F5 – Performance Management

ACCA
ACCA
PAPER
PAPERF5
F5
PERFORMANCE MANAGEMENT
PERFORMANCE MANAGEMENT
JUNE
JUNE2011
2011REVISION
REVISIONCLASS
CLASS

1
 AMG
PROFESSIONALS

Prepared by
Gbenga Okubadejo

F5 - Management accounting 2
 F5 – Performance Management

Presentation Objective

 To provide a revision tool to students writing paper F5

 To provide exam focus study that saves time

3
 F5 – Performance Management

Outline

 F2 revision

 Modern management accounting

 Cost volume profit (CVP) analysis

 The Concept of limiting factor analysis

 Pricing decisions

 Short-term decisions

 Risk and uncertainty

 Budget and budgetary control

 Quantitative analysis in budgeting

 Standard costing and variance analysis

 Performance measurement 4
 F5 – Performance Management

1 F2
F2––Management
Managementaccounting
accountingrevision
revision

5
 F5 – Performance Management
Introduction to Management accounting

F2 – Management Accounting gave the background to paper f5. It is better

you’re confident with the concepts and techniques learnt at the lower level.

Costing is the process of determining the cost of products, services or activities. Methods
include absorption costing and process costing.
Direct cost = D.M + D.L + D. EXP
All direct production costs are referred to as PRIME COSTS.
Addition of all indirect costs = Overheads.
Direct + indirect = Total factor cost.
Absorption costing is a method of sharing out overheads incurred amongst units produced. It follows
three processes:
Allocation
Apportionment
Absorption: may lead to under/over absorbed overhead

6
 F5 – Performance Management
F2 revision

1 Forabsorption
For absorption Formarginal
For marginalcosting
costing
2

When sales fluctuate It shows how an organisation's

because of seasonality in cash flows and profits are
sales demand but production affected by changes in sales
is held constant, absorption volumes since contribution varies
costing avoids large in direct proportion to units sold.
fluctuations in profit.  By using absorption costing
 Prices based on marginal and setting a production level
cost (minimum prices) does greater than sales demand, profits
not guarantee profit. can be manipulated.
Absorption recognises that Total costs need separation for
all costs are variable in the decision making
long run.  For short-run decisions in
It is the method allowed which fixed costs do not change,
by accounting standards. fixed costs are irrelevant.

7
 F5 – Performance Management

2 Modern
Modernmanagement
managementaccounting
accounting techniques
techniques

Activity based costing (ABC)

Target costing

Life cycle costing

Throughput accounting

Environmental accounting
8
 F5 – Performance Management
Activity based costing (ABC)

Steps to follow in ABC

1Identify major activities.
2 Identify cost drivers (factors which determine the
size of an activity/cause the costs of an activity).
3 Collect costs associated with each activity into
cost pools.
4 Charge costs to products on the basis of the Why ACT is not enough
number of an activity’s cost driver they generate. One basis of absorption – volume
Companies now produce variety
Cost drivers of Products
•Volume related (eg labour hrs) for costs that vary May hide inefficiency.
with production volume in the short term (eg power Allocate more ohds to
costs) volume-based product
• Transactions in support departments for other costs
(eg No of visit for site supervisor costs)

9
 F5 – Performance Management
Target costing
Involves setting a target cost by subtracting a
desired profit margin from a competitive market
price
 The target cost may be less that the initial
product cost but it is expected to be achieved
by the time the product reaches maturity
There is a focus on price-led costing, customer
requirements and design
Steps in target costiing
1. Do market research to obtain a competitive price
2. Determine the required magin
3. Cal. target cost = estimated SP – req’d margin
4. Compare the estimated costs with the target
5. Cost gap exists if estimated > target.
10
 F5 – Performance Management
Life cycle costing
This method tracks and accumulates costs
and revenues over a product’s entire life. This cycle include
1. Development 2. Introduction 3. Growth 4.Maturity 5. Decline

Maximising returns over the product life cycle

1. Design costs out of products

2. Minimise the time to market
3. Minimise breakeven time
4. Maximise the length of the life span
5. Minimise product proliferation
6. Manage the product’s cashflows

11
 F5 – Performance Management
Life cycle costing

Sales
Volume

Sales

Profit

Time

Introduction Growth Maturity Decline

12
 F5 – Performance Management
Throughput accounting
Basic concept of throughput
 In the short run, all costs except materials are fixed
 In a JIT environment, the ideal inventory level is zero. So unavoidable, idle
capacity in some operations must be accepted
 The factory spends money when goods are produced and a product makes money when it
sold. Overall profitability is determined by how fast the product makes money compare to
how the factory spends.

