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2012 EDITION | Revision Question Bank
ACCA
Paper F5 | PERFORMANCE MANAGEMENT
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ACCA
PAPER F5
PERFORMANCE MANAGEMENT
REVISION QUESTION BANK
JUNE 2012
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©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
CONTENTS
Question
Page
Answer Marks
Date worked
ACTIVITY BASED COSTING
1
2
3
4
Jola Publishing Co (ACCA J08)
Abkaber Co (ACCA D02)
Admer (ACCA J04)
Spring Co (ACCA D04)
1
2
4
5
1001
1003
1006
1009
25
25
25
25
6
7
8
8
9
1012
1015
1016
1019
1019
25
20
25
9
20
9
10
11
1021
1024
1025
25
20
20
12
14
1027
1030
15
20
Higgins Co (ACCA J08)
Albion Co (ACCA J03)
Kobrin Engineers Co
15
16
17
1033
1036
1038
25
25
20
BIL Motor Components Co (ACCA)
Jason Grimes
Kadok Co
Autodes Co
Essential aspect
18
19
19
20
21
1040
1042
1043
1045
1047
20
15
15
20
20
22
23
23
1049
1050
1052
20
25
10
DEVELOPMENTS IN MANAGEMENT ACCOUNTING
5
6
7
8
9
Edward Co (ACCA D07)
Yam Co (ACCA J09)
Wagrin (ACCA D08)
Scovet (ACCA J01)
Environmental management accounting
RELEVANT COST ANALYSIS
10
11
12
Sniff Co (ACCA D07)
Bits and Pieces (ACCA J09)
Stay Clean (ACCA D09)
COST VOLUME PROFIT ANALYSIS
13
14
Buttery Restaurant
A to C Co
LIMITING FACTOR DECISIONS
15
16
17
PRICING
18
19
20
21
22
RISK AND UNCERTAINTY
23
24
25
Stow Health Care (ACCA PP)
Shifters Haulage (ACCA D08)
Decision tree
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
(iii)
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
CONTENTS
Question
Page
Answer Marks
Date worked
BUDGETING
26
27
28
29
Northland (ACCA J09)
Budget behaviour (ACCA)
ZBB (ACCA J02)
Budgeting & costing (ACCA J05)
24
25
26
26
1054
1055
1057
1060
20
20
25
25
26
28
28
29
30
1063
1064
1066
1067
1069
20
25
10
25
20
30
31
1071
1072
13
20
31
33
33
1074
1076
1078
25
25
10
34
36
37
38
1079
1083
1085
1086
25
20
14
20
38
39
1088
1090
25
20
40
41
1091
1094
20
20
1096
1098
1099
1103
20
15
20
20
QUANTITATIVE TECHNIQUES FOR BUDGETING
30
31
32
33
34
The Western (ACCA D09)
Storrs Co (ACCA J03)
South
Henry Co (ACCA D08)
Big Cheese Chairs (ACCA D09)
BUDGETING AND STANDARD COSTING
35
36
Standard costing (ACCA D01)
Information source (ACCA)
BASIC VARIANCE ANALYSIS
37
38
39
Woodeezer Co (ACCA D02)
Mermus Co (ACCA D04)
Murgatroyd Co (ACCA D05)
ADVANCED VARIANCE ANALYSIS
40
41
42
43
Chaff Co (ACCA J08)
Crumbly Cakes (ACCA J09)
AVX Co
Milboa Co
BEHAVIOURAL ASPECTS OF STANDARD COSTING
44
45
Spike Co (ACCA D07)
Secure Net (ACCA D09)
PERFORMANCE MEASUREMENT
46
47
Oliver (ACCA J09)
Thatcher International Park (ACCA D09)
FURTHER ASPECTS OF PERFORMANCE MANAGEMENT
48
49
50
51
(iv)
Eatwell Restaurant (ACCA J02)
Balanced Scorecard (ACCA)
BLA Co
AV
43
43
44
46
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
CONTENTS
Question
Page
Answer Marks
Date worked
DIVISIONAL PERFORMANCE EVALUATION
52
53
54
55
Bridgewater Co (ACCA J08)
Osborne Co
Responsibility centres (ACCA D05)
Pace Co (ACCA D08)
48
49
50
51
1106
1109
1110
1113
25
10
25
25
52
53
1116
1118
20
13
2
3
4
5
8
9
11
12
25
25
25
25
TRANSFER PRICING
56
57
Business Solutions (ACCA J02)
Manuco Co
PILOT PAPER1
1
2
3
4
1
Triple 2
Simply Soup
BFG
Preston Financial Services
Since the publication of this Pilot Paper in December 2007 the examination format has changed to
five questions of 20 marks each.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
(v)
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Formulae Sheet
Learning curve
y = axb
Where
y = cumulative average time per unit to produce x units
a = the time taken for the first unit of output
x = the cumulative number of units produced
b = the index of learning (log LR/log 2)
LR = the learning rate as a decimal
Regression analysis
y = a + bx
b =
a =
r =
∑ xy − ∑ x∑ y
n∑ x − (∑ x )
∑ y − b∑ x
n
2
2
n
n
∑ xy − ∑ x∑ y
(n∑ x − (∑ x) )(n∑ y − (∑ y ) )
n
2
2
2
2
Demand curve
P = a – bQ
b=
change in price
change in quality
a = price when Q = 0
MR = a – 2bQ
(vi)
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Question 1 JOLA PUBLISHING CO
Jola Publishing Co publishes two forms of book.
The company publishes a children’s book (CB), which is sold in large quantities to governmentcontrolled schools. The book is produced in only four large production runs but goes through frequent
government inspections and quality assurance checks.
The paper used is strong, designed to resist the damage that can be caused by the young children it is
produced for. The book has only a few words and relies on pictures to convey meaning.
The second book is a comprehensive technical journal (TJ). It is produced in monthly production runs,
12 times a year. The paper used is of relatively poor quality and is not subject to any governmental
controls and consequently only a small number of inspections are carried out. The TJ uses far more
machine hours than the CB in its production.
The directors are concerned about the performance of the two books and are wondering what the impact
would be of a switch to an activity based costing (ABC) approach to accounting for overheads. They
currently use absorption costing, based on machine hours for all overhead calculations. They have
accurately produced an analysis for the accounting year just completed as follows:
CB
$per unit
Direct production costs
Paper
Printing ink
Machine costs
TJ
$per unit
0.75
1.45
1.15
$per unit
0.08
4.47
1.95
3.35
2.30
5.65
9.05
3.40
Overheads
Total cost
Selling price
Margin
$per unit
6.50
3.95
10.45
13.85
3.40
The main overheads involved are:
Overhead
Property costs
Quality control
Production set up costs
% of total overhead
75.0%
23.0%
2.0%
Activity driver
Machine hours
Number of inspections
Number of set ups
If the overheads above were re-allocated under ABC principles then the results would be that the
overhead allocation to CB would be $0.05 higher and the overhead allocated to TJ would be $0.30
lower than previously.
Required:
(a)
Explain why the overhead allocations have changed in the way indicated above.
(8 marks)
(b)
Briefly explain the implementation problems often experienced when ABC is first
introduced.
(4 marks)
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
(c)
The directors are keen to introduce ABC for the coming year and have provided the following
cost and selling price data:
(1)
The paper used costs $2 per kg for a CB but the TJ paper costs only $1 per kg. The
CB uses 400 gms of paper for each book, four times as much as the TJ uses.
(2)
Printing ink costs $30 per litre. The CB uses one third of the printing ink of the
larger TJ. The TJ uses 150 ml of printing ink per book.
(3)
The CB needs six minutes of machine time to produce each book, whereas the TJ
needs 10 minutes per book. The machines cost $12 per hour to run.
(4)
The sales prices are to be $9.30 for the CB and $14.00 for the TJ.
As mentioned above there are three main overheads, the data for these are:
Overhead
Property costs
Quality control
Production set up costs
Total
Annual cost for the coming year
$
2,160,000
668,000
52,000
–––––––––
2,880,000
–––––––––
The CB will be inspected on 180 occasions next year, whereas the TJ will be inspected just 20
times.
Jola Publishing will produce its annual output of 1,000,000 CBs in four production runs and
approximately 10,000 TJs per month in each of 12 production runs.
Required:
(i)
Calculate the cost per unit and the margin for the CB and the TJ using
machine hours to absorb the overheads.
(5 marks)
(ii)
Calculate the cost per unit and the margin for the CB and the TJ using activity
based costing principles to absorb the overheads.
(8 marks)
(25 marks)
Question 2 ABKABER CO
Abkaber Co assembles three types of motorcycle at the same factory: the 50 cc Sunshine, the 250 cc
Roadster and the 1000 cc Fireball. It sells the motorcycles throughout the world. In response to market
pressures Abkaber has invested heavily in new manufacturing technology in recent years and, as a
result, has significantly reduced the size of its workforce.
Historically, the company has allocated all overhead costs using total direct labour hours, but is now
considering introducing Activity Based Costing (ABC). Abkaber’s accountant has produced the
following analysis:
2
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Annual
output
(units)
Sunshine
Roadster
Fireball
2,000
1,600
400
Annual direct
labour
hours
200,000
220,000
80,000
Selling
price
($ per unit)
4,000
6,000
8,000
Raw
material
cost
($ per unit)
400
600
900
The three cost drivers that generate overheads are:
Deliveries to retailers – the number of deliveries of motorcycles to retail showrooms;
Set-ups
– the number of times the assembly line process is re-set to
accommodate a production run of a different type of motorcycle;
Purchase orders
– the number of purchase orders.
The annual cost driver volumes relating to each activity and for each type of motorcycle are as follows:
Sunshine
Roadster
Fireball
Number of
deliveries
to retailers
100
80
70
Number of
set-ups
35
40
25
Number of
purchase
orders
400
300
100
The annual overhead costs relating to these activities are as follows:
Deliveries to retailers
Set-up costs
Purchase orders
$
2,400,000
6,000,000
3,600,000
All direct labour is paid at $5 per hour. The company holds no inventory.
At a board meeting there was some concern over the introduction of activity based costing.
The finance director argued: “I very much doubt whether selling the Fireball is viable but I am not
convinced that activity based costing would tell us any more than the use of labour hours in assessing
the viability of each product.”
The marketing director argued: “I am in the process of negotiating a major new contract with a
motorcycle rental company for the Sunshine model. For such a big order they will not pay our normal
prices but we need to at least cover our incremental costs. I am not convinced that activity based
costing would achieve this as it merely averages costs for our entire production.”
The managing director argued: “I believe that activity based costing would be an improvement but it
still has its problems. For instance if we carry out an activity many times surely we get better at it and
costs fall rather than remain constant. Similarly, some costs are fixed and do not vary either with
labour hours or any other cost driver”.
The chairman argued: “I cannot see the problem. The overall profit for the company is the same no
matter which method of allocating overheads we use. It seems to make no difference to me”.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
3
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Required:
(a)
Calculate the total profit on each of Abkaber Co’s three types of product using each of
the following methods to attribute overheads:
(i)
(ii)
(b)
the existing method based on labour hours; and
activity based costing.
(13 marks)
Write a report to the directors of Abkaber Co, as its management accountant. The
report should:
(i)
evaluate the labour hours and the activity based costing methods in the
circumstances of Abkaber Co; and
(ii)
examine the implications of activity based costing for Abkaber Co, and in so
doing evaluate the issues raised by each of the directors.
Refer to your calculations in requirement (a) above where appropriate.
(12 marks)
(25 marks)
Question 3 ADMER
Admer owns several home furnishing stores. In each store, consultations, if needed, are undertaken by
specialists, who also visit potential customers in their homes, using specialist software to help
customers realise their design objectives. Customers visit the store to make their selections from the
wide range of goods offered, after which sales staff collect payment and raise a purchase order.
Customers then collect their self-assembly goods from the warehouse, using the purchase order as
authority to collect. Administration staff process purchase orders and also arrange consultations.
Each store operates an absorption costing system and costs other than the cost of goods sold are
apportioned on the basis of sales floor area.
Results for one of Admer’s stores for the last three months are as follows:
Department
Sales
Cost of goods sold
Other costs
Profit
Kitchens
$
210,000
63,000
130,250
–––––––
16,750
–––––––
Bathrooms Dining Rooms
$
$
112,500
440,000
37,500
176,000
81,406
113,968
–––––––
–––––––
(6,406)
150,032
–––––––
–––––––
Total
$
762,500
276,500
325,624
–––––––
160,376
–––––––
The management accountant of Admer is concerned that the bathrooms department of the store has
been showing a loss for some time, and is considering a proposal to close the bathrooms department in
order to concentrate on the more profitable kitchens and dining rooms departments. He has found that
other costs for this store for the last three months are made up of:
$
Employees
Sales staff wages
64,800
12
Consultation staff wages
24,960
4
Warehouse staff wages
30,240
6
Administration staff wages
30,624
4
General overheads (light, heat, rates, etc)
175,000
–––––––
325,624
–––––––
4
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
He has also collected the following information for the last three months:
Department
Number of items sold
Purchase orders
Floor area (square metres)
Number of consultations
Kitchens
1,000
1,000
16,000
798
Bathrooms Dining Rooms
1,500
4,000
900
2,500
10,000
14,000
200
250
The management accountant believes that he can use this information to review the store’s performance
in the last three months from an activity-based costing (ABC) perspective.
Required:
(a)
Discuss the management accountant’s belief that the information provided could be
used in an activity-based costing analysis.
(4 marks)
(b)
Explain and illustrate, using supporting calculations, how an ABC profit statement
might be produced from the information provided. Clearly explain the reasons behind
your choice of cost drivers.
(8 marks)
(c)
Evaluate and discuss the proposal to close the bathrooms department.
(d)
Discuss the advantages and disadvantages that may arise for Admer from introducing
activity-based costing in its stores.
(7 marks)
(6 marks)
(25 marks)
Question 4 SPRING CO
At a recent board meeting of Spring Co, there was a heated discussion on the need to improve financial
performance. The Production Director argued that financial performance could be improved if the
company replaced its existing absorption costing approach with an activity-based costing system. He
argued that this would lead to better cost control and increased profit margins. The Managing Director
agreed that better cost control could lead to increased profitability, but informed the meeting that he
believed that performance needed to be monitored in both financial and non-financial terms. He
pointed out that sales could be lost due to poor product quality or a lack of after-sales service just as
easily as by asking too high a price for Spring’s products. He suggested that while the board should
consider introducing activity-based costing, it should also consider ways in which the company could
monitor and assess performance on a wide basis.
Required:
(a)
Describe the key features of activity-based costing and discuss the advantages and
disadvantages of adopting an activity-based approach to cost accumulation. (14 marks)
(b)
Explain the need for the measurement of organisational and managerial performance,
giving examples of the range of financial and non-financial performance measures that
might be used.
(11 marks)
(25 marks)
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
5
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Question 5 EDWARD CO
Edward Co assembles and sells many types of radio. It is considering extending its product range to
include digital radios. These radios produce a better sound quality than traditional radios and have a
large number of potential additional features not possible with the previous technologies (station
scanning, more choice, one touch tuning, station identification text and song identification text, etc).
A radio is produced by assembly workers assembling a variety of components. Production overheads
are currently absorbed into product costs on an assembly labour hour basis.
Edward is considering a target costing approach for its new digital radio product.
Required:
(a)
Briefly describe the target costing process that Edward Co should undertake.
(3 marks)
(b)
Explain the benefits to Edward Co of adopting a target costing approach at such an
early stage in the product development process.
(4 marks)
(c)
Assuming a cost gap was identified in the process, outline possible steps Edward Co
could take to reduce this gap.
(5 marks)
(d)
A selling price of $44 has been set in order to compete with a similar radio on the market that
has comparable features to Edward’s intended product. The board have agreed that the
acceptable margin (after allowing for all production costs) should be 20%. Cost information
for the new radio is as follows:
Component 1 (Circuit board) – these are bought in and cost $4.10 each. They are bought in
batches of 4,000 and additional delivery costs are $2,400 per batch.
Component 2 (Wiring) – in an ideal situation 25 cm of wiring is needed for each completed
radio. However, there is some waste involved in the process as wire is occasionally cut to the
wrong length or is damaged in the assembly process. Edward estimates that 2% of the
purchased wire is lost in the assembly process. Wire costs $0.50 per metre to buy.
Other material – other materials cost $8.10 per radio.
Assembly labour – these are skilled people who are difficult to recruit and retain. Edward
has more staff of this type than needed but is prepared to carry this extra cost in return for the
security it gives the business. It takes 30 minutes to assemble a radio and the assembly
workers are paid $12.60 per hour. It is estimated that 10% of hours paid to the assembly
workers is for idle time.
Production Overheads – recent historic cost analysis has revealed the following production
overhead data:
Total production
Total assembly
overhead
labour hours
$
Month 1
620,000
19,000
Month 2
700,000
23,000
Fixed production overheads are absorbed on an assembly hour basis based on normal annual
activity levels. In a typical year 240,000 assembly hours will be worked by Edward.
6
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Required:
Calculate the expected cost per unit for the radio and identify any cost gap that might
exist.
(13 marks)
(25 marks)
Question 6 YAM CO
Yam Co is involved in the processing of sheet metal into products A, B and C using three processes,
pressing, stretching and rolling. Like many businesses Yam faces tough price competition in what is a
mature world market.
The factory has 50 production lines each of which contain the three processes: Raw material for the
sheet metal is first pressed then stretched and finally rolled. The processing capacity varies for each
process and the factory manager has provided the following data:
Pressing
Stretching
Rolling
Processing time per metre in hours
Product A
Product B
Product C
0.50
0.50
0.40
0.25
0.40
0.25
0.40
0.25
0.25
The factory operates for 18 hours each day for five days per week. It is closed for only two weeks of
the year for holidays when maintenance is carried out. On average one hour of labour is needed for
each of the 225,000 hours of factory time. Labour is paid $10 per hour.
The raw materials cost per metre is $3.00 for product A, $2.50 for product B and $1.80 for product C.
Other factory costs (excluding labour and raw materials) are $18,000,000 per year. Selling prices per
metre are $70 for product A, $60 for product B and $27 for product C.
Yam carries very little inventory.
Required:
(a)
Identify the bottleneck process and briefly explain why this process is described as a
“bottleneck”.
(3 marks)
(b)
Calculate the throughput accounting ratio (TPAR) for each product assuming that the
bottleneck process is fully utilised.
(8 marks)
(c)
Assuming that the TPAR of product C is less than 1:
(i)
explain how Yam could improve the TPAR of product C;
(4 marks)
(ii)
briefly discuss whether this supports the suggestion to cease the production of
product C and briefly outline three other factors that Yam should consider
before a cessation decision is taken.
(5 marks)
(20 marks)
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
7
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Question 7 WARGRIN
Wargrin designs, develops and sells many PC games. Games have a short lifecycle lasting around three
years only. Performance of the games is measured by reference to the profits made in each of the
expected three years of popularity. Wargrin accepts a net profit of 35% of turnover as reasonable. A
rate of contribution (sales price less variable cost) of 75% is also considered acceptable.
Wargrin has a large centralised development department that carries out all the design work before it
passes the completed game to the sales and distribution department to market and distribute the product.
Wargrin has developed a brand new game called Stealth and this has the following budgeted
performance figures.
The selling price of Stealth will be a constant $30 per game. Analysis of the costs shows that at a
volume of 10,000 units a total cost of $130,000 is expected. However at a volume of 14,000 units a
total cost of $150,000 is expected. If volumes exceed 15,000 units the fixed costs will increase by 50%.
Stealth’s budgeted volumes are as follows:
Sales volume
Year 1
Year 2
8,000 units 16,000 units
Year 3
4,000 units
In addition, marketing costs for Stealth will be $60,000 in year one and $40,000 in year two. Design
and development costs are all incurred before the game is launched and has cost $300,000 for Stealth.
These costs are written off to the income statement as incurred (i.e. before year 1 above).
Required:
(a)
Explain the principles behind lifecycle costing and briefly state why Wargrin in
particular should consider these lifecycle principles.
(4 marks)
(b)
Produce the budgeted results for the game “Stealth” and briefly assess the game’s
expected performance, taking into account the whole lifecycle of the game.
(9 marks)
(c)
Explain why incremental budgeting is a common method of budgeting and outline the
main problems with such an approach.
(6 marks)
(d)
Discuss the extent to which a meaningful standard cost can be set for games produced by
Wargrin. You should consider each of the cost classifications mentioned above. (6 marks)
(25 marks)
Question 8 SCOVET
Scovet Co has identified a market for a new product D for which the following estimated information is
available:
(1)
Sales revenue for the years 20X2, 20X3 and 20X4 of $6m, $7m and $6m respectively. No
sales are expected after 20X4. The selling price will be $10 per unit throughout the period.
(2)
Contribution to sales percentage of 60% for each year.
(3)
Product specific fixed costs in the years 20X2, 20X3 and 20X4 of $2.5m, $2.2m and $1.8m
respectively.
(4)
Capital investment of $4.5m on 1 January 20X2 with nil residual value at 31 December 20X4.
Note: Ignore taxation and the time value of money.
8
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Required:
(a)
Calculate the total profit of product D over its life.
(4 marks)
(b)
Calculate the cost per unit of product D, which includes absorption of all product
specific costs over the life of the product.
(3 marks)
(7 marks)
Question 9 ENVIRONMENTAL MANAGEMENT ACCOUNTING
(a)
Explain the meaning of environmental costs.
(8 marks)
(b)
Explain why the management of environmental costs is becoming increasingly
important to organizations.
(4 marks)
(c)
Explain why traditional management accounting does not enable managers of a business
to manage their environmental costs.
(4 marks)
(d)
Explain the meaning of the term environmental management accounting, and illustrate
how it can help managers to manage environmental costs more effectively.
(4 marks)
(20 marks)
Question 10 SNIFF CO
Sniff Co manufactures and sells its standard perfume by blending a secret formula of aromatic oils with
diluted alcohol. The oils are produced by another company following a lengthy process and are very
expensive. The standard perfume is highly branded and successfully sold at a price of $39.98 per 100
millilitres (ml).
Sniff Co is considering processing some of the perfume further by adding a hormone to appeal to
members of the opposite sex. The hormone to be added will be different for the male and female
perfumes. Adding hormones to perfumes is not universally accepted as a good idea as some people
have health concerns. On the other hand, market research carried out suggests that a premium could be
charged for perfume that can “promise” the attraction of a suitor. The market research has cost $3,000.
Data has been prepared for the costs and revenues expected for the following month (a test month)
assuming that a part of the company’s output will be further processed by adding the hormones.
The output selected for further processing is 1,000 litres, about a tenth of the company’s normal
monthly output. Of this, 99% is made up of diluted alcohol, which costs $20 per litre. The rest is a
blend of aromatic oils costing $18,000 per litre. The labour required to produce 1,000 litres of the basic
perfume before any further processing is 2,000 hours at a cost of $15 per hour.
Of the output selected for further processing, 200 litres (20%) will be for male customers and 2 litres of
hormone costing $7,750 per litre will then be added. The remaining 800 litres (80%) will be for female
customers and 8 litres of hormone will be added, costing $12,000 per litre. In both cases the adding of
the hormone adds to the overall volume of the product as there is no resulting processing loss.
Sniff Co has sufficient existing machinery to carry out the test processing.
The new processes will be supervised by one of the more experienced supervisors currently employed
by Sniff Co. His current annual salary is $35,000 and it is expected that he will spend 10% of his time
working on the hormone adding process during the test month. This will be split evenly between the
male and female versions of the product.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
9
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Extra labour will be required to further process the perfume, with an extra 500 hours for the male
version and 700 extra hours for the female version of the hormone-added product. Labour is currently
fully employed, making the standard product. New labour with the required skills will not be available
at short notice.
Sniff Co allocates fixed overhead at the rate of $25 per labour hour to all products for the purposes of
reporting profits.
The sales prices that could be achieved as a one-off monthly promotion are:
–
–
Male version:
Female version:
$75.00 per 100 ml;
$59.50 per 100 ml.
Required:
(a)
Outline the financial and other factors that Sniff Co should consider when making a
further processing decision.
Note: no calculations are required.
(4 marks)
(b)
Evaluate whether Sniff Co should experiment with the hormone adding process using
the data provided. Provide a separate assessment and conclusion for the male and the
female versions of the product.
(15 marks)
(c)
Calculate the selling price per 100 ml for the female version of the product that would
ensure further processing would break even in the test month.
(2 marks)
(d)
Sniff Co is considering outsourcing the production of the standard perfume. Outline the
main factors it should consider before making such a decision.
(4 marks)
(25 marks)
Question 11 BITS AND PIECES
Bits and Pieces (B&P) operates a retail store selling spares and accessories for the car market. The
store has previously only opened for six days per week for the 50 working weeks in the year, but B&P
is now considering also opening on Sundays.
The sales of the business on Monday through to Saturday averages at $10,000 per day with average
gross profit of 70% earned.
B&P expects that the gross profit % earned on a Sunday will be 20 percentage points lower than the
average earned on the other days in the week. This is because they plan to offer substantial discounts
and promotions on a Sunday to attract customers. Given the price reduction, Sunday sales revenues are
expected to be 60% more than the average daily sales revenues for the other days. These Sunday sales
estimates are for new customers only, with no allowance being made for those customers that may
transfer from other days.
B&P buys all its goods from one supplier. This supplier gives a 5% discount on all purchases if annual
spend exceeds $1,000,000.
It has been agreed to pay time and a half to sales assistants that work on Sundays. The normal hourly
rate is $20 per hour. In total five sales assistants will be needed for the six hours that the store will be
open on a Sunday. They will also be able to take a half-day off (four hours) during the week. Staffing
levels will be allowed to reduce slightly during the week to avoid extra costs being incurred.
10
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
The staff will have to be supervised by a manager, currently employed by the company and paid an
annual salary of $80,000. If he works on a Sunday he will take the equivalent time off during the week
when the assistant manager is available to cover for him at no extra cost to B&P. He will also be paid a
bonus of 1% of the extra sales generated on the Sunday project.
The store will have to be lit at a cost of $30 per hour and heated at a cost of $45 per hour. The heating
will come on two hours before the store opens in the 25 “winter” weeks to make sure it is warm enough
for customers to come in at opening time. The store is not heated in the other weeks
The rent of the store amounts to $420,000 per annum.
Required:
(a)
Calculate whether the Sunday opening incremental revenue exceeds the incremental
costs over a year (ignore inventory movements) and on this basis reach a conclusion as
to whether Sunday opening is financially justifiable.
(12 marks)
(b)
Discuss whether the manager’s pay deal (time off and bonus) is likely to motivate him.
(4 marks)
(c)
Briefly discuss whether offering substantial price discounts and promotions on Sunday
is a good suggestion.
(4 marks)
(20 marks)
Question 12 STAY CLEAN
Stay Clean manufactures and sells a small range of kitchen equipment. Specifically the product range
contains a dishwasher (DW), a washing machine (WM) and a tumble dryer (TD). The TD is of a rather
old design and has for some time generated negative contribution. It is widely expected that in one
year’s time the market for this design of TD will cease, as people switch to a washing machine that can
also dry clothes after the washing cycle has completed.
Stay Clean is trying to decide whether or not to cease the production of TD now or in 12 months’ time
when the new combined washing machine/drier will be ready. To help with this decision the following
information has been provided:
(1)
The normal selling prices, annual sales volumes and total variable costs for the three products
are as follows:
DW
WM
TD
Selling price per unit
$200
$350
$80
Material cost per unit
$70
$100
$50
Labour cost per unit
£50
$80
$40
Contribution per unit
$80
$170
–$10
Annual sales
5,000 units 6,000 units 1,200 units
(2)
It is thought that some of the customers that buy a TD also buy a DW and a WM. It is
estimated that 5% of the sales of WM and DW will be lost if the TD ceases to be produced.
(3)
All the direct labour force currently working on the TD will be made redundant immediately
if TD is ceased now. This would cost $6,000 in redundancy payments. If Stay Clean waited
for 12 months the existing labour force would be retained and retrained at a cost of $3,500 to
enable them to produce the new washing/drying product. Recruitment and training costs of
labour in 12 months’ time would be $1,200 in the event that redundancy takes place now.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
11
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
(4)
Stay Clean operates a just in time (JIT) policy and so all material cost would be saved on the
TD for 12 months if TD production ceased now. Equally, the material costs relating to the
lost sales on the WM and the DW would also be saved. However, the material supplier has a
volume based discount scheme in place as follows:
Total annual expenditure ($)
0–600,000
600,001–800,000
800,001–900,000
900,001–960,000
960,001 and above
Discount
0%
1%
2%
3%
5%
Stay Clean uses this supplier for all its materials for all the products it manufactures. The
figures given above in the cost per unit table for material cost per unit are net of any discount
Stay Clean already qualifies for.
(5)
The space in the factory currently used for the TD will be sublet for 12 months on a shortterm lease contract if production of TD stops now. The income from that contract will be
$12,000.
(6)
The supervisor (currently classed as an overhead) supervises the production of all three
products spending approximately 20% of his time on the TD production. He would continue
to be fully employed if the TD ceases to be produced now.
Required:
(a)
Calculate whether or not it is worthwhile ceasing to produce the TD now rather than
waiting 12 months (ignore any adjustment to allow for the time value of money).
(13 marks)
(b)
Explain two pricing strategies that could be used to improve the financial position of the
business in the next 12 months assuming that the TD continues to be made in that
period.
(4 marks)
(c)
Briefly describe three issues that Stay Clean should consider if it decides to outsource
the manufacture of one of its future products.
(3 marks)
(20 marks)
Question 13 BUTTERY RESTAURANT
(a)
The current average weekly trading results of the Buttery Restaurant are shown below.
$
Revenue
Operating costs:
Profit
12
Materials
Power
Staff
Building occupancy costs
1,540
280
340
460
——–
$
2,800
(2,620)
——–
180
——–
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
The average selling price of each meal is $4. Materials and power may be regarded as a
variable cost varying with the number of meals provided. Staff costs are semi-variable with a
fixed cost element of $200 per week. The building occupancy costs are all fixed.
Required:
Calculate the number of meals that must be sold in order to earn a profit of $300 per
week.
(4 marks)
(b)
The owners of the restaurant are considering expanding their business and using underutilised space by diversifying into:
either
or
(1)
(2)
take-away food;
high quality meals.
The estimated sales and costs of each proposal are shown below:
Sales volume per week
Average selling price per meal
Variable costs per meal
Incremental fixed costs per week
Take-away
Quality meals
720 meals
200 meals
$
$
1.60
6.00
0.85
4.66
610.00
282.00
The sales estimate for both of the above proposals is rather uncertain and it is recognised that
actual sales volume could be up to 20% either higher or lower than that estimated.
If either of the above proposals were implemented it has been estimated that the existing
restaurant’s operations would be affected as follows:
(1)
As a result of bulk purchasing material costs incurred would be reduced by 10 cents
per meal. This saving would apply to all meals produced in the existing restaurant.
(2)
Because more people would be aware of the existence of the restaurant it is
estimated that Revenue would increase. If the “take-away food” section were
opened, then for every ten take-away meals sold the existing restaurant’s sales
would increase by one meal; alternatively, if the “high quality meals” section were
open, then for every five such meals sold the existing restaurant’s sales would
increase by one meal.
A specific effect of implementing the “take-away food” proposal would be a change
in the terms of employment of the staff in the existing restaurant, the result of which
would be that the staff wage of $340 per week would have to be regarded as a fixed
cost.
Required:
Calculate, for each of the proposed methods of diversification:
(i)
the additional profit that would be earned by the owners of the restaurant if
the estimated sales were achieved
(8 marks)
(ii)
the sales volume at which the owners of the restaurant would earn no
additional profit from the proposed diversification.
(3 marks)
(15 marks)
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
13
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Question 14 A TO C CO
A to C Co manufactures three products, A, B, and C. The selling price and direct cost per unit of each
of these products are as follows:
Product
A
Selling price
Materials cost
Direct labour
B
$
10
6.2
2.0
$
20
7.6
8.0
C
$
30
20.4
3.0
The company uses flexible budgets based on budgeted production and sales of 3,000 units and 5,000
units per month. An extract from these budgets relating to overhead costs is as follows:
Product
Total overhead costs
3,000 units
5,000 units
A
$000
B
$000
C
$000
6
8
13
19
11
17
These include both fixed and variable overhead costs. Fixed costs represent common costs that are
apportioned to each of the three products, but which are not product specific.
Required:
(a)
Calculate the contribution per unit of each of the four products.
(3 marks)
(b)
Calculate the total fixed costs for the month.
(3 marks)
Budgeted production and estimated maximum demand for each product for the following month are as
follows:
Product
Budgeted sales
Maximum demand
A
Units
4,000
4,100
B
Units
2,000
4,600
C
Units
4,000
4,100
Required:
(c)
Calculate monthly break-even revenue assuming that sales of the three products are
made in the budgeted mix.
(4 marks)
(d)
Draw a profit volume chart, showing two lines:
(i)
On the assumption that sales of all products are made using the budgeted mix
of products.
