisional sales by granting overly
generous credit terms. Hence he will obtain the rewards from the additional
sales without being charged the additional cost of capital incurred for the
higher accounts receivables balances.
369
Homework Question Lecture 19
Question 1
Whites Ltd, a well established company, has operated in a good but static
market for many years where it has been the dominant supplier. Over the past
two years it has developed two new product areas unrelated to each other
and to the original business.
Whites Ltd has organised the operation of its three activities on a divisional
basis with each divisional general manager having responsibility for all
aspects of running their Division. Division A is the original operation, Division
B is in a high risk, high technology area where it is expected to improve
profitability over the next three years and Division C is in a high growth but
low risk area.
Head Office operating costs were £1.2 million in 2007. The company’s cost of
capital is 16%. The results for the Divisions for the year ended 31 December
2007 are as follows:
A B C
£M £M £M
Annual trading profit after charging Head Office costs 4.1 1.2 1.3
shown below.
Head Office costs charged in calculating trading profit 0.4 0.4 0.4
Required:
(a)Calculate the Return on Investment and the Residual Income for each
Division.(6 marks)
(c) Explain the ways in which the information calculated in (a) and (b) above
would be used by the management of Whites Ltd and indicate, with reasons,
370
which calculation of Residual Income would be most equitable. (7 marks)
(d) Discuss ways in which the profits and asset values of the Divisions could
be adjusted to provide fairer measures of performance. (6 marks)
(UOL adapted 2008 Zone A Question 3)
Question 2
Discuss the issues that arise in designing appropriate financial measures of
performance in a multi-divisional company where divisions are sub-divided
into departments.
(25 marks)
371
University Of London
Management
Accounting
Lecture Notes
Lecture 20
Topics Covered
Transfer Pricing
372
Transfer Pricing (TP)
A transfer price is the price charged by one division to another division for
any intercompany transfer of goods or services.
The transfer price creates revenue for the selling unit and purchase cost for
the buying unit, affecting operating profit of both divisions which are normally
considered investment centres.
To maximise
Objectives of transfer pricing system their division
profit, A want
1. Provide information for performance evaluation of the divisions involved a high TP, B
which are normally investment or profit centres. want a low TP
This type of transfer price considers both the cost and the market price.
They also involve allowing the subunits the freedom to negotiate the
transfer prices between themselves promoting a high degree of autonomy
for the divisions.
374
Transfer Pricing decisions
There are two basic issues in a transfer pricing decision:
375
Lecture Illustration - Transfer Price
A component is being transferred internally between two divisions, Division A
to Division B, both being autonomous investment centres.
The component is then used in the manufacture of the final product by
Division B after adding an additional $4 of cost to it.
Required:
a) Assume that Division A is currently not operating at full capacity.
Full capacity is 100,000 units per month. Currently, Division A is only
producing 60,000 units per month to satisfy external demand.
Division B requires 30,000 units per month and can purchase all its
requirements on the external market for $9 per unit or purchase it from
Division A.
Determine if Division B should be allowed to source the component
from the external market?.(Make or buy decision)
b) Assuming next the demand for Division A’s component in the external
market was 100,000 units. That is, Division A could actually produce and
sell all its full production capacity for $15.00 per unit to the external market.
376
c) Compute the division and company’s profit per unit assuming a
transfer price of $10 and $15 per unit and comment on your results.
(a)
Savings to Make
377
(b)
Div. A (Seller) No Excess Capacity = Hence, it will incur an opportunity
cost to transfer to Division B
Per unit
$
Incremental(variable) cost
Cost to Make
Savings to Buy
378
(c)
Division A
Sales
Profit
Division B
Transfer In Cost
Full Cost 4 4
Total Cost
Selling Price 25 25
Profit (Loss)
Company Profit
Note:
1)TP has no impact on co. profit aa profit constant @ $11 per unit.
Only impact divisional profit.
379
A General guideline for transfer –pricing situations
The minimum transfer price should be set at:
Minimum transfer price
Equal: Incremental cost plus opportunity cost per unit to the seller division
2. Where the seller division has idle capacity, its opportunity cost of
transferring the product internally is zero because the seller division does
not forgo any external sales and hence does not forgo any contribution
from transferring internally.