Throughput accounting ratio

= Return per factory hour
Total conversion cost per factory hour
TPAR > 1 = Continue Product
TPAR < 1 = Cease Product
Before cessation, consider other qualitative factors. Or consider working on the
product for TPAR to > 1.

13
 F5 – Performance Management
Environmental management accounting (EMA)

Definition

The generation and analysis of both financial and

non-financial information in order to support
environmental management processes.

Typical environmental costs

Importance Consumables and raw materials
Identifying environmental costs associated Transport and travel
with individual products and services can Waste and effluent disposal
assist with pricing decisions Water consumption
 Ensuring compliance with regulatory Energy
standards
 Potential for cost savings

14
 F5 – Performance Management
Cost volume profit (CVP analysis)
How to calculate a multi-product breakeven point
1. Calculate the contribution per unit.
2. Calculate the contribution per mix.
3. Calculate the breakeven point in number of mixes.
4. Calculate the breakeven point in units and revenue.

How to calculate a multi-product C/S (or profit volume or P/V) ratio

Calculation of breakeven sales:
5. Calculate the revenue per mix.
6. Calculate the contribution per mix.
7. Calculate the average C/S ratio. It is vital to remember that for
8. Calculate the total breakeven point. multi-product Breakeven analysis,
9. Calculate the revenue ratio per mix. a constant product sales mix
10. Calculate the breakeven sales.
must be assumed.

15
 F5 – Performance Management
Cost volume profit (CVP analysis)

Target profits
1. Calculate the contribution per mix.
2. Calculate the required number of mixes.
3. Calculate the required number of units and
4. sales revenue of each product.

Limitations of CVP analysis

 It is assumed that fixed costs are the same in total and variable costs are the
same per unit at all levels of output
 It is assumed that sales prices will be constant at all levels of activity
 Production and sales are assumed to be the same
 Uncertainty in estimates of fixed costs and unit variable costs is often
ignored

16
 F5 – Performance Management
Decision making time

“Decision making is an
important aspect of the Paper
F5 syllabus, and questions on
this topic will be
common…….but this article
will focus on only one: linear
“…….The first step in any linear
programming.”
programming problem is to produce the
equations for constraints and the
contribution function. This should not be
difficult at this level.”

Excerpts from technical article by Geoff Cordwell

former examiner for Paper F5.
 F5 – Performance Management
Linear programming
Formulating the problem

Steps in linear programming

1. Define variable
2. Construct objective function
3. Establish constraints
4. Graph
5. Find the optimal solution
There are two methods of finding the optimal
solution:
1. Graphical method
2. Using equations

18
 F5 – Performance Management
Linear Programming
Slack Surplus

Occurs when maximum availability of a Occurs when more than a minimum

resource is not used. requirement is used.
The resource is not binding at the optimal Surplus is associated with ≥ constraints eg
solution. Slack is associated with ≤ a minimum production requirement
constraints.

Shadow price

 It is the increase in contribution created by the availability of an extra

unit of a limited resource at its original cost.
 It is the maximum premium an organisation should be willing to
pay for an extra unit of a resource.
It provides a measure of the sensitivity of the result.
It is only valid for a small range before the constraint becomes non-
binding or different resources become critical.

19
 F5 – Performance Management
Pricing decisions
Influence on price
1. Cost Price elasticity of demand (η)
A measure of the extent of change in market demand
2. Demand
for a good, in response to a change in its price
3. Income level = change in quantity demanded, as a % of demand ÷
4. Competition change in price, as a % of price
5. Quality perception
6. Market structure
Inelastic demand
7. Product life cycle η<1
8. E.c.t.  Demand falls by a smaller % than % rise in price
 Pricing decision: increase prices
Elastic demand
η>1
 Demand falls by a larger % than % rise in price
 Pricing decision: decide whether change in cost will be
less than change in revenue.