(3 marks)
(ii)
On the assumption that sales of the product with the highest contribution to
sales ratio are made first, followed by the product with the second highest, and
so on, with sales of each product being made up until maximum demand.
(7 marks)
(20 marks)
14
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Question 15 HIGGINS CO
Higgins Co (HC) manufactures and sells pool cues and snooker cues. The cues both use the same type
of good quality wood (ash), which can be difficult to source in sufficient quantity. The supply of ash is
restricted to 5,400 kg per period. Ash costs $40 per kg.
The cues are made by skilled craftsmen (highly skilled labour) who are well known for their
workmanship. The skilled craftsmen take years to train and are difficult to recruit. HC’s craftsmen are
generally only able to work for 12,000 hours in a period. The craftsmen are paid $18 per hour.
HC sells the cues to a large market. Demand for the cues is strong, and in any period, up to 15,000 pool
cues and 12,000 snooker cues could be sold. The selling price for pool cues is $41 and the selling price
for snooker cues is $69.
Manufacturing details for the two products are as follows:
Craftsmen time per cue
Ash per cue
Other variable costs per cue
Pool cues
0.5 hours
270 g
$1.20
Snooker cues
0.75 hours
270 g
$4.70
HC does not keep inventory.
Required:
(a)
Calculate the contribution earned from each cue.
(2 marks)
(b)
Determine the optimal production plan for a typical period assuming that HC is seeking
to maximise the contribution earned. (You should use a linear programming graph to
identify the optimal solution and accurately solve the relevant equations.)
(12 marks)
(c)
Some of the craftsmen have offered to work overtime, provided that they are paid double time
for the extra hours over the contracted 12,000 hours. HC has estimated that up to 1,200 hours
per period could be gained in this way.
Required:
(i)
Explain the meaning of a shadow price (dual price) and calculate the shadow
price of both the labour (craftsmen) and the materials (ash).
(5 marks)
(ii)
Advise HC whether to accept the craftsmen’s initial offer of working overtime,
discussing the rate of pay requested, the quantity of hours and one other factor
that HC should consider.
(6 marks)
(25 marks)
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
15
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Question 16 ALBION CO
The managers of Albion Co are reviewing the operations of the company with a view to making
operational decisions for the next month. Details of some of the products manufactured by the
company are given below.
Product
Selling price ($/unit)
Material R2 (kg/unit)
Material R3 (kg/unit)
Direct labour (hours/unit)
Variable production overheads ($/unit)
Fixed production overheads ($/unit)
Expected demand for next month (units)
AR2
21.00
2.0
2.0
0.6
1.10
1.50
950
GL3
28.50
3.0
2.2
1.2
1.30
1.60
1,000
HT4
27.30
3.0
1.6
1.5
1.10
1.70
900
XY5
3.0
1.7
1.40
1.40
Products AR2, GL3 and HT4 are sold to customers of Albion, while Product XY5 is a component that
is used in the manufacture of other products. Albion manufactures a wide range of products in addition
to those detailed above.
Material R2, which is not used in any other of Albion’s products, is expected to be in short supply in
the next month because of industrial action at a major producer of the material. Albion has just
received a delivery of 5,500 kg of Material R2 and this is expected to be the amount held in Inventory
at the start of the next month. The company does not expect to be able to obtain further supplies of
Material R2 unless it pays a premium price. The normal market price is $2.50 per kg.
Material R3 is available at a price of $2.00 per kg and Albion does not expect any problems in securing
supplies of this material. Direct labour is paid at a rate of $4.00 per hour.
Folam Co has recently approached Albion with an offer to supply a substitute for Product XY5 at a
price of $10.20 per unit. Albion would need to pay an annual fee of $50,000 for the right to use this
patented substitute.
Required:
(a)
Determine the optimum production schedule for Products AR2, GL3 and HT4 for the
next month, on the assumption that additional supplies of Material R2 are not
purchased.
(8 marks)
(b)
If Albion Co decides to purchase further supplies of Material R2 to meet demand for
Products AR2, GL3 and HT4, calculate the maximum price per kg that the company
should pay.
(3 marks)
(c)
Discuss whether Albion Co should manufacture Product XY5 or buy the substitute
offered by Folam Co. Your answer must be supported by appropriate calculations.
(7 marks)
(d)
Discuss the limitations of marginal costing (variable costing) as a basis for making shortterm decisions.
(7 marks)
(25 marks)
16
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Question 17 KOBRIN ENGINEERS CO
Kobrin Engineering Co is experiencing trouble with its suppliers. The firm produces a variety of valves
requiring a complex bought-in component and specially imported high-grade steel. The standard cost
cards for the types of valve produced are as follows:
Valve type
TW
$
Steel
250
Bought-in component
50
Direct labour
60
Variable production costs
40
Fixed production costs
180
Selling and administration costs 145
Profit
35
_____
VE
$
500
50
60
50
240
225
55
_____
EC
$
190
50
50
40
150
120
30
_____
SE
$
390
50
100
50
270
215
55
_____
Selling price
1,180
_____
630
_____
1,130
_____
760
_____
All the selling and administration costs are fixed and the same single component is used for each of the
four products. Direct labour is paid $4 per standard hour and each member of the workforce is capable
of producing any of the valves.
Kobrin’s major customer has ordered 30 TW, 30 EC, 20 VE and 20 SE valves for the coming month.
Despite the firm’s difficulties, it is felt that these must be supplied to ensure future business. It is
thought that this order represents some 10% of total demand for each valve.
Required:
Establish the best production plan for Kobrin if, in the coming month:
(a)
Supplies of steel are limited to $250,000;
(b)
Only 400 bought-in components are likely to be available;
(c)
Labour disputes will restrict productive hours to 4,250;
(d)
All four products could be sub-contracted at a cost per unit of $475, $705, $380 and $640 for
TW, VE, EC and SE respectively; labour is still restricted to 4,250 hours but the major
customer insists that the special order is completed by Kobrin and not sub-contracted.
Note: Each of the restrictions on production is to be treated independently.
(20 marks)
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
17
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Question 18 BIL MOTOR COMPONENTS CO
(a)
In an attempt to win over key customers in the motor industry and to increase its market share,
BIL Motor Components Co have decided to charge a price lower than their normal price for
component TD463 when selling to the key customers who are being targeted. Details of
component TD463’s standard costs are as follows:
Batch size 200 units
Materials (per unit)
Labour (per unit)
Variable overheads (per unit)
Fixed overheads (per unit)
Setting-up costs per
batch of 200 units
Machine
Group 1
Machine
Group 7
Machine
Group 29
Assembly
26.00
2.00
0.65
3.00
_____
17.00
1.60
0.72
2.50
_____
–
0.75
0.80
1.50
_____
3.00
1.20
0.36
0.84
_____
31.65
_____
21.82
_____
3.05
_____
5.40
_____
$6
$4
–
$10
Required:
Compute the lowest selling price at which one batch of 200 units could be offered, and
critically evaluate the adoption of such a pricing policy.
(8 marks)
(b)
The company is also considering the launch of a new product, component TDX489, and have
provided you with the following information:
Product TDX489
Standard cost per box
$
6.20
1.60
_____
Variable cost
Fixed cost
7.80
_____
Market research – forecast of demand
Selling price ($)
Demand (boxes)
13
5,000
12
6,000
11
7,200
10
11,200
9
13,400
The company only has enough production capacity to make 7,000 boxes. However, it would
be possible to purchase product TDX489 from a sub-contractor at $7.75 per box for orders up
to 5,000 boxes, and $7 per box if the orders exceed 5,000 boxes.
Required:
Prepare and present a computation that illustrates which price should be selected in
order to maximise profits.
(8 marks)
(c)
Where production capacity is the limiting factor explain briefly the ways in which
management can increase it without having to acquire more plant and machinery.
(4 marks)
(20 marks)
18
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Question 19 JASON GRIMES
Jason Grimes’ results for the past year are as follows:
$000
Sales (1,000,000 units)
Less
Cost of goods sold
Labour
Materials
Gross profit
Less
Variable selling expenses (50¢ per unit)
Fixed overheads
550
2,000
_____
$000
3,000
(2,550)
_____
450
500
250
____
(750)
____
(300)
––––
For the coming year Jason can hire a machine for $575,000 which will cause his material usage per unit
to halve. Whether the machine is hired or not, the labour cost will rise to 80¢ per unit and variable
selling expenses fall to 20¢ per unit.
Jason’s demand curve is P = 5 –
0.03
Q, where P is the price per unit and Q is annual sales.
15,000
This gives marginal revenue of 5 –
0.06
Q.
15,000
Required:
Advise Jason on:
(a)
(b)
whether or not to hire the machine;
the price to be charged to maximise profit.
(15 marks)
Question 20 KADOK CO
Kadok Co manufactures a number of products, with cameras being produced in department C. The
company draws up budgets for each department based on the fullest practical capacity. For the year
commencing 1 January 20X9 the following budget has been formulated for department C:
Direct costs:
Materials
Labour
Production overheads
Administrative and marketing overheads
Full costs
Profit
Revenue *
$000
60
40
——
100
100
——
200
50
——
250
50
——
300
——
* From budgeted sales of 20,000 units.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
19
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Production overheads are absorbed on the basis of 100% of direct costs. However, half are fixed, while
the remainder relate to the machining of the materials. The administrative and marketing overheads are
based on 25% of factory costs and do not vary within wide ranges of activity. For each department a
profit margin of 20% is applied to the “full costs”, as this is felt to give a fair return on assets employed
as well as to provide a reasonable reward for entrepreneurial effort. This also results in a price that
appears to be fair to consumers.
Halfway through the budget period it became obvious to the management of Kadok that there was
going to be a shortfall in sales that could be expected to be 25% below the forecast. At about the same
time that this shortfall in sales became evident, a chain of photographic shops showed an interest in
purchasing 5,000 units of a special camera that would be stripped down to bare essentials and sold
under the chain’s brand name Noxid. If Kadok were to produce such a model there would obviously be
a saving on the usual material and labour unit costs. The management accountant of Kadok estimated
that materials costing $12,000 and labour of $8,000 would be required to produce the 5,000 cameras.
As the production could take place within the firm’s existing capacity, fixed costs would not be
affected.
Required:
(a)
Give computations showing the price that should be quoted for the order based on the
following:
(i)
(ii)
(iii)
(b)
full cost plus pricing, on the current basis;
a price that would enable the original budget profit to be attained;
overheads being absorbed on a unit basis, with profit applied on the current
basis.
(8 marks)
Give your advice to the management of Kadok Co on a pricing policy for this quotation.
Discuss any factors that you feel should be brought to the attention of management
when it considers the pricing strategy for this special order.
(7 marks)
(15 marks)
Question 21 AUTODES CO
Autodes Co designs, manufactures and sells a range of components for the motor car industry, selling
exclusively to car manufacturers. The design team has recently developed and patented a new
component for incorporation into any car. The component will greatly improve fuel consumption and
reduce emissions of greenhouse gases. Initial trials have been successful and the company is now
planning to launch the product. The design team believes that they are at least 24 months ahead of any
of their competitors who are currently developing similar products. The product has been developed
under the working title “Autolong”.
You are a consultant to the company and have been tasked with developing a pricing policy for the
Autolong. You have gathered the following data for each unit:
Direct Materials:
Code
WZ954
RT429
Other
Direct Labour
1.5 hours at $21 per hour
Quantity
3 gms
5 gms
Price
$4.74 per gm
$6.12 per gm
$5.01 per unit
Overheads are absorbed on a direct labour hour basis, at $29 per hour.
20
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Costs of developing the Autolong were $3,675,000. Autodes has a policy of recovering development
costs in the first three years of a product’s life cycle.
Supplies of material WZ954 are limited to 180,000 gms per annum. Autodes currently uses all of its
available supplies in another product, which generates a contribution of $15 per unit. Each unit of this
product requires 4 gms of WZ954. (Development costs of this product have been fully recovered.)
Product prices are calculated to obtain a 25% profit margin on sales.
A market report indicates that:
–
–
–
the market is reasonably price sensitive;
provided the price is not above $225, demand is expected to exceed production capacity;
introduction of the Autolong will not affect the sales volumes of other products.
The Managing Director has also asked you to comment on the suggestion of a non-executive director
that the Autolong should be priced on a “more competitive basis, such as market skimming or market
penetration”.
Required:
(8 marks)
(a)
Calculate the price of the Autolong based on the current pricing policy.
(b)
In a report to the Managing Director, comment on the non-executive director’s
suggestion, and recommend an initial price for the Autolong.
(12 marks)
(20 marks)
Question 22 ESSENTIAL ASPECT
An essential aspect of financial and business planning is concerned with estimating costs and revenues
and deciding the optimum output and price levels. A company produces a single product and operates
in a market where it has to lower the sale price of all its units if it wishes to sell more. The company’s
costing and marketing departments currently use the following cost and revenue model (all output is
sold in the current period):
Current Model:
Total Costs = 5,000 + 0.6x
Total Revenue = 20x – 0.01x2
Where x = the number of units sold
The company has recently updated its cost and revenue model to:
Total costs = 4,750 + 0.8x
Total revenue = 19x – 0.009x2
The acceptability of the current model and the proposed changes as a basis for profit planning and for
monitoring performance is to be reviewed.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
21
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Required:
(4 marks)
(a)
Explain the structure of the current and the revised model.
(b)
It has been estimated that the revised model will result in an optimal output of 1,011 units
being produced and sold.
(c)
(i)
Suggest two alternative ways of determining this optimal level of output.
(3 marks)
(ii)
Discuss the extent to which adherence to this output target is a satisfactory
indicator of managerial performance.
(3 marks)
Name and comment on cost and revenue factors which should be considered in order to
(10 marks)
improve the validity of the model as a profit forecasting model.
(20 marks)
Question 23 STOW HEALTH CENTRE
Stow Health Centre specialises in the provision of sports/exercise and medical/dietary advice to clients.
The service is provided on a residential basis and clients stay for whatever number of days suits their
needs. Budgeted estimates for the year ending 30 June 201X are as follows:
(i)
The maximum capacity of the centre is 50 clients per day for 350 days in the year.
(ii)
Clients will be invoiced at a fee per day. The budgeted occupancy level will vary with the
client fee level per day and is estimated at different percentages of maximum capacity as
follows:
Occupancy as
Client fee
percentage of
per day
Occupancy level
maximum capacity
$180
High
90%
$200
Medium
75%
$220
Low
60%
(iii)
Variable costs are also estimated at one of three levels per client day. The high, most likely
and low levels per client day are $95, $85 and $70 respectively. The range of cost levels
reflects only the possible effect of the purchase prices of goods and services.
Required:
(a)
Prepare a summary which shows the budgeted contribution earned by Stow Health
Centre for the year ended 30 June 201X for each of nine possible outcomes.
(6 marks)
(b)
State the client fee strategy for the year to 30 June 201X that will result from the use of
each of the following decision rules:
(i)
(ii)
(iii)
maximax;
maximin;
minimax regret.
Your answer should explain the basis of operation of each rule. Use the information
from your answer to (a) as relevant and show any additional working calculations as
necessary.
(9 marks)
22
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
(c)
The probabilities of variable cost levels occurring at the high, most likely and low levels
provided in the question are estimated as 0·1, 0·6 and 0·3 respectively.
Using the information available, determine the client fee strategy that will be chosen
where maximisation of expected value of contribution is used as the decision basis.
(5 marks)
(20 marks)
Question 24 SHIFTERS HAULAGE
Shifters Haulage (SH) is considering changing some of the vans it uses to transport crates for
customers. The new vans come in three sizes; small, medium and large. SH is unsure about which type
to buy. The capacity is 100 crates for the small van, 150 for the medium van and 200 for the large van.
Demand for crates varies and can be either 120 or 190 crates per period, with the probability of the
higher demand figure being 0.6.
The sale price per crate is $10 and the variable cost $4 per crate for all van sizes subject to the fact that
if the capacity of the van is greater than the demand for crates in a period then the variable cost will be
lower by 10% to allow for the fact that the vans will be partly empty when transporting crates.
SH is concerned that if the demand for crates exceeds the capacity of the vans then customers will have
to be turned away. SH estimates that in this case goodwill of $100 would be charged against profits per
period to allow for lost future sales regardless of the number of customers that are turned away.
Depreciation charged would be $200 per period for the small, $300 for the medium and $400 for the
large van.
SH has in the past been very aggressive in its decision-making, pressing ahead with rapid growth
strategies. However, its managers have recently grown more cautious as the business has become more
competitive.
Required:
(a)
Explain the principles behind the maximax, maximin and expected value criteria that
(4 marks)
are sometimes used to make decisions in uncertain situations.
(b)
Prepare a profits table showing the SIX possible profit figures per period.
(c)
Using your profit table from (b) above discuss which type of van SH should buy taking
into consideration the possible risk attitudes of the managers.
(6 marks)
(d)
Describe THREE methods other than those mentioned in (a) above, which businesses
(6 marks)
can use to analyse and assess the risk that exists in its decision-making.
(9 marks)
(25 marks)
Question 25 DECISION TREE
The owner of a tourist hotel is facing a difficult decision. It is low season and, because the weather is
unpredictable at this time of the year, it is difficult to predict the demand for the hotel’s facilities. If the
weather is poor then there will be 200 room nights demanded for the hotel’s facilities. There is a 70%
likelihood of the weather being poor. If the weather is good then there will be 600 room nights
demanded for the hotel’s facilities, but there is only a 30% chance that the weather will be good.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
23
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
The owner of the hotel is considering advertising some reduced prices locally or nationally in order to
improve the demand during this period.
If the reduced prices are advertised locally and if the weather is poor, then there is a 60% chance that
the lower prices would affect demand and would cause there to be 300 room nights demanded; but if
the weather is good, then there is a 40% chance that the lower prices would affect demand and would
cause there to be 800 room nights demanded.
If these lower prices were advertised nationally there is a 50% chance that these demand levels would
increase to 400 room nights and 900 room nights respectively.
Expected earnings (before deducting the costs of any local or national advertising) at different levels of
demand are as follows:
Room nights demanded
Earnings
$
200
(35,000)
300
(15,000)
400
(5,000)
500
20,000
600
30,000
700
45,000
800
65,000
900
90,000
The costs of advertising locally and nationally are $10,000 and $25,000 respectively.
Required:
(a)
Prepare a decision tree to illustrate the above problem and use this to recommend, with
reasons, the best course of action for the owner of the hotel.
(7 marks)
(b)
Briefly discuss the limitations of using a decision tree to solve this problem.
(3 marks)
(10 marks)
Question 26 NORTHLAND
Northland’s major towns and cities are maintained by local government organisations (LGO), which are
funded by central government. The LGOs submit a budget each year that forms the basis of the funds
received. You are provided with the following information as part of the 20X3 budget preparation:
Overheads
Overhead costs are budgeted on an incremental basis, taking the previous year’s actual expenditure and
adding a set % to allow for inflation. Adjustments are also made for known changes. The details for
these are:
Overhead cost category
Property cost
Central wages
Stationery
20X2 cost ($)
120,000
150,000
25,000
Known changes
None
Note 1
Note 2
Inflation adjustment
between 20X2 and 20X3
+5%
+3%
0%
Note 1: One new staff member will be added to the overhead team; this will cost $12,000 in 20X3.
Note 2: A move towards the paperless office is expected to reduce stationery costs by 40% on the
20X2 spend.
24
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Road repairs
In 20X3 it is expected that 2,000 metres of road will need repairing but a contingency of an extra 10%
has been agreed.
In 20X2 the average cost of a road repair was $15,000 per metre repaired, but this excluded any cost
effects of extreme weather conditions. The following probability estimates have been made in respect
of 20X3:
Weather type predicted
Good
Poor
Bad
Probability
0.7
0.1
0.2
Increase in repair cost
0
+10%
+25%
Inflation on road repairing costs is expected to be 5% between 20X2 and 20X3.
New roads
New roads are budgeted on a zero base basis and will have to compete for funds along with other
capital projects such as hospitals and schools.
Required:
(a)
Calculate the overheads budget for 20X3.
(3 marks)
(b)
Calculate the budgets for road repairs for 20X3.
(6 marks)
(c)
Explain the problems associated with using expected values in budgeting by an LGO
(8 marks)
and explain why a contingency for road repairs might be needed.
(d)
Explain the process involved for zero-based budgeting.
(3 marks)
(20 marks)
Question 27 BUDGET BEHAVIOUR
For many organisations in both the private and public sectors the annual budget is the basis of much
internal management information. When preparing and using budgets, however, management and the
accountant must be aware of their behavioral implications.
Required:
(8 marks)
(a)
Briefly discuss four purposes of budgets.
(b)
Explain the behavioral factors that should be taken into account and the difficulties of
applying them in the process of budgeting and budgetary control.
(12 marks)
(20 marks)
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
25
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Question 28 ZBB
(a)
Explain why zero-based budgeting might be a useful tool to employ to ensure that
budgetary requirements are kept up to date.
(4 marks)
(b)
Describe the steps necessary to implement a zero-based budgeting system in respect of:
–
–
–
questioning why expenditure needs to be incurred;
deciding which activities should be provided with a budget; and
questions to be asked when budgeted activities are to be ranked to allocate
scarce resources.
(8 marks)
(c)
Critically assess the use of zero-based budgeting as a tool that might be used to motivate
(6 marks)
employees.
(d)
Explain the advantages of encouraging employee participation in budget setting.
(7 marks)
(25 marks)
Question 29 BUDGETING & COSTING
Required:
(a)
Discuss how costing information and principles may be applied in a not-for-profit
organisation in the following areas:
(i)
(ii)
(iii)
The selection of cost units;
The use of performance measures to measure output and quality;
The comparison of planned and actual performance.
(10 marks)
(b)
Discuss the key features of zero-based budgeting and explain how it may be applied in a
not-for-profit organisation.
(8 marks)
(c)
Briefly discuss how activity-based budgeting might be introduced into a manufacturing
organisation and the advantages that might arise from the use of activity-based
budgeting in such an organisation.
(7 marks)
(25 marks)
Question 30 THE WESTERN
The Western is a local government organisation responsible for waste collection from domestic
households. The new management accountant of The Western has decided to introduce some new
forecasting techniques to improve the accuracy of the budgeting. The next budget to be produced is for
the year ended 31 December 2010.
Waste is collected by the tonne (T). The number of tonnes collected each year has been rising and by
using time series analysis the new management accountant has produced the following relationship
between the tonnes collected (T) and the time period in question Q (where Q is a quarter number. So Q
= 1 represents quarter 1 in 2009 and Q = 2 represents quarter 2 in 2009 and so on)
T = 2,000 + 25Q
26
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Each quarter is subject to some seasonal variation with more waste being collected in the middle
quarters of each year. The adjustments required to the underlying trend prediction are:
Quarter
1
2
3
4
Tonnes
–200
+250
+150
–100
Once T is predicted the new management accountant hopes to use the values to predict the variable
operating costs and fixed operating costs that The Western will be subjected to in 2010. To this end he
has provided the following operating cost data for 2009:
Volume of waste
Tonnes
2,100
2,500
2,400
2,300
Total operating cost in 2009
(fixed + variable)
$000s
950
1,010
1,010
990
Inflation on the operating cost is expected to be 5% between 2009 and 2010.
The regression formula is shown on the formula sheet.
Required:
(4 marks)
(a)
Calculate the tonnes of waste to be expected in the calendar year 2010.
(b)
Calculate the variable operating cost and fixed operating cost to be expected in 2010
using regression analysis on the 2009 data and allowing for inflation as appropriate.
(10 marks)
(c)
Many local government organisations operate incremental budgeting as one of their main
budgeting techniques. They take a previous period’s actual spend, adjust for any known
changes to operations and then add a % for expected inflation in order to set the next period’s
budget.
Required:
Describe two advantages and two disadvantages of a local government organisation
funded by taxpayer’s money using incremental budgeting as its main budgeting
technique.
(6 marks)
(20 marks)
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
27
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Question 31 STORRS CO
It is mid-June and the new managing director of Storrs Co is reviewing sales forecasts for Quarter 3 of
201Z, which begins on 1 July, and for Quarter 4. The company manufactures garden furniture and
experiences seasonal variations in sales, which has made forecasting difficult in the past. Sales for the
last two calendar years were as follows:
Year
201X
201Y
Quarter 1
$2,700,000
$3,100,000
Quarter 2
$3,500,000
$3,900,000
Quarter 3
$3,400,000
$3,600,000
Quarter 4
$3,000,000
$3,400,000
Sales in Quarter 1 of 201Z were $3,600,000. There is two weeks to go until the end of Quarter 2 and
the managing director of Stores is confident that it will achieve sales of $4,400,000 in this quarter.
The existing sales forecasts for the two remaining quarters of the year 201Z were made by the sales
director (who has been with the company for several years) during last year’s budget-setting process.
These forecasts are $3,800,000 for Quarter 3 and $3,600,000 for Quarter 4. Budgets in Storrs have
traditionally been prepared and agreed by the directors of the company before being implemented by
junior managers.
As a basis for revising the sales forecasts for the two remaining quarters of 201Z, the management
accountant of Storrs has begun to apply time series analysis in order to identify the seasonal variations
in sales. He has so far calculated the following centred moving averages, using a base period of four
quarters:
Year
201X
201Y
Quarter 1
Quarter 2
$3,375,000
$3,450,000
Quarter 3
$3,200,000
$3,562,500
Quarter 4
$3,300,000
$3,687,500
Required:
(a)
Using the sales information and centred moving averages provided, and assuming an
additive model, forecast the sales of Storrs Co for Quarter 3 and Quarter 4 of 201Z, and
comment on the sales forecasts made by the sales director.
Note: you are NOT required to use regression analysis.
(8 marks)
(b)
Discuss the limitations of the sales forecasting method used in part (a).
(5 marks)
(c)
Discuss the relative merits of top-down and bottom-up approaches to budget setting.
(12 marks)
(25 marks)
Question 32 SOUTH
South has reported the following costs for the past four months:
Month
1
2
3
4
28
Activity level (units)
300
400
150
260
Total cost
$3,800
$4,000
$3,000
$3,500
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Required:
(a)
Using regression analysis calculate the total cost equation.
(b)
Calculate the total cost at the following activity levels:
(i)
(ii)
(6 marks)
200 units;
500 units,
and comment on the usefulness of your equation with regard to these estimates. (4 marks)
(10 marks)
Question 33 HENRY CO
Henry Co (HC) provides skilled labour to the building trade. They have recently been asked by a
builder to bid for a kitchen-fitting contract for a new development of 600 identical apartments. HC has
not worked for this builder before. Cost information for the new contract is as follows:
Labour for the contract is available. HC expects that the first kitchen will take 24 man-hours to fit but
thereafter the time taken will be subject to a 95% learning rate. After 200 kitchens are fitted the
learning rate will stop and the time taken for the 200th kitchen will be the time taken for all the
remaining kitchens. Labour costs $15 per hour.
Overheads are absorbed on a labour hour basis. HC has collected overhead information for the last four
months and this is shown below:
Hours worked
Overhead cost
$
Month 1
9,300
115,000
Month 2
9,200
113,600
Month 3
9,400
116,000
Month 4
9,600
116,800
HC normally works around 120,000 labour hours in a year.
HC uses the high low method to analyse overheads.
The learning curve equation is y = axb, where
LogLR
= –0.074
Log 2
Required:
(a)
Describe FIVE factors, other than the cost of labour and overheads mentioned above,
(10 marks)
that HC should take into consideration in calculating its bid.
(b)
Calculate the total cost including all overheads for HC that it can use as a basis of the
bid for the new apartment contract.
(13 marks)
(c)
If the second kitchen alone is expected to take 21.6 man-hours to fit demonstrate how
the learning rate of 95% has been calculated.
(2 marks)
(25 marks)
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
29
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Question 34 BIG CHEESE CHAIRS
Big Cheese Chairs (BCC) manufactures and sells executive leather chairs. They are considering a new
design of massaging chair to launch into the competitive market in which they operate.
They have carried out an investigation in the market and, using a target costing system, have targeted a
competitive selling price of $120 for the chair. BCC wants a margin on selling price of 20% (ignoring
any overheads).
The frame and massage mechanism will be bought in for $51 per chair and BCC will upholster it in
leather and assemble it ready for despatch.
Leather costs $10 per metre and two metres are needed for a complete chair although 20% of all leather
is wasted in the upholstery process.
The upholstery and assembly process will be subject to a learning effect as the workers get used to the
new design. BCC estimates that the first chair will take two hours to prepare but this will be subject to
a learning rate (LR) of 95%. The learning improvement will stop once 128 chairs have been made and
the time for the 128th chair will be the time for all subsequent chairs. The cost of labour is $15 per
hour.
The learning formula is shown on the formula sheet and at the 95% learning rate the value of b is –
0.074000581.
Required:
(a)
Calculate the average cost for the first 128 chairs made and identify any cost gap that
(8 marks)
may be present at that stage.
(b)
Assuming that a cost gap for the chair exists suggest four ways in which it could be
closed.
(6 marks)
(c)
The production manager denies any claims that a cost gap exists and has stated that the cost of
the 128th chair will be low enough to yield the required margin.
Required:
Calculate the cost of the 128th chair made and state whether the target cost is being
achieved on the 128th chair.
(6 marks)
(20 marks)
Question 35 STANDARD COSTING
Outline the uses of standard costing and discuss the reasons why standards have to be reviewed.
(13 marks)
30
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Question 36 INFORMATION SOURCE
A major information source for many businesses is a system of standard costing and variance analysis.
Required:
(4 marks)
(a)
Describe briefly four purposes of a system of standard costing.
(b)
Explain three different levels of performance which may be incorporated into a system
of standard costing and comment on how these may relate to the purposes set out in (a)
above.
(6 marks)
(c)
Comment on whether standard costing applies in both manufacturing and service
businesses and how it may be affected by modern initiatives of continuous performance
(4 marks)
improvement and cost reduction.
(d)
A standard costing system enables variances for direct costs, variable and fixed overheads to
be extracted.
Required:
Identify and briefly discuss some of the complexities and practical problems in
(6 marks)
calculation, which may limit the usefulness of those variances.
(20 marks)
Question 37 WOODEEZER CO
Woodeezer Co makes quality wooden benches for both indoor and outdoor use. Results have been
disappointing in recent years and a new managing director, Peter Beech, was appointed to raise
production volumes. After an initial assessment Peter Beech considered that budgets had been set at
levels that made it easy for employees to achieve. He argued that employees would be better motivated
by setting budgets which challenged them more in terms of higher expected output.
Other than changing the overall budgeted output, Mr Beech has not yet altered any part of the standard
cost card. Thus, the budgeted output and sales for the most recent month was 4,000 benches and the
standard cost card below was calculated on this basis:
$
Wood
25 kg at $3.20 per kg
80.00
Labour
4 hours at $8 per hour
32.00
Variable overheads
4 hours at $4 per hour
16.00
Fixed overhead
4 hours at $16 per hour
64.00
––––––
192.00
Selling price
220.00
––––––
Standard profit
28.00
––––––
Overheads are absorbed on the basis of labour hours and the company uses an absorption costing
system. There were no inventories at the beginning of the most recent month. Inventories are valued at
standard cost.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
31
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Actual results for the month were as follows:
Wood
Labour
Variable overhead
Fixed overhead
80,000 kg at $3.50
16,000 hours at $7
Total production cost (3,600 benches)
Closing Inventory (400 benches at $192)
Cost of sales
Sales (3,200 benches)
Actual profit
$
280,000
112,000
60,000
196,000
––––––––
648,000
76,800
––––––––
571,200
720,000
––––––––
148,800
––––––––
The average monthly production and sales for some years prior to the most recent month had been
3,400 units and budgets had previously been set at this level. Very few operating variances had
historically been generated by the standard costs used.
Mr Beech has made some significant changes to the operations of the company. However, the other
directors are now concerned that Mr Beech has been too ambitious in raising production targets. Mr
Beech had also changed suppliers of raw materials to improve quality, increased selling prices, begun to
introduce less skilled labour, and significantly reduced fixed overheads.
The finance director suggested that an absorption costing system is misleading and that a marginal
costing system should be considered at some stage in the future to guide decision-making.
Required:
(a)
Prepare an operating statement for the most recent month. This should show all
operating variances and should reconcile budgeted and actual profit for the month for
Woodeezer Co.
(14 marks)
(b)
In so far as the information permits, examine the impact of the operational changes
made by Mr Beech on the profitability of the company. In your answer, consider each
of the following:
(i)
(ii)
(c)
Motivation and budget setting; and
Possible causes of variances.
(6 marks)
Re-assess the impact of your comments in part (b), using a marginal costing approach to
evaluating the impact of the operational changes made by Mr Beech.
Show any relevant additional calculations to support your arguments.
(5 marks)
(25 marks)
32
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Question 38 MERMUS CO
Mermus Co is comparing budget and actual data for the last three months.
