AMSTERDAM BOSTON HEIDELBERG LONDON NEW YORK OXFORD
PARIS SAN DIEGO SAN FRANCISCO SINGAPORE SYDNEY TOKYO
PUBLISHING

The CIMA Learning System xi
Acknowledgements xi
How to use your CIMA Learning System xi
Guide to the Icons used within this Text xii
Study technique xiii
The Performance Evaluation syllabus xiv
1 Basic Aspects of Management Accounting 1
Learning Outcomes 3
1.1 Introduction 3
1.2 Cost behaviour 3
., 1.2.1 Fixed cost 4
1.2.2 Variable cost 5
1.2.3 Semi-variable cost 7
1.2.4 Analysing semi-variable costs 8
1.2.5 Using historical data 10
1.3 Costs and activity-based techniques 10
1.4 Breakeven or cost-volume-profit analysis 11
1.4.1 Calculating the breakeven point 11
1..5 The margin of safety 11
Iv6 The contribution to sales (C/S) ratio 12
1:7 Drawing a basic breakeven chart 13
1.8 The contribution breakeven chart 15
1.9 The PV chart 15
1.9.1 The advantage of the PV chart 16
1.10 The limitations of breakeven (or CVP) analysis 17
1.11 The economist's breakeven chart 18
1.12 Using costs for decision-making 18
1.12.1 Short-term decision-making 19
1.13 Evaluating proposals 19
1.14 Relevant costs 21
1.14.1 Non-relevant costs 21
1.15 Opportunity costs 23
1.15.1 Examples of opportunity costs 23
1.15.2 Notional costs and opportunity costs 23
1.16 Avoidable, differential and incremental costs 24
1.16.1 Avoidable costs 24
1.16.2 Differential/incremental costs 24
1.16.3 Using incremental costs . 24
1.16.4 Incremental revenues 24 in

iv MANAGEMENT ACCOUNTING - PERFORMANCE EVALUATION P1
H? 1.17 Limiting factor decision-making 25 j±i 1.17.1 Decisions involving a single limiting factor 26
Q 1.18 Summary 28
Revision Questions 29
Solutions to Revision Questions 35
Learning Outcomes 43
2.1 Introduction 43
' 2.2 The difference between marginal costing and absorption costing 43
2.3 Preparing profit statements using each method 45
2.3.1 Profit statements using marginal costing 46
2.3.2 Profit statements using absorption costing 46
2.4 Reconciling the profit figures 47
2.4.1 Reconciling the profits given by the different methods 47
2.4.2 Reconciling the profits for different periods 48
2.4.3 Profit differences in the long term 48
2.5 Marginal costing or absorption costing? , 49
., 2.6 Specific order costing 49
2.7 Job costing 50
2.7.1 Job cost cards and databases 50
2.7.2 Collecting the direct costs of each job 50
2.7.3 Attributing overhead costs to jobs 51
2.7.4 A worked example , 52
2.7.5 Other applications.for job costing 53
2.8 Batch costing 54 y
2.9 Process costing 54
2.9.1 Previous process costs . 58
2.9.2 Opening work in progress . 58
2.9.3 Solution to Example 1 using the FIFO method 60
2.9.4 Discussion of Example 1 61
I 2.9.5 Choice of methods and standard costing . 62
2.9.6 Process costing with opening work in progress 63
2.9.7 Solution to Example 2 using the FIFO method 64
2.9.8 Process losses 66
2.10 Joint products and by-products . 67
2.10.1 Joint product costing 68
2.10.2 Apportioning common costs to joint products 68
2.10.3 Using notional or proxy sales values for common cost apportionment 69
2.10.4 The final sales value method of common cost apportionment 70
2.10.5 Using joint product costs for decision-making 71
2.10.6 Joint products and the further processing decision: an example 71
2.10.7 Costing by-products 72
2.10.8 Joint and by-products: an example 73
2.11 Summary 74
Revision Questions 77
Solutions to Revision Questions 83

MANAGEMENT ACCOUNTING - PERFORMANCE EVALUATION v
3 The Theory and Practice of Standard Costing 89 8
Learning Outcomes 91 ppj
3.1 Introduction 91 ?
3.2 The theory and practice of standard costing 92
3.3 What is a standard cost? 92
3.4 • Performance levels 93
3.4.1 A standard . 93
3.4.2 Ideal standard . 9 3
3.4.3 Attainable standard 93
3.4.4 Basic standard 94
3.5 Setting standard costs 94
3.5.1 Standard material price 94
3.5.2 Standard material usage 94
3.5.3 Standard labour rate
o
94
3.5.4 Standard labour times 94
3.5.5 Production overhead costs 95
3.6 Updating standards 96
3.7 Standard costing in the modern industrial environment 96
3.8 '' What is variance analysis? 96
3.9 Variable cost variances . 97 .
3.9.1 Direct material cost variances 97
3.9.2 The direct material price variance and stock valuation 98
3.9.3 Direct labour cost variances 99
3.9.4 Variable overhead cost variances . 100
3.10 Fixed production overhead variances 101
3.10.1 The reasons for under-or over-absorption of overhead 101
"f 3.10.2 The fixed production overhead total variance 102 i3.10.3 % The fixed production overhead expenditure variance 102
' 3.10.4 The fixed production overhead volume variance 102
3.10.5 Analysing the fixed production overhead volume variance 103
3.10.6 Fixed production overhead capacity variance 103
3.10.7 Fixed production overhead efficiency variance 103
3.11 Sales variances 104
3.11.1 The selling price variance 104
3.11.2 The sales volume variance 105
3.11.3 The sales volume profit variance 105
3.12 Reconciling the actual and budget profit 105
3.13 Standard marginal costing 108
3.13.1 The fixed overhead volume variance . 108
3.13.2 The fixed overhead expenditure variance 108
3.13.3 The sales volume contribution variance 108
3.13.4 Reconciling the actual and budget profit 109
3.14 Idle time variances 110
3.14.1 Expected idle time 111
3.15 Calculating actual data from standard cost details and variances 112
3.16 Example: Preparing a reconciliation statement 113
3.16.1 Reconciliation of budgeted and actual profit 115
3.16.2 Calculation of cost variances shown in reconciliation above 116