NB: For pricing strategy to be adopted, make reference to

PED.
20
 F5 – Performance Management
Profit Maximisation
Determining the profit-maximising selling
price/output level Pricing strategy
Profits are maximised when Full cost plus
MC = MR. Advantages
Quick, simple, cheap method
Ensures company covers fixed
Other Pricing strategy costs.
Penetrating pricing Disadvantages
Doesn’t recognise profit
Skimming pricing
maximising price and output
Product-line pricing Budgeted output needs to be
Complimentary pricing established
Suitable basis for overhead
absorption needed

21
 F5 – Performance Management
Short-term decisions

Relevant costs are Make or Buy

 Future e.g sunk not relevant Compare internal
 Incremental e.g the amount by differential production
which fixed cost steps up costs with supplier’s
 Cash flows e.g provisions, notional quotation.
costs, absorbed overheads not Consider other
relevant.
qualitative factors before
N.B:
sub-contracting or
1. Useful for one-off contract outsourcing
2. Minimum pricing
3. The key note is “I don’t want to be
worse off”. if I can’t make money
then I don’t wanna loose any!

22
 F5 – Performance Management
Short-term decision
Further processing decision
Determine the contribution earned on the
current operation.
Calculate incremental costs and revenue
Compare the results and act accordingly.
Bear in mind that some fixed costs may no
Shut down decision
longer be incurred if the decision is to shut
down and they are therefore relevant to the Any short-term decision must
decision. consider qualitative
Consider the size of the incremental factors related to the impact on
employees, customers,
contribution that would be earn.
competitors and suppliers
Lastly, consider other qualitative factors e.g
current brand loyalty, legal implication, social
effect, accuracy of data available.

23
 F5 – Performance Management
Risk and uncertainty
The technique that a decision maker will use in dealing with
risk and uncertainty will be dependent on his risk attitude.
Attitude to risk
 Risk seeker A decision maker interested in the best outcomes no
matter how small the chance that they may occur
 Risk neutral A decision maker concerned with what will be the
most likely outcome
 Risk averse A decision maker who acts on the assumption that
the worst outcome might occur

24
 F5 – Performance Management
Methods of dealing with risk and uncertainty

Methods of dealing with risk and uncertainty

 Market research: Primary & secondary

 Expected values (EV) - indicate what an outcome is likely to be in
the long term with repetition. The expected value will never actually
occur. EV = PR * OUTCOME
 Decision rule: This involves calculation of
1. Maximax
2. Maximin
3. Minimax regret rule
 Sensitivity analysis
 Simulation
 Brainstorming or scenario building

25
 F5 – Performance Management
Budgeting and budgetary control

Objectives of a budgetary planning and Negative effects of budgets include

control system
 Ensure the organisation’s objectives At the planning stage
are achieved – Managers may fail to co-ordinate plans
 Compel planning with those of other budget centres.
– They may build slack into expenditure
 Communicate ideas and plans
estimates.
 Co-ordinate activities When putting plans into action
 Provide a framework for – Minimal co-operation and communication
responsibility accounting between managers.
– Managers might try to achieve targets but
 Establish a system of control
not beat them.
 Motivate employees to improve their Using control information
performance – Resentment, managers seeing the
information as part of a system of trying to
find fault with their work.
– Scepticism of the value of information if
it is inaccurate, too late or not understood.

26
 F5 – Performance Management
Budgetary systems

Traditional budgetary systems

Incremental budgeting
Flexible budget
This involves adding a certain percentage to last
These are budgets which, by
year’s budget to allow for growth and inflation. It
recognising different cost behaviour
encourages slack and wasteful spending to creep
patterns, change as activity levels
into budgets.
change.
 At the planning stage, flexible
Fixed budget budgets can be drawn up to show the
effect of the actual volumes of output
These are prepared on the basis of an estimated and sales differing from budgeted
volume of production and an estimated volume of volumes.
sales. No changes are made to the budgets and are not  At the end of a period, actual
adjusted (in retrospect) to results can be compared to a flexed
reflect actual activity levels. budget (what results should have
been at actual output and sales
volumes) as a control procedure.