380
Lecture Illustration
Assume the same information as Illustration 1, determine an appropriate
transfer price for situation a) and b).
(a) Excess Capacity
Minimum TP $
Incremental cost
+ Opportunity Cost
Minimum TP
Recommend $8 + $9 = $8.50
2
Opportunity Cost
Minimum TP
Division B manager will reject internal transfer and prefer to buy from the
outside market and this is also right sourcing decision from the
company’s perspective.
1) Division A to sell 100,000 units to external market @ $15 per unit.
2) Division B to buy in 30,000 units @ $9 per unit.
381
Lecture Ill 3: Super Mechanics plc has various divisions making equipment for the building trade. Division D
makes complex electronic components that recognise dampness in wood and concrete structures.
These are sold to outside customers and to Division M. Division M uses the components in the
production of damp meters which it sells to outside customers.
The market price for each electronic component sold by Division D is £800 and the transfer price to
Division M has been set at market price, in line with company transfer pricing policy.
Division D’s production capacity is 2,400 units per month, but current sales are only 1,000 units per
month to external customers and 600 units per month to Division M.
D
Division M sells the completed meters for £1,500 each.
Division M wishes to expand sales and has performed market research to determine the effect of
demand to changes in price. The results are as follows:
ii. Calculate the total profits earned by the two divisions. (5 marks)
(b) Determine the quantity and price at which Division M should sell the damp meter:
(c) Prepare estimated profit statements for one month for each division and for the impact on the
profits of Super Mechanics plc as a whole, based on your answers to (b) ii. above.
(3 marks)
(d) Provide a considered view of the effectiveness of company’s existing transfer pricing policy
(using market price) and discuss one other alternative basis that can be used.
UOL adapted 2010 Zone A Question 3 (4 marks)
Note: 382
Profit maximising price equal to the price that
maximises total contribution, this was done in
Lecture 10 & 11(pricing decision) page number 190
Exam Tip:
In this question, better to do a MC Profit Statement Exam Tip: Note the
as the total fixed cost and variable cost information presentation of the
given in the question separately. answer to Part a,
(ai) Profit Statement tabulated in column
Division form
D M
£’000 £’000
Sales:
D to external market
D To M
M to external market:
M:
Total contribution
Net Profit
(bi) Price to maximise Division M profit (use the Division M variable cost)
1,500 600
1,400 750
1,300 900
1,200 1,050
1,100 1,200
1,000 1,350
for
383
(bii) Price to maximise company’s profit
(use the company’s variable cost)
1,600 450
1,500 600
1,400 750
1,300 900
1,200 1,050
1,100 1,200
1,000 1,350
for
Note:
This past exam question actually integrated two topics, pricing
decision and transfer pricing issues.
384
c) Profit Statement
Division
D M
£’000 £’000
Sales:
D to external market
D To M
M to external market:
M:
Total contribution
Net Profit
Company Profit =
d)
1) Transfer price only impact profit at the division level, no impact on the
company’s profit overall.
385
International Transfer Pricing
The problem of setting transfer prices is compounded when dealing with
international divisions. Several more factors need to be taken into
consideration.
386
Homework Question Lecture 20
Question 1
The Australian and Polish tax authorities only allow transfer prices between
the full manufacturing cost per unit and the Australian market price of A$325.
Import duty paid to the Polish authorities is a deductible expense in
calculating Polish tax due.