Budget
$
Sales
Cost of sales
Raw materials
133,000
Direct labour
152,000
Variable production overheads 100,700
Fixed production overheads 125,400
––––––––
Actual
$
950,000
$
$
922,500
130,500
153,000
96,300
115,300
––––––––
511,100
––––––––
438,900
––––––––
495,100
––––––––
427,400
––––––––
The budget was prepared on the basis of 95,000 units produced and sold, but actual production and
sales for the three-month period were 90,000 units.
Mermus uses standard costing and absorbs fixed production overheads on a machine hour basis. A total
of 28,500 standard machine hours were budgeted. A total of 27,200 machine hours were actually used
in the three-month period.
Required:
(a)
Prepare a revised budget at the new level of activity using a flexible budgeting approach.
(4 marks)
(b)
Calculate the following:
(i)
(ii)
(iii)
(iv)
(v)
(c)
(8 marks)
Suggest possible explanations for the following variances:
(i)
(ii)
(iii)
(d)
Raw material total cost variance;
Direct labour total cost variance;
Fixed overhead efficiency variance;
Fixed overhead capacity variance;
Fixed overhead expenditure variance.
Raw materials total cost variance;
Fixed overhead efficiency variance;
Fixed overhead expenditure variance.
Explain three key purposes of a budgeting system.
(6 marks)
(7 marks)
(25 marks)
Question 39 MURGATROYD CO
Murgatroyd Co, which manufactures a single product, uses standard absorption costing. A summary of
the standard product cost is as follows:
Direct materials
Direct labour
Fixed overheads
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
$ per unit
15
20
12
33
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Budgeted and actual production for last month was 10,000 units and 9,000 units respectively. The
actual costs incurred were:
$
138,000
178,000
103,000
Direct materials
Direct labour
Fixed overheads
Required:
(a)
Prepare a statement that reconciles the standard cost of actual production with its
actual cost for last month and highlights the total variance for each of the three elements
of cost.
(4 marks)
(b)
Last month 24,000 litres of direct material were purchased and used by the company. The
standard allows for 2.5 litres of the material, at $6 per litre, to be used in each unit of product.
Required:
Provide an appropriate breakdown of the total direct materials cost variance included
in your statement in (a).
(3 marks)
(c)
Explain who in the company should be involved in setting:
(i)
(ii)
the standard price; and
the standard quantity for direct materials.
(3 marks)
(10 marks)
Question 40 CHAFF CO
Chaff Co processes and sells brown rice. It buys unprocessed rice seeds and then, using a relatively
simple process, removes the outer husk of the rice to produce the brown rice. This means that there is
substantial loss of weight in the process. The market for the purchase of seeds and the sales of brown
rice has been, and is expected to be, stable. Chaff Co uses a variance analysis system to monitor its
performance.
There has been some concern about the interpretation of the variances that have been calculated in
month 1.
(1)
The purchasing manager is adamant, despite criticism from the production director, that he
has purchased wisely and saved the company thousands of dollars in purchase costs by
buying the required quantity of cheaper seeds from a new supplier.
(2)
The production director is upset at being criticised for increasing the wage rates for month 1;
he feels the decision was the right one, considering all the implications of the increase.
Morale was poor and he felt he had to do something about it.
(3)
The maintenance manager feels that saving $8,000 on fixed overhead has helped the
profitability of the business. He argues that the machines’ annual maintenance can wait for
another month without a problem, as the machines have been running well.
34
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
The variances for month 1 are as follows:
Material price
Material usage
Labour rate
Labour efficiency
Labour idle time
Variable overhead expenditure
Variable overhead efficiency
Fixed overhead expenditure
Sales price
Sales volume
$
48,000
52,000
15,000
18,000
12,000
18,000
30,000
8,000
85,000
21,000
Favourable
Adverse
Adverse
Favourable
Favourable
Adverse
Favourable
Favourable
Adverse
Adverse
Chaff Co uses labour hours to absorb the variable overhead.
Required:
(a)
Comment on the performance of the purchasing manager, the production director and
the maintenance manager using the variances and other information above and reach a
conclusion as to whether or not they have each performed well.
(9 marks)
(b)
In month 2 the following data applies:
Standard costs for 1 tonne of brown rice:
–
1.4 tonnes of rice seeds are needed at a cost of $60 per tonne;
–
It takes 2 labour hours of work to produce 1 tonne of brown rice and labour is
normally paid $18 per hour. Idle time is expected to be 10% of hours paid; this is
not reflected in the rate of $18 above;
–
2 hours of variable overhead at a cost of $30 per hour;
Standard selling price is $240 per tonne.
Standard contribution per tonne is $56 per tonne.
Budget information for month 2 is:
–
–
Fixed costs were budgeted at $210,000 for the month
Budgeted production and sales were 8,400 tonnes
Actual results for month 2 were as follows:
–
–
–
–
–
–
–
Production and sales, 8,000 tonnes;
12,000 tonnes of rice seeds were bought and used, costing $660,000;
15,800 labour hours were paid for, costing $303,360;
15,000 labour hours were worked;
Variable production overhead cost $480,000;
Fixed costs were $200,000;
Sales revenue achieved was $1,800,000.
Required:
Calculate the variances for month 2 in as much detail as the information allows and
reconcile the budget profit to the actual profit using marginal costing principles. You
are not required to comment on the performance of the business or its managers for
their performance in month 2.
(16 marks)
(25 marks)
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
35
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Question 41 CRUMBLY CAKES
Crumbly Cakes make cakes, which are sold directly to the public. The new production manager (a
celebrity chef) has argued that the business should use only organic ingredients in its cake production.
Organic ingredients are more expensive but should produce a product with an improved flavour and
give health benefits for the customers. It was hoped that this would stimulate demand and enable an
immediate price increase for the cakes.
Crumbly Cakes operates a responsibility-based standard costing system that allocates variances to
specific individuals. The individual managers are paid a bonus only when net favourable variances are
allocated to them.
The new organic cake production approach was adopted at the start of March 2009, following a
decision by the new production manager. No change was made at that time to the standard costs card.
The variance reports for February and March are shown below (Fav = Favourable and Adv = Adverse):
Manager responsible Allocated variances
February
Production manager
March
Material price (total for all ingredients)
Material mix
Material yield
$
25 Fav
0
20 Fav
$
2,100 Adv
600 Adv
400 Fav
Sales price
Sales contribution volume
40 Adv
35 Adv
7,000 Fav
3,000 Fav
Sales manager
The production manager is upset that he seems to have lost all hope of a bonus under the new system.
The sales manager thinks the new organic cakes are excellent and is very pleased with the progress
made.
Crumbly Cakes operate a JIT stock system and holds virtually no inventory.
Required:
(a)
Assess the performance of the production manager and the sales manager and indicate
whether the current bonus scheme is fair to those concerned.
(7 marks)
(b)
In April 2009 the following data applied:
Standard cost card for one cake (not adjusted for the organic ingredient change):
Ingredients
Flour
Eggs
Butter
Sugar
Total input
Normal loss (10%)
Standard weight of a cake
Standard sales price of a cake
Kg
0.10
0.10
0.10
0.10
0.40
(0.04)
0.36
0.85
Standard contribution per cake after all variable costs
36
$
0.12 per kg
0.70 per kg
1.70 per kg
0.50 per kg
0.35
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
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 used
Flour
Eggs
Butter
Sugar
Total input
Actual loss
Actual output of cake mixture
Actual sales price of a cake
Kg
5,700
6,600
6,600
4,578
23,478
(1,878)
21,600
$
741
5,610
11,880
2,747
20,978
0.99
All cakes produced must weigh 0.36 kg, as this is what is advertised.
Required:
Calculate the material price, mix and yield variances and the sales price and sales
contribution volume variances for April. You are not required to make any comment
on the performance of the managers.
(13 marks)
(20 marks)
Question 42 AVX CO
AVX Co assembles circuit boards for use by high technology audio video companies. Due to the
rapidly advancing technology in this field, AVX is constantly being challenged to learn new techniques.
AVX uses standard costing to control its costs against targets set by senior managers. The standard
labour cost per batch of one particular type of circuit board (CB45) is set out below:
Direct labour – 50 hours @$10 per hour.
The following labour efficiency variances arose during the first six months of the assembly of CB45:
November
December
January
February
March
April
-
Batches made
and sold
Number
1
1
2
4
8
16
Efficiency
variance
$
nil
170.00
452.20
1089.30
1711.50
3423.00
Favourable
Favourable
Favourable
Favourable
Favourable
An investigation has confirmed that all of the costs were as expected except that there was a learning
effect in respect of the direct labour that had not been anticipated when the standard cost was set.
Required:
(8 marks)
(a)
Calculate the rates of learning that applied during the six months.
(b)
Identify when the learning period ended and briefly discuss the implications of your
findings for AVX Co.
(2 marks)
(c)
Explain the difference between standard costs and target costs.
(4 marks)
(14 marks)
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
37
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Question 43 MILBAO CO
Milbao Co makes and sells three types of electronic game for which the following budget/standard
information and actual information is available for a four-week period:
Model
Superb
Excellent
Good
Budget
sales
(units)
30,000
50,000
20,000
Standard unit data
Selling price Variable cost
$
$
100
40
80
25
70
22
Actual
sales
(units)
36,000
42,000
18,000
Budgeted fixed costs are $2,500,000 for the four-week period. Budgeted fixed costs should be charged
to product units at an overall budgeted average cost per unit where it is relevant to do so.
Required:
(a)
Calculate the sales volume variance for each model and in total for the four-week period
where (i) turnover (ii) contribution and (iii) net profit is used as the variance valuation
(10 marks)
base.
(b)
Discuss the relative merits of each of the valuation bases of the sales volume variance
calculated in (a) above.
(6 marks)
(c)
Calculate the TOTAL sales quantity and sales mix variances for Milbao Co for the fourweek period, using contribution as the valuation base. (Individual model variances are
(4 marks)
not required.)
(20 marks)
Question 44 SPIKE CO
Spike Co manufactures and sells good quality leather bound diaries. Each year it budgets for its profits,
including detailed budgets for sales, materials and labour. If appropriate, the departmental managers
are allowed to revise their budgets for planning errors.
In recent months, the managing director has become concerned about the frequency of budget revisions.
At a recent board meeting he said, “There seems little point budgeting any more. Every time we have a
problem the budgets are revised to leave me looking at a favourable operational variance report and at
the same time a lot less profit than promised.”
Required:
(a)
Describe the circumstances when a budget revision should be allowed and when it
should be refused.
(5 marks)
(b)
Two specific situations have recently arisen, for which budget revisions were sought:
Materials
A local material supplier was forced into liquidation. Spike’s buyer managed to find another
supplier, 150 miles away at short notice. This second supplier charged more for the material
and a supplementary delivery charge on top. The buyer agreed to both the price and the
delivery charge without negotiation. “I had no choice”, the buyer said, “The production
manager was pushing me very hard to find any solution possible!” Two months later, another,
more competitive, local supplier was found.
A budget revision is being sought for the two months where higher prices had to be paid.
38
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Labour
During the early part of the year, problems had been experienced with the quality of work
being produced by the support staff in the labour force. The departmental manager had
complained in his board report that his team were “unreliable, inflexible and just not up to the
job”.
It was therefore decided, after discussion of the board report, that something had to be done.
The company changed its policy so as to recruit only top graduates from good quality
universities. This has had the effect of pushing up the costs involved but increasing
productivity in relation to that element of the labour force.
The support staff departmental manager has requested a budget revision to cover the extra
costs involved following the change of policy.
Required:
Discuss each request for a budget revision, putting what you see as both sides of the
argument and reach a conclusion as to whether a budget revision should be allowed.
(8 marks)
(c)
The market for leather bound diaries has been shrinking as the electronic versions become
more widely available and easier to use. Spike has produced the following data relating to
leather bound diary sales for the year to date:
Budget
Sales volume
Sales price
Standard contribution
180,000 units
$17.00 per unit
$7.00 per unit
The total market for diaries in this period was estimated in the budget to be 1.8m units. In
fact, the actual total market shrank to 1.6m units for the period under review.
Actual results for the same period
Sales volume
176,000 units
Sales price
$16.40 per unit
Required:
(4 marks)
(i)
Calculate the total sales price and total sales volume variance.
(ii)
Analyse the total sales volume variance into components for market size and
market share.
(4 marks)
(iii)
Comment on the sales performance of the business.
(4 marks)
(25 marks)
Question 45 SECURE NET
Secure Net (SN) manufacture security cards that restrict access to government owned buildings around
the world.
The standard cost for the plastic that goes into making a card is $4 per kg and each card uses 40 gms of
plastic after an allowance for waste. In November 100,000 cards were produced and sold by SN and
this was well above the budgeted sales of 60,000 cards.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
39
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
The actual cost of the plastic was $5.25 per kg and the production manager (who is responsible for all
buying and production issues) was asked to explain the increase. He said “World oil price increases
pushed up plastic prices by 20% compared to our budget and I also decided to use a different supplier
who promised better quality and increased reliability for a slightly higher price. I know we have
overspent but not all the increase in plastic prices is my fault”.
The actual usage of plastic per card was 35 gms per card and again the production manager had an
explanation. He said “The world-wide standard size for security cards increased by 5% due to a change
in the card reader technology, however, our new supplier provided much better quality of plastic and
this helped to cut down on the waste.”
SN operates a just in time (JIT) system and hence carries very little inventory.
Required:
(a)
Calculate the total material price and total material usage variances ignoring any
possible planning error in the figures.
(4 marks)
(b)
Analyse the above total variances into component parts for planning and operational
(8 marks)
variances in as much detail as the information allows.
(c)
Assess the performance of the production manager.
(8 marks)
(20 marks)
Question 46 OLIVER
Oliver is the owner and manager of Oliver’s Salon, which is a quality hairdresser that experiences high
levels of competition. The salon traditionally provided a range of hair services to female clients only,
including cuts, colouring and straightening
A year ago, at the start of his 20X1 financial year, Oliver decided to expand his operations to include
the hairdressing needs of male clients. Male hairdressing prices are lower, the work simpler (mainly
haircuts only) and so the time taken per male client is much less.
The prices for the female clients were not increased during the whole of 20X0 and 20X1 and the mix of
services provided for female clients in the two years was the same.
The latest financial results are as follows:
20X0
$
Sales
Less: Cost of sales:
Hairdressing staff costs
Hair products – female
Hair products – male
65,000
29,000
–––––––
Gross profit
Less: Expenses:
Rent
Administration salaries
Electricity
Advertising
Profit
40
$
200,000
10,000
9,000
7,000
2,000
–––––––
94,000
––––––––
106,000
28,000
––––––––
78,000
––––––––
20X1
$
91,000
27,000
8,000
–––––––
10,000
9,500
8,000
5,000
–––––––
$
238,500
126,000
––––––––
112,500
32,500
––––––––
80,000
––––––––
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Oliver is disappointed with his financial results. He thinks the salon is much busier than a year ago and
was expecting more profit. He has noted the following extra information:
(1)
Some female clients complained about the change in atmosphere following the introduction of
male services, which created tension in the salon.
(2)
Two new staff were recruited at the start of 20X1. The first was a junior hairdresser to
support the specialist hairdressers for the female clients. She was appointed on a salary of
$9,000 per annum. The second new staff member was a specialist hairdresser for the male
clients. There were no increases in pay for existing staff at the start of 20X1 after a big rise at
the start of 20X0 that was designed to cover two years’ worth of increases.
Oliver introduced some non-financial measures of success two years ago:
Number of complaints
Number of male client visits
Number of female client visits
Number of specialist hairdressers for female clients
Number of specialist hairdressers for male clients
20X0
12
0
8,000
4
0
20X1
46
3,425
6,800
5
1
Required:
(a)
Calculate the average price for hair services per male and female client for each of the
(3 marks)
years 20X0 and 20X1.
(b)
Assess the financial performance of the Salon using the data above.
(c)
Analyse and comment on the non-financial performance of Oliver’s business, under the
headings of quality and resource utilisation.
(6 marks)
(11 marks)
(20 marks)
Question 47 THATCHER INTERNATIONAL PARK
Thatcher International Park (TIP) is a theme park and has for many years been a successful business,
which has traded profitably. About three years ago the directors decided to capitalise on their success
and reduced the expenditure made on new thrill rides, reduced routine maintenance where possible
(deciding instead to repair equipment when it broke down) and made a commitment to regularly
increase admission prices. Once an admission price is paid customers can use any of the facilities and
rides for free.
These steps increased profits considerably, enabling good dividends to be paid to the owners and
bonuses to the directors. The last two years of financial results are as follows:
Sales
Less: Expenses:
Wages
Maintenance – routine
Repairs
Directors salaries
Directors bonuses
Other costs (including depreciation)
Net profit
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
2008
$
5,250,000
2009
$
5,320,000
2,500,000
80,000
260,000
150,000
15,000
1,200,000
–––––––––
1,045,000
–––––––––
2,200,000
70,000
320,000
160,000
18,000
1,180,000
–––––––––
1,372,000
–––––––––
41
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Book value of assets at start of year
Dividend paid
Number of visitors
2008
$
13,000,000
500,000
150,000
2009
$
12,000,000
650,000
140,000
TIP operates in a country where the average rate of inflation is around 1% per annum.
Required:
(14 marks)
(a)
Assess the financial performance of TIP using the information given above.
(b)
During the early part of 2008 TIP employed a newly qualified management accountant. He
quickly became concerned about the potential performance of TIP and to investigate his
concerns he started to gather data to measure some non-financial measures of success. The
data he has gathered is shown below:
Table 1
Hours lost due to breakdown of rides (Note)
Average waiting time per ride
2008
9,000 hours
20 minutes
2009
32,000 hours
30 minutes
Note: TIP has 50 rides of different types. It is open 360 days of the year for 10 hours each
day.
Required:
Assess the quality of the service that TIP provides to its customers using Table 1 and any
other relevant data and indicate the risks it is likely to face if it continues with its current
policies.
(6 marks)
(20 marks)
42
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Question 48 EATWELL RESTAURANT
The owners of Eatwell Restaurant have diversified business interests and operate in a wide range of
commercial areas. Since buying the restaurant in 201V they have carefully recorded the data below:
Recorded Data for Eatwell Restaurant (201W – 201Z)
201W
201X
Total meals served
3,750
5,100
Regular customers attending weekly
5
11
Number of items on offer per day
4
4
Reported cases of food poisoning
4
5
Special theme evenings introduced
0
3
Annual operating hours with no customers
380
307
Proposals submitted to cater for special events 10
17
Contracts won to cater for special events
2
5
Complimentary letters from satisfied customers 0
4
Average number of customers at peak times
18
23
Average service delay at peak times (mins)
32
47
Maximum seating capacity
25
25
Weekly opening hours
36
36
Written complaints received
8
12
Idle time
570
540
New meals introduced during the year
16
8
Financial Data
$
$
Average customer spend on wine
3
4
Total Revenue
83,000
124,500
Revenue from special events
2,000
13,000
Profit
11,600
21,400
Value of food wasted in preparation
1,700
1,900
Total revenue of all restaurants in locality 895,000 1,234,000
201Y
201Z
6,200
6,700
15
26
7
9
7
7
9
13
187
126
29
38
15
25
3
6
37
39
15
35
40
40
40
36
14
14
465
187
27
11
$
$
4
7
137,000
185,000
25,000
55,000
43,700
57,200
3,600
1,450
980,000 1,056,000
Required:
(a)
Assess the overall performance of the business and submit your comments to the
owners. They wish to compare the performance of the restaurant with their other
business interests and require your comments to be grouped into the key areas of
performance such as those described by Fitzgerald and Moon.
(14 marks)
(b)
Identify any additional information that you would consider of assistance in assessing
the performance of Eatwell Restaurant in comparison with another restaurant. Give
reasons for your selection and explain how they would relate to the key performance
area categories used in (a).
(6 marks)
(20 marks)
Question 49 BALANCED SCORECARD
Discuss the advantages that may be claimed for Kaplan and Norton’s balanced scorecard as a
basis for performance measurement over traditional management accounting views of
performance measurement. Your answer should include specific examples of quantitative
measures for each aspect of the balanced scorecard.
(15 marks)
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43
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Question 50 BLA CO
BLA Co is a design consultancy that provides advice to clients regarding property maintenance and
improvements. Three types of consultant are employed by BLA. These are:
(1)
Architectural consultants who provide advice with regard to exterior building improvements.
(2)
Interior design consultants who provide advice regarding interior design, and
(3)
Landscape consultants who provide advice regarding landscaping of properties and garden
design improvements.
BLA does not undertake building work on behalf of its clients and will only recommend contractors
that undertake the three types of work when requested to do so by its clients. The following
information is relevant:
(i)
Each consultation, other than those detailed in notes (iv) and (v), is charged at a rate of $150
per consultation.
(ii)
The consultants are each paid a fixed annual salary of $45,000. In addition they receive a
bonus of 40% of the fee income generated in excess of budget. The bonus is shared equally
among the consultants employed by BLA on 31 October in the year to which the bonus
relates.
(iii)
Other operating expenses (excluding the salaries of the consultants) were budgeted at
$2,550,000 for the year to 31 October 201X. The actual amount incurred in respect of the
year to 31 October 201X was $2,805,000, which excludes payments to subcontractors per
note (vii) below.
(iv)
In an attempt to gain new business, consultants may undertake consultations on a “no-fee”
basis. Such consultations are regarded as Business Development Activity by the management
of BLA.
(v)
Consultants will sometimes undertake remedial consultations with clients who experience
problems at the time when work commences on each client’s site. Remedial consultations are
also provided on a non-chargeable (i.e. “no fee” basis).
(vi)
In November 201Y, BLA purchased “state of the art” business software for use by its
consultants in simulating design improvements. The software was used throughout the year
by consultants who specialise in landscape and garden design. It is now planned to introduce
the use of the software by the other categories of consultant in BLA.
(vii)
BLA has a policy of maintaining staff at a level of 45 consultants on an on-going basis,
irrespective of fluctuations in the level of demand. Also, BLA has retained links with retired
consultants and will occasionally subcontract work to them at a cost of $150 per consultation,
if current full-time consultants in a particular category are fully utilised. During the year
ended 31 October 201X subcontractors only undertook non-chargeable client consultations.
44
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REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
BLA Co
Sundry statistics for year ended 31 October 201X
Number of consultants by category:
Exterior design
Interior design
Landscape & garden design
Total client enquiries:
New business
Repeat business
Number of chargeable client consultations:
New business
Repeat business
Mix of chargeable client consultations:
Exterior design
Interior design
Landscape and garden design
Number of non-chargeable client consultations
undertaken by BLA consultants:
Number of business development consultations
Number of remedial consultations
Number of non-chargeable client consultations
undertaken by subcontractors:
Other statistics:
Number of complaints
Budget
Actual
18
18
9
15
18
12
67,500
32,400
84,000
28,000
24,300
16,200
22,400
19,600
16,200
16,200
8,100
13,830
17,226
10,944
1,035
45
1,200
405
120
324
630
Required:
(a)
Fitzgerald and Moon have suggested that business performance should be measured in a
number of ways.
Using FIVE different performance indicators and the quantitative data contained above,
(15 marks)
comment on the performance of BLA Co.
(b)
Briefly discuss THREE factors that should be considered in the determination of
expected standards in a performance measurement system.
(5 marks)
(20 marks)
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45
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Question 51 AV
AV is a charitable organisation, the primary objective of which is to meet the accommodation needs of
persons in its locality.
BW is a profit-seeking organisation that provides rented accommodation to the public.
Income and Expenditure accounts for the most recent financial year were as follows:
AV
$
2,386,852
Rents received
Less:
Staff and management costs
Major repairs and planned maintenance
Day-to-day repairs
Sundry operating costs
Net interest payable and other similar charges
BW
$
2,500,000
450,000
620,000
682,400
202,200
478,320
127,600
305,500
235,000
526,222
750,000
––––––––– –––––––––
2,442,442
1,934,800
(55,590)
565,200
Total costs
Operating (deficit)/surplus
Operating information in respect of the year was as follows:
(1)
Property and rental information:
Size of Property
1 bedroom
2 bedrooms
3 bedrooms
4 bedrooms
AV
Number of
properties
80
160
500
160
Rent payable
per week ($’s)
40
45
50
70
BW
Number of
properties
40
80
280
nil
AV had certain properties that were unoccupied during part of the year. The rents lost as a
consequence of unoccupied properties amounted to $36,348. BW did not have any
unoccupied properties at any time during the year.
(2)
Staff salaries were payable as follows:
Number of staff
2
2
3
18
46
AV
Salary ($’s) per
staff member
per annum
35,000
25,000
20,000
15,000
Number of staff
3
2
20
–
BW
Salary ($’s) per
staff member
per annum
50,000
35,000
20,000
–
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REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
(3)
Planned maintenance and major repairs undertaken:
Nature of work
Number of
properties
Miscellaneous construction work
Fitted kitchen replacements
(all are the same size)
Heating upgrades/replacements
Replacement sets of windows and
doors for 3-bedroomed properties
20
AV
Cost per
property
$
1,250
BW
Number of
Cost per
properties
property
$
–
–
90
15
2,610
1,500
10
–
5,220
–
100
4,000
25
6,000
All expenditure on planned maintenance and major repairs may be regarded as revenue
expenditure.
(4)
Day-to-day repairs information:
Classification
Emergency
Urgent
Non-urgent
AV
Number of repairs
of repair
960
1,880
1,020
Total cost
undertaken
$134,400
$225,600
$118,320
BW
Number of repairs
undertaken
320
752
204
Each repair undertaken by BW costs the same irrespective of the classification of repair.
Required:
(a)
Critically evaluate how the management of AV could measure the “value for money” of
(7 marks)
its service provision during the most recent financial year.
(b)
(i)
Identify TWO performance measures in relation to EACH of the following
dimensions of performance measurement that could be used by the
management of AV when comparing its operating performance for the most
recent financial year with that of the previous year:
–
–
(ii)
(c)
flexibility:
service quality.
(2 marks)
Calculate and comment on THREE performance measures relating to “cost
and efficiency” that could be utilised by the management of AV when
comparing its operating performance against that achieved by BW. (6 marks)
Explain why differing objectives make it difficult for the management of AV to compare
its operating and financial performance with that of BW, and comment briefly on
additional information that would assist in the appraisal of the operating and financial
performance of BW for the most recent financial year.
(5 marks)
(20 marks)
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
47
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Question 52 BRIDGEWATER CO
Bridgewater Co provides training courses for many of the mainstream software packages on the market.
The business has many divisions in Waterland, the one country in which it operates. The senior
managers of Bridgewater Co have very clear objectives for the divisions and these are communicated to
divisional managers on appointment and subsequently in quarterly and annual reviews. These are:
(1)
(2)
(3)
(4)
Each quarter, sales should grow and annual sales should exceed budget;
Trainer (lecture staff) costs should not exceed $180 per teaching day;
Room hire costs should not exceed $90 per teaching day;
Each division should meet its budget for profit per quarter and annually.
It is known that managers will be promoted based on their ability to meet these targets. A member of
the senior management is to retire after quarter 2 of the current financial year, which has just begun.
The divisional managers anticipate that one of them may be promoted at the beginning of quarter 3 if
their performance is good enough.
The manager of the Northwest division is concerned that his chances of promotion could be damaged
by the expected performance of his division. He is a firm believer in quality and he thinks that if a
business gets this right, growth and success will eventually follow.
The current quarterly forecasts, along with the original
as follows:
Q1
$000
Sales
40.0
Less:
Trainers
8.0
Room hire
4.0
Staff training
1.0
Other costs
3.0
–––––
Forecast net profit
24.0
–––––
Original budgeted profit
25.0
Annual sales budget
–––––
Teaching days
40
budgeted profit for the Northwest division, are
Q2
$000
36.0
Q3
$000
50.0
Q4
$000
60.0
Total
$000
186.0
7.2
3.6
1.0
1.7
–––––
22.5
–––––
26.0
10.0
5.0
1.0
6.0
–––––
28.0
–––––
27.0
12.0
6.0
1.0
7.0
–––––
34.0
–––––
28.0
–––––
36
–––––
50
–––––
60
37.2
18.6
4.0
17.7
–––––
108.5
–––––
106.0
180.0
–––––
Required:
(a)
Assess the financial performance of the Northwest division against its targets and reach
(8 marks)
a conclusion as to the promotion prospects of the divisional manager.
(b)
The manager of the Northwest division has been considering a few steps to improve the
performance of his division.
Voucher scheme
As a sales promotion, vouchers will be sold for $125 each, a substantial discount on normal
prices. These vouchers will entitle the holder to attend four training sessions on software of
their choice. They can attend when they want to but are advised that one training session per
quarter is sensible. The manager is confident that if the promotion took place immediately, he
could sell 80 vouchers and that the customers would follow the advice given to attend one
session per quarter. All voucher holders would attend planned existing courses and all will be
new customers.
48
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Software upgrade
A new important software programme has recently been launched for which there could be a
market for training courses. Demonstration programs can be bought for $1,800 in quarter 1.
Staff training would be needed, costing $500 in each of quarters 1 and 2 but in quarters 3 and
4 extra courses could be offered selling this training. Assuming similar class sizes and the
usual sales prices, extra sales revenue amounting to 20% of normal sales are expected
(measured before the voucher promotion above). The manager is keen to run these courses at
the same tutorial and room standards as he normally provides. Software expenditure is written
off in the income statement as incurred.
Delaying payments to trainers
The manager is considering delaying payment to the trainers. He thinks that, since his
commitment to quality could cause him to miss out on a well-deserved promotion, the trainers
owe him a favour. He intends to delay payment on 50% of all invoices received from the
trainers in the first two quarters, paying them one month later than is usual.
Required:
(i)
Revise the forecasts to take account of all three of the proposed changes.
(7 marks)
(ii)
Comment on each of the proposed steps and reach a conclusion as to whether,
if all the proposals were taken together, the manager will improve his chances
(6 marks)
of promotion.
(iii)
Suggest two improvements to the performance measurement system used by
Bridgewater Co that would encourage a longer-term view being taken by its
managers.
(4 marks)
(25 marks)
Question 53 OSBORNE CO
Osborne Co is a subsidiary of Butler Co, which operates a decentralised system of management.
Group companies have control over their own working capital and make proposals to the main board
for capital expenditure projects. They are appraised by reference to two measures:
(1)
(2)
Return on investment, where a minimum return of 12% is expected;
Residual income, which must be positive.
Extracts from the accounts of Osborne for the most recent financial year yield the following
information:
Statement of financial position
Non-current assets
Current assets
Current liabilities
Land and buildings
Plant and machinery
Fixtures and fittings
Inventory
Receivables
Cash
Trade payables
Other payables
Long-term loan
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
$000
2,000
1,200
300
800
500
100
400
200
1,000
49
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Income statement
Revenue
Cost of sales
Controllable overheads
Non-controllable overheads
Head office recharge
$000
8,500
5,300
1,700
950
700
A project, involving an investment of $840,000 financed by an increase in the company’s loan, is under
discussion by the board of Osborne.
The project is expected to last three years, at the end of which there will be no scrap proceeds. Net cash
flows are expected as follows:
Year
1
2
3
Flow
300,000
600,000
700,000
The finance director, Mr Rhodes, says, “We must go for this project. It has a positive net present value
and enhances both ROI and RI of the company”.
The managing director of Osborne, Mr Iommi, whose bonus is linked to the division achieving its
targets and is due to retire at the end of year 1, is not so sure.
Required:
(a)
Establish whether the company will achieve its two performance targets for the most
recent financial year.
(4 marks)
(b)
Assuming that (with the exception of changes resulting from acceptance of the proposed
project) the profitability and assets employed by Osborne Co will be constant for the
foreseeable future, show why Mr Iommi might be reluctant about accepting the project.
(6 marks)
(10 marks)
Question 54 RESPONSIBILITY CENTRES
(a)
Identify the types of responsibility centres used in responsibility accounting and discuss
how the performance of each responsibility centre type might be measured, including in
(12 marks)
your discussion examples of controllable and non-controllable factors.
(b)
Critically discuss whether return on investment or residual income should be used to
assess managerial performance in an investment centre.
(13 marks)
(25 marks)
50
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Question 55 PACE CO
Pace Co (PC) runs a large number of wholesale stores and is increasing the number of these stores all
the time. It measures the performance of each store on the basis of a target return on investment (ROI)
of 15%. Store managers get a bonus of 10% of their salary if their store’s annual ROI exceeds the
target each year. Once a store is built there is very little further capital expenditure until a full four
years have passed.
PC has a store (store W) in the west of the country. Store W has historic financial data as follows over
the past four years:
20X8
20X9
20Y0
20Y1
Sales ($000)
200
200
180
170
Gross profit ($000)
80
70
63
51
Net profit ($000)
13
14
10
8
Net assets at start of year ($000) 100
80
60
40
The market in which PC operates has been growing steadily. Typically, PC’s stores generate a 40%
gross profit margin.
Required:
(a)
Discuss the past financial performance of store W using ROI and any other measure you
feel appropriate and, using your findings, discuss whether the ROI correctly reflects
(8 marks)
Store W’s actual performance.