v i MANAGEMENT ACCOUNTING - PERFORMANCE EVALUATION P1
I
LU
I—
3.17 Some miscellaneous ideas 117
3.18 Summary 118
Revision Questions 119
Solutions to Revision Questions 127
S t a n d a r d Costing a n d P e r f o r m a n c e Evaluation 137
Learning Outcomes 139
4.1 Introduction 139
4.2 Material mix and yield variances 139
4.3 Labour mix and yield variances 142
4.4 Sales variances 144
4.5 Planning and operational variances 146
4.6 Capacity ratios 150
4.6.1 Standard hour 150
4.6.2 Calculating the capacity ratios 151
4.7 Investigation and interpretation of variances 152
4.7.1 Percentage variance charts 153
4.7.2 The reasons for variances 154
4.7.3 Investigation models 155
4.7.4 Interrelationship of variances 157
4.8 Behavioural considerations 158
4.8.1 ,'Organisational goals ' 158
4.8.2 Target levels for standards and budgets 159
4.8.3 Performance measures and evaluation 159
4.8.4 Participation in setting standards and budgets 160
4.8.5 Budget bias 161
4.9 Standard costing in the modern business environment 161
4.9.1 Criticisms of standard costing 161
4.9.2 Addressing the criticisms 162
4.9.3 Standards and variances: a cautionary note' 162
4.101 Benchmarking 163
4.11 . Developments and current thinking in the application of standard costing 165
4.11.1 McDonaldisation - Another angle on things 165
4.11.2 Diagnostic reference groups 165
4.12 Summary 166
Revision Questions 169
Solutions to Revision Questions 175
The Theory and Practice of Budgeting 183
Learning Outcomes 185
5.1 Introduction 185
5.2 The purposes of budgeting 185
5.2.1 Budgetary planning and control 186
5.2.2 What is a budget? 186
5.2.3 The budget period 187

MANAGEMENT ACCOUNTING - PERFORMANCE EVALUATION v i i
5.2.4 Strategic planning, budgetary planning and Q operational planning 187 5
5.3 The preparation of budgets 188 z
5.3.1 Co-ordination: the budget committee 188 °°
5.3.2 Participative budgeting 188
5.3.3 Information: the budget manual 188
5.3.4 Early identification of the principal budget factor 189
5.3.5 The interrelationship of budgets 189
5.3.6 Using spreadsheets in budget preparation 190
5.3.7 The master budget 192
5.4 Preparation of operational budgets 192
5.4.1 Using stock control formulae in budget preparation 194
5.4.2 Budget interrelationships 194
5.5 The cash budget . 194
5.5.1 Preparing cash budgets 195
5.5.2 . Interpretation of the cash budget 196
5.5.3 Cash budget: second example , 197
5.6 Rolling budgets 199
5.7 -t Forecasting and planning 201
5.8 Time series 203
5.8.1 The concept 203
5.8.2 Factors that, cause variations 204
5.8.3 Time series modelling 205
5.9 Sensitivity analysis 207
5.10 Zero-based budgeting ^ 209
5.10.1 Advantages of ZBB 210
,., p
5.10.2 Disadvantages of ZBB 210
*' ,5.10.3 „ ZBB in practice 211
5.11 Programme-planning budgeting systems 211
5.12 Activity-bjased budgeting " 214
5.13 Efficiency,and effectiveness in the not-for-profit sector 215
5.13.1 Efficiency 216
5.13.2 Effectiveness 216
5.14 Summary 217
Revision Questions 219
Solutions to Revision Questions 229
Learning Outcomes 241
6.1 Introduction 241
6.2 The Theory of Systems 242
6.3 System design 242
6.3.1 The characteristics and components of a system 242
6.3.2 Control systems - 242
6.4 Feedback control loops and system operation 243
6.5 Budgetary control information 244
6.5.1 Budget centres 244
6.5.2 Budgetary control reports 245