Required:
(a) Calculate the increase in Outback Corp’s after-tax profit if the Melbourne
division sells 2,000 units in Australia for A$300 and the Polish division sells
2,000 units of the G12 equivalent in Poland. (4 marks)
(b) Outback Corp’s Head office wants the two divisions to trade with each
other. Calculate the after-tax income earned by the Australian and Polish
divisions if they transferred 2,000 units of product G12 at either the highest or
the lowest price allowed by the tax authorities. Explain what transfer price,
complying with the rules, would be most profitable for the company as a
whole.(10 marks)
387
(c) If divisional managers acted autonomously to maximize their own
division’s after-tax income, discuss the likely range within which the transfer
price will lie, given the restrictions imposed by the tax authorities. (6 marks)
(d) Briefly discuss how companies trading internationally can maintain
divisional autonomy and maximize profits relating your answer to the
circumstances in the question. (5 marks)
388
Question 2
Fine Clays plc extracts and refines china clay. It is organised into two trading
divisions: The Industrial Clays Division handles wholesale business and the
Clay Shops Division sells to retailers.
The Industrial Clays Division extracts moulding clay and sells it to external
customers and to the Clay Shops Division. The external wholesale market
price is £1,800 per tonne. The transfer price per tonne has been set at market
price, in line with company transfer pricing policy.
The Industrial Clays Division’s production capacity is 2,000 tonnes per month,
but current sales are only 1,000 tonnes per month to external customers and
600 tonnes per month to Clay Shops Division.
The Clay Shops Division produces 100 bags of refined clay from each tonne
of moulding clay, which it sells at £40 per bag.
Other data relevant to the operation are:
The Clay Shops Division wishes to expand sales and has performed market
research to determine the effect of changes in price on demand.
The results are as follows:
Required:
(a) Prepare estimated profit statements for one month for each division
and for Fine Clays plc as a whole, based on transfer price of £1,800
per tonne at current output.
(5 marks)
389
(b) Determine the quantity and price at which the Clay Shops Division
should sell the
bags:
i. to maximise Clay Shop’s divisional profit at the existing transfer price.
ii. to maximise Fine Clay plc’s overall profit. (10 marks)
(c) Prepare estimated profit statements for one month for each division
and for Fine Clays plc as a whole, based on your answers to (b) i. and
ii. above. (6 marks)
390
University Of London
Management
Accounting
Lecture Notes
Lecture 21
Topics Covered
391
Main idea in benchmarking is that to improve and
achieve optimal performance, we need to compare
Benchmarking ourselves to the best performers.
392
Quality as a competitive tool
These are the costs incurred as a result of producing products that do not
meet quality standards and costs incurred to prevent the production of such
products.
4) External failure costs are costs incurred on defective products after they
are delivered to customers. Example of these costs warranty cost, and
customer support.
Example:
Prevention & Appraisal cost = $4 million
Avoid: Failure cost = $10 million 393
Net Benefit = $ 6 millon
This is the most important failure because it affects customer attitudes and the
company’s long-term reputation. All other activities are aimed at minimising
this failure.
Prevention and appraisal cost are also referred to as cost of quality
conformance and internal and external failure cost are considered cost of non-
conformance or non-compliance.
The labour rate for design is £80 per hour and the rate for testing and
inspection is £50 per hour.
Required:
a) Calculate the cost of quality for Frostaire and Coolaire, classifying them
into prevention, appraisal, internal failure and external failure costs.
394
a&b Frostaire Coolaire
£‘000 % £‘000 %
Revenue:
Prevention Cost
Design cost:
Frostaire
Coolaire
Appraisal
Testing cost:
Frostaire:
Coolaire:
Internal Failure
In Plant Rework
Frostaire:
Coolaire:
External Failure
Site Repair
Frostaire:
Coolaire:
Lost Contribution(Sales)
Frostaire:
Coolaire:
395
(c )
1) Coolaire has a higher cost of quality (11.8%) compared to
Frostaire (8.6%)
2) They allow the company to evaluate the trade-offs among prevention costs,
appraisal costs, internal failure costs, and external failure costs.
396
Just in time (JIT) systems
Aim of JIT is to reduce waste by producing the required item, at the required
quality and in the required quantity at the precise time at which they are
required.
The demand pull starts from the customer demand for the finished product all
the way back to the demand for direct materials that arrive just in time to be
used in the production process.
Long term contracts with suppliers are necessary, to facilitate the detailed
planning necessary.
Hence employees will be more competent, motivated and flexible and require
less supervision.
397
Advantages
3. Need for quality inspection at the raw material stage is eliminated, thus
saving further costs.