(b)
Explain how a manager in store W might have been able to manipulate the results so as
to gain bonuses more frequently.
(4 marks)
(c)
PC has another store (store S) about to open in the south of the country. It has asked you for
help in calculating the gross profit, net profit and ROI it can expect over each of the next four
years. The following information is provided:
Sales in the first year will be 18,000 units. Sales volume will grow at the rate of 10% for
years two and three but no further growth is expected in year 4. Sales price will start at $12
per unit for the first two years but then reduce by 5% per annum for each of the next two
years.
Gross profit will start at 40% but will reduce as the sales price reduces. All purchase prices
on goods for resale will remain constant for the four years.
Overheads, including depreciation, will be $70,000 for the first two years rising to $80,000 in
years three and four.
Store S requires an investment of $100,000 at the start of its first year of trading.
PC depreciates non-current assets at the rate of 25% of cost. No residual value is expected on
these assets.
Required:
(i)
Calculate (in columnar form) the revenue, gross profit, net profit and ROI of
store S over each of its first four years.
(9 marks)
(ii)
Calculate the minimum sales volume required in year 4 (assuming all other
variables remain unchanged) to earn the manager of S a bonus in that year.
(4 marks)
(25 marks)
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
51
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Question 56 BUSINESS SOLUTIONS
Business Solutions is a firm of management consultants, which experienced considerable business
growth during the last decade. Recently the firm’s senior managers had begun to experience difficulties
in managing the business, so at the end of last year the firm was reorganised and a regional divisional
structure was introduced with individual profit targets being set for each of the semi-autonomous profit
centres. Although North division has its own customer base that is distinct from that of its sister
division South, it does occasionally call upon the services of a South consultant to assist with its
projects. North has to pay a cross charge to South per consulting day. HQ determines the amount of
the charge. North is free to choose whether it employs a South consultant or subcontracts the project to
an external consultant. The manager of North division believes that the quality of the external
consultant and the one from South division are identical and on this basis will always employ the one
who is prepared to work for the lower fee.
The following information is also available:
„
„
„
North division is very busy and it charges its clients $1,200 per consulting day;
North division pays its external consultant $500 per consulting day;
The variable cost per internal consulting day is $100.
Required:
(a)
Determine a possible optimal daily cross charge that should be paid by North for the
services of a consultant from South in the scenarios outlined below. The charges that
you select must induce both divisional managers to arrive at the same decision
independently. Explain how you have determined your cross charges and state any
assumptions that you think necessary.
(i)
(ii)
(iii)
(b)
South division has spare consulting capacity;
South division is fully occupied earning fees of $400 per consulting day;
South division is fully occupied earning fees of $700 per consulting day.
(10 marks)
Identify the possible factors that may have prompted the senior management to
introduce a divisional structure last year and suggest some potential problems that may
arise.
(10 marks)
(20 marks)
52
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Question 57 MANUCO CO
Manuco Co has been offered supplies of special ingredient Z at a transfer price of $15 per kg by Helpco
Co, which is part of the same group of companies. Helpco processes and sells special ingredient Z to
customers external to the group at $15 per kg. Helpco bases its transfer price on total cost plus 25%
profit mark-up. Total cost has been estimated as 75% variable and 25% fixed.
Required:
Discuss the transfer prices at which Helpco Co should offer to transfer special ingredient Z to
Manuco Co in order that group profit maximising decisions may be taken on financial grounds in
each of the following situations:
(i)
Helpco Co has an external market for all of its production of special ingredient Z at a selling
price of $15 per kg. Internal transfers to Manuco Co would enable $1.50 per kg of variable
packing cost to be avoided.
(ii)
Conditions are as per (i) but Helpco Co has production capacity for 3,000 kgs of special
ingredient Z for which no external market is available.
(iii)
Conditions are as per (ii) but Helpco Co has an alternative use for some of its spare
production capacity. This alternative use is equivalent to 2,000 kgs of special ingredient Z
and would earn a contribution of $6,000.
(13 marks)
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53
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
54
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Answer 1 JOLA PUBLISHING CO
(a)
Changes in overhead allocations
The first thing to point out is that the overhead allocations to the two products have not
changed by that much. For example the CB has absorbed only $0.05 more overhead. The
reason for such a small change is that the overheads are dominated by property costs (75% of
total overhead) and the “driver” for these remains machine hours once the switch to ABC is
made. Thus no difference will result from the switch to ABC in this regard.
The major effect on the cost will be for quality control. It is a major overhead (23% of total)
and there is a big difference between the relative number of machine hours for each product
and the number of inspections made (the ABC driver). The CB takes less time to produce
than the TJ, due to the shortness of the book. It will therefore carry a smaller amount of
overhead in this regard. However, given the high degree of government regulation, the CB is
subject to “frequent” inspections whereas the TJ is inspected only rarely. This will mean that
under ABC the CB will carry a high proportion of the quality control cost and hence change
the relative cost allocations.
The production set up costs are only a small proportion of total cost and would be, therefore,
unlikely to cause much of a difference in the cost allocations between the two products.
However this hides the very big difference in treatment. The CB is produced in four long
production runs, whereas the TJ is produced monthly in 12 production runs. The relative
proportions of overhead allocated under the two overhead treatments will be very different.
In this case the TJ would carry much more overhead under ABC than under a machine hours
basis of overhead absorption.
(b)
ABC implementation problems
There are many problems with ABC, which, despite its academic superiority, cause issues on
its introduction.
(c)
„
Lack of understanding. ABC is not fully understood by many managers and
therefore is not fully accepted as a means of cost control.
„
Difficulty in identifying cost drivers. In a practical context, there are frequently
difficulties in identifying the appropriate drivers. For example, property costs are
often significant and yet a single driver is difficult to find.
„
Lack of appropriate accounting records. ABC needs a new set of accounting
records, this is often not immediately available and therefore resistance to change is
common. The setting up of new cost pools is time consuming.
Cost per unit
(i)
Machine hours for overhead absorption
CB
$
Paper (400g at $2/kg)
0.80
Printing (50ml at $30/litre)
1.50
Machine cost (6 mins at $12/hr)
1.20
Overheads (6 mins at $24/hr) (W)
2.40
–––––
Total cost
5.90
Sales price
9.30
–––––
Margin
3.40
–––––
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
(100g at $1/kg)
(150ml at $30/litre)
(10 mins at $12/hr)
(10 mins at $24/hr)
TJ
$
0.10
4.50
2.00
4.00
–––––
10.60
14.00
–––––
3.40
–––––
1001
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
WORKING
Overheads cost per hour
Total overhead
Total machine hours
(1,000,000 × 6 mins) + (120,000 × 10 mins) =
Which is
Cost per hour =
(ii)
$2,880,000
7,200,000 mins
120,000 hours
$2,880,000
= $24/hr
120,000 hrs
ABC principles
Paper (400g at $2/kg)
Printing (50ml at $30/litre)
Machine cost (6 mins at $12/hr)
Overheads (W)
Total cost
Sales price
Margin
CB
$
0.80
1.50
1.20
2.41
–––––
5.91
9.30
–––––
3.39
–––––
TJ
$
0.10
4.50
2.00
3.88
–––––
10.48
14.00
–––––
3.52
–––––
(100g at $1/kg)
(150ml at $30/litre)
(10 mins at $12/hr)
(W)
WORKING
ABC overheads cost per unit
Total
Property costs
Quality control
Production set up
Total
Production level
Cost per unit
CB
TJ
$
$
$
2,160,000 1,800,000 360,000
668,000
601,200 66,800
52,000
13,000 39,000
––––––––– ––––––––– –––––––
2,880,000 2,414,200 465,800
1,000,000 120,000
2.41
3.88
No of
drivers
Cost/
driver
CB
TJ
120,000
200
16
18/hr
1.80
3.00
3,340 0.6012
0.56
3,250 0.013 0.325
––––– –––––
Cost per unit
2.41
3.88
––––– –––––
The above overheads have been split on the basis of the following activity levels
Property costs
Quality control
Production set up
Driver
Machine hours
Inspections
Set ups
CB
100,000
180
4
TJ
20,000
20
12
A cost per driver approach is also acceptable.
1002
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Answer 2 ABKABER CO
(a)
Total profit
(i)
Labour hours
Total overhead cost
Total labour hours
Overhead per labour hour
= $12,000,000
= 500,000 hours
= $12,000,000/500,000 = $24
Sunshine
Roadster
Fireball
$
$
$
1,000,000
1,100,000
400,000
800,000
960,000
360,000
4,800,000
5,280,000
1,920,000
––––––––– ––––––––– –––––––––
6,600,000
7,340,000
2,680,000
––––––––– ––––––––– –––––––––
Direct labour ($5 per hour)
Materials (at $400/600/900)
Overheads (at $24)
Total Costs
Output (Units)
Cost per unit
Selling price
2,000
$3,300
$4,000
––––––––
$700
––––––––
$1,400,000
Profit/(loss) per unit
Total profit/(loss)
(ii)
1,600
$4,587.5
$6,000
––––––––
$1,412.5
––––––––
$2,260,000
400
$6,700
$8,000
–––––––
$1,300
–––––––
$520,000
Total
$
$4,180,000
––––––––
Activity-based costing
Deliveries to retailers
Set-ups
Deliveries inwards
$2,400,000/250 = $9,600
$6,000,000/100 = $60,000
$3,600,000/800 = $4,500
Direct labour ($5 per hour)
Materials (at $400/600/900)
Overheads:
Deliveries at $9,600
Set-ups at $60,000
Purchase orders at $4,500
Output (Units)
Cost per unit
Selling price
Profit/(loss) per unit
Total profit/(loss)
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
Sunshine
$
1,000,000
800,000
960,000
2,100,000
1,800,000
–––––––––
6,660,000
–––––––––
2,000
$3,330
$4,000
–––––––––
$670
–––––––––
$1,340,000
Roadster
$
1,100,000
960,000
Fireball
$
400,000
360,000
Total
768,000
672,000
2,400,000
1,500,000
1,350,000
450,000
––––––––– –––––––––
6,578,000
3,382,000
––––––––– –––––––––
1,600
400
$4,111.25
$8,455
$6,000
$8,000
––––––––– –––––––––
$1,888.75
($455)
––––––––– –––––––––
$3,022,000
($182,000) $4,180,000
–––––––––
1003
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
(b)
REPORT – ABKABER CO
To:
From:
Subject:
Date:
Directors of Abkaber Co
Management Accountant
The Introduction of Activity Based Costing
June 201X
(i)
Evaluation of labour hours and activity-based costing methods
Direct costs
The direct costs of labour and materials are unaffected by the use of ABC as they are directly
attributable to units of output.
Notwithstanding the fact that labour is a relatively minor cost, however, the use of labour
hours to allocate overheads magnifies its importance.
The labour hours allocation basis
As labour appears to be paid at a constant rate an allocation using labour cost or labour hours
gives the same result.
The central concern is, however, whether there is a cause and effect relationship between
overheads and labour hours. Moreover for this allocation base to be correct overheads would
need to be linearly variable with labour hours. This seems unlikely on the basis of the
information available.
ABC and labour hours cost allocation
ABC attempts to allocate overheads using a number of cost drivers rather than just one as
with labour hours. It thus attempts to identify a series of cause and effect relationships.
Moreover, those in favour of ABC argue that it is activities that generate costs, not labour
hours.
While costs are likely to be caused by multiple factors, the accuracy of any ABC system will
depend on both the number of factors selected and the appropriateness of each of these
activities as a driver for costs. Each cost driver should be appropriate to the pool of overheads
to which it relates. As noted already there should ideally be a direct cause and effect
relationship between the cost driver and the relevant overhead cost pool, but this should also
be a linear relationship (i.e. costs increase proportionately with the number of activities
operated).
The contrast between the labour hours costing system and ABC can be seen in requirement
(a). These differences can be brought out by reviewing the comments of the directors.
(ii)
Implications of activity-based costing and evaluation of director issues
The Finance Director
Using the labour hours method of allocation the Fireball makes an overall profit of $520,000
but using ABC it makes a loss of $182,000. There is thus a significant difference in the levels
of cost allocated and in profitability between the two methods to the extent it affects the
conclusions on the Fireball’s viability.
1004
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
The major reason for the difference appears to be that while labour hours are not all that
significant for Fireball production, the low volumes of Fireball sales cause a relatively high
amount of set-ups, deliveries and purchase processes, and this is recognised by ABC.
If the Fireball model is to continue, a review of the assembly and distribution systems may be
needed in order to reduce costs.
There may, however, be other non-financial reasons to maintain the Fireball, (e.g. maintaining
a wide product range and raising the reputation of the motorcycles, which may increase sales
of other models).
The Marketing Director
The marketing director suggests that ABC may have a number of problems and its
conclusions should not be believed unquestioningly. These problems include:
„
For decisions such as the closure of Fireball production or the pricing of the new
motorbike rental contract, what is really needed is the incremental cost to determine
a break-even position. While ABC may be closer to this concept than a labour
hours allocation basis, its accuracy depends on identifying appropriate cost drivers.
„
The use of ABC for one-off decisions can be distinguished from its use in normal,
on-going costing procedures. It is perfectly possible that while labour hours may
have been used for normal costing, an incremental costing analysis would be
undertaken for important one-off decisions such as the closure of Fireball
production or the pricing of the new motorbike rental contract. In these
circumstances the introduction of ABC in normal costing procedures may have
restricted benefits.
„
There may be interdependencies between both costs and revenues that ABC is
unlikely to capture. Where costs are truly common to more than one product then
this may be difficult to capture by any given single activity.
„
As with labour hours allocations it is the future that matters. Any relationship
between costs and activities based on historic experience and observation may be
unreliable as a guide to the future.
The Managing Director
„
ABC normally assumes that the cost per activity is constant as the number of times
the activity is repeated increases. In practice there may be a learning curve, such
that costs per activity are non-linear. As a result, the marginal cost of increasing the
number of activities is not the same as the average.
„
Also, in this case, fixed costs are included which would also mean that the marginal
cost does not equal the average cost.
„
The MD is correct in stating that some costs do not vary with either labour hours or
any cost driver, and thus do not fall easily under ABC as a method of cost
attribution as there is no cause and effect relationship. Depreciation on the factory
building might be one example.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1005
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
The Chairman
From a narrow perspective of reporting profit it is true that the two methods give the same
overall profit as is illustrated in requirement (a) at $4,180,000. There are, however, a number
of qualifications to this statement:
„
If the company carried inventory then the method of cost allocation would, in the
short term at least, affect inventory values and thus would influence profit.
„
If the ABC information can be relied upon, notwithstanding the above
qualifications, then a decision could be taken to cease Fireball production as it
generates a negative contribution of $182,000. This was not apparent from the use
of labour hours; thus by the introduction of ABC and the subsequent closure
decision profits would, all other things being equal, improve by $182,000.
Further Issues
The following should also be considered in evaluating ABC:
„
„
„
The need to develop new data capture systems, and the relevant costs of doing so;
Increased and on-going analysis work;
Continued evaluation of cause and effect relationships between cost drivers and cost
pools.
Answer 3 ADMER
(a)
Use of information in activity-based costing (ABC) analysis
ABC is based on identifying the activities that give rise to costs and this identification does
not seem to have happened in this case. Simply collecting information on different activities
is not enough. A detailed analysis of business operations is needed in order to identify
relationships between costs and cost drivers. There should ideally be a one-to-one
relationship between cost and cost driver. To the extent that this is not so, ABC provides less
useful information on product cost and for cost control.
The management accountant believes that he can use the information provided to review the
store’s performance from an ABC perspective, but the relationship between “other costs” for
the three-month period and the proposed cost drivers (number of items sold, purchase orders,
etc.) is unclear.
If sales staff, warehouse staff, consultation staff and administration staff are on fixed salaries,
their wage costs will not be linked to items sold, purchase orders or consultations. If wage
costs are apportioned on to product cost using the proposed cost drivers, it is likely that better
product cost information will arise, simply because the apportionment bases being used are
likely to be more appropriate to retailing than floor area. But at what point does a more
sophisticated absorption costing system become an ABC system?
The information provided can be used in an ABC analysis if wage costs do depend to some
extent on the proposed cost drivers, for example if sales staff wages include a commission for
each purchase order raised. The management accountant needs to eliminate confusion by
undertaking an investigation to establish and clarify the links between costs and activities if
he wishes to use ABC.
1006
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
(b)
Proposed cost drivers
Total number of items sold = 1,000 + 1,500 + 4,000 = 6,500
Total number of purchase orders = 1,000 + 900 + 2,500 = 4,400
Total floor area = 16,000 + 10,000 + 14,000 = 40,000
Total number of consultations = 798 + 200 + 250 = 1,248
Are sales staff wages linked to items sold or to purchase orders? If sales staff wages are
linked to items sold:
Sales staff wages recovery rate = $64,800/6,500 = $9.97 per item sold
If sales staff wages are linked to purchase orders:
Sales staff wages recovery rate = $64,800/4,400 = $14.727 per purchase order
It seems reasonable to link consultation staff wages to the number of consultations:
Consultation staff wages recovery rate = $24,960/1,248 = $20.00 per consultation
Warehouse staff wages could be linked to either purchase orders fulfilled or to items sold: if
each item needs to be handled, items sold might be preferred;
Warehouse staff wages recovery rate = $30,240/6,500 = $4.652 per item sold
If warehouse staff wages are linked to purchase orders fulfilled:
Warehouse staff wages recovery rate = $30,240/4,400 = $6.873 per purchase order
Administration staff process purchase orders and organize consultations, but no indication is
given as to whether these tasks are equally weighted. If they are, the total number of tasks =
4,400 + 1,248 = 5,648 and:
Administration staff wages recovery rate = $30,624/5,648 = $5.422 per task
General overheads appear to be related to floor space, but there will be other overheads that
are not space costs; these will need to be apportioned on a different basis, or even not
apportioned at all. Using the information provided:
General overheads absorption rate = $175,000/40,000 = $4.375 per square metre
Possible ABC profit statement:
Department
Sales
Cost of goods sold
Variable contribution
Sales staff wages
Consultation staff wages
Warehouse staff wages
Admin staff wages
General overheads
Profit
Kitchens
$
210,000
(63,000)
–––––––
147,000
(14,727)
(15,960)
(4,652)
(9,749)
(70,000)
–––––––
31,912
–––––––
Bathrooms Dining Rooms
$
$
112,500
440,000
(37,500)
(176,000)
–––––––
–––––––
75,000
264,000
(13,255)
(36,818)
(4,000)
(5,000)
(6,978)
(18,610)
(5,964)
(14,911)
(43,750)
(61,250)
–––––––
–––––––
1,053
127,411
–––––––
–––––––
Total
$
762,500
(276,500)
–––––––
486,000
(64,800)
(24,960)
(30,240)
(30,624)
(175,000)
–––––––
160,376
–––––––
Tutorial note: Sales staff wages are apportioned using purchase orders, warehouse staff
wages are apportioned using items sold, other choices are possible.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1007
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
(c)
Evaluation of proposal to close the bathrooms department
From the perspective of the absorption costing system currently used by the company, the
bathrooms department does appear to make a loss.
When viewed from an ABC perspective, however, it may make a small profit. The
department makes a contribution towards other costs and overheads of $75,000 and a profit
before general overheads of $44,803. Therefore financial grounds for closure do not appear
to be compelling, although there may be a need to investigate the department with a view to
improving profitability.
A more detailed profitability analysis of bathroom sales might lead to greater understanding
of which products were relatively profitable, which products were slow-moving and which
products might be removed from sale without adversely affecting sales of other lines. Less
drastic alternatives than closure might be suggested by such an analysis.
If the department were closed, it could be argued that general overheads would still need to be
met and so overall profit would fall by about $45,000 in each three-month period. Overall
profit could fall by more than this if some of the other costs allocated to the bathroom
department remained after the closure. For example, the number of staff laid off would not
correspond exactly to allocated wage costs.
However, it is unlikely the space vacated by the bathrooms department would remain unused.
The remaining departments might be expanded to fill it, or it might be used for a new venture
(selling carpets, for example). The key question is whether a better use exists for the space.
If an alternative use is found, staff redundancies might be reduced or eliminated entirely.
A further problem is that closure of the bathrooms department could affect sales of the other
departments. The store might be seen as no longer offering an adequate range of products and
potential customers might prefer other stores with a greater range of home furnishings. The
potential for satisfied customers to return with further business would also be reduced if the
store offered a more limited range of products.
It is also unlikely that the closure decision would be made at the level of an individual store,
since it carries consequences for the company as a whole. The image of the company might
suffer if it were seen to be changing its product range, or if it were seen as being unable to
compete with other stores selling bathrooms.
(d)
Advantages and disadvantages of ABC
ABC could help Admer understand more clearly the origin of its costs. The nature of
Admer’s business means that only a small number of cost drivers are likely to exist, but even
given the limited information provided, the revised profit statement is likely to be more useful
than treating all overhead costs as being related to floor area.
ABC can help Admer to control costs by highlighting the activities that generate them. For
example, consultation staff wages are high compared to sales staff wages in the kitchen
department in this store. Perhaps sales staff could be trained to provide in-store consultations
and the number of home visits reduced; this could lower administration costs and reduce the
cost of consultations.
It is clear that general overheads are the most significant cost other than cost of sales and
existing information does not suggest ways of reducing these. However, a more detailed
analysis of overheads might reveal activity-based costs that are currently aggregated. Once
disaggregated, they become more amenable to understanding and control.
1008
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
It is argued that ABC leads to more accurate product costs, and in order to achieve this Admer
needs a more detailed analysis of sales revenue and cost based on the nature of the products
sold. For example, the company might be able to classify kitchens as basic, intermediate and
deluxe, and collect sales and cost data accordingly.
A key advantage claimed for ABC is that it can provide better information to aid decisionmaking. In this case, it could provide more appropriate information to aid managers in
reaching a decision on whether to close the bathrooms department. With better or more
detailed information on product cost, managers are likely to make better decisions in key
areas such as product pricing and cost control.
Even after introducing ABC, however, Admer will still face the problem that some arbitrary
apportionment of costs may still be required when pooling costs. The general overheads of
light, heat and rates, for example, are likely to need to be treated in this way, along with the
wages of administration staff. A related problem is that not all costs are generated by
activities that can be measured in quantitative terms.
The management accountant of Admer should also be aware that the costs of introducing and
maintaining an ABC system may exceed the benefits that such a costing system might
generate. Appropriate cost drivers will need to be determined and the required information
may not be available. The existing management accounting information system may
therefore need to be modified to generate the required information, and perhaps new
accounting software purchased or developed.
Answer 4 SPRING CO
(a)
Features, advantages and disadvantages of ABC
ABC is based on the insight that activities create costs, while products consume activities. It
is claimed that ABC attaches overheads to product cost in a more meaningful way than
traditional absorption costing.
A key feature of ABC is that overhead costs are collected in cost pools, which correspond to a
particular activity or group of activities that generate costs. A classic example of a cost pool
is set-up costs for a production line. The cost of each set-up is included in the cost pool
reflecting the recognition that it is set-ups that incur costs, rather than the volume of
production on the production line. Set-up costs are an example of an indirect cost, and both
traditional absorption costing and ABC are concerned with the allocation of indirect costs
onto product cost. Traditional absorption costing assigns indirect costs or overheads to
production departments and service departments and then reallocates service department
overheads to production centres. ABC is likely to use, or has the potential to use,
considerably more cost pools than traditional absorption costing uses production centres.
In ABC the link between cost pools and product cost is called a cost driver. A cost driver
represents the extent to which a particular activity has been used by a particular product in its
production. Continuing our example, an appropriate cost driver would be number of set-ups.
A product that is produced in frequent short production runs would therefore incur a greater
share of set-up costs than a product produced in a single production run. In traditional
absorption costing, overheads are linked to product cost through overhead absorption rates
such as cost per machine hour or cost per labour hour. ABC is likely to use considerably
more cost drivers than traditional absorption costing uses overhead absorption rates.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1009
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
The key steps in introducing an ABC system are as follows:
(1)
(2)
(3)
(4)
Identify the main activities that generate costs through activity analysis;
Assign costs to cost pools;
Select appropriate cost drivers for assigning cost pool costs to products;
Calculate activity-based charge rates to assign the cost of activities to products.
The following benefits have been claimed for ABC:
„
Product costs are more accurate due to the more sophisticated analysis and
assignment of overhead costs. Overhead costs are assigned on a cause-and-effect
basis rather than on an ad hoc or subjective basis.
„
Cost behaviour is better understood due to the analysis of activities.
„
Cost control is facilitated through the identification and management of costgenerating activities. For example, in order to reduce set-up costs, production
planning could be used to eliminate short production runs and hence reduce the
number of set-ups.
„
Poor decisions due to inadequate cost information are less likely to occur.
As for disadvantages, identifying the main activities that generate costs in an organisation is
expensive. Careful thought must also be given to the ability of existing management
accounting information systems to provide the detailed activity and cost information required
by an ABC system: upgrading or replacement may be needed. A further expense is the cost
of training staff to use the new costing system. Once introduced, an ABC system can be
significantly more expensive than a traditional absorption costing system. It is possible,
therefore, that in some organisations the cost of introducing and maintaining an ABC system
may exceed the benefits gained.
ABC may be most appropriate in an organisation where indirect costs are a significant
proportion of total cost, or where a wide product range is maintained with a variety of
different activity consumption patterns. Spring should consider the significance of indirect
costs to its product costs and undertake a cost-benefit analysis before making a decision to
implement an ABC system. Spring should also consider that further developments could flow
from the introduction of an ABC system, for example in budgeting (activity-based budgeting)
and management philosophy (activity-based management).
(b)
Measurement of managerial and organisational performance
Managerial performance and organisational performance are inextricably linked, since
managers are the key decision makers in an organisation and their decisions therefore
determine organisational performance.
Managerial and organisational performance needs to be measured as part of the control
process in an organisation. The three elements of the control process are recording or
measuring actual performance or output, comparing performance with planned performance
or some benchmark, and taking action to correct or modify continuing performance in order
to achieve planned performance. Managerial and organisational performance can be
measured in a wide variety of ways, depending on which aspect of performance, financial or
non-financial, is the object of interest.
1010
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
A wide variety of financial (or money) performance measures can be used to assess
managerial and organisational performance. Financial performance is of interest to internal
and external stakeholders who are concerned to monitor the progress and risk of their
investment, the security of their employment, and so on. Examples of financial performance
measures include:
Profit
Profit before interest and tax or profit after tax are usually expected to increase on an annual
basis and the financial media often refer to profit when discussing managerial and
organisational performance. Managers are expected to deliver increasing profits and
organisations are expected to produce profit increases equal to or greater than their
competitors.
Earnings per share
Earnings per share are a profit measure of interest to shareholders and the financial market,
since it represents the maximum dividend per share that a company could pay. Managerial
rewards could be linked in part to meeting performance targets based on earnings per share.
Cash flow
Because profit may be affected by arbitrary adjustments linked to accounting policies and
because profit does not measure directly the ability to generate returns for investors, many
shareholders and providers of debt finance prefer to concentrate on changes in cash flow as a
means of assessing managerial and organisational performance.
Costs
A focus on managerial and organisational performance in terms of cost control or cost
reduction may be especially appropriate for organisations in the public sector. Here,
profitability is an inappropriate performance measure and a key objective is value for money,
in terms of the drive for economy, efficiency and effectiveness.
Share price
Since one of the ways in which shareholders receive a return from their investment in a
company is through capital growth, they will be interested in assessing managerial and
organisational performance in terms of share price growth. If managers invest in projects
with a positive net present value then, theoretically, the share price should increase to reflect
the rise in corporate net present value. Conversely, organisations in which managers are
believed to be poor performers will experience a share price decrease.
Measuring financial performance alone is not sufficient, since financial performance results
from a range of organisational activities that must also therefore be monitored. Non-financial
performance measures may be quantitative or qualitative.
An example of a quantitative performance measure is the number of complaints received from
customers. An example of a qualitative performance measure is feedback from a sales
representative to the effect that most customers are very happy with the after-sales service
provided by the organisation.
An attempt is usually made to replace qualitative performance measures with a substitute
measure that can be quantified. For example, the number of customer complaints can be used
as a substitute measure of product quality or customer satisfaction. Similarly, the number of
warranty claims can be used as a substitute measure of product reliability.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1011
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Modern organisations compete in terms of product quality, flexibility and reliability, customer
satisfaction, and product dimensions such as after-sales care and customer loyalty. These
features are captured by non-financial indicators such as number of customer complaints,
number of warranty claims, and quality ratings (such as the star ratings of hotels or
restaurants, or the position of an organisation in a league table).
A more balanced assessment of organisational and managerial performance will consider both
financial and non-financial performance. For example, Kaplan and Norton’s Balanced
Scorecard considers the customer perspective, the innovation perspective, the internal process
perspective and the financial perspective, and requires the identification of quantitative and
non-quantitative goals and performance measures.
Answer 5 EDWARD CO
(a)
Target costing process
Target costing begins by specifying a product an organisation wishes to sell. This will
involve extensive customer analysis, considering which features customers value and which
they do not. Ideally only those features valued by customers will be included in the product
design.
The price at which the product can be sold at is then considered. This will take in to account
the competitor products and the market conditions expected at the time that the product will
be launched. Hence a heavy emphasis is placed on external analysis before any consideration
is made of the internal cost of the product.
From the above price a desired margin is deducted. This can be a gross or a net margin. This
leaves the cost target. An organisation will need to meet this target if their desired margin is
to be met.
Costs for the product are then calculated and compared to the cost target mentioned above.
If it appears that this cost cannot be achieved then the difference (shortfall) is called a cost
gap. This gap would have to be closed, by some form of cost reduction, if the desired margin
is to be achieved.
(b)
1012
Benefits of adopting target costing
„
The organisation will have an early external focus to its product development.
Businesses have to compete with others (competitors) and an early consideration of
this will tend to make them more successful. Traditional approaches (by calculating
the cost and then adding a margin to get a selling price) are often far too internally
driven.
„
Only those features that are of value to customers will be included in the product
design. Target costing at an early stage considers carefully the product that is
intended. Features that are unlikely to be valued by the customer will be excluded.
This is often insufficiently considered in cost plus methodologies.
„
Cost control will begin much earlier in the process. If it is clear at the design stage
that a cost gap exists then more can be done to close it by the design team.
Traditionally, cost control takes place at the “cost incurring” stage, which is often
far too late to make a significant impact on a product that is too expensive to make.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
(c)
„
Costs per unit are often lower under a target-costing environment. This enhances
profitability. Target costing has been shown to reduce product cost by between
20% and 40% depending on product and market conditions. In traditional cost plus
systems an organisation may not be fully aware of the constraints in the external
environment until after the production has started. Cost reduction at this point is
much more difficult as many of the costs are “designed in” to the product.
„
It is often argued that target costing reduces the time taken to get a product to
market. Under traditional methodologies there are often lengthy delays whilst a
team goes “back to the drawing board”. Target costing, because it has an early
external focus, tends to help get things right first time and this reduces the time to
market.
Steps to reduce a cost gap
Review radio features
Remove features from the radio that add to cost but do not significantly add value to the
product when viewed by the customer. This should reduce cost but not the achievable selling
price. This can be referred to as value engineering or value analysis.
Team approach
Cost reduction works best when a team approach is adopted. Edward should bring together
members of the marketing, design, assembly and distribution teams to allow discussion of
methods to reduce costs. Open discussion and brainstorming are useful approaches here.
Review the whole supplier chain
Each step in the supply chain should be reviewed, possibly with the aid of staff
questionnaires, to identify areas of likely cost savings. The team can then focus on areas that
are identified by staff as being likely cost saving areas. For example, the questionnaire might
ask, “Are there more than five potential suppliers for this component?” Clearly a “yes”
response to this question will mean that there is the potential for tendering or price
competition.
Components
Edward should look at the significant costs involved in components. New suppliers could be
sought or different materials could be used. Care would be needed not to damage the
perceived value of the product. Efficiency improvements should also be possible by reducing
waste or idle time that might exist. Avoid, where possible, non-standard parts in the design.
Assembly workers
Productivity gains may be possible by changing working practices or by de-skilling the
process. Automation is increasingly common in assembly and manufacturing and Edward
should investigate what is possible here to reduce the costs. The learning curve may
ultimately help to close the cost gap by reducing labour costs per unit.
Clearly reducing the percentage of idle time will reduce product costs. Better management,
smoother workflow and staff incentives could all help here. Focusing on continuous
improvement in production processes may help.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1013
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Overheads
Productivity increases would also help here by spreading fixed overheads over a greater
number of units. Equally Edward should consider an ABC approach to its overhead
allocation; this may reveal more favourable cost allocations for the digital radio or ideas for
reducing costs in the business.