v i i i MANAGEMENT ACCOUNTING - PERFORMANCE EVALUATION P1
£ 6.6 Fixed and flexible budgets 247 j±! 6.6.1 Preparing a flexible budget 247
O 6.6.2 Using flexible budgets for planning . 249 u
6.6.3 Flexible budgets 249
6.6.4 Extrapolating outside the relevant range 251
6.7 Behavioural aspects of budgetary control 251
6.7.1 Motivation and co-operation . 252
6.7.2 Failure of goal congruence 252
6.7.3 The budget as a pot of cash 253
6.7.4 Budget negotiation 253
6.7.5 Influence on accounting policies . 254
6.7.6 Budget constrained management styles 254
6.7.7 Budgets and motivation 255
6.8 Modern developments in control systems 255
6.8.1 The problem of discretionary costs 255
6.8.2 Developments from financial modelling and budgeting packages 256
6.8.3 Rethinking the purpose of the monthly report and
•t decision support systems 256
6.8.4 Beyond budgeting 257
6.9 Summary 262
Reading ; 263
Revision Questions 267
Solutions to Revision Questions 273
,, 7 Budgeting a n d P e r f o r m a n c e Evaluation 285
, .Learning Outcomes 287
. ] 7.1 Introduction 287
'7.2 Performance evaluation 288
7.2.1 The profit and loss account 288
7.2.2 Return on capital employed 289
7.2.3 Asset turnover 290
7.2.4 Liquidity 290
7.3 Exercise 292
7.4 Understanding the business 292
7.5 Reporting a performance evaluation 292
7.6 Non-financial performance indicators 293
7.7 Benchmarking 296
7.8 The balanced scorecard 299
7.9 Performance evaluation in the not-for-profit sector 300
7.10 Summary 303
Reading 305
Revision Questions 311
Solutions to Revision Questions 313

MANAGEMENT ACCOUNTING - PERFORMANCE EVALUATION i x
8 Developments in Management Accounting 319 8
Learning Outcomes 321 ^
8.1 Introduction 321 ?
GO
8.2 The modern economic environment " 321
8.2.1 Traditional production processes 321
8.2.2 The background to change 322
8.3 The new manufacturing 323
8.3.1 Computer-aided design 323
8.3^2 Computer-aided manufacturing 323
8.3.3 Computer-integrated manufacturing 324
8.3.4 Flexible manufacturing systems 324
8.4 The value chain 325
8.5 Production operations systems and management strategies 325
8.5.1 Material requirements planning 325
8.5.2 Manufacturing resources planning 326
8.5.3 Optimised production technology 327
8.5.4 ERP, CRM and SCM 328
8.5.5 Just-in-time concept 329
8.6 '* Total quality management 331
8.7 Synchronous manufacturing 334
8.8 The emphasis on continuous improvement 335
8.9 Activity-based costing 336
8.9.1 Traditional''versus activity-based cost 336
8.10 Transaction analysis and cost drivers ' 339
8.11 Favourable conditions for ABC 341
8.12 Establishing an activity-based product cost 341
8.12.1 Comparison with traditional costing 341
8.12.2 % Analysis of activities 342
8.12.3 Cost management and ABC 345
8.12.4 A comprehensive example of ABC 346
8.12.5 Variance analysis and ABC 356
8.13 Throughput accounting 357
8.13.1 The theory of constraints 357
8.13.2 Throughput accounting 358
8.13.3 Throughput cost control and effectiveness measures . 361
8.13.4 Summary of throughput accounting 362
8.14 Backflush accounting 363
8.15 Summary 366
Revision Questions 371
Solutions to Revision Questions 377
9 Responsibility Centres and Transfer Pricing 391
Learning Outcomes 393
9.1 Introduction " 393
9.2 Cost, revenue, profit and investment centres 394
9.2.1 Cost centres 394
9.2.2 Profit centres 395

x MANAGEMENT ACCOUNTING - PERFORMANCE EVALUATION PI
£ 9,2.3 Revenue centres and investment centres 395
£! 9.2.4 Reporting responsibility centre results 396
O 9.3 Transfer pricing . 398 u
• 9.3.1 Aims and features 399
9.3.2 General rules 399
9.3.3 Cost-based prices 400
9.3.4 Market-based prices 402
9.3.5 Marginal cost 405
9.3.6 Dual pricing , 406
9.3.7 Profit-maximising transfer prices 406
9.3.8 Negotiated transfer prices 407
9.3.9 Other behavioural considerations 408
9.3.10 Opportunity Cost — the 'mathematically correct' transfer price 409
9.4 Taxation and other financial aspects of transfer pricing 411
9.4.1 Taxation 412
9.4.2 Repatriation of funds 415
9.4.3 Minority shareholders 415
9.5 Investment centres and performance measures . 415
•t 9.5.1 Investment centres/strategic business units 415
9.5.2 Return on investment . 416
9.5.3 T h e problems with ROI 417
9.5.4 .Residual income (RI) 419
9.5.5 , Current thinking about performance metrics 421
9.6 Summary 423
Revision Questions 425
Solutions to Revision Questions 431 i • . . •
, Preparing f o r t h e Examination 443 j Revision Questions 445
Solutions to Revision Questions 509
November 2007 Examinations 587
I n d e x 619