Disadvantages
398
BPR very similar in concept to
Business Process Re-engineering (BPR) ABM
BPR is a radical and dramatic redesign of a business process to achieve
dramatic improvements in critical contemporary measure of performance such
as cost, quality, service and speed.
• Focus is on cost, quality and service. Thus, BPR requires the adoption
of new management techniques and philosophies such as JIT, TQM,
ABC to create major changes in the processes involved and improve
performance.
1. Often several jobs are combined into one, thus avoiding duplication.
399
Lean accounting
Lean accounting is a costing method that supports creating value for the
customer by creating value stream, not just individual products thereby
eliminating waste in the accounting process.
Waste is any addition to cost that the customer is not willing to pay for.
(2) It excludes many of the support costs as it focuses only on value added
cost.
(3) It does not account for inventories under generally accepted accounting
principles as do normal accounting methods such as absorption costing.
400
Environmental Accounting
There are three main reasons why the management of environmental costs is
becoming increasingly important in companies.
The key idea with managing environmental cost is that it is better to incur a
smaller amount of prevention & detection cost to avoid a larger failure cost.
(“An once of prevention better that a pound of cure”)
401
Why is the management of environmental cost difficult
These costs need to be controlled but this can only be done if they have been
separately identified in the first place and traced to the responsible products
and processes.
The fact that environmental costs are often ‘hidden’ in this way makes it
difficult for management to identify opportunities to cut environmental costs.
402
Strategic Performance Measurement
Strategic Performance measurement is a vital part of the management control
system.
Lead measures are the actions which drive future performance. Examples of
lead measures include product innovation and customer satisfaction.
When they are performed they do not guarantee a specific outcome but if they
are not performed there will be no outcome at all.
Lag measures are the outcomes that arise as a result of lead measures. The
outcomes are usually measured in financial terms, such as profit or return on
investment.
This means that the strategic management system must direct, measure and
reward activities which implement strategy and enhance present and future
performance.
403
The Balance Scorecard (BSC)
The Balance Scorecard integrates financial and non-financial performance
measures that are linked to the company strategy.
The BSC aims to translate the firm’s vision and strategy into operational
objectives and performance measures using four perspectives as follows:
Objectives Measures
1) Revenue growth % of revenue from new products
Sales growth %
The main objective here will be to increase market share and improve
customer core value propositions.
Objectives Measures
1) Core: Increase Market share Market share
Increase customer retention % of existing customers retained
Increase customer acquisition Sales to new customers
Increase customer satisfaction Customer satisfaction rating
Increase customer profitability Customer profitability analysis
404
3)Internal business process-What must we excel at – Lead measures
Focuses on internal processes that the company must excel in achieving
its strategy.
Firms must excel in three processes here namely the innovation process,
operation process and the post sales process. Examples given below:
Objectives Measures
1) Innovation process
Increase the number of new products % of sales from new poducts
2) Operations process
Improve process efficiency output/inputs ratio
The firm and its employees must keep learning and developing in order to
create long-term growth and improvement.
The firm must invest in its infrastructure in term of its employees, systems
and organisational procedures in order to achieve the other three
perspectives.
405
Examples given below:
Objectives Measures
1) Increase employee capability Employee satisfaction survey
ratings
406
Lead and Lag measures in the BSC
Lag measures fall within the financial perspective and are the result of
past actions.
The Important point to take note is that the balance scorecard is used to
ensure that management takes the right action (processes) in order to
increase profit (outcome). Hence, management is being evaluated on
both outcome and processes.
If only financial performance measures are used, then theres the risk
that management will try to increase profit (outcome) by gaming
important processes. For example, increasing profit by postponing
important maintenance of equipment.
4) There should be a limited the number of measures only, hence only the
most critical ones should be used.
407
Criticisms of the balanced Scorecard
1) There is an absence of a time dimension as to when the “cause and
effect” relationship will take place.
408
Fitzgerald and Moon- Performance Measures for service industries
Like the BSC, this framework recognises that the lag measures of competitive
performance and financial performance (downstream results) will be achieved
or driven by the activities described as upstream determinants, the lead
measures.