(d)
Cost per unit and cost gap calculation
$ per unit
$2,400 

Component 1:  4.10 +

4,000 units 

4.70
100 
 25
Component 2: 
× 0 .5 ×

98 
 100
0.128
Material – other
8.10
100 
 30
Assembly labour:  × $12.60 /hr ×

60
90 

7.00
 30

Variable production overhead:  × $20 /hr 
 60

10.00
 30

Fixed production overhead:  × $12 /hr 
60


6.00
––––––
35.928
35.20
––––––
0.728
––––––
Total cost
Desired cost: ($44 × 0.8)
Cost gap
WORKINGS
(1)
Production overhead cost
Using a high low method
Extra overhead cost between month 1 and 2
Extra assembly hours
Variable cost per hour
$80,000
4,000
$20/hr
Monthly fixed production overhead
$700,000 – (23,000 × $20/hr)
Annual fixed production overhead ($240,000 × 12)
$2,880,000
FPO absorption rate
=
240,000 hrs
1014
$240,000
$2,880,000
$12/hr
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Answer 6 YAM CO
(a)
The bottleneck process
The total processing hours of the factory is given but can be proven as follows:
18 hours × 5 days × 50 weeks × 50 production lines = 225,000 hours.
Given this, the production capacity for pressing must be 225,000 hours/0.5 hours per metre =
450,000 metres. Using this method the production capacity for all processes is as follows:
Pressing
Stretching
Rolling
Product A
450,000
900,000
562,500
Product B
450,000
562,500
900,000
Product C
562,500
900,000
900,000
The bottleneck is clearly the pressing process, which has a lower capacity for each product.
The other processes will probably be slowed to ensure smooth processing.
Clearly an alternative approach is simply to look at the original table for processing speed and
pick out the slowest process. This is pressing. (Full marks available for that explained
observation.)
(b)
TPAR for each product
Product A
Selling price
70.0
Raw materials
3.0
Throughput
67.0
Throughput per bottleneck hour* 134.0
Fixed costs per hour (W1)
90.0
TPAR
1.49
Working*
67/0.5 = 134
(1)
Product B
60.0
2.5
57.5
115.0
90.0
1.28
57.5/0.5 = 115
Product C
27.0
1.8
25.2
63.0
90.0
0.7
25.2/0.4 = 63
The fixed cost per bottleneck hour can be calculated as follows:
Total fixed costs are $18,000,000 plus the labour cost. Labour costs $10 per hour for each of
the 225,000 processing hours, a cost of $2,250,000.
Total fixed cost is therefore $18,000,000 + $2,250,000 = $20,250,000
Fixed cost per bottleneck hours is $20,250,000/225,000 = $90 per hour
(c)
TPAR for product C
(i)
Yam could improve the TPAR of product C in various ways:
Speed up the bottleneck process. By increasing the speed of the bottleneck process the rate
of throughput will also increase, generating a greater rate of income for Yam if the extra
production can be sold. Automation might be used or a change in the detailed processes.
Investment in new machinery can also help here but the cost of that would need to be taken
into account.
Increase the selling prices. It can be difficult to increase selling prices in what is said to be a
competitive market. Volume of sales could be lost leaving Yam with unsold stock or idle
equipment. On the other hand, a price increase may be possible given that the business
appears to be selling all it can produce.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1015
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Reduce the material prices. Reducing material prices will increase the net throughput rate.
Metal is available from many sources being far from a unique product. Given the industry is
mature the suppliers of the raw material could be willing to negotiate on price; this could have
volume or quality based conditions attached. Yam will have to be careful to protect its
quality levels. Bulk buying increases stock levels and the cost of that would need to be
considered.
Reduce the level of fixed costs. The fixed costs should be listed and targets for cost
reduction be selected. ABC techniques can help to identify the cost drivers and with
management these could be used to reduce activity levels and hence cost. Outsourcing, deskilling or using alternative suppliers (for stationery for example) are all possible cost
reduction methods.
(ii)
Suggestion to cease the production of product C
A TPAR of less than one indicates that the rate at which product C generates throughput
(sales revenue less material cost) is less than the rate at which Yam incurs fixed cost. So on a
simple level, producing a product that incurs fixed cost faster than it generates throughput
does not seem to make commercial sense. Clearly the TPAR could be improved (using the
methods above) before cessation is considered any further.
However, cessation decisions involve consideration of many wider issues (only three
required).
„
Long-term expected net cash flows from the product allowing for the timing of
those cash flows (NPV) are an important factor in cessation decisions
„
Customer perception could be negative in that they will see a reduction in choice
„
Lost related sales: if product C is lost will Yam lose customers that bought it along
with another product?
„
What use could be made of the excess capacity that is created
„
Throughput assumes that all costs except raw materials are fixed; this may not
necessarily be the case and only avoidable fixed costs need to be taken into account
for a cessation decision. If few fixed costs can be avoided then product C is making
a contribution that will be lost if the product ceased.
Answer 7 WARGRIN
(a)
Lifecycle costing principles
Lifecycle costing is a concept that traces all costs to a product over its complete lifecycle,
from design through to cessation. It recognises that for many products there are significant
costs to be incurred in the early stages of its lifecycle. This is probably very true for Wargrin.
The design and development of software is a long and complicated process and it is likely that
the costs involved would be very significant.
The profitability of a product can then be assessed taking all costs into consideration.
It is also likely that adopting lifecycle costing would improve decision-making and cost
control. The early development costs would have to be seen in the context of the expected
trading results, therefore preventing a serious over spend at this stage or under-pricing at the
launch point.
1016
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
(b)
Budgeted results for game
Sales
Variable cost (W1)
Fixed cost (W1)
Marketing cost
Profit
Year 1
$
240,000
40,000
80,000
60,000
––––––
60,000
––––––
Year 2
$
480,000
80,000
120,000
40,000
–––––––
240,000
–––––––
Year 3
$
120,000
20,000
80,000
––––––
20,000
––––––
Total
$
840,000
140,000
280,000
100,000
–––––––
320,000
–––––––
On the face of it the game will generate profits in each of its three years of life. Games only
have a short lifecycle, as the game players are likely to become bored of the game and move
on to something new.
The pattern of sales follows a classic product lifecycle with poor levels of sales towards the
end of the life of the game.
The Stealth product has generated $320,000 of profit over its three-year life measured on a
traditional basis. This represents 40% of turnover – ahead of its target. Indeed it shows a
positive net profit in each of its years on existence.
The contribution level is steady at around 83% indicating reasonable control and reliability of
the production processes. This figure is better than the stated target.
Considering traditional performance management concepts, Wargrin is likely to be relatively
happy with the game’s performance.
However, the initial design and development costs were incurred and were significant at
$300,000 and are ignored in the annual profit calculations. Taking these into consideration,
the game only just broke even, making a small $20,000 profit. Whether this is enough is
debatable, it represents only 2.4% of sales for example. In order to properly assess the
performance of a product the whole lifecycle needs to be considered.
WORKINGS
(1)
Split of variable and fixed cost for Stealth
Volume
High
Low
Difference
14,000 units
10,000 units
4,000 units
Cost
$
150,000
130,000
20,000
Variable cost per unit = $20,000/4,000 unit = $5 per unit
Total cost = fixed cost + variable cost
$150,000 = fixed cost + (14,000 × $5)
$150,000 = fixed cost +$70,000
Fixed cost = $80,000 (and $120,000 if volume exceeds 15,000 units in a year)
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1017
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
(c)
Incremental budgeting
Incremental budgeting is a process whereby this year’s budget is set by reference to last
year’s actual results after an adjustment for inflation and other incremental factors. It is
commonly used because:
„
It is quick to do and a relatively simple process.
„
The information is readily available, so very limited quantitative analysis is needed.
„
It is appropriate in some circumstances. For example, in a stable business, the
amount of stationery spent in one year is unlikely to be significantly different in the
next year, so taking the actual spend in year one and adding a little for inflation
should be a reasonable target for the spend in the next year.
There are problems involved with incremental budgeting:
(d)
„
It builds on wasteful spending. If the actual figures for this year include overspends
caused by some form of error then the budget for the next year would potentially
include this overspend again.
„
It encourages organisations to spend up to the maximum allowed in the knowledge
that if they don’t do this then they will not have as much to spend in the following
year’s budget.
„
Assessing the amount of the increment can be difficult.
„
It is not appropriate in a rapidly changing business.
„
Can ignore the true (activity based) drivers of a cost leading to poor budgeting.
Setting standard costs
Design and development costs: Setting a standard cost for this classification of cost would
be very difficult. Presumably each game would be different and present the program writers
with different challenges and hence take a varying amount of time.
Variable production cost: A game will be produced on a CD or DVD in a fairly standard
format. Each CD/DVD will be identical and as a result setting a standard cost would be
possible. Allowance might need to be made for waste or faulty CDs produced. Some
machine time will be likely and again this should be the same for all items and therefore
setting a standard would be valid.
Fixed production cost: The standard fixed production cost of a game will be the product of
the time taken to produce the game and the standard fixed overhead absorption rate for the
business. This brings into question whether this is “meaningful”. Allocating fixed costs to
products in a standard way may not provide meaningful data. It can sometimes imply a
variability (cost per unit) that is not the case and can therefore confuse non-accountants,
causing poor decisions. The time per unit will be fairly standard.
Marketing costs: Games may have different target audiences and therefore require different
marketing strategies. As such setting a standard may be difficult to do. It may be possible to
set standards for each marketing media chosen. For example the rates for a page advert in a
magazine could be set as a standard.
1018
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Answer 8 SCOVET CO
(a)
Profit over the life of the product
Initial investment
Contribution (at 60%)
Fixed costs
1 Jan.
20X2
$m
–4.5
3.6
Net cash flow
____
–4.5
31 Dec.
20X2
$m
31 Dec.
20X3
$m
31 Dec.
20X4
$m
4.2
–2.5
____
3.6
–2.2
____
–1.8
____
1.1
2.0
1.8
Net cash flow and therefore profit 0.4 million
Hence product D is viable on financial grounds since it generates positive profit over its life. .
(b)
Cost per unit
Variable cost per unit ($10 × 0.4)
Fixed cost per unit (working)
Total cost per unit
$
4.00
5.79
––––
9.79
––––
WORKING
Total lifecycle fixed costs per unit
Initial investment
Fixed costs:
20X2
20X3
20X4
Total product specific fixed costs
Budgeted sales units (millions)
Budgeted fixed cost per unit ($)
Budgeted sales units: Total revenue over the life of the product
Budgeted units (at $10 per unit)
$m
4.5
2.5
2.2
1.8
––––
11.0
1.9
––––
5.79
$m
19
1.9
Answer 9 ENVIRONMENTAL MANAGEMENT ACCOUNTING
(a)
Meaning of environmental costs
Various organisations have come up with different definitions of environmental cost so there
is no definitive answer to the question “what is meant by environmental costs.” In most cases,
the term “environmental costs” is taken to mean any costs that have relevance to the
environment. The following are perhaps the most significant of these:
„
Costs of waste, particularly wasting scarce resources, such as energy and water.
Here poor environmental behaviour costs more than good environmental behaviour.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1019
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
(b)
„
Costs incurred to protect the environment such as investing in production processes
to reduce pollution.
„
Costs of compliance with environmental regulations or voluntary codes. This may
include employment of compliance officers, and monitoring equipment.
„
Costs of cleaning up pollution or contamination caused by activities. Some such
costs may not become payable until operations cease (e.g. decontamination of the
site on which a nuclear power station stands). However, such costs can be
significant.
„
Image and relationship costs. The environment is an important political issue.
Many organisations that have committed environmental crimes have suffered as a
result of product boycotts, which have affected their bottom line. Many
organisations spend huge amounts to publicise their environmental credentials.
Why the management of environmental costs is becoming increasingly important
There are three main reasons why the management of environmental costs is becoming
increasingly important.
(c)
(1)
Increasing awareness of environmental issues means that organisations are expected
to behave in an environmentally friendly way, as discussed above.
(2)
Environmental costs account for a huge portion of costs for many industrial
companies. As such they need to be managed.
(3)
Increasing regulation by governments means that costs of non-compliance (e.g.
fines) are becoming ever larger.
Weakness of traditional management accounting
Traditional management accounting systems do not provide management with enough
information about the impact of the organisations environmental costs. Many environmental
related costs are simply included in general overheads, so management are not aware of them.
Since managers are not aware of them, they have no information with which to manage them
and no incentive to reduce them.
Since traditional management accounts do not provide management with an accurate view of
environmental costs, management make decisions that are bad for the environment and bad
for the organisation’s profits. Many organisations, for example, spend too much on energy
due to inefficient practices and waste. Good energy management would reduce the waste,
thus conserving a scarce resource, and reducing the costs of energy.
(d)
Environmental management accounting
As with environmental costs, there is an absence of a clear definition of environmental
management accounting. Many organisations have provided definitions, many of which
contain much jargon and are not very clear.
Management accounting aims to provide detailed information to managers of an organisation,
to help them plan and control its activities, and make decisions. Environmental management
accounting is simply an extension of this, whereby information is provided to management to
help them to manage the environmental costs and activities.
1020
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Environmental management accounting does not provide only financial information. The
United Nations Division for Sustainable Development distinguishes between:
„
Physical information such as the use, flows and destinies of energy, water and
materials, including waste.
„
Monetary information on environment related costs, earning and savings.
Environmental management accounting makes use of management accounting techniques
such as activity-based costing (ABC), and life cycle costing, which can be used to manage
environmental costs more effectively. In ABC, for example, the drivers that cause
environmental costs to be incurred can be identified. Managers can then take steps to reduce
the use of the drivers, so that the environmental costs are reduced without reducing the output
of the organisation.
Environmental management accounting makes managers more aware of the costs of their
environmental activities. If they are more aware, they can manage them more effectively.
Tutorial note: This solution is not the definitive solution to such a question. It has been
provided to give a “general” view of the issues, without becoming too involved in the jargon
of the various definitions that have been provided. As such it is probably longer than the
marking scheme would warrant. The examiner stated that she would not set a whole question
on environmental management accounting. Any questions on this area would appear for up
to eight marks as part of a 20-mark question. The examiner also stated that she would not set
numerical questions on this area.
Answer 10 SNIFF CO
(a)
Financial and other factors to consider
Sniff should consider the following factors when making a further processing decision:
„
Incremental revenue. The new perfume, once further processed, should generate a
higher price and the extra revenue is clearly relevant to the decision.
„
Incremental costs. A decision to further process can involve more materials and
labour. Care must be taken to only include those costs that change as a result of the
decision and therefore sunk costs should be ignored. Sunk costs would include, for
example, fixed overheads that would already be incurred by the business before the
further process decision was taken. The shortage of labour means that its “true”
cost will be higher and need to be included.
„
Impact on sales volumes. Sniff is selling a “highly branded” product. Existing
customers may well be happy with the existing product. If the further processing
changes the existing product too much there could be an impact on sales and
loyalty.
„
Impact on reputation. As is mentioned in the question, adding hormones to a
product is not universally popular. Many groups exist around the world that protest
against the use of hormones in products. This association could damage sniff.
„
Potential legal cases being brought regarding allergic reactions to hormones.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1021
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
(b)
Evaluation of experimenting with the hormone adding process
Production costs for 1,000 litres of the standard perfume
Aromatic oils
Diluted alcohol
$
10 litres × $18,000/litre
990 litres × $20/litre
Material cost
Labour
2,000 hrs. × $15/hour
Total
Cost per litre
Sales price per litre
Lost contribution per hour of labour used on new products
($399,800 – $199,800) ÷ 2,000 hours = $100/hour
180,000
19,800
–––––––
199,800
30,000
–––––––
229,800
–––––––
229·80
399·80
Incremental costs
Male version
Hormone
Supervisor
Labour
Fixed cost
Market research
Total
Female version
$
2 litre × $7,750/litre 15,500
Sunk cost
0
500 hours × $100/hour 50,000
Sunk cost
0
Sunk cost
0
––––––
65,500
––––––
8 litre × $12,000/litre
Sunk cost
700 hours × $100/hour
Sunk cost
Sunk cost
$
96,000
0
70,000
0
0
–––––––
166,000
–––––––
Incremental revenues
Male version
Female version
$
Standard
200 litre × $399.80/litre 79,960 800 litre × $399.80
Hormone added 202 litre × $750/litre 151,500 808 litre × $595/litre
––––––
Incremental revenue
71,540
––––––
Net benefit/(cost)
6,040
––––––
$
319,840
480,760
–––––––
160,920
–––––––
(5,080)
–––––––
The Male version of the product is worth further processing in that the extra revenue exceeds
the extra cost by $6,040.
The Female version of the product is not worth further processing in that the extra cost
exceeds the extra revenue by $5,080.
In both cases the numbers appear small. Indeed, the benefit of $6,040 may not be enough to
persuade management to take the risk of damaging the brand and the reputation of the
business. To put this figure into context: the normal output generates a contribution of $170
per litre and on normal output of about 10,000 litres this represents a monthly contribution of
around $1.7m (after allowing for labour costs).
1022
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Future production decisions are a different matter. If the product proves popular, however,
Sniff might expect a significant increase in overall volumes. If Sniff could exploit this and
resolve its current shortage of labour then more contribution could be created. It is worth
noting that resolving its labour shortage would substantially reduce the labour cost allocated
to the hormone added project. Equally, the prices charged for a one off experimental
promotion might be different to the prices that can be secured in the long run.
(c)
Selling price per 100 ml for female version of product
The selling price charged would have to cover the incremental costs of $166,000. For 808
litres that would mean the price would have to be
($166,000 + $319,840)
= $601.29/litre
808 ltrs
or about $60.13 per 100 ml.
This represents an increase of only 1.05% on the price given and so clearly there may be
scope for further consideration of this proposal.
(d)
Outsourcing involves consideration of many factors, the main ones being:
„
Cost. Outsourcing often involves a reduction in the costs of a business. Cost
savings can be made if the outsourcer has a lower cost base than, in this case, Sniff.
Labour savings are common when outsourcing takes place.
„
Quality. Sniff would need to be sure that the quality of the perfume would not
reduce. The fragrance must not change at all given the product is branded. Equally
Sniff should be concerned about the health and safety of its customers since its
perfume is “worn” by its customers
„
Confidentiality. The blend of aromatic oils used in the production process is
secret. This may not remain so if an outsourcer is employed. Strict confidentiality
should be maintained and be made a contractual obligation.
„
Reliability of supply. Sniff should consider the implications of late delivery on its
customers.
„
Primary Function. Sniff is apparently considering outsourcing its primary
function. This is not always advisable as it removes Sniff’s reason for existence. It
is more common to outsource a secondary function, like payroll processing for
example.
„
Access to expertise. Sniff may find the outsourcer has considerable skills in
fragrance manufacturing and hence could benefit from that.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1023
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Answer 11 BITS AND PIECES
(a)
Decision to open on Sundays
The decision to open on Sundays is to be based on incremental revenue and incremental costs:
$
Incremental revenue
(W1)
Incremental costs
– Cost of sales
(W2)
– Staff
(W3)
– Lighting (6 hours × $30 per hour × 50 days)
– Heating (8 hours × $45 per hour × 25 days)
– Manager’s bonus ($800,000 × 1% or $160 per day)
– Total
$
800,000
335,000
45,000
9,000
9,000
8,000
–––––––
406,000
–––––––
Net incremental revenue
394,000
–––––––
On the basis of the above it is clear that the incremental revenue exceeds the incremental costs
and therefore it is financially justifiable.
WORKINGS
(1)
Incremental revenue
Day
Sales
$
Average
10,000
Sunday (+60% of average)
16,000
Annually (50 days)
800,000
Current results (300 days) 3,000,000
New results
3,800,000
(2)
Gross profit Gross profit Cost of Sales
%
$
$
70%
50%
8,000
8,000
400,000
400,000
70·0%
2,100,000
65·8%
2,500,000
Purchasing and discount on purchasing
Extra purchasing from Sunday trading is $800,000 – $400,000 = $400,000
Current annual purchasing is $18,000 × 50 =$900,000
New annual purchasing is ($900,000 + $400,000) × 0.95 = $1,235,000
Incremental cost is $1,235,000 – $900,000 = $335,000 (a $65,000 discount)
(3)
Staff costs
Staff costs on a Sunday are 5 staff × 6 hours × $20 per hour × 1.5 = $900 per day
Annual cost is $900 × 50 days = $45,000
(b)
Manager’s pay deal
The manager’s rewards can be summarised as follows:
Time off
This appears far from generous. The other staff are being paid time and a half and yet the
manager does not appear to have this option and also is only being given time off in lieu
(TOIL) at normal rates. Some managers may want their time back as TOIL so as to spend
time with family or social friends; others may want the cash to spend. One would have
thought some flexibility would have been sensible if the manager is to be motivated properly.
1024
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Bonus
The bonus can be calculated at $8,000 per annum (W6); on a day worked basis, this is $160
per day. This is less than that being paid to normal staff; at time and a half they earn 6 hours
× $20 × 1.5 = $180 per day. It is very unlikely to be enough to keep the presumably better
qualified manager happy. Indeed the bonus is dependent on the level of new sales and so
there is an element of risk involved for the manager. Generally speaking higher risk for lower
returns is far from motivating.
The level of sales could of course be much bigger than is currently predicted. However, given
the uplift on normal average daily sales is already +60%, this is unlikely to be significant.
(c)
Discounts and promotion
When new products or in this case opening times are launched then some form of market
stimulant is often necessary. B&P has chosen to offer substantial discounts and promotions.
There are various issues here:
Changing buying patterns: It is possible that customers might delay a purchase a day or two
in order to buy on a Sunday. This would cost the business since the margin earned on Sunday
is predicted to be 20% points lower than on other days.
Complaints: Customers that have already bought an item on another day might complain
when they see the same product on sale for much less when they come back in for something
else on a Sunday. Businesses need to be strong in this regard in that they have to retain
control over their pricing policy. Studies have shown that only a small proportion of people
will actually complain in this situation. More might not, though, be caught out twice and
hence will change the timing of purchases (as above).
Quality: The price of an item can say something about its quality. Low prices tend to suggest
poor quality and vice versa. B&P should be careful so as not to suggest that lower prices do
not damage the reputation of the business as regards quality.
Answer 12 STAY CLEAN
(a)
Decision to cease to produce the TD
The relevant costs of the decision to cease the manufacture of the TD are needed:
Cost or Revenue
Lost revenue
Saved labour cost
Lost contribution from other products
Redundancy and recruitment costs
Supplier payments saved
Sublet income
Supervisor
Note
(1)
(2)
(3)
(4)
(5)
(6)
Net cash flow
Amount ($)
(96,000)
48,000
(118,500)
(3,700)
88,500
12,000
0
–––––––
(69,700)
–––––––
Conclusion: It is not worthwhile ceasing to produce the TD now.
Note 1: All sales of the TD will be lost for the next 12 months, this will lose revenue of
1,200 units × $80 = $96,000
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1025
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Note 2: All normal labour costs will be saved at 1,200 units × $40 = $48,000
Note 3: Related product sales will be lost.
This will cost the business 5% × ((5,000u × $150) + (6,000u × $270)) = $118,500 in
contribution (material costs are dealt with separately below)
Note 4: If TD is ceased now, then:
Redundancy cost
Retraining saved
Recruitment cost
($6,000)
$3,500
($1,200)
–––––––
($3,700)
Total cost
Note 5: Supplier payments:
DW ($)
WM ($)
TD ($) Net cost Discount Gross cost
($)
level
($)
Current buying cost
350,000 600,000 60,000 1,010,000
5% 1,063,158
Loss of TD
(60,000) (60,000)
5%
(63,158)
Loss of related sales at cost (17,500) (30,000)
(47,500)
5%
(50,000)
New buying cost
921,500
3%
950,000
Difference in net cost
88,500
Note 6: There will be no saving or cost here as the supervisor will continue to be fully
employed.
An alternative approach is possible to the above problem:
Cash flow
Lost contribution – TD
Lost contribution – other products
Redundancy and recruitment
Lost discount
Sublet income
Supervisor
Net cash flow
Note
(7)
(8)
(4)
(9)
(6)
Amount ($)
12,000
(71,000)
(3,700)
(19,000)
12,000
0
–––––––
(69,700)
–––––––
Note 7: There will be a saving on the contribution lost on the TD of 1,200 units × $10 per
unit = –$12,000
Note 8: The loss of sales of other products will cost a lost contribution of 5% ((5,000 × $80)
+ (6,000 × $170)) = $71,000
Note 9:
Current buying cost
Saved cost
New buying cost
Lost discount
1026
DW
WM
TD Total (net) Discount Total gross
350,000 600,000 60,000 1,010,000
5% 1,063,158
(17,500 (30,000) (60,000)
332,500 (570,000)
0 902,500
5%
950,000
921,500
3%
950,000
(19,000)
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
(b)
Pricing Strategies
Complementary pricing
Since the washing machine and the tumble dryer are products that tend to be used together,
Stay Clean could link their sales with a complementary price. For example they could offer
customers a discount on the second product bought, so if they buy (say) a TD for $80 then
they can get a WM for (say) $320. Overall then Stay Clean make a positive contribution of
$130 (320 + 80 – 180 – 90).
Product line pricing
All the products tend to be related to each other and used in the utility room or kitchen. Some
sales will involve all three products if customers are upgrading their utility room or kitchen
for example. A package price could be offered and as long as Stay Clean make a contribution
on the overall deal then they will be better off.
(c)
Outsourcing decision
Outsourcing requires consideration of a number of issues (only 3 required):
„
The cost of manufacture should be compared to cost of buying in from the
outsourcer. If the outsourcer can provide the same products more cheaply then it is
perhaps preferable.
„
The reliability of the outsourcer should be assessed. If products are delivered late
then the ultimate customer could be disappointed. This could damage the goodwill
or brand of the business.
„
The quality of work that the outsourcer produces needs to be considered. Cheaper
products can often be at the expense of poor quality of materials or assembly.
„
The loss of control over the manufacturing process can reduce the flexibility that
Stay Clean has over current production. If Stay Clean wanted, say, to change the
colour of a product then at present it should be able to do that. Having contracted
with an outsourcer this may be more difficult or involve penalties.
Answer 13 BUTTERY RESTAURANT
(a)
Profit
Number of meals required to be sold each week to earn a profit of $300
Sales volume
=
Fixed costs + Required profit
Contribution per unit
=
$660 (W1) + £300
$1.20 (W2)
= 800 meals
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1027
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
(b)
Additional profit and break-even
(i)
Additional profit earned by owners of the restaurant by each proposed
diversification
Contribution per meal (W5)
Anticipated sales volume
Total contribution
Less Fixed costs
Weekly profit
Add Additional profit from existing
business (at current level)
caused by reduction in
material costs
700 meals × 10¢ (W7)
Additional weekly profits
Take-away Quality meals
$0.90
$1.60
720 meals
200 meals
$
648
(610)
——
38
$
320
(282)
——
38
70
70
108
108
(ii)
Sales volume at which owners of the restaurant would earn no additional profit
from the proposed diversification
Take-away Quality meals
$
$
Incremental fixed costs
610
282
Minimum additional profit from
existing business caused by
reduction in material costs
700 meals × 10¢
(70)
(70)
——
——
540
212
——
——
Contribution per meal (W5)
Break-even point
0.90
600 meals
1.60
132.5 meals
WORKINGS
(1)
Fixed costs
Staff
Building occupancy
1028
$
200
460
——
660
——
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
(2)
Contribution per meal
$
Selling price
Variable costs
Materials ($1,540 ÷ 700) (W3)
Power ($280 ÷ 700) (W3)
Staff ($140 ÷ 700) (W3)
$
4.00
2.20
0.40
0.20
——
(2.80)
——
1.20
——
Contribution
(3)
Average weekly sales
$2,800
= 700 meals
$4
(4)
Calculation of contribution per meal in the existing restaurant if the following
method of diversification were implemented
$
Average selling price
Variable costs
Materials (10p saving)
Power
Staff
2.10
0.40
Nil
——
Contribution per meal
(5)
Take-away
$
4.00
(2.70)
——
1.30
——
Calculation of contribution per meal of the two proposals
Variable costs
Contribution per meal
Take-away
$
1.60
0.15
——
1.75
(0.85)
——
0.90
——
Quality meals
$
6.00
0.26
——
6.26
(4.66)
——
1.60
——
Incremental contribution from existing restaurant as a result of proposed
diversification
For take-away foods
For high quality meals
(7)
Quality meals
$
4.00
2.10
0.40
0.20
——
(2.50)
——
1.50
——
Selling price
Incremental contribution from existing restaurant (W6)
(6)
$
$1.50 (W4) ÷ 10 = $0.15
$1.30 (W4) ÷ 5 = $0.26
Saving in material cost
The saving in material cost of 10¢ per meal at activity levels above 700 meals per week is
included in the contribution per unit calculation in W5.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1029
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Answer 14 A TO C CO
(a)
Contribution per unit
Product
Selling price
Less
Materials cost
Direct labour
Variable overhead
Contribution per unit
A
$
10
B
$
20
C
$
30
(6.2)
(2.0)
(1)
–––––
0.8
–––––
(7.6)
(8.0)
(3)
–––––
1.4
–––––
(20.4)
(3.0)
(3) (working)
–––––
3.6
–––––
WORKING – calculation of variable overhead per unit
Product
Total overhead costs:
For 3,000 units
For 5,000 units
Increase in total cost
Increase in output
Variable cost per unit
(b)
A
$
B
$
C
$
6,000
8,000
––––––
2,000
2,000
––––––
1
––––––
13,000
19,000
––––––
6,000
2,000
––––––
3
––––––
11,000
17,000
––––––
6,000
2,000
––––––
3
––––––
A
$
B
$
C
$
8,000
19,000
17,000
(5,000)
––––––
3,000
––––––
(15,000)
––––––
4,000
––––––
(15,000)
––––––
2,000
––––––
Calculation of total fixed cost
Product
Total overhead costs for
5,000 units:
Less variable portion
(5,000 × 1)/(5,000 × 3)
Fixed portion
Total fixed costs are therefore $9,000 per month.
(c)
Calculation of monthly break even revenue
Using the formula:
Break even
revenue
1030
=
Fixed cost
$9,000
=
= $88,236
Weighted average C/S ratio
0.102
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
WORKING – break even revenue
Weighted average C/S ratio = =
Product
Budgeted sales (units)
Selling price per unit
Budgeted revenue
Contribution per unit
Budgeted contribution
C/S Ratio
Budgeted total contribution
Budgeted total revenue
A
4,000
10
––––––
40,000
––––––
0.8
3,200
––––––
0.08
B
2,000
20
––––––
40,000
––––––
1.4
2,800
––––––
0.07
C
4,000
30
––––––
120,000
––––––
3.6
14,400
––––––
0.12
Total
200,000
–––––––
20,400
–––––––
0.102
Weighted average C/S ratio is therefore 0.102.
Tutorial note: The C/S ratios of the individual products are not required to calculate the
weighted average C/S ratio. However, they are needed for the next part of the question.
(d)
Profit volume charts
See the chart on the next page. The X-axis shows total revenue; the Y-axis profit.
(i)
Sales in standard product mix
In order to draw this line it is sufficient to know only two points, and to draw a
straight line between them:
When revenue = 0, loss = total fixed cost, = $9,000.
When revenue is as per budget, it is $200,000 (see part (c) above). Profit at this
point is total contribution less fixed costs, being $20,400 – $9,000 = $11,400.
(ii)
Products sold in order of C/S ratio
In this situation it is assumed that product C would be sold first, as it has the highest
C/S ratio. Sales of product C would be made up until maximum demand for product
C is reached, after which sales of product A would start, up to maximum demand
for product A, and finally sales of product C.
The Profit volume chart will be multi gradient, as the gradient depends on the C/S
ratio of the product. In order to draw the chart, it is necessary to calculate revenue
and profit at each of the following points:
„
„
„
„
Zero revenue;
Maximum sales of Product C only;
Maximum sales of Product C and Product A;
Maximum sales of all three products.
Zero revenue
Sell 4,100 units of C
Sell 4,100 units of A and C
Sell 4,100 units of A and C
and 4,600 units of B
Sales revenue Contribution
0
0
123,000
14,760
164,000
18,040
256,000
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
24,480
Fixed cost
(9,000)
(9,000)
(9,000)
Profit
(9,000)
5,760
9,040
(9,000)
15,480
1031
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Profit
$
Line 1 – standard
sales mix
15,480
11,400
9,040
5,760
75,000
Revenue
88,236
123,000
164,000
200,000
256,000
(9,000)
1032
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Answer 15 HIGGINS CO
(a)
Contribution per cue
Pool cue
Snooker cue
$
$
41.00
69.00
(10.80)
(10.80)
(9.00)
(13.50)
(1.20)
(4.70)
––––––
––––––
20.00
40.00
––––––
––––––
Selling price
Material cost at $40/kg
Craftsmen cost at $18/hr
Other Variable cost
Contribution per cue
(b)
Optimal production plan
Variables
Let P and S be the number of pool and snooker cues made and sold in any three-month
period.