27
 F5 – Performance Management
Zero-based budgeting

Zero-based budgeting
This approach treats the preparation
of the budget for each period as an
Merit
independent planning exercise: the Identifies and
initial budget is zero and every item removes inefficient
of expenditure has to be justified in and/or obsolete
its entirety to be included. It is operations
usually developed as a package.  Provides a
psychological impetus
Steps in ZBB
to employees to
1. Define decision packages avoid wasteful
2. Evaluate and rank packages on the expenditure
basis of their benefit to the  Leads to a more
organisation. efficient allocation of
resources
3. Allocate resources according to the
funds available and the ranking of
packages.

28
 F5 – Performance Management
Standard costing
Uses of standard costing
 To act as a control device (variance Types of standard
analysis)
Ideal
 To value inventories and cost
production Perfect operating conditions
 To assist in setting budgets and
Unfavourable motivational impact
evaluating managerial performance Attainable
 To enable the principle of
Allowances made for inefficiencies and
‘management by exception’ to be wastage
practiced Incentive to work harder (realistic but
 To provide a prediction of future challenging)
costs for use in decision-making Current
situations Based on current working conditions
 To motivate staff and management No motivational impact
by providing challenging targets Basic
 To provide guidance on possible Unaltered over a long period of time
ways of improving efficiency Unfavourable impact on performance

29
 F5 – Performance Management
Variance analysis
A standard cost card will look as follows:
$/unit
Direct material (20kg@$5/kg) 100
Direct labour (10hrs@$5/hr) 50
Prime costs 150
Variable Overheads(10hrs@$10/hr) 100
Total variable cost 250
Fixed cost (10hrs@$12/hr) 120
Total factory cost 370
Profit (25% mark-up) 92.50
Selling price 462.50

30
 F5 – Performance Management
Reasons for variances
Material price (F) – unforeseen discounts received
(A) – price increase, careless purchasing
Material usage (F) – material used higher quality than
standard
(A) – defective material, waste, theft
Labour rate (F) – use of less skilled (lower paid) workers
(A) – rate increase
Idle time (always (A)) – machine breakdown, illness
Labour efficiency (F) – better quality materials
(A) – lack of training
Overhead expenditure (F) – cost savings
(A) – excessive use of services
Overhead volume - production greater or less than budgeted

31
 F5 – Performance Management
Planning and operation
Planning variances Operational variances
Arise because of inaccurate Caused by adverse/favourable
planning/faulty standards and so operational performance
not controllable by operational Calculated by comparing actual results
managers but by senior management with a realistic, revised standard/budget

Calculated by comparing an
original standard with a revised
standard

32
 F5 – Performance Management
Performance measurement
Financial performance Non-financial performance
indicators (FPI) indicators (NFPI)
Profitability ratio Look at a wider range of
 ROCE variables
 Provide information on quality
 Profit margin and customer satisfaction
 Sales growth  Better indicator of future
 Asset turnover prospects
 Can be provided quickly and
 Liquidity ratios tailored to circumstances
 Inventory days
 Receivable days
 etc

33
 F5 – Performance Management
Balanced Scorecard
Perspective Question Explanation

Customer What do existing and new customers Gives rise to targets that matter to
value from us? customers: cost,
quality, delivery, inspection, handling and
so on.

Internal What processes must we excel at to Aims to improve internal processes and
achieve our financial and customer decision
objectives? making.

Innovation and Can we continue to improve and create Considers the business's capacity to
learning future value? maintain its competitive position through
the acquisition of new skills and the
development of new products.

Financial How do we create value for our Covers traditional measures such as
shareholders? growth, profitability and shareholder
value but set through talking to the
shareholder or shareholders direct.

34
 F5 – Performance Management
Not-for-profit organisations
Problem with performance
measurement
Suggested way out
 Multiple objectives
Judge performance in terms of
 Measuring outputs inputs
 Use experts’ subjective
 Lack of profit measure judgment
 Use benchmarking
 Nature of service provided  Use unit cost quantitative
measures
 Financial constraints
 Political, social and legal
considerations

35
 F5 – Performance Management
Value for money
3 E’S

Efficiency: Relationship between inputs and outputs (getting

out as much as possible for what goes in)
Effectiveness: Relationship between outputs and objectives
(getting done what was supposed to be done)
Economy: Obtaining the right quality and quantity of inputs at
lowest cost (being frugal)

For further reading: BPP revision kits

36
 F5 – Performance Management

????