Standards
409
Rewards
410
Performance measurement for not-for-profit making organisations
(NPO’s)
(a) NPOs tend to have multiple objectives, so it is not possible to say which is
the most important objective.
(c) Public sector organisations are subject to many political influences and
legal constraints.
Their performance is usually judged in terms of inputs & outputs and this ties
with the ‘value for money’ criteria that are often used to access NPOs.
Economy
Economy deals with the costs of inputs, and it is achieved by obtaining those
inputs at the lowest acceptable cost.
Efficiency
Efficiency means maximizing output for a given input or using the minimum
input for a given output,
Effectiveness
Effectiveness means success in achieving objectives.
411
Some possible Solutions to the above problems:
a) Inputs
One possible solution is to judge performance in terms of inputs.
b) Judgment
A second possibility is to accept that performance measurement must to
some extent be subjective. Judgment can be made by experts.
c) Comparisons
Most NPO’s do not face competition but this does not mean that all NPO’s are
unique. Bodies like local governments, health services and so on can judge
their performance against each other and against the historical results of their
predecessors.
Unit cost measurements like 'cost per patient day' or 'cost of borrowing one
library book’ can be established to allow organisations to assess whether they
are doing better or worse than their counterparts.
412
Strategic consideration in the Theory of Constraints (TOC)
These are:
a. Financial measures—revenue losses or price discounts due to delays;
carrying cost of inventories; throughput contribution minus operating costs.
Note the cause-and-effect linkages across the measures. For example, better
training leads to better management of bottlenecks, which leads to better
customer-response times and higher throughput contributions.
413
Customer profitability analysis
Many companies can identify their customers clearly, either because they
have a supply chain relationship with them or because most customers have
repeat purchases. The customer profitability analysis requires sales, product
costs, delivery costs, discounts, etc. to be traced to each customer for each
accounting period.
b) The trend in sales per customer. This could indicate that the customer
relationship is getting stronger or weaker and can lead to investigation of
customer satisfaction.
d) Whether some types of customer are more demanding than others, e.g. in
requiring higher discounts, longer or inconvenient delivery times, etc. Here
Menu Pricing may be applied where the price charged to customer mat
depend on the complexity of the order.
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Decision Making Process and Strategic Management Accounting
Note:
Management accounting (MA)
Strategic management accounting (SMA)
Example: A loss making product may be in the short term but presents
because it necessary to do so to protect the reputation in the long run.
MA focus on measuring its effects and learn from any unexpected result in the
short run.
Example: fixed costs have changed and variable were more than proportional.
SMA focus on evaluation based on the new lead measures created by the
new scenario, learning from unexpected results and be ready to create two or
more scenarios.
Example: competitors reacted less than expected and the market share
increased more than expected. Logistics have been strained. Investors
appreciated the clear steer towards more corporate social responsibility but
are still more prudent than expected, i.e. expect higher returns than
envisaged, affecting the firm’s economic value added (EVA®).
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Homework Questions Lecture 21
Question 1
a)
High Quality Toys Ltd manufactures and sells model train sets. The following
table presents information pertaining to the company’s analysis of quality.
Required:
i)Classify the items in the table into the four cost of quality categories.
(8 marks)
iii)Discuss the trends in costs of quality between 2007 and 2008.(3 marks)
b)
High Quality Toys Ltd has just acquired a patent to produce a replica of the
Japanese bullet train using a different type of track from its previous models.
This will require new design, new jigs and staff training. The financial
information concerning the new train set is as follows: Investment costs will be
– patent £0.5 million, design cost £2.6 million, jigs cost £2.0 million, training
costs £0.5 million.
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Required:
i.) Calculate the target production cost per bullet train in order that High
Quality Toys Ltd can achieve its return on investment objectives. (5 marks)
ii)Briefly explain the difference between target costing and traditional product
costing. ( 5 marks)
(UOL adapted 2008 Zone A Question 4)
Question 2
a) Discuss the advantages and limitations of using financial measures to
monitor and appraise the performance of sections of a business. (12 marks)
Question 3
Describe the four different categories into which the costs and benefits of
activities to improve quality within organisations are often divided. Give
examples of the costs which would appear in each category. Explain how
benefits can be quantified financially and describe how non - financial benefits
can be identified and measured.