Let C represent the contribution earned in any three-month period
Constraints
Craftsmen:
Ash:
Demand levels
– Pool cues
– Snooker cues
Non-negativity:
0.5P + 0.75S
0.27P + 0.27S
P
S
P, S
≤
≤
≤
≤
≥
12,000
5,400
15,000
12,000
0
Objective: Higgins seeks to maximise contribution in a three month period, subject to:
20P + 40S = C
Solution
See diagram on next page. The feasible region is identified as the area inside OABCDE.
The contribution line is identified as the dotted line. Pushing the contribution line outward
increases the contribution gained (theory of iso-contribution). The contribution line last
leaves the feasible region at point D which is the intersection of the skilled labour line and the
maximum demand line for S.
Solving at point D:
S =
0.5P + 0.75S =
Maximum demand
Craftsmen
12,000 (1)
12,000 (2)
Substituting S = 12,000 in equation (2)
0.5P + (0.75 × 12,000)
0.5P + 9,000
0.5P
0.5P
P
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
=
=
=
=
=
12,000
12,000
12,000 – 9,000
3,000
6,000
1033
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Therefore the maximum contribution is earned when 6,000 pool cues and 12,000 snooker
cues are made and sold in a three-month period.
The contribution earned is:
C = (20 × 6,000) + (40 × 12,000)
C = 120,000 + 480,000
C = $600,000
Graph
P
Craftsmen
24
22
20
Max contribution
18
16
A
Max S
B
Max P
14
C
12
Feasible region = 0ABCDE
Optimal point at point D
10
F
8
6
D
4
2
contribution
0
(c)
2
4
6
Ash
E
8
10
12
14
16
18
20
Labour cost
(i)
Shadow prices
A shadow price is the value assigned to changes in the quantity of a scarce resource available,
normally measured in terms of contribution. If more critical scarce resource becomes
available then the feasible region would tend to expand and this means that the optimal point
would tend to move outward away from the origin thus earning more contribution. This
increase in the contribution is the shadow price which is measured on a per unit of scarce
resource basis.
1034
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
S
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Management can use the shadow price as a measure of how much they would be willing to
pay to gain more of a scarce resource. It represents the maximum they should be willing to
pay for more scarce resource over and above the normal price subject to any non-financial
issues that may be present.
If the availability of a non-critical scarce resource increased then the feasible region would
not tend to expand and therefore no more contribution could be earned. In this case extra
non-critical scarce resource has no value and a nil shadow price.
Calculation of shadow prices
Ash: This is a non-critical scarce resource and as such it has a shadow price of nil. There is
“slack” (spare material) of ash and therefore no desire to pay more to get more of it.
Craftsmen: This is a critical scarce resource and if more became available then the feasible
region would expand and the optimal point would move outward thus earning more
contribution. Assuming that just one more hour becomes available it is necessary to find the
new optimal point and measure the increase in contribution earned.
Resolving at point D based on the available craftsmen hours being one more than previously:
S =
0.5P + 0.75S =
12,000 (3)
12,001 (4)
Substituting S = 12,000 in equation (4):
0.5P + 0.75(12,000)
0.5P + 9,000
0.5P
P
=
=
=
=
12,001
12,001
3,001
6,002
The new optimal solution would be where 12,000 snooker cues and 6,002 pool cues are made.
This would earn an extra $40 (2 × $20) in contribution.
The shadow price is therefore $40 per extra hour of craftsmen time.
(ii)
Acceptability of the craftsmen’s offer
Rate of pay
The rate of pay requested (double time) is on the face of it less than the shadow price and is
therefore affordable by Higgins Co. The business would be better off by accepting the offer.
However, it is common for overtime to be paid at time and a half ($27 per hour) and Higgins
would be well advised to negotiate on this point. Higgins takes the commercial risks in this
business and would therefore be justified in keeping the majority of the rewards that come
with it. Equally it is a dangerous precedent to accept the first offer and pay such a high rate
for overtime, Higgins would have to ask itself what would happen next time an overtime
situation arose. It is also possible that double time, being so generous, encourages slow
working in normal time so as to gain the offer of overtime.
Quantity of hours to buy
The problem here is that as Higgins buys more craftsmen time, the craftsmen constraint line
will move outward, changing the shape of the feasible region. Once the craftsmen line
reaches point F (see diagram) then there would be little point buying any more hours since
Higgins would then not have the materials (ash) to make more cues.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1035
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Calculating the number of hours needed at point F.
Maximum demand for S
Ash
S =
0.27P + 0.27S =
12,000 (5)
5,400 (6)
Substituting S = 12,000 in equation (6)
0.27P + 0.27(12,000)
0.27P + 3,240
0.27P
P
=
=
=
=
5,400
5,400
2,160
8,000
Point F falls where S = 12,000 and P = 8,000
The craftsmen hours needed at this point would be given by putting the above P and S values
in the craftsmen constraint formula.
Craftsmen hours = (0.5 × 8,000) + (0.75 × 12,000)
Craftsmen hours = 13,000 hours
Therefore Higgins should only buy 1,000 hours (13,000 – 12,000).
In general terms Higgins need only buy the number of hours that the business can use to make
and sell more products. If more ash can also be bought then more labour hours may be
desirable.
Quality of work
Higgins should consider the quality of work. Overtime hours can force tiredness on
craftsmen that have already worked a full day. Tired people often produce sub-standard
work. If quality is important then this could damage the reputation of the business.
Tutorial note: Any other sensible points would be accepted.
Answer 16 ALBION CO
(a)
Optimum production schedule
The optimum production schedule is found using limiting factor analysis.
Material R2 ($/unit)
Material R3 ($/unit)
Labour ($/unit)
Variable o/h ($/unit)
Variable costs ($/unit)
Selling price ($/unit)
Contribution ($/unit)
Material R2 (kg/unit)
Contribution ($/kg of R2)
Ranking
1036
AR2
2.5 × 2 = 5.00
2 × 2 = 4.00
4 × 0.6 = 2.40
1.10
–––––
12.50
21.00
–––––
8.50
–––––
2
8.5/2 = 4.25
1
GL3
2.5 × 3 = 7.50
2 × 2.2 = 4.40
4 × 1.2 = 4.80
130
–––––
18.00
28.50
–––––
10.50
–––––
3
10.5/3 = 3.50
2
HT4
2.5 × 3 = 7.50
2 × 1.6 = 3.20
4 × 1.5 = 6.00
1.10
–––––
17.80
27.30
–––––
9.50
–––––
3
9.5/3 = 3.17
3
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Product
AR2
GL3
HT4
Demand
units
950
1,000
900
R2 used
kg
1,900
3,000
600
––––––
5,500
––––––
Production
units
950
1,000
200
Contribution
$
8,075
10,500
1,900
–––––––
20,475
–––––––
The optimum production schedule is 950 units of Product AR2, 1,000 units of GL3 and 200
units of HT4, giving a total contribution of $20,475. The fixed production overheads are
ignored in this analysis because they are assumed not to vary with changes in the level of
production.
(b)
Maximum price
Further supplies of Material R2 will be used to produce additional units of Product HT4. The
contribution per kg of Material R2 of Product HT4 is $3.17 and so if Albion pays 3.17 + 2.50
= $5.67 per kg for Material R2, the additional units of Product HT4 produced will make a
zero contribution towards fixed costs. $5.67 is therefore the maximum price.
(c)
Manufacture or buy
Material R3: 3 × 2 =
Labour: 1.7 × 4 =
Variable overhead:
Variable cost of Product XY5
$/unit
6.00
6.80
1.40
–––––
14.20
–––––
The substitute offered by Folam gives a saving of $4 per unit. However, Albion would also
pay an annual fee of $50,000 for the right to use the substitute. The company would need to
manufacture more than 50,000/4 = 12,500 units per year of Product XY5, or 1,042 units per
month, in order for the offered substitute to be financially acceptable. If it needed less than
12,500 units of Product XY5 per year, it would be cheaper to manufacture the product in
house. This evaluation is from a short-term perspective: in the longer term, buying in may
lead to fixed cost savings and lower investment, increasing the benefits of buying in and
lowering the break-even point.
Albion would also need to assure itself that the quality of the substitute was acceptable and
that this quality could be maintained: the lower price offered by Folam might be associated
with poorer quality than that deemed necessary by Albion. Orders for the substitute product
would also need to be delivered promptly in order to avoid production hold-ups. Albion
could also become dependent on Folam for supplies of the substitute product and might be
vulnerable to future price increases by the supplier. Such price increases might reduce or
even eliminate the cost saving of buying in.
(d)
Limitations of marginal costing
Marginal costing (variable costing) treats fixed costs as a period cost, on the assumption that
fixed costs do not change in the short term. The difference between selling price and variable
costs is the variable contribution made by units sold towards meeting fixed costs and
generating profit.
Marginal costing has traditionally been used for short-term decisions such as whether to cease
production of a product, whether to make a product or buy it from a supplier, and how to
allocate scarce resources in order to maximise contribution.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1037
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
A major limitation with using marginal costing as the basis for making short-term decisions is
the assumption that fixed costs are irrelevant to short-term decisions. In the longer term,
fixed costs will change: for example, rent is usually regarded as a fixed cost and in the longer
term rent might be expected to increase due to inflation. However, a change in fixed costs
may be the result of a short-term decision: for example, if a product is discontinued and as a
result the work of the marketing department decreases, in the longer term marketing costs
would be expected to decrease.
This points to the danger of relying on a simplistic analysis of costs into fixed costs and
variable costs, and of assuming that only variable costs are relevant for decision-making
purposes. It is possible for a fixed cost to be a relevant cost. It is also possible for a variable
cost to be irrelevant, for example in the case where a variable cost is common to two decision
alternatives. If fuel costs are incurred whether a machine is leased or bought, for example,
these costs are not relevant to the decision on whether to lease or buy.
Reliance on marginal costing as a basis for making short-term decisions may therefore lead to
sub-optimal decisions overall for a company, as the analysis may fail to consider all relevant
costs. A relevant cost is an incremental or differential cost at the whole company level. If a
cost changes or is incurred, now or in the future, as a result of a decision, it is a relevant cost
and should be considered when making a decision. When making short-term decisions,
therefore, it is essential to adopt a whole company perspective in determining relevant costs.
When making short-term decisions, a detailed analysis of cost behaviour is therefore needed
in order to determine not only variable costs and fixed costs, but relevant costs as well.
Answer 17 KOBRIN ENGINEERING CO
WORKING
(a)
Profit
Fixed costs
TW
35
325
____
VE
55
465
____
Product
EC
30
270
____
SE
55
485
____
Contribution
360
____
520
____
300
____
540
____
Steel in short supply
Contribution
Steel costs
Contribution/key factor
Rank
Production (units)
1038
$520
$500
$1.04
4
30
20
$300
$190
$1.58
1
$540
$390
$1.38
3
Steel used
Special order
Remaining sales of EC
Remaining sales of TW
Remaining sales of SE
31,000
51,300
67,500
70,200
_______
Balance of steel on VE
220,000
30,000
_______
Total steel available
250,000
_______
Total production
$360
$250
$1.44
2
30
270
20
270
180
60
_____
_____
_____
_____
300
_____
80
_____
300
_____
200
_____
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
(b)
Components in short supply
Contribution
Components
Contribution/key factor
Rank
$360
1
$360
3
$520
1
$520
2
$300
1
$300
4
$540
1
$540
1
TW
Product
VE
EC
SE
30
20
30
20
180
Components
Production (units)
Special order
Sales of SE
100
180
_____
Remaining components
280
120
_____
Total components available
400
_____
Total production
(c)
120
_____
_____
_____
_____
30
_____
140
_____
30
_____
200
_____
Labour in short supply
Contribution
Labour hours
Contribution/key factor
Rank
$360
15
$24
2=
$520
15
$34.67
1
$300
12.5
$24
2=
$540
25
$21.60
4
20
175
30
20
_____
_____
_____
_____
30
_____
195
_____
30
_____
20
_____
Contribution if made
Contribution if bought in
$
360
285
____
$
520
475
____
$
300
250
____
$
540
490
____
Extra contribution if made
75
____
45
____
50
____
50
____
15
$5
15
$3
12.5
$4
25
$2
{
}
|
~
Hours
Production (units)
Special order
Remaining hours
Total hours
1,625
2,625
4,250
_____
Total production
(d)
30
_____
Make or buy
÷ Labour hours
Extra contribution/labour hours
Rank
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1039
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
TW
Product
VE
EC
SE
Production (units)
Special order
Remaining hours
Hours
1,625
2,625
_____
30
175
20
30
20
Total hours
4,250
_____
_____
_____
_____
_____
Made in-house
Sub-contracted
205
95
_____
20
180
_____
30
270
_____
20
180
_____
Total made and sold
300
_____
200
_____
300
_____
200
_____
Answer 18 BIL MOTOR COMPONENTS CO
(a)
Lowest selling price
←Machine Group→
Per unit
1
$
31.65
3.00
_____
7
$
21.82
2.50
_____
29
Assembly
$
$
3.05
5.40
1.50
0.84
_____
____
Setting
28.65
0.05
_____
19.32
0.03
_____
1.55
0.02
_____
4.56
–
____
Variable cost
28.70
_____
19.35
_____
1.57
_____
4.56
____
Total cost
Less: Fixed overheads
Total
$
54.18
_____
The lowest possible price would be that which covers the whole of the variable cost (i.e.
(200 × 54.18) = $10,836 per batch of 200).
Evaluation of policy
1040
„
This price would not be making any contribution towards the recovery of the fixed
overheads. If the company is to make a profit, it has to recover its fixed overheads.
„
The selling price cannot really be set simply by reference to the variable costs. The
prices at which competitors are offering the same product, plus engaging in market
research should also be considered. Of particular importance is the likely reactions of
competitors (e.g. if the strategy starts a price war BIL could lose more than it gains).
„
BIL should consider the possible impact on business if other customers of the
product find out about the “special price”.
„
This kind of strategy takes time to introduce. It could, in fact, be a number of years
before the company can charge the customer the full price.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
(b)
Maximising profits
For outputs and sales up to 7,000 units
Selling price
Less: Variable cost
$
13.00
6.20
_____
$
12.00
6.20
_____
$
11.00
6.20
_____
$
10.00
6.20
_____
$
9.00
6.20
_____
6.80
_____
5.80
_____
4.80
_____
3.80
_____
2.80
_____
For outputs and sales over 7,000 units
Selling price
Less: Bought-out finished price
Selling price
Volume
units
$
11.00
7.75
_____
$
10.00
7.75
_____
$
9.00
7.00
_____
3.25
_____
2.25
_____
2.00
_____
Contribution
per unit
$
6.80
13
5,000
12
6,000
5.80
11
7,000
200
4.80
3.25
10
7,000
4,200
9
7,000
6,400
3.80
2.25
2.80
2.00
$
Total
contribution
$
34,000
______
34,800
______
33,600
650
_____
26,600
9,450
_____
19,600
12,800
_____
34,250
______
36,050
______
32,400
______
The price of $10 and sales of 11,200 units would maximise the profit, as illustrated above at
$36,050 provided the estimates prove to be correct.
(c)
Ways in which management can increase production capacity
„
Improving product design so that the production process can be simplified and take
up less time.
„
Improving plant layout, production methods and production scheduling, to reduce
idle time and avoid bottlenecks.
„
Introducing overtime working and/or “shift working”, if this has not already been
done, to make more production time available.
„
Introducing or improving an existing incentive scheme that makes use of the
standard costing system, to enhance productivity.
„
Buying certain components from outside suppliers rather than manufacturing them,
which free machines and equipment for other purposes.
„
Employing sub-contracting manufacturers to produce completed products, which
also frees-up production facilities.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1041
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Answer 19 JASON GRIMES
(a)
Hiring the machine
Without new machine
$
0.80
2.00
0.20
——
3.00
––––
Variable costs/unit
Labour
Materials
Variable selling expenses
Fixed costs
Overheads
Machine hire
With new machine
$
0.80
1.00
0.20
——
2.00
––––
250,000
–
———–
250,000
–––––––
250,000
575,000
———–
825,000
–––––––
Extra contribution $1.00 per unit
Extra fixed costs $575,000
For sales over 575,000 units the machine is worth hiring. A more definitive answer can only
be given after considering the optimum activity level, as determined in (b).
(b)
Maximizing profit
Profit maximised where Marginal revenue = Marginal cost
0.06Q
=3
15,000
where
5–
Thus
Q = 500,000
Therefore
P = 5–
0.03 × 500,000
= $4
15,000
Contribution
= Revenue – Variable costs
= 500,000 × $(4 – 3) = $500,000
Profit
= Contribution – Fixed costs
= $(500,000 – 250,000) = $250,000
With machine
Profit maximised where MR = MC
0.06Q
=2
15,000
where
5–
Thus
Q = 750,000
Therefore
Contribution
Profit
P = 5–
0.03 × 750,000
= $3.5
15,000
= 750,000 × $(3.5 – 2) = $1,125,000
= $(1,125,000 – 825,000) = $300,000
Therefore
(a)
(b)
1042
Hire new machine
Price = $3.50
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Answer 20 KADOK CO
(a)
Possible selling prices
(i)
Full cost pricing plus, on the current basis
Materials
Labour
Direct cost
Production overheads (100% of direct cost)
Factory cost
Administrative and marketing overheads
(25% of factory cost)
Full cost
Profit (20% of full cost)
Selling price for order
(ii)
$000
12
8
—
20
20
—
40
10
—
50
10
—
60
—
Price to maintain budgeted profit
Current budgeted profit is $50,000. If sales volume falls by 25%, profit will be:
Direct costs $100,000 × 0.75
Variable overheads $50,000 × 0.75
Variable cost
Fixed overheads $(50,000 + 50,000)
Total cost
Profit (balancing figure)
Revenue $300,000 × 0.75
$000
75.0
37.5
——–
112.5
100.0
——–
212.5
12.5
——–
225.0
——–
For the Noxid order to generate $37,500 contribution to profit the price for the order must be:
Materials
Labour
Direct cost
Variable overhead $12,000 × (50,000 ÷ 60,000)
Variable cost
Contribution
Selling price
$000
12.0
8.0
——
20.0
10.0
——
30.0
37.5
——
67.5
——
Variable overheads are assumed to vary with materials cost, per original budget $50/60 per $1
materials cost.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1043
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
(iii)
Price absorbing overheads on a unit basis
Based on the original budget, when production overheads were $100,000 and administrative
and marketing overheads $50,000, the unit overhead for the budgeted 20,000 units output
would have been:
$( 100 ,000 + 50 ,000 )
= $7.50
20 ,000
Basing overhead recovery on this and assuming that when full cost is determined this way,
the same profit margin (i.e. 20%) is added to the full cost, the computations for the price
charged would be as follows:
$000
Material
12.0
Labour
8.0
——
Direct cost
20.0
Overheads $7.5 × 5,000
37.5
——
57.5
Profit at 20%
11.5
——
Selling price of order
69.0
——
(b)
Advice
Discussion of methods used
On first sight it may seem that a simple answer to this part of the question is to advise Kadok
to select and set the highest price from those computed using the mechanisms required by the
question. However, it must be obvious that there are other ways of computing even higher
prices if obtaining the highest possible price from a set of calculations were to be the price
objective. Why stop at the methods asked for in (a)? Why not look for those that produce
even higher prices? This brings to attention the need to consider demand factors and to ask
what price the market will bear. However, before discussing demand conditions further, it
will be useful to make some comments about the methods dealt with in (a).
First, concerning the full price mechanism, it is frequently suggested that this procedure
provides an entrepreneur with a figure of a “fair” price to charge – assuming that the profit
percentage mark-up is fair for the industry concerned. However, such assumptions about
fairness tend to overlook the cost classification problems that will be associated with the first
two stages of the full cost price plus mechanism. Where there is difficulty in the classification
and allocation of costs (e.g. between direct and indirect absorption techniques, this may cause
distortions to the “fair price”). Method (iii) is a variant of the full cost plus method based on
the view that it seems fairer to apportion overheads in absolute terms based on units rather
than applying a percentage.
However, method (iii) overlooks the fact that units of production may not be homogeneous.
The homogeneity of units in this question has been somewhat diluted because of changes in
product specification. The special enquiry for unbranded cameras requires them to be
stripped down to their barest essentials.
1044
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Developing methods (i) and (iii) into a marginal costing method would in fact provide the
best basis of costing for an enquiry for a special order. This is because, although such an
approach does not tell the price-setter what to charge as the final price, it does provide a base
line for the price floor below which the good should not be sold. The price-setter can then try
to ascertain the best price that can be obtained above this minimum. In method (ii) in the
question, a constraint has been imposed by saying that the price set must enable the
organisation to achieve its original budgeted profit figures. Such a constraint is probably
unreasonable as it may cause the order to be lost, when any “contribution” that could be
earned above the marginal costs would have been helpful and placed the firm in a better
position than if the order had been rejected.
However, it should be noted that the presentation of data for method (ii) does show the
marginal cost information.
Other factors
It might be helpful in such cases as those depicted in this question to use market intelligence
to find out what the potential customer expects to make as a profit when he re-sells the goods
that he buys. The manufacturing organisation should also try to find out at what price its
competitors are selling comparable lines. Also, in cases where sales of the manufacturer’s
brand have been reduced, it is important to try to ascertain whether sales by the photographic
dealer of a cheaper house brand might affect these even more – or even whether the
manufacturer would find it worthwhile to produce a stripped-down model for sale through its
existing customers. Discussions should be held with the photographic chain’s purchasing
officer to get the “feel” of what sort of price he expects – remembering that once a price has
been sent off to him, this tends to pre-empt opportunities for negotiating prices upwards,
especially if the price set was well below that which he would have been prepared to pay. If
the “exploratory” price is set too high, then there is the danger that the high-priced firm will
be precluded from further negotiations. When this is not the case it is likely, after bids for
some products have been negotiated downwards, to mean the buyer will expect to be able to
negotiate all future initial “bids” downwards, even if he would have been happy to pay the price
originally asked.
All in all, it can be seen that price setting in such a situation is extremely difficult. Although the
seller should know the price below which he is not prepared to fall, it is certainly worth any effort
and resources expended within reason on market intelligence to ensure that the best possible price
is obtained for products.
Answer 21 AUTODES CO
(a)
Price based on current pricing policy
Materials
WZ954
RT429
Other materials
Opportunity cost of using WZ954
Labour
Overheads
Development Costs
Total cost
Plus profit (25% margin = ⅓ of cost)
Selling price
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
3g at $4.74 =
5g at $6.12 =
(W1)
1.5 hours at $21 =
1.5 hours at $29 =
(W2)
$
14.22
30.60
5.01
––––––
49.83
11.25
31.50
43.50
20.42
––––––
156.50
52.17
––––––
208.67
––––––
1045
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
WORKINGS
(1)
Opportunity cost of WZ954
Contribution per unit of other product
Each unit produced requires 4g
∴ Contribution per g = $15 ÷ 4
Each unit of Autolong uses 3g ∴
(2)
$15
$3.75
$11.25
Development costs
Total of development costs
$3,675,000
NB WZ954 is in short supply
Maximum supply of 180,000g is sufficient for 60,000 units
On maximum sales of 60,000 p.a. for three years, the impact of development
costs is $3,675,000 ÷ 180,000 = $20.42 per unit
(b)
Report to the managing director
To:
From:
Ref:
Date:
Managing Director
Management Consultant
Pricing of Autolong
5 June 20XX
Introduction
This report considers the options available to the company with regard to the initial pricing of
Autolong. The report is based on the information provided by the company and the Market
Report.
Pricing policy
There are a number of strategies that the company could adopt in respect of pricing. Two of
these (market skimming and market penetration) have been specifically referred to by a nonexecutive director, while the company currently operates a policy of cost plus pricing. Before
considering these in detail, it may be useful to provide an overview of the alternatives referred
to by the non-executive director.
Market skimming
Essentially this strategy is used to achieve high unit profits in the early stages of a product’s
life cycle. This is done by charging a high price on entry to the market and stimulating
demand through advertising and promotion. As the product enters later stages of its life
cycle, the price will be reduced. There are many examples of products that have been brought
to market in this way, including laptop computers, digital cameras, and DVD players. The
approach essentially “skims” the profit in the early stages of the life cycle before increased
competition leads to lower prices.
Market penetration
This strategy is based on charging lower prices in order to achieve a high level of penetration
into the market and so build market share. This allows economies of scale to be built rapidly
so that unit costs can be reduced.
1046
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Application to Autodes
Using the company’s current policy, the price of the Autolong would be $209. There are two
important points to note about this price. The first is that it is well below the upper price limit
of $225 referred to in the market report. The second is that it is based on a significant
assumption regarding the recovery of development costs.
Development costs
The company has a policy that development costs should be recovered in the first three years
of a product’s life cycle. In the case of the Autolong, the fact that the supply of one of the
materials (WZ954) is limited, places an upper limit of 60,000 units on the market penetration
for the product. As it will be two years before our competitors bring their products to market,
a shorter recovery period should be considered.
The indications are that full production capacity of 60,000 units will be sold in each of the
first two years. The impact of this shorter recovery period would be that the costs of
$3,675,000 would be recovered over 120,000 units. This would increase the cost of the
Autolong by $10.21 to $167. When the profit margin is added the selling price will be
increased by almost $14 to $223.
Recommendation
There is a two-year window during which Autodes will probably be able to sell the full
production volume of the product, and also achieve full recovery of the development costs at
a price of $223. Market research indicates that the maximum price that can be achieved is
$225 per unit.
I would recommend a market skimming approach using a price of $223. This will give the
opportunity to reduce the price by around $40 or 18% in order to respond to competitors
entering the market.
Answer 22 ESSENTIAL ASPECT
(a)
Structure of current and revised model
The cost model is a simple linear equation of the form y = a + bx, where a represents the fixed
costs and b the variable costs per unit. Hence the current cost model has fixed costs of $5,000
and a unit variable cost of $0.6. The revised cost model reduces the fixed cost element to
$4,750 but the unit variable cost rises to $0.8 Therefore, the revised model generates lower
cost estimates at lower output levels, but higher cost estimates at higher output levels than the
current model.
The revenue function depicts a conventional non-linear downward sloping demand curve
where the company has to lower its sale price of all of its units if it wishes to sell more. The
revised coefficients in the revised model result in a lower initial price (from $20 to $19) but a
slower decline in price as the units sold increase. The revision in the coefficient from 0.01 to
0.009 results in the price declining at a slower rate than previously for any given change in
units sold (i.e. the revised model depicts a lower price elasticity of demand). Therefore the
revised model generates lower total revenue estimates at low unit sales, but greater total
revenue estimates at high unit sales than the current model.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1047
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
(b)
Optimal output
(i)
Optimal level of output
The optimal sales level could be determined by:
„
using differential calculus to determine the marginal cost (MC) and marginal
revenue (MR) functions. Where MR = MC the optimal demand occurs. Solve the
equation to find the optimal level.
„
by calculating the values of total revenue and total cost at all potential unit output
levels and identifying where revenues exceeded costs by the greatest absolute
amount.
(ii)
Adherence to output target
The amended model should quantify the current efficient application of resources in the
achievement of the optimum demand level. It should therefore be a measure of current
efficient managerial performance. However, managerial performance should be measured in
terms of identifying, quantifying and responding to changing business variables.
The model would require to be updated in order to reflect such changes. It is unlikely that the
model is sufficiently sophisticated to incorporate all the variables that reflect managerial
performance.
(c)
1048
Cost and revenue factors to improve validity of model
„
The structure of cost and revenue models frequently relies on historical information
as source data – but how reliable is this for forecasting? How effective is the past as
a predictor for the future? Cost and revenue relationships can alter radically over
time with technological and market changes – there is a need to consider the
significance and impact of these issues on long-term forecasts. The solution may be
to have different models for short and long-term forecasts with more detailed and
stringent accuracy requirements for the shorter-term estimates.
„
The cost models assume a constant fixed cost over all ranges of output – how
realistic is this? Perhaps the cost model could incorporate a step cost function that
increases as specific output levels are attained. Is the step cost necessarily an abrupt
change or is it possible to incorporate a sliding step cost that results from capacity
being temporarily expanded by short-term measures until the higher demand level is
regarded as permanent.
„
The cost models assume that unit variable costs remain constant over all ranges of
output – is this a reasonable assumption? What about the possibility of deriving
economies or diseconomies of scale and hence resulting in a non-constant unit
variable cost. For example, bulk purchase discounts will result in unit variable costs
decreasing as output expands. These discounts may generate a downward step
function in unit variable cost or even a smooth decreasing function depending on
the purchase contract terms.
„
Are the revenue and cost forecasts based at constant prices or does an allowance for
inflation need to be incorporated? This will probably depend on the length of the
time horizon. What inflation factor should be used? Is RPI appropriate or is a more
specific inflator required because the industry prices change at a different rate to the
general economy? Indeed in certain high tech areas the forecast may be for a
general decrease in prices.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
„
The forecast price elasticity of demand incorporated into the model is critical in
forecasting revenues, but how accurate can this be in a changing business
environment? The model could be improved by considering the factors that
determine the price elasticity of demand and incorporating the variables into the
model (i.e. by making the model more sensitive to the critical issues). This will
increase both the potential accuracy of the model and unfortunately, the complexity
of it.
„
The revenue functions are extremely simple with price being the only factor in
determining the units sold. The model concentrates on movements down the
demand curve to influence the total revenue estimates and gives no consideration to
movements in the demand curve (i.e. the other factors apart from price that
influences the amount sold). The model would have greater validity if it were to
incorporate other factors such as: tastes, customer income, competitors’ prices,
population size and structure, advertising etc. How would these variables be
incorporated into the model? Is there appropriate quantifiable data available that is
suitable for inclusion?
Answer 23 STOW HEALTH CENTRE
(a)
Budgeted net profit/loss outcomes for year ending 30 June 201X
Client
Days
15,750
15,750
15,750
13,125
13,125
13,125
10,500
10,500
10,500
(b)
Fee per
Client day
$
180
180
180
200
200
200
220
220
220
Variable cost
per client day
$
95
85
70
95
85
70
95
85
70
Contribution
per client day
$
85
95
110
105
115
130
125
135
150
Total annual
contribution
$
1,338,750
1,496,250
1,732,500
1,378,125
1,509,375
1,706,250
1,312,500
1,417,500
1,575,000
Client fee strategy based on decision rules
The maximax rule looks for the largest contribution from all outcomes. In this case the
decision maker will choose a client fee of $180 per day where there is a possibility of a
contribution of $1,732,500.
The maximin rule looks for the strategy that will maximise the minimum possible
contribution. In this case the decision maker will choose client fee of $200 per day where the
lowest contribution is $1,378,125. This is better than the worst possible outcome from client
fees per day of $180 or $220 that will provide contribution of $1,338,750 and $1,312,500
respectively.
The minimax regret rule requires the choice of the strategy that will minimise the maximum
regret from making the wrong decision. Regret in this context is the opportunity lost through
making the wrong decision.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1049
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Using the calculations from part (a) an opportunity loss table can be created as follows:
State of variable cost
High
Most likely
Low
Maximum regret
Client fee per day strategy
$180
39,375
13,125
0
39,375
$200
0
0
26,250
26,250
$220
65,625
91,875
157,500
157,500
Example of the workings: at the low level of variable costs, the best strategy would be a client
fee of $180. The opportunity loss from using a fee of $200 or $220 per day would be $26,250
(1,732,500 – $1,706,250) or $157,500 (1,732,500 –1,575,000) respectively.
The minimum regret strategy (client fee $200 per day) is that which minimises the maximum
regret (i.e. $26,250 in the maximum regret row above).
(c)
Client fee strategy
Expected value of variable cost = $95 × 0.1 + $85 × 0.6 + $70 × 0.3 = $81.50
For each client fee strategy the expected value of budget contribution for the year may be
calculated:
* Fee of $180: 15,750 (180 – 81·50) = $1,551,375
* Fee of $200: 13,125 (200 – 81·50) = $1,555,312·50
* Fee of $220: 10,500 (220 – 81·50) = $1,454,250
Hence choose a client fee of $200 per day to give the maximum expected value contribution
of $1,555,312.50. Note that there is virtually no difference between this and the contribution
where a fee of $180 per day is used.
Answer 24 SHIFTERS HAULAGE
(a)
Making decisions in uncertain situations
Maximax stands for maximising the maximum return an investor might expect. An investor
that subscribes to the maximax philosophy would generally select the strategy that could give
him the best possible return. He will ignore all other possible returns and only focus on the
biggest; hence this type of investor is often accused of being an optimist or a risk-taker.
Maximin stands for maximising the minimum return an investor might expect. This type of
investor will focus only on the potential minimum returns and seek to select the strategy that
will give the best worst-case result. This type of investor could be said to be being cautious
or pessimistic in his outlook and a risk-avoider.
Expected value averages all possible returns in a weighted average calculation.
For example, if an investor could expect $100 with a 0.30 probability and $300 with a 0.70
probability, then on average the return would be:
(0.3 × $100) + (0.7 × $300) = $240
This figure would then be used as a basis of the investment decision. The principle here is
that if this decision was repeated again and again, then the investor would get the expected
valued (EV) as a return. Its use is more questionable for use on one-off decisions.