(UOL adapted 2010 Zone A Question 6, 25 marks)
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Question 4
Sweets Galore Ltd has three production divisions in different parts of the
country. The divisional financial reports on a historical cost basis for the year
ended 31st March 2009 for each division are as follows:
Division E F G
£000 £000 £000
Income Statement
Revenues 500 700 920
Less: operating expenses 294 412 541
straight-line depreciation 84 120 160
Net profit 122 168 219
Required:
(a) Using the historical cost approach to asset valuation, calculate the three
measures indicated above for each division and discuss the performance of
the divisions as revealed by the calculations. (4 marks)
(b) The manager of Division G feels that the method of assets valuation for
is unfair and requests that a current cost accounting approach be applied to
Fixed Asset valuation and depreciation charges. It is agreed that the net
current assets figures represent current values and the price index should be
used to revalue the fixed assets. For each of the divisions, calculate the three
measures calculated in a) but using current cost accounting. Discuss the
performance of the divisions as revealed by the calculations. (8 marks)
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(c) A new member of the head office accounting staff argues that a fairer
method would be to ignore depreciation completely and calculate the ratios
using EBITDA/historical gross fixed assets plus net current assets. He argues
that this measure most closely represents the original investment decision.
The manager of Division G would prefer this measure to use current cost
valuations. Calculate the ratios using these two bases and discuss the
performance of the divisions as revealed by the calculations. (8 marks)
(d) Briefly explain which of the methods in (a) - (c) above seems fairest for
evaluation purposes. (5 marks)
Question 5
What is meant by the balanced scorecard approach to management
information? Outline and discuss the four perspectives which are normally
identified in the balanced scorecard. Are there any further perspectives that
you might identify, and why?
(25 marks)
Question 6
Explain why quality is important to businesses and the difficulties in
measuring quality costs. For each of the four categories of quality
measurement indicate the accounting records which are required to collect
quality costs and indicate complementary non-financial measures which can
be used. (15 marks)
(UOL adapted 2008 Zone B Question 5a)
Question 7
Theories of managerial performance measurement vary from advocating a
single all encompassing figure such as Economic Value Added to
recommending a wide variety of measures such as those seen in the
Balanced Scorecard.
Explain the two terms ‘Economic Value Added’ and ‘Balanced Scorecard’ and
critically evaluate their different approaches to performance evaluation.
(25 marks)
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Question 8
(a) Greenwood Ltd manufactures and sells car accessories. The following
table presents information pertaining to the company’s analysis of quality.
Required:
i. Classify the items in the table into the four cost of quality categories.
(8 marks)
ii. Calculate the sum of each category of cost of quality and the total as a
percentage of the revenues in each year, 2007 and 2008. (4 marks)
iii. Comment on the trends in costs of quality between 2007 and 2008.
(3 marks)
(b) Greenwood Ltd has just acquired a patent on an antifreeze recycler which
filtersa car’s used antifreeze to remove dissolved chemicals, and returns it to
the car.
Investment costs will be – patent cost of £2.2 million, plant cost of £9.6 million,
and additional working capital of £3.0 million.
The company expects to earn a pretax return on the initial investment of 20%.
Market analysis shows that the company can sell 2,960 units in the first year.
To achieve this level of sales, the firm forecasts that the selling price cannot
exceed £2,500 per recycler.
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Variable selling commissions will be £70 per unit.
Fixed administrative cost for this activity is estimated to be £740,000 for the
year.
Required:
i. Calculate the target production cost per recycler in order for Greenwood Ltd
to achieve return on investment objectives. (5 marks)
ii. Briefly explain the difference between target costing and traditional product
costing. (5 marks)
Question 9
Describe ways in which the financial information provided by lifecycle costing
can be used in strategic planning, decision making and control
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