Tutorial note: You were not asked for a critique of this method.
1050
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
(b)
Profit calculations
Small Van Medium Van
100
150
468 W3
300 W1
300 W2
500 W4
Capacity
Low Demand (120)
High Demand (190)
Large Van
200
368 W5
816 W6
WORKINGS
Sales
Variable cost
Goodwill
VC adjustment
Depreciation
Profit
(c)
W1
1,000
(400)
(100)
W2
1,000
(400)
(100)
(200)
300
(200)
300
W3
1,200
(480)
48
(300)
468
W4
1,500
(600)
(100)
(300)
500
W5
1,200
(480)
W6
1,900
(760)
48
(400)
368
76
(400)
816
Van purchase decision
The type of van to buy depends on the risk attitude of the investor. If they were optimistic
about the future then the maximax criteria would suggest that they choose the large van as this
has the potentially greatest profit. If they are more pessimistic, then they would focus on the
minimum expected returns and choose the medium van, as the worst possible result is $468,
which is better than the other options. As the business managers are becoming more cautious
they may prefer a maximin criterion.
Expected values could be calculated thus:
Small van
Medium van ($468 × 0.4) + ($500 × 0.6) =
Large van ($368 × 0.4) + ($816 × 0.6) =
$300
$487
$637
Given SH is considering replacing a number of vans you could argue that an EV approach has
merit (not being a one-off decision – assuming individual booking sizes are independent of
each other).
The final decision lies with the managers, but given their cautiousness, a medium-sized van
would seem the logical choice. The small van could never be the correct choice.
(d)
Methods of uncertainty reduction
Market research. This can be desk-based (secondary) or field-based (primary). Desk-based
is cheap but can lack focus. Field-based research is better in that you can target your
customers and your product area, but can be time consuming and expensive. The Internet is
bringing down the cost and speeding up this type of research, email is being used to gather
information quickly on the promise of free gifts etc.
Simulation. Computer models can be built to simulate real life scenarios. The model will
predict what range of returns an investor could expect from a given decision without having
risked any actual cash. The models use random number tables to generate possible values for
the uncertainty the business is subject to. Again, computer technology is assisting in bringing
down the cost of such risk analysis.
Sensitivity analysis. This can be used to assess the range of values that would still give the
investor a positive return. The uncertainty may still be there, but the affect that it has on the
investor’s returns will be better understood. Sensitivity calculates the % change required in
individual values before a change of decision results. If only a (say) 2% change is required in
selling price before losses result an investor may think twice before proceeding. Risk is
therefore better understood.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1051
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Calculation of worst and best case figures. An investor will often be interested in range. It
enables a better understanding of risk. An accountant could calculate the worst-case scenario,
including poor demand and high costs whilst being sensible about it. He could also calculate
best-case scenarios including good sales and minimum running costs. This analysis can often
reassure an investor. The production of a probability distribution to show an investor the
range of possible results is also useful to explain risks involved. A calculation of standard
deviation is also possible.
Answer 25 DECISION TREE
(a)
Decision tree
Demand
unchanged 0.5
$60,000
Weather good 0.3
$4,000
Demand up 0.5
Demand
unchanged 0.5
Weather poor 0.7
$(20,000)
600 room nights
$30,000
900 room nights
$90,000
200 room nights
$(35,000)
Demand up 0.5
400 room nights
$(5,000)
National advert
$(25,000)
600 room nights
$30,000
Weather good 0.3
No advert
$(15,500)
$0
Weather poor 0.7
200 room nights
$(35,000)
Demand
unchanged 0.6
$(10,000)
Local advert
Weather good 0.3
$(2,900)
Weather poor 0.7
$44,000
Demand up 0.4
Demand
unchanged 0.4
$(23,000)
600 room nights
$30,000
800 room nights
$65,000
200 room nights
$(35,000)
Demand up 0.6
300 room nights
$(15,000)
1052
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
From decision tree:
No advert
Expected value = $(15,500)
Local advertisement
Expected value before advertising costs = $(2,900)
Expected net value = $(2,900) – $10,000 = $(12,900)
Do nothing
Expected value before advertising costs = $4,000
Expected net value = $4,000 – $25,500 = $(21,000)
As it can be seen from the above, although the highest expected value before costs of
advertising is with the national advertisement, once the cost of the advertising is taken into
account the lowest expected net loss is for a local advert. The highest net loss is from the
national advert.
The highest possible gain is from the national advert if the weather is good and the demand
increases which would lead to net earnings of $65,000 after advertising costs. However the
national advert could also lead to the highest net loss if the weather is poor and the demand is
unaffected the potential net loss is $60,000. The possible outcomes from the local advert vary
from net earnings of $55,000 to a net loss of $45,000. The national advert is therefore the
most risky option as it has the greatest spread of outcomes and the option of not advertising is
the least risky.
The actual decision of the owner will be dependent on his attitude to risk. However with this
proviso, it is recommended that the owner take out a local advertisement as this is the option
with the lowest expected net loss and is less risky that the national advert.
(b)
Limitations of using a decision tree
The main limitation of using a decision tree is that it is based on probability forecasts of the
outcome to enable the expected net present value to be calculated. However the calculated
figure is actually an average of the possible outcomes weighted by their relative probabilities.
As such, it is a hypothetical figure – in fact one or other of the outcomes must occur, not some
average. If the project were carried out many times, the average results would equal the
expected value. However, the technique is being applied to a project that will only be done
once.
There are other problems associated with expected values. One important factor is that they
ignore the decision maker’s attitude towards risk. Risk-averse decision makers will often
accept considerable reductions in expected value for only small decreases in risk.
Calculations of the expected net present values do not of themselves give any idea of the
nature of the dispersion of possible outcomes around the expected value. As uncertainty is
present, the owner needs to know more than just what the expected return would be from
different options. The expected net present value does not tell us the maximum possible loss
that could be incurred.
Finally, the use of expected net present values as a basis for the decision rests on the use of
“subjective” probabilities that may not be valid. In this case, the decision tree is based on
forecasts of the weather that are known for being difficult to estimate to any degree of
accuracy.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1053
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Answer 26 NORTHLAND
(a)
Overhead budget
Overhead costs for the 20X3 budget:
Property cost = $120,000 × 1.05 = $126,000
Central wages = ($150,000 × 1.03) + $12,000 = $166,500
Stationery = $25,000 × 0.6 = $15,000
(b)
Budget for road repairs
The road repair budget will be based on 2,200 metres of road repairs; it is common to include
a contingency in case roads unexpectedly need repair (see part (c)).
The weather conditions could add an extra cost to the budget if poor or bad conditions exist.
The adjustment needed is based on an expected value calculation:
(0.7 × 0%) + (0.1 × 10%) + (0.2 × 25%) = 6%
Hence the budget (after allowing for a 5% inflation adjustment) will be:
2,200 × $15,000 × 1.06 × 1.05 = $36,729,000
This could be shown as:
(2,200 × 15,000 × 1.0 × 0.7) + (2,200 × 15,000 × 1.1 × 0.1) + (2,200 × 15,000 × 1.25 × 0.2) =
$34,980,000
The $34,980,000 could then be adjusted for inflation at 5% to give $36,729,000 as above.
(c)
Problems with using expected value in budgeting
An expected value calculation used in budgeting has the following problems associated with
it:
1054
„
It is often difficult to estimate the probabilities associated with different (in this
case) weather conditions. The weather in one year may not reflect the weather in
the following year leading to wildly inaccurate estimates and hence budgeting
errors.
„
It is difficult to estimate the precise monetary value attaching to each of the
outcomes. “Bad” weather can presumably take many forms (extreme cold, heat or
water); the effect of each of these could be difficult to assess. Whilst using
expected values it is common to group the events together and have one probability
estimate. This may prove inadequate or inaccurate.
„
The expected value that is calculated might not reflect the true cost leading to over
or under spends on budget.
„
The managers will have an easy fall-back position should the budgets turn out to be
incorrect. It would probably be accepted that the weather (and hence the probability
of it) is outside their control and over spends could not then be blamed on them.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
A contingency is often added to a budget in the event that there is uncertainty on the likely
spend. In this case there would be much uncertainty over the level and indeed type of road
repairs required. Roads could be damaged by weather conditions (extreme cold or heat) or
unexpected land movements (earthquakes). Public safety could be at risk meaning that a
repair is essential. This could result in a higher spend.
Equally the type of repair needed would vary and be unpredictable. Small holes might be
simply filled in but larger holes or cracks might involve repairs to the foundations of the road.
The costs could differ considerably between the different types of repairs.
(d)
Zero-based budgeting process
Zero based budgeting involves three main steps:
„
Define decision packages. These are detailed descriptions of the activities to be
carried out. There will be some standardisation in the data to allow comparison
with other activities (costs, time taken and so on). A cost-benefit analysis is often
carried out at this stage to ensure the most cost effective and beneficial approach to
the activity is taken.
„
Evaluation and ranking of activities. Each activity is assessed; those that are
perhaps part of a legal obligation become “must do” activities; others may be
viewed as discretionary. The LGO will have to decide which of the activities offer
the greatest value for money (VFM) or the greatest benefit for the lowest cost.
„
Allocation of resource. The budget will then be created for the accepted activities.
Answer 27 BUDGET BEHAVIOUR
(a)
Purposes of budgets
Planning
The budget is a major short-term planning device placing the overall direction of the company
into a quarterly, monthly and, perhaps, weekly focus. It ensures that managers have thought
ahead about how they will utilise resources to achieve company policy in their area.
Control
Once a budget is formulated a regular reporting system can be established so that the extent to
which plans are, or are not, being met can be established. Some form of management by
exception can be established so that deviations from plans are identified and reactions to the
deviation developed if desirable.
Co-ordination
As organisations grow the various departments benefit from the co-ordination effect of the
budget. In this role budgets ensure that no one department is out of line with the action of
others. They may also hold in check anyone who is inclined to pursue his or her own desires
rather than corporate objectives.
Communication
The construction of the budget can be a powerful aid to defining or clarifying the lines of
horizontal or vertical communication in the enterprise. Managers should have a clearer idea
of what their responsibilities are, what is expected of them, and are likely to work better with
others to achieve it.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1055
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Performance evaluation
When budgets are “tailored” to a department or manager they become useful tools for
evaluating how the manager or department is performing. If sales targets are met or
satisfactory service provided within reasonable spending limits then bonus or promotion
prospects are enhanced.
Motivation
The value of a budget is enhanced still further if it not only states expectations but also
motivates managers to strive towards those expectations. This is more likely achieved if a
manager has had some involvement in the budget construction, understands its implications
and agrees it is fair and controllable by him/her.
(b)
Behavioural factors
If budgetary control is to be successful, attention must be paid to behavioural aspects (i.e. the
effect of the system on people in the organisation and vice versa). The following are some of
the points that should be borne in mind:
Budget difficulty
It is generally agreed that the existence of some form of target or expected outcome is a
greater motivation than no target at all. The establishment of a target, however, raises the
question of the degree of difficulty or challenge of the target. If the performance standard is
set too high or too low then sub-optimal performance could be the result.
The degree of budget difficulty is not easy to establish. It is influenced by the nature of the
task, the organisational culture and personality factors. Some people respond positively to a
difficult target others, if challenged, tend to withdraw their commitment.
Budgets and performance evaluation
The emphasis on achievement of budget targets can be increased, but also the potential for
dysfunctional behaviour, if the budget is subsequently used to evaluate performance. This
evaluation is frequently associated with specific rewards such as remuneration increases or
improved promotion prospects. In such cases it is likely that individuals will concentrate on
those items that are measured and rewarded neglecting aspects on which no measurement
exists. This may result in some aspects of the job receiving inadequate attention because they
are not covered by goals or targets due to the complexity of the situation or the difficulty of
measurement.
Managerial style
The use of budgets in evaluation and control is also influenced by the way they are used by
the superior. Different management styles of budget use have been observed, for example:
1056
„
budget constrained – placing considerable emphasis on meeting budget targets;
„
profit conscious – where a balanced view is taken between budget targets, long-term
goals and general effectiveness;
„
non-accounting – where accounting data is seen as relatively unimportant in the
evaluation of subordinates.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
The style is suggested to influence, in some cases, the superior/subordinate relationship, the
degree of stress and tension involved and the likelihood of budget attainment. The style
adopted and its implications are affected by the environment in which management is taking
place. For example, the degree of interdependency between areas of responsibility, the
uncertainty of the environment and the extent to which individuals feel they influence results
are all factors to consider in relation to the management style adopted and its outcomes.
Participation
It is often suggested that participation in the budget process and discussion over how results
are to be measured has benefits in terms of budget attitude and performance. Views on this
point are varied however, and the personality of the individuals participating, the nature of the
task (narrowly defined or flexible) and the organisation structure influence the success of
participation. But a budget when carefully and appropriately established can extract a better
performance from the budget holder than one in which these considerations are ignored.
Bias
Budget holders who are involved in the process from which the budget standards are set are
more likely to accept them as legitimate. However, they may also be tempted to seize the
opportunity to manipulate the desired performance standard in their favour. That is, they may
make the performance easier to achieve and hence be able to satisfy personal goals rather than
organisational goals. This is referred to as incorporating “slack” into the budget. In this
context there may be a relationship between the degree of emphasis placed on the budget and
the tendency of the budget holder to bias the budget content or circumvent its control.
Any organisational planning and control system has multiple objectives but primary amongst
these is encouraging staff to take organisationally desirable actions. It is never possible to
predict with certainty the outcomes of all behavioural interaction however it is better to be
aware of the various possible behavioural implications than to be ignorant of them.
Answer 28 ZBB
(a)
Usefulness
Zero-based budgeting (ZBB) is a method of budgeting that re-examines, at each budgeting
exercise, whether the budgeted activity is to be funded at any level. Hence, the budgeting
exercise begins at a zero or nil cost base. It is a device that is particularly useful when an
organisation is unsure if its costs are at the most efficient levels. Most efficient costs are not
the same as minimum levels since very low costs might impinge on service or product
quality. The purpose of ZBB is to overcome inefficient forms of budgeting that might lead to
slack practices that consequently consume more resources than the most effective and
efficient organisations face.
(b)
Steps to implement ZBB
There are a series of steps that would ordinarily be taken in order to implement an effective
ZBB system.
Questioning why expenditure needs to be incurred
The development of a questioning attitude to activities that incur costs is the first step to
ensuring that costs are kept to most efficient levels. It is important to recall that ZBB, in the
short term, can only change costs over which the organisation has short-term control. Longer
term, or period costs, can only be changed over a longer horizon. Taxes and other regulatory
costs cannot be the focus of ZBB because they are difficult to influence.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1057
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Thus ZBB can be immediately effective where costs can be related to identifiable activities.
The questions that might emerge in such situations are as follows:
„
Can costs associated with an activity be isolated? If costs cannot be identified to a
particular activity to a degree that provides management with confidence that they
can change the costs then there is little point in applying ZBB techniques to the
cost;
„
An even more basic question is to ask how important the activity is to the business
and what, if the costs can be identified, is the total cost saving that might result
should the activity be stopped. In this respect, it is important to identify effects on
costs elsewhere in the business. If the activity to be stopped absorbed fixed costs,
then the fixed costs will have to be re-apportioned without absorption to the activity
that is to be stopped. Moreover, there may be joint costs such that stopping one
activity may have an uncertain effect on joint costs incurred with another activity;
„
Is the activity in question the cheapest way of providing the service or contribution
to production? Thus, it is important not to ask simply if the costs relating to the
activity are the most efficient, but are there alternatives that might reduce costs still
further and still maintain a given level of service or production;
„
A more fundamental question about conducting ZBB processes is whether the
benefits of employing ZBB outweigh the costs. It is important to appreciate that
conducting a ZBB exercise is not a costless process if, as will inevitably be the case,
management time is consumed.
Deciding which activities should be provided with a budget
Budgeted activities should be capable of being monitored and controlled. If an activity is
recognised as a budget centre, and is going to be subject to a ZBB process, then it is important
that management undertake the task of monitoring costs in relation to activity and taking
corrective action when appropriate. Thus, if an activity consumes resources and is capable of
being monitored and controlled then it should be provided with a budget. This will then make
the activity subject to ZBB processes.
“Decision packages” are sometimes referred to in the context of ZBB and activities. These
relate to how activities can be described when thinking about how ZBB can be used to judge
an activity. There are two types of decision activity:
1058
„
Mutually exclusive decisions: when ZBB assessments are made of an activity,
alternative courses of action are sometimes benchmarked against existing activities.
A choice is then made over which activity might be the preferable course of action.
The preferred choice will involve budgeted information, but may also involve other
factors such as product quality and service level provision.
„
Incremental decisions: ZBB assessments are often related to the level of activity in a
budget centre. Thus, there will be a minimum level of activity that provides the
essential level of product or service. This is often referred to as the “base” activity.
Further levels of activity are then incremental and, subject to correctly identifying
and isolating the variable costs related to an activity, ZBB assessments can be made
separately of both the base and the incremental activities. This division might then
provide management with an understanding of the degree of flexibility the
organisation has.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Questions to be asked when ranking budgeted activities for scarce resources
The allocation of scarce resources is a key management task. Scarce resources will have to be
allocated to the activities of a business in terms of providing appropriate labour and materials,
along with any other costs related to an activity. Whilst ZBB is most often applied to support
activities, the technique can also be applied to a production process.
Some sorting of ranking will have to be applied in order to determine which activities are
funded by a budget against those that are not. The key question for budgeting purposes
relates to:
„
Defining the appropriate decision package (as described above);
„
The importance of the activity in relation to the organisation in terms of:
‰
‰
„
Support for the organisation’s objective (e.g. maximising shareholder wealth);
Support for other service or product activities;
How the ranking system is to be used:
‰
Are all activities to be funded above a certain rank; or
‰
Is there a scaling of funds allocated against funds requested as determined
by the rank; or
‰
Is there a combination of methods?
Essentially, a judgement has to be made by management of the benefit of the activity to the
organisation. Theoretically, this is best achieved by determining deprival value. In practice,
deprival values are difficult tools and some level of arbitrary judgement has to take place in
which non-financial factors might play a significant role.
(c)
Critical assessment of the use of ZBB
The motivation of employees is one of the most difficult tasks facing management since the
problems are complex and not always referable to financial performance indicators. To the
extent that employees are not responsive to financial performance indicators then ZBB is
going to be less effective as a device to motivate employees.
The problem of employee motivation is one of achieving goal congruence with the
organisational objectives. ZBB can be useful in this respect as a method of tackling the
problem of motivating employees to achieve targeted performance when a clear
understanding of the activities and their related decision packages is essential for the
management tasks of monitoring and controlling an activity.
In this respect ZBB has the following advantages
„
It ensures that only forward-looking objectives are addressed. This limits the
potential for historical abuses in budget setting to be established. Employees can be
set targets that are consistent with the future objectives of the organisation.
„
Building “budget slack” is minimised because, in principle, the entire costs of an
activity are reviewed at each budget setting stage. Employees are then set realistic
targets that relate to activity levels that are the most efficient.
„
Managers are made to understand, as part of the ZBB process, the activity itself.
This reduces tension between those who decide (management) and those who have
to implement manager decisions. Claims that management do not really understand
the nature of an activity are thus reduced.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1059
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
„
(d)
ZBB encourages flexibility in employees since they know that potentially activities
may be stopped. Flexibility induces goal consistency by enabling incentive
schemes to reflect activity. In other words, employees are more likely to be
responsive to management directives if they are aware and trust that the budget
setting process encourages and supports payments that are responsive to flexibility.
Advantages of encouraging employee participation in budget setting
Generally, participative budget setting will result in:
„
An informed budget setting process such that management are aware of the detail of
budgeted activities as provided by the people who work daily in the budgeted
activity;
„
Avoids the criticism that budgets are unrealistic;
„
Participation reduces the adverse effects of budget imposition when difficult
management decisions have to be made (e.g. staff reduction);
„
Employees become aware and more involved in the management activities of the
organisations. To the extent that they become more aware, then a greater
understanding of the needs of the organisation as a whole is reached;
„
Coordination in an activity might be improved. If activities are jointly budgeted, or
are part of the same process, then coordination between activities might be
improved;
„
Budgetary slack may be reduced as management become more aware of the
operational activities in an activity;
„
Achievable budgets are more likely to be set;
„
When budgets are not met management are more likely to have a deeper knowledge
of the operational issues involved;
„
There is less risk that subordinates will undermine budgets.
Answer 29 BUDGETING & COSTING
(a)
Application to not-for-profit organisations
Not-for-profit (NFP) organisations such as charities deliver services that are usually limited
by the resources available to them. It may be possible neither to express their objectives in
quantifiable or measurable terms, nor to measure their output in terms of the services they
deliver. The financial focus in NFP organisations is therefore placed on the control of costs.
Selection of cost units
A cost unit for a NFP organisation is a unit of service for which costs are ascertained. These
cost units will be used to assess the efficiency and effectiveness of the organisation. The
problem for a NFP organisation is that it may not have easily identifiable cost units, and it
may not be possible to identify costs with specific outputs. Once appropriate cost units have
been identified, however, they can be used to provide cost control information. Examples of
costs units used by an NFP organisation are patients, wards, drug treatment programmes, bednights and operations, which are all used by a hospital.
1060
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Use of performance measures to measure output and quality
Where output for a NFP organisation can be quantified, targets can be set and performance
against these targets can be measured. In a university, for example, targets could be set in
terms of the number of students graduating with a first-class degree, the number of students in
a tutorial group, and the percentage of students who complete a degree course having started
it. Information could easily be gathered to enable an assessment of the University’s
performance compared to agreed, budgeted or imposed targets.
Measuring performance in terms of quality is not so easy. It may be possible to use a
surrogate or substitute performance measure if a quality cannot be directly measured. For
example, the efficiency of hospital outpatient treatment could be measured by the average
length of the queue for treatment. The quality of a University course could be assessed by a
composite weighting of responses to individual student questionnaires.
Comparison of planned and actual performance
It is likely that a NFP organisation will have a budget that details expected levels of income
(for example from donations and investments) and expenditure (for example on staff wages,
continuing programmes, fixed overheads and planned purchases). The use and application of
costing principles and information here is no different than in a profit-making organisation.
Planned performance can be compared to actual performance, income and cost variances
calculated and investigated, and corrective action taken to remedy under-performance.
Where objectives cannot be specified in terms of quantifiable targets, costing information will
serve no purpose and assessment of actual performance with planned performance will need
to be undertaken from a more subjective perspective.
(b)
Key features of zero-based budgeting
Zero-based budgeting requires that activities be re-evaluated as part of the budget process so
that each activity, and each level of activity, can justify its consumption of the economic
resources available. This is in contrast to incremental budgeting, where the current budget is
increased to allow for expected future conditions. Zero-based budgeting prevents the carrying
forward of past inefficiencies that can be a feature of incremental budgeting and focuses on
activities rather than departments or programmes. Each activity is treated as though it was
being undertaken for the first time and is required to justify its inclusion in the budget in
terms of the benefit expected to be derived from its adoption.
The first step in zero-based budgeting is the formulation of decision packages. These are
documents which identify and describe a given activity or group of activities in detail. The
base package represents the minimum level of activity that is consistent with the achievement
of organisational objectives. Incremental packages describe higher levels of activity that may
be delivered if they are acceptable from a cost-benefit perspective.
Following the formulation of decision packages, they are evaluated by senior management
and ranked by decreasing benefit to the budgeting organisation. Resources should then be
allocated, theoretically at least, to decision packages in order of decreasing marginal utility
until all resources have been allocated.
Advantages claimed for zero-based budgeting are that it eliminates the inefficiencies that can
arise with incremental budgeting, that it fosters a questioning attitude towards current
activities and that it focuses attention on the need to obtain value for money from the
consumption of organisational resources.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1061
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Value for money is important in not-for-profit (NFP) organisations, where the profit motive
found in the private sector is replaced by the need to derive the maximum benefits from
limited resources available. Providers of funds to NFP organisations expect to see their cash
being used wisely, with as much as possible being devoted to the achievement of
organisational aims. For this reason, NFP organisations emphasise cost control and the need
for economy in the selection of resources, efficiency in the consumption of resources and
effectiveness in the use of resources to achieve organisational objectives (i.e. value for
money).
Zero-based budgeting can therefore be applied in a NFP organisation to analyse its activities
and the services it provides into decision packages, with a view to ranking them on a costbenefit basis relative to organisational aims and objectives. In has been noted that zero-based
budgeting can be applied more effectively in service-based rather than manufacturing
organisations and so it may be ideally suited to a NFP organisation such as a charity.
(c)
Activity-based budgeting
Activity-based budgeting (ABB) would need a detailed analysis of costs and cost drivers so as
to determine which cost drivers and cost pools were to be used in the activity-based costing
(ABC_ system. However, whereas ABC uses activity-based recovery rates to assign costs to
cost objects, ABB begins with budgeted cost-objects and works back to the resources needed
to achieve the budget.
Once the budgeted activity levels have been determined, the demand for resource-consuming
activities is assessed from an organisational perspective. The resources needed to provide for
these activities are then assessed and action taken to ensure that these resources are available
when needed in the budget period.
The budgeted activity levels are determined in the same way as for conventional budgeting in
that a sales budget and a production budget are drawn up. ABB then determines the quantity
of activity cost drivers (e.g. number of purchase orders, number of set-ups) needed to support
the planned sales and production. Standard cost data would be compiled that included details
of the activity cost drivers required to produce a product or number of products.
The resources needed to support the budgeted quantity of activity cost drivers would then be
determined (e.g. number of labour hours to process purchase orders, number of maintenance
hours needed to complete set-ups). This resource need would then be matched against the
available capacity (i.e. number of purchase clerks to process purchase orders) to see whether
any capacity adjustments were needed.
One advantage suggested for ABB is that organisational resources are allocated more
efficiently due to the detailed cost and activity information obtained by implementing an ABB
system. Another advantage of ABB is that it avoids the pitfalls of incremental budgeting due
to its detailed assessment of the activities and resources needed to support planned sales and
production. In ABB the costs of support activities are not seen as fixed costs to be increased
by annual increments, but as depending to a large extent on the planned level of activity.
1062
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Answer 30 THE WESTERN
(a)
Tonnes of waste calculation
In 2010 the four quarters will be numbers 5–8, consequently the trend figures for waste to be
collected will be:
Quarter 1 (Q = 5): 2,000 + 25(5) = 2,125 tonnes
Quarter 2 (Q = 6): 2,000 + 25(6) = 2,150 tonnes
Quarter 3 (Q = 7): 2,000 + 25(7) = 2,175 tonnes
Quarter 4 (Q = 8): 2,000 + 25(8) = 2,200 tonnes
Seasonal adjustments are needed thus:
Quarter 1: 2,125 – 200 = 1,925
Quarter 2: 2,150 + 250 = 2,400
Quarter 3: 2,175 + 150 = 2,325
Quarter 4: 2,200 – 100 = 2,100
Total tonnage is 1,925 + 2,400 + 2,325 + 2,100 = 8,750 tonnes for the year.
(b)
Variable and fixed operating cost
Regression analysis can be used to calculate the variable operating and fixed operating costs
in 2009.
Tonnes (X)
Sum
2,100
2,500
2,400
2,300
9,300
Total Cost (Y)
$000’s
950
1,010
1,010
990
3,960
X2
XY
1,995,000
2,525,000
2,424,000
2,277,000
9,221,000
4,410,000
6,250,000
5,760,000
5,290,000
21,710,000
Y = a +bX
Where “a” is fixed operating cost and “b” is variable operating cost in this context.
Using the formula given:
b = (4 × 9,221,000 – 9,300 × 3,960)/(4 × 21,710,000 – (9,300)2)
b = 0.16 or $160 per tonne as the original data is in $000’s. This was the variable operating
cost per tonne for 2009.
a = (3,960/4) – (0.16 × 9,300/4)
a = 618 or $618,000 as the original data is in $000’s. This was the fixed operating cost in
2009.
Allowing for inflation:
The variable operating cost in 2010 will be $160 × 1.05 = $168 per tonne
The fixed operating cost in 2010 will be $618,000 × 1.05 = $648,900
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1063
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
(c)
Advantages and disadvantages of incremental budgeting approach
Advantages
„
Local government organisations are often complex and incremental budgeting will
be seen as a simple approach to a budget that will take little effort.
„
Budget processes can be long ones, however incremental approaches do tend to be
quicker than most. Complex local government organisations can suffer from very
long budget processes and incremental budgeting can alleviate this a little.
Disadvantages
„
Public bodies, such as local governments, will be encouraged to use up this year’s
entire budget in order to ensure that next year’s budget will be as high as possible to
give them the flexibility they need to do whatever is needed. The public services
required can be unpredictable and so local government organisations prefer to be
able to be flexible.
„
Overspends made in this year will be budgeted for again next year, this is hardly
giving taxpayers value for money.
Answer 31 STORRS CO
(a)
Sales forecast
The centred moving averages can be compared with actual sales for each quarter in order to
determine the seasonal variations.
Quarter
Actual
Sales
$000
Centred
Seasonal
moving average variation
$000
$000
201X
Q3
Q4
3,400
3,000
3,200
3,300
200
(300)
201Y
Q1
Q2
Q3
Q4
3,100
3,900
3,600
3,400
3,375
3,450
3,562.5
3,687.5
(275)
450
37.5
(287.5)
The average seasonal variations and the residual error term can now be calculated.
Quarter 1 Quarter 2
$0000
$000
201X
201Y
Average
(275)
(275)
450
450
Quarter 3
$000
200
37.5
118.75
Quarter 4
$000
(300)
(287.5)
(293.75)
Total
$000
nil
Since the residual error term is nil, there is no need to net this off against the average seasonal
variations. The average trend of the centred moving averages is (3,687.5 – 3,200)/5 =
$97,500
The sales for Quarter 3 of 201Z can now be forecast.
1064
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Forecast centred moving average = 3,687.5 + (3 × 97.5) = $3,980,000
Forecast sales for Quarter 3 = 3,980,000 + 118,750 = $4,098,750
The sales for Quarter 4 of 201Z can now be forecast.
Forecast centred moving average = 3,687.5 + (4 × 97.5) = $4,077,500
Forecast sales for Quarter 4 = 4,077,500 – 293,750 = $3,783,750
Both forecasts are higher than those made by the Sales Director (7.9% more for the Quarter 3
forecast and 5.1% for the Quarter 4 forecast). This may be because the Sales Director built
some slack into his forecasts, or because the forecasts were made using data prior to the
current year (although applying the additive model to earlier sales data does not support this).
(b)
Limitations of the sales forecasting method
The additive model assumes that the trend and seasonal variations are independent of each
other, and that an increasing trend is not linked to increasing seasonal variations. There is no
evidence of an increasing trend in the sales of Storrs, and in such circumstances use of the
additive model may be acceptable.
The model assumes that the historic pattern of the trend and the seasonal variations will
continue in the future. This may not happen for a number of reasons, for example because of
the occurrence of unexpected events or because of changes in consumer preferences. The
forecast sales figures should be compared with the expectations and opinions of sales staff,
who may have a more detailed knowledge of likely sales and market factors.
The reliability of the forecasting method is linked to the amount and accuracy of the data
analysed. Since only two years of data has been considered, the forecast is unlikely to be
reliable. The reliability of the forecast will also decrease as the forecasting period increases,
but the forecast period here is only six months.
(c)
Relative merits of top-down and bottom-up approaches
The top-down approach to budget setting implies that senior management imposes budgets.
This has the advantage that budgets are more likely to support the strategic objectives of the
company, and the operations of different divisions are more likely to be co-ordinated. It may
be an appropriate form of budget setting in small organisations, where senior managers are
likely to have a detailed knowledge of all aspects of the business, or in situations where close
control of planned costs is called for, such as business start-up or difficult economic
conditions. It also has the advantage of decreasing the amount of time taken, and the
resources consumed, by budget preparation.
There are number of difficulties with the top-down approach that make it likely that it will not
regularly be used in isolation. Staff may be de-motivated if they have not been involved in
the formulation of budgets that produce targets they are expected to achieve, especially if
their rewards and incentives are linked to their performance against budget. This reduction in
motivation could result in strategic objectives and organisational goals being less than fully
supported at the operational level, with company performance and profitability suffering as a
result. Initiative and innovation could also be lost as staff simply “work to budget”, rather
than making creative suggestions for improving performance that they feel are unlikely to be
rewarded, or form part of future plans.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1065
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
The bottom-up approach to budget setting implies that functional and other junior managers
participate in the preparation of budgets. This approach is likely to lead to more realistic and
more co-ordinated budgets than the top-down approach if these managers have a more
detailed knowledge of the operations and markets of the organisation. It is also likely to be
useful in large, established companies where the complexity of the budget-setting process
calls for detailed input from lower levels of the organisation. This approach will also lead to
higher levels of motivation and commitment, since managers will have contributed towards
the targets against which their performance will be measured.
There are a number of difficulties with the bottom-up approach. For example, it can be more
time-consuming than the top-down approach because of the larger number of participants in
the budget-setting process. Participants may become dissatisfied if senior managers
subsequently amend their budget proposals. Managers may introduce an element of
budgetary slack into their budget estimates, giving them a “zone of comfort” in reaching
budget targets. Any variances between planned and actual performance are then likely to be
favourable ones. The bottom-up approach also requires detailed planning and co-ordination
of the budget-setting process, perhaps supported by a budget manual.
The top-down and bottom-up approaches represent two extremes of the budget-setting
process. In practice, a compromise or negotiated approach is likely to be used, with senior
management reviewing and amending the budget proposals of junior or operational managers
in the light of the organisation’s strategic plan, and junior or operational managers negotiating
amendments to aspects of the budget they find unacceptable.
Answer 32 SOUTH
(a)
Regression analysis
x
units
300
400
150
260
–––––
1,110
–––––
y
$000
3.8
4
3
3.5
––––
14.3
––––
xy
x2
1,140
1,600
450
910
–––––
4,100
–––––
90,000
160,000
22,500
67,600
–––––––
340,100
–––––––
n=4
b=
4 × 4,100 - 1,110 × 14.3
4 × 340,100 - (1,110) 2
b=
527
= 0.0041
128,300
a=
14.3
1,110
– 0.0041 ×
4
4
a = 2.437
Total cost = 2.437 + 0.0041 × activity (with total cost in $000)
Total cost = 2,437 + 4.1 × activity (with total cost in $)
1066
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
(b)
Total cost
Total cost at 200 units = 2,437 + 4.1 × 200 = $3,257.
Since the value of 200 units lies within the range of the data (i.e. interpolation) some reliance
can be placed on the value generated.
Total cost at 500 units = 2,437 + 4.1 × 500 = $4,487
Since the value of 500 units lies outside the range of the data (i.e. extrapolation) very little
reliance can be placed on the value generated.
Answer 33 HENRY CO
(a)
Factors to consider in calculating bid
There are various issues that HC should consider in making the bid. (Only five are required
for two marks each.)
Contingency allowance. HC should consider the extent to which its estimates are accurate
and hence the degree of uncertainty it is subjected to. It may be sensible to allow for these
uncertainties by adding a contingency to the bid.
Competition. HC must consider which other businesses are likely to bid and recognise that
the builder may be able to choose between suppliers. Moreover, HC has not worked for this
builder before, and so they will probably find the competition stiff and the lack of reputation a
problem.
Inclusion of fixed overhead. In the long run fixed overhead must be covered by sales
revenue in order to make a profit. In the short run it is often correctly argued that the level of
fixed cost in a business may not be affected by a new contract and therefore could be ignored
in bid calculation. HC needs to consider to what extent the fixed costs of its business will
change if it wins this new contract. It is these incremental fixed costs that are relevant to a bid
calculation.
Materials and loose tools. No allowance has been made for the use of tools and the various
fixings (screws etc.) that will be needed to assemble and fit the kitchens. It is possible that
most fixings would be provided with the kitchen units, but HC should at least consider this.
Supervision of labour. The time given in the question is 24 hours to “fit” the first kitchen.
There seems to be no allowance for supervision of the labour force. It could, of course, be
included in the overhead figures but no detail is shown.
Idle time. It is common for building works to be delayed by lack of materials for example.
The labour time figure needs to reflect this.
Likelihood of repeat business. Some businesses consider it worthwhile to accept a low price
for a new contract if it establishes a reputation with a new buyer. HC could offer to do this
work cheaper in the hope of more profitable work later on.
The risk of non-payment. HC may decide not to bid at all if it feels that the builder may
struggle to pay.
Opportunity costs of alternate work.
Possibility of working in overtime.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1067
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
(b)
Total cost
Bid calculations for HC to use as a basis for the apartment contract.
Cost
$
Labour
Variable Overhead
Fixed Overhead
Hours
Rate per hour
9,247 (W1)
9,247
9,247
$15
$8 (W2)
$4 (W2)
Total Cost
Total
138,705
73,976
36,988
–––––––
249,669
–––––––
WORKINGS
(1)
Learning curve effect
Need to calculate the time for the 200th kitchen by taking the total time for the 199 kitchens
from the total time for 200 kitchens.
For 199 Kitchens
Using
y = axb
y = 24x199–0.074
y = 16.22169061hours
Total time = 16.22169061 × 199
Total time = 3,228·12hours
OR
y = axb
y = (24 × 15) × 199–0.074
y = 243.32536
Total cost = $48,421.75
OR
y = axb
y = (24 × 15) × 200–0.074
y = 243.2351198
Total cost = $48,647.02
200th cost = $225.27
For 200 Kitchens
y = axb
y = 24x200–0.074
y = 16.21567465hours
Total time = 16.21567465 × 200
Total time = 3,243.13hours
The 200th Kitchen took 3,243.13 – 3,228.12 = 15.01 hours
Total time is therefore:
For first 200
For next 400 (15.01 hours × 400)
Total
(2)
3,243.13 hours
6,004.00 hours
9,247.13 hours (9,247 hours)
Analysis between variable and fixed cost elements
Taking the highest and lowest activity levels from the information given:
Hours
Highest
Lowest
Difference
9,600
9,200
400
Cost
$
116,800
113,600
3,200
Variable cost per hours is $3,200/400hours = $8 per hour
1068
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Total cost = variable cost + fixed cost
116,800 = 9,600 × 8 + fixed cost
Fixed cost = $40,000 per month
Annual fixed cost = $40,000 × 12 = $480,000
Fixed absorption rate is $480,000/120,000 hours = $4 per hour
(c)
Calculation of learning rate
A table is useful to show how the learning rate has been calculated:
Number of
Kitchens
1
2
Time for Kitchen
(hours)
24.00
21.60
Cumulative time
(hours)
24.00
45.60
Average time
(hours)
24.00
22.80
The learning rate is calculated by measuring the reduction in the average time per kitchen as
cumulative production doubles (in this case from 1 to 2).
The learning rate is therefore 22.80/24.00 or 95%.
Answer 34 BIG CHEESE CHAIRS
(a)
Average cost
First 128 chairs
$
51.00
25.00
20.95
––––––
96.95
––––––
Frame and massage mechanism
Leather 2 metres × $10/metre × 100/80
Labour (W1)
Total
Target selling price is $120.
Target cost of the chair is therefore $120 × 80%
Cost gap
$96
$0.95 per chair
WORKING
(1)
Labour cost
Tutorial note: This is calculated using learning curve principles. Either the formula or a
tabular approach would give the average cost of 128 chairs. Both methods are acceptable.
Cumulative output
(units)
1
2
4
8
16
32
64
128
Average time per
unit (hours)
2
1.9
1.805
1.71475
1.6290125
1.54756188
1.47018378
1.39667459
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
Total time
(hours)
Average cost per
chair at $15 per hour
178.77
20.95
1069
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Formula:
Y = axb
Y = 2 × 128–0·074000581
Y = 1.396674592
The average cost per chair is 1.396674592 × $15 = $20.95
(b)
Closing the cost gap
To reduce the cost gap various methods are possible (only four are needed for full marks):
(c)
„
Re-design the chair to remove unnecessary features and hence cost.
„
Negotiate with the frame supplier for a better cost. This may be easier as the
volume of sales improve as suppliers often are willing to give discounts for bulk
buying. Alternatively a different frame supplier could be found that offers a better
price. Care would be needed here to maintain the required quality.
„
Leather can be bought from different suppliers or at a better price also. Reducing
the level of waste would save on cost. Even a small reduction in waste rates would
remove much of the cost gap that exists.
„
Improve the rate of learning by better training and supervision.
„
Employ cheaper labour by reducing the skill level expected. Care would also be
needed here not to sacrifice quality or push up waste rates.
Calculation of cost
The cost of the 128th chair will be:
$
51.00
25.00
19.35
––––––
95.35
––––––
Frame and massage mechanism
Leather 2 metres × $10/metre × 100/80
Labour 1.29 hours × $15 per hour (W2)
Total
Against a target cost of $96 the production manager is correct in his assertion that the required
return is now being achieved.
WORKING
(2)
Using the formula to calculate the cost of the first 127 chairs and then deducting that cost
from the cost of the first 128 chairs gives:
Y = axb
Y = 2 × 127–0.074000581
Y = 1.39748546
Total time is 127 × 1.39748546 = 177.48 hours
Time for the 128th chair is 178.77 – 177.48 = 1.29 hours
1070
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REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Answer 35 STANDARD COSTING
Standard costing has been employed for many years in situations where there is a significant degree of
repetition in the production process or the service supplied. Repetition is a condition since standards
presuppose that averages, as expected values, are accurate to a fair degree.
The main uses of standard costing relate to:
„
Valuation of inventory and costs of production for reporting purposes, either internally or for
statutory reasons.
„
Providing an excellent management device, which enables costs to be monitored, reviewed
and controlled.
„
Enabling exception reporting through the use of variance analysis. Exception reporting
allows management to exercise control with a lower degree of effort and less time than
otherwise would be the case.
„
Assisting in the budgeting process. Standards, once established in a business, become the
common language by which performance is discussed and measured.
„
Evaluating managerial performance.
„
Motivation of staff by setting standards at levels to which staff feel able to respond. In this
respect, standards have been characterised as “ideal”, “attainable”, “current”, and “basic” as a
way of categorising the different ways standards may be viewed in terms of their motivational
impact.
„
Improving efficiency. Standard setting is often viewed as a way of understanding the detail of
a process through monitoring its important components. If standards are an accurate
reflection of a process, then they can be used to highlight ways of improving efficiency and
act as signals when the process becomes inefficient.
Once standards have been set they cannot be assumed to be accurate over long periods of time.
Standards have to be reviewed to enable the benefits of standard costing to continue. In this respect,
standards must change with the changing practices of an organisation. For example, in environments
that continuously seek greater efficiency and reduced costs of production, standards have to change to
reflect such improvements. In fact, under such circumstances, standards can very quickly become out
of date. In order to review standards, they must be continually assessed to ensure that the basis of their
calculation still applies. Moreover, other purposes of standards are undermined if they are not
continually reviewed. Thus, for example:
„
The motivational impact of standards may no longer be effective if standards are out of date.
„
Assessment of managerial performance becomes inaccurate.
„
Reporting procedures are undermined.
„
The credibility of standards in their role in assisting with the budget setting process is called
into question.
„
The fate of standard costing as a management tool is put at risk if management do not trust the
standards. Alternative mechanisms for management control inevitably emerge which may be
undesirable, untested and lack organisational approval.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1071
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Answer 36 INFORMATION SOURCE
(a)
Purposes of standard costing
A standard costing system can support a wide range of management requirements. For
example:
It can help in the development of budgets; standards are in effect the building blocks of
periodic budgets.
If handled correctly by management the existence of an appropriately set standard can act as a
target and hence become a source of employee motivation
To the extent that standards are measures of expected performance by departments or
individuals standard costs are the basis for measuring performance.
Following on from the above, the variances that are derived from standard costs act as a
control device by highlighting those activities that are different from plans. This signals to
decision makers the need for action to take advantage of any circumstances that have
produced favourable variances or minimise the repercussions of any adverse variances.
Standard costs are predicted future costs, which can be used to support decision making, for
example in making pricing decisions.
In manufacturing companies a key requirement of costing is the valuation of inventory.
Standard costs simplify the process of tracing costs to products for inventory valuation.
NB. The question asks for four of the above.
(b)
Different levels of performance
Basic standards – such standards are left unchanged for a long period, perhaps from the
inception of the product or service concerned. They may be useful in demonstrating a
progression of improved performance over a period of time, but do not represent current
targets. Therefore, they do not motivate, they do not result in representative unit costs and are
inappropriate as predicted costs for decisions.
Ideal standards – these represent perfect performance and the most efficient operating
conditions reflecting the lowest possible costs. They are a useful objective to which the firm
can aspire over the long term but firms will rarely achieve this level of performance
consistently. As a result adverse variances will almost always be reported, this will inevitably
have an adverse effect on employee attitude and motivation. They represent budget figures
which are too tight and inappropriate from which to set prices or to use directly as
performance measures in most circumstances.
Currently attainable standards – these standards represent costs, which should be attained
under current efficient operating conditions. They are a reasonable target and represent a
likely level of future costs if operations are managed efficiently. They are a level of
performance, which does not demotivate staff. They are therefore the figures that can be used
to manage the current operations of a business unit. They are figures that can support
planning and decision-making and as current cost levels they are appropriate for inventory
valuation. It should be expected that most companies would run their systems based on these
standards. The first two levels mentioned above may, on the other hand, be useful for
strategic purposes, demonstrating on an ad hoc basis, how far the company has come or how
far it has to go.
1072
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
(c)
Standard costing application
Standard costing is most suited to organisations whose activities consist of a series of
common or repetitive operations. Typically, mass production manufacturing operations are
indicative of its area of application. It is also possible to envisage operations in the service
sector to which standard cost may apply, though this may not be costed with the same degree
of accuracy of standards that apply in manufacturing. For example, hotels and restaurants
often use standard recipes for food preparation; dealing with conference attendance can be
like a mass production environment. Similarly, banks will have common processes for
dealing with customer transactions, processing cheques etc. It is possible therefore that the
principles of standard costing may be extended to service industries.
In modern manufacturing and service businesses, continuous improvement and cost reduction
are topical. In order to remain competitive it is essential that businesses address the cost
levels of their various operations. To do this they have to deal with the costing of operations.
But the drive to “cost down” may mean in some cases that standards do not apply for long
before a redesign or improvement renders them out of date. In such a setting an alternative to
the use of standard costs is to compare actual costs with those of the previous operating
period. As seen in (a) above, a standard costing system has a variety of purposes. It is for
management to judge their various reasons for employing standard costing, and consequently
whether their aims of continuous improvement and cost reduction render the system
redundant.
(d)
Factors which limit the usefulness of variances
Standard costing variances are a convenient way of summarising the results of an operating
period by focusing on the financial impact of deviations from a budgeted result. The
variances, which can be identified as to cause and responsibility, are in total the absolute
difference that actual results bear to an original plan. The exercise of variance analysis is not
without difficulty however, and the following is a critique of the technique, bringing out some
of the practical problems.
For direct costs the traditionally adopted formula creates an analysis of price and usage
variances. However, this division is only by the convention of the variance formula and the
existence of joint variances influenced by a combination of price and usage could also be
compiled in certain circumstances, say when remuneration is based on the results of the
reported variance.
The complexity of the variance calculation can at times however, be taken too far, for
example the extraction of mix, yield and price variances say in relation to materials costs can
be questionable. Most of these variances can be inter-related. It is dangerous to interpret
individual variances in isolation, interdependency should be recognised.
Concerning variable and fixed overheads, the level of costs is controllable against a budget
and this is often a fixed budget. When activity levels change it is important to remember that
the variable costs need to be flexed to allow for this. This raises the problem of which costs
to flex and what measure of activity (i.e. number of units, hours of work etc.) to use as the
basis of flexing. There is unlikely to be exact correlation between the measure of activity
chosen (say labour hours) and the cost change, therefore care should be exercised in the
interpretation of these variances. A comparison of the actual and standard activity levels
facilitates the extraction of an efficiency variance in relation to variable overheads. Whether
the results of such analysis reflect a more or less efficient use of variable overhead resources
has been questioned.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1073
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Perhaps the variance that attracts most criticism is the fixed overhead volume variance. This
variance represents the fixed overhead cost or benefit of working at a volume level below or
above that that was budgeted. Though it is important to reconcile budget and actual volumes,
the value applied to the volume variance does not report a meaningful cost in all
circumstances. For example, as costs are fixed, by definition, extra volume, if available, is
“free” up to a certain limit. In other circumstances if time is scarce then the cost of any time
wasted, for example, may be far higher than the fixed overhead rate. It has been pointed out
that the calculation of an overhead recovery rate per unit or per hour applied to fixed
overheads may be unhelpful because it is in effect treating fixed overheads as if they were
variable costs.
Tutorial note: In the latter stages of this question, especially parts (c) and (d), there is scope
for slightly different content or views to be expressed than those in the outline answer. Credit
will be given for points other than those stated above.
Answer 37 WOODEEZER CO
(a)
Operating statement
Budgeted profit (4,000 × $28)
Sales volume profit variance (3,200 – 4,000) $28
Standard profit on actual sales
Selling price variance (225 – 220) 3,200
$
112,000
(22,400) A
–––––––
89,600
16,000 F
–––––––
105,600
Cost variances
(b)
Favourable Adverse
Material usage
[(3,600 × 25) – 80,000] $3·2
32,000
Material price
(3·2 – 3.5) 80,000
24,000
Labour efficiency
[(4 × 3,600) – 16,000)] $8
12,800
Labour rate
(8 – 7) 16,000
16,000
Var O/H efficiency [(4 × 3,600) – 16,000)] $4
6,400
Var O/H expenditure ($4 × 16,000) – 60,000
4,000
Fixed O/H expenditure (256,000 – 196,000)
60,000
Fixed O/H efficiency [(4 × 3,600) – 16,000)] $16
25,600
Fixed O/H capacity [16,000 – (4 × 4,000)] $16
nil
––––––– –––––––
112,000
68,800
43,200
––––––– ––––––– –––––––
Actual profit
148,800
–––––––
Impact of operational changes
Motivation and budget setting
Absorption costing profit has increased by $53,600 from $95,200 (28 × 3,400) to $148,800.
It would appear that in the past an expectations budget has been set whereby the target output
was set at the level that employees were expected to achieve.
Mr Beech appears to have considered the evidence that suggests that the best budget for
motivating employees to maximise achievement (in this case output) is one which is difficult
but credible (an aspirations budget). In maximising actual performance, however, it is
normally expected that production will fall short of the budget target. This means that there is
an expectation of adverse planning variances.
1074
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REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Explanations of variances
The sales volume variance and the sales price variance may be inter-related as an increase in
price is likely to reduce demand, thus an adverse sales volume variance is consistent with a
favourable sales price variance given the price increase.
Better quality materials are being purchased by Mr Beech and, given this was not foreseen at
the time of the budget, it may explain a higher price resulting in an adverse materials price
variance. Conversely, with better materials there may be less waste and thus it may have
contributed to the favourable materials usage variance.
The lower skilled labour may account for the favourable labour rate variance but may also
account for the adverse labour efficiency variance as less skilled labour may take longer to
complete a given task. Also if new labour is introduced there may be an initial learning
effect.
The impact of the labour efficiency variance is magnified by the variable and fixed overhead
efficiency variances as they are merely linear functions of the labour efficiency variance.
Their meaning is questionable however, as variable overheads seldom vary proportionately to
labour hours. By definition fixed overheads do not vary with labour hours and this variance
merely “balances the books” in an absorption costing system.
The fixed overhead expenditure variance is significant and requires further consideration.
This is particularly the case if it involves discretionary expenditure which has been reduced
but which may have a long-term impact on the business.
(c)
Marginal costing
Marginal cost statement (this could be in summarised form by candidates)
$
368,000
(73,600) A
–––––––
294,400
16,000 F
–––––––
310,400
Budgeted contribution (4,000 × $92)
Sales volume variance (3,200 – 4,000) $92
Standard contribution on actual sales
Sales price variance (220 – 225) 3,200
Cost variances
Materials usage [(3,600 × 25) – 80,000] $3.2
Materials price (3.2 – 3.5) 80,000
Labour efficiency [(4 × 3,600) – 16,000)] $8
Labour rate (8 – 7) 16,000
Var O/H efficiency [(4 × 3,600) – 16,000)] $4
Var O/H expenditure ($4 × 16,000) – 60,000
Actual contribution
Fixed overheads
Budgeted
Expenditure variance
Actual profit
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
Favourable Adverse
32,000
24,000
12,800
16,000
6,400
4,000
–––––– ––––––
52,000 43,200
8,800
–––––––
319,200
256,000
60,000
––––––– (196,000)
–––––––
123,200
–––––––
1075
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Reconciliation
Absorption costing profit
Fixed costs in inventory [400 × $64]
(inventory is now restated to variable cost)
Variable costing profit
148,800
(25,600)
–––––––
123,200
–––––––
Thus some of the “success” of Mr Beech in increasing profit arises from the fact that fixed
overheads of $25,600 are not being written off in the current month but are being carried
forward as part of closing inventory, notwithstanding that they are period costs and are thus
sunk. Unless sales can be increased this position is unsustainable.
Nevertheless, some improvement has been made as the previous contribution was, taking the
budget as the historic norm, $312,800 [3,400 × ($220 – 128)], which is lower than the
$319,200 achieved by Mr Beech. The difference is, however, much lower than would be
implied by the absorption costing statement.
Answer 38 MERMUS CO
(a)
Revised budget using flexible budgeting
The flexed budget will be based on the actual activity level of 90,000 units.
$
Sales: $950,000 × 90/95 =
Cost of sales
Raw materials: 133,000 × 90/95 =
Direct labour: 152,000 × 90/95 =
Variable production overheads: 100,700 × 90/95 =
Fixed production overheads:
$
900,000
126,000
144,000
95,400
125,400
–––––––
490,800
–––––––
409,200
–––––––
(b)
Variance calculations
Raw materials cost total variance = 126,000 – 130,500 = $4,500 (Adverse)
Direct labour cost total variance = 144,000 – 153,000 = $9,000 (Adverse)
Fixed overhead absorption rate = 125,400/28,500 = $4.40 per machine hour
Standard machine hours for actual production = 28,500 × 90/95 = 27,000 hours
Standard fixed overhead (actual production) = 27,000 × 4.4 = $118,800
Fixed overhead absorbed on actual hours = 27,200 × 4.4 = $119,680
Fixed overhead efficiency variance = 118,800 – 119,680 = 880 (Adverse)
Fixed overhead absorbed on actual hours = 27,200 × 4.4 = $119,680
Fixed overhead absorbed on budgeted hours = 28,500 × 4.4 = $125,400
Fixed overhead capacity variance = 119,680 – 125,400 = $5,720 (Adverse)
Budgeted overhead expenditure = $125,400
Actual overhead expenditure = $115,300
Fixed overhead expenditure variance = 125,400 – 115,300 = $10,100 (Favourable)
1076
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REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
(c)
Variance explanations
Raw materials cost variance
The budgeted raw material cost for production of 95,000 units was $1.40 per unit
(133,000/95,000) but the actual raw material cost for production of 90,000 units was $1.45
per unit (130,500/90,000). The raw material cost per unit may have increased either because
more raw materials per unit were used than budgeted, or because the price per unit of raw
material was higher than budgeted. Calculation of the raw material price and usage subvariances would indicate where further explanation should be sought.
Fixed overhead efficiency variance
The fixed overhead efficiency variance measures the extent to which more or less standard
hours were used for the actual production than budgeted. In this case, a total of 27,200
machine hours were actually used, when only 27,000 standard machine hours should have
been used. The difference may be due to poorer production planning than expected or to
machine breakdowns.
Fixed overhead expenditure variance
The fixed overhead expenditure variance measures the extent to which budgeted fixed
overhead differs from actual fixed overhead. Here, actual fixed overhead is $10,100 less than
budgeted. This could be due to an error in forecasting fixed production overheads such as
rent and power costs, or to a decrease in fixed production overheads, such as changing to a
cheaper cleaning contractor.
(d)
Purposes of a budgeting system
Key purposes of a budgeting system that could be discussed include planning, co-ordination,
communication, control, motivation and performance evaluation. Students were required
only to discuss three key purposes.
Planning
One of the key purposes of a budgeting system is to require planning to occur. Strategic
planning covers several years but a budget represents a financial plan covering a shorter
period (i.e. a budget is an operational plan). Planning helps an organisation to anticipate key
changes in the business environment that could potentially impact on business activities and
to prepare appropriate responses. Planning also ensures that the budgeted activities of the
organisation will support the achievement of the organisation’s objectives.
Co-ordination
Many organisations undertake a number of activities, which need to be co-ordinated, if the
organisation is to meet its objectives. The budgeting system facilitates this co-ordination
since organisational activities and the links between them are thoroughly investigated during
budget preparation, and the overall coherence between the budgeted activities is reviewed
before senior managers agree the master budget. Without the framework of the budgeting
system, individual managers may be tempted to make decisions that are not optimal in terms
of achieving organisational objectives.
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1077
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Communication
The budgeting system facilitates communication in the organisation both vertically (for
example between senior and junior managers) and horizontally (for example between
different organisational functions). Vertical communication enables senior managers to
ensure that employees at all levels understand organisational objectives. Communication also
occurs at all stages of the budgetary control process, for example during budget preparation
and during investigation of end-of-period variances.
Control
One of the most important purposes of a budgeting system is to facilitate cost control through
the comparison of budgeted costs and actual costs. Variances between budgeted and actual
costs can be investigated in order to determine the reason why actual performance has
differed from what was planned. Corrective action can be introduced if necessary in order to
ensure that organisational objectives are achieved. A budgeting system also facilitates
management by exception, whereby only significant differences between planned and actual
activity are investigated.
Motivation
The budgeting system can influence the behaviour of managers and employees, and may
motivate them to improve their performance if the target represented by the budget is set at an
appropriate level. An inappropriate target has the potential to be de-motivating, however, and
a key factor here is the degree of participation in the budget-setting process. It has been
shown that an appropriate degree of participation can have a positive motivational effect.
Performance evaluation
Managerial performance is often evaluated by the extent to which budgetary targets for which
individual managers are responsible have been achieved. Managerial rewards such as
bonuses or performance-related pay can also be linked to achievement of budgetary targets.
Managers can also use the budget to evaluate their own performance and clarify how close
they are to meeting agreed performance targets.
Answer 39 MURGATROYD CO
(a)
Reconciliation of standard cost and actual cost
$
Standard cost of actual production
9,000 units × $(15 + 20 + 12)
Total variances:
Direct materials (W1)
Direct labour (W2)
Fixed overheads (W3)
Actual cost
1078
$
423,000
3,000 A
2,000 F
5,000 F
————
4,000 F
————
419,000
————
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
WORKINGS
(1)
Materials
Actual
$
138,000
Standard cost of actual production (9,000 × $15)
135,000
Variance ($)
3,000 A
(2)
Labour
Actual
178,000
2,000 F
Standard cost of actual production (9,000 × $20)
(3)
180,000
Fixed overhead
Actual
103,000
Standard cost of actual production (9,000 × $20)
108,000
5,000 F
(b)
Direct materials cost variance
Actual quantity × actual cost
138,000
Price
6,000 F
Actual quantity × standard cost
(24,000 × $6)
Standard quantity for actual production
X standard cost [(as in (a)]
(c)
144,000
Usage
9,000 A
135,000
Setting the standard price and standard quantity for direct materials
(i)
Standard price
The standard price per litre is set by the person in the organisation with the specialist
knowledge about the prices charged by suppliers for the raw materials used by Murgatroyd.
This would be the manager responsible for purchasing (sometimes referred to as the Buying
Manager or the Procurement Manager).
(ii)
Standard quantity
The standard quantity per unit is set by the person in the organisation with the specialist
knowledge about the product specification and the amount of each raw material that should be
used in the manufacture of one unit of the product. This would be a manager in the
production (manufacturing) function or technical department in Murgatroyd.
Answer 40 CHAFF CO
(a)
Performance evaluation
When assessing variances it is important to consider the whole picture and the
interrelationships that exist. In Chaff there appears to be doubt about the wisdom of some of
the decisions that have been made. Favourable variances have been applauded and adverse
variances criticised and the managers in charge dispute the challenge to their actions.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1079
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Purchasing manager. The purchasing manager has clearly bought a cheaper product, saving
$48,000. The cause of this is not specified and it could be due to good buying or negotiation,
reductions in quality or changes in overall market conditions. The market for buying seeds is
stable so there is more likely to be an internal reason for the problem. The material usage
variance is significantly adverse, indicating much more waste than is normal has occurred in
month 1. This suggests that the quality of the seed bought was poor and as a result a $52,000
excess loss has occurred. It is possible that the labour force working poorly or too quickly
caused the waste and this has to be considered.
The sales price achieved is also well down on standard with the sales price variance showing
an $85,000 loss of revenue and (therefore) profit. The market for sales of brown rice is stable
so it is reasonable to presume that the fall in sales price achieved is as a result of internal
quality issues rather than general price falls. The purchasing manager of the only ingredient
may well be responsible for this fall in quality. This may have also led to a fall in the volume
of sales, another $21,000 of adverse variance.
In conclusion the purchasing manager appears mainly responsible for a loss of $110,000*
taking the four variances above together.
* ($85,000 + $52,000 + $21,000 – $48,000)
Production director. The production director has increased wage rates and this has cost an
extra $15,000 in month 1. However one could argue that this wage increase has had a
motivational effect on the labour force. The labour efficiency variance is $18,000 favourable;
and so it is possible that a wage rise has encouraged the labour force to work harder.
Academic evidence suggests that this effect might only be temporary as workers get used to
the new level of wages.
Equally the amount of idle time has reduced considerably, with a favourable variance of
$12,000 resulting. Again it is possible that the better-motivated labour force has been more
willing to work than before. Idle time can have many causes, including, material shortages or
machine breakdowns. However, the machines are running well and the buyer has bought
enough rice seeds.
In conclusion the increase in the wage rate did cost more money but it may have improved
morale and enhanced productivity. The total of the three variances above is $15,000*
favourable. *($18,000 + $12,000 – $15,000)
Maintenance manager. The maintenance manager has decided to delay the annual
maintenance of the machines and this has saved $8,000. This will increase profits in the short
term but could have disastrous consequences later. In this case only time will tell. If the
machines breakdown before the next maintenance then lost production and sales could result.
The maintenance manager has only delayed the spending and has not prevented it altogether.
A saving of $8,000 as suggested by the variance has not been made. It is also possible that
the adverse variable overhead expenditure variance has been at least partly caused by poor
machine maintenance.
The variance calculated is not the saving made as it represents a timing difference only. The
calculation also ignores the risks involved.
1080
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REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
(b)
Variance calculations
The standard contribution is given, but could be calculated as follows (not required by the
question but shown as a proof):
$
$
Sales price
240
Less:
Rice seed (1.4 Tonnes × $60/tonne)
84
Labour (2 hours × $20/hr)
40
Variable overhead (2 hours × $30/hr)
60
–––
Marginal costs of production
184
–––
Standard contribution
56
–––
The standard labour charge needs to be adjusted to reflect the cost to the business of the idle
time. It is possible to adjust the time spent per unit or the rate per hour. In both cases the
adjustment would be to multiply by 10/9 – a 10% adjustment. In the case above the rate per
hour has been adjusted to $18 × 10/9 = $20/hr. (Both approaches would gain full marks.)
In order to reconcile the budget profit to the actual profit, both these profits need to be
calculated and an operating statement prepared.
Budget profit statement for month 2
$
Sales (8400u × $240/u)
Less:
Rice seed (1.4 tonnes × $60/tonne × 8,400 tonnes)
Labour (2 hours × $20/hr × 8,400 tonnes)
Variable overhead (2 hours × $30/hr × 8,400 tonnes)
$
2,016,000
705,600
336,000
504,000
–––––––––
Marginal costs of production
1,545,600
–––––––––
470,400
210,000
–––––––––
260,400
–––––––––
Contribution
Less Fixed costs
Budget profit
Actual profit for month 2
$
Sales
Less:
Rice seed
Labour
Variable overhead
Marginal costs of production
Contribution
Less Fixed costs
Actual profit
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
$
1,800,000
660,000
303,360
480,000
–––––––––
1,443,360
–––––––––
356,640
200,000
–––––––––
156,640
–––––––––
1081
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Operating statement for month 2
$
Budget contribution
Variances:
Sales price
Sales volume
Adverse
120,000
22,400
–––––––
$
$
470,400
Favourable
142,400
–––––––
328,000
Material price
Material usage
Labour rate
Labour efficiency
Idle time
Variable overhead efficiency
Variable overhead expenditure
Actual contribution
Budget fixed cost
Less: Fixed cost expenditure variance
60,000
48,000
18,960
20,000
15,600
30,000
30,000
––––––
96,960
–––––––
125,600
28,640
–––––––
356,640
210,000
10,000
–––––––
Actual fixed cost
200,000
–––––––
156,640
–––––––
Actual profit
WORKINGS for the variances in month 2
1082
1.
Sales price: (225 – 240) 8,000 = 120,000 Adverse
2.
Sales volume: (8,000 – 8,400) 56 = 22,400 Adverse
3.
 660,000

− 60  12,000 = 60,000 Favourable
Material price: 
 12,000

4.
Material usage: (12,000 – 11,200*) 60 = 48,000 Adverse
*(8,000 × 1·4 = 11,200)
5.
Labour rate: (19·20 – 18) 15,800 = 18,960 Adverse
6.
Labour efficiency: (15,000 – 16,000) 20 = 20,000 Favourable
7.
Idle time: (800 – 1,580*) 20 = 15,600 Favourable
*10% of 15,800
8.
 480,000

− 30  15,000 = 30,000 Adverse
Variable overhead expenditure: 
 15,000

9.
Variable overhead efficiency variance: (15,000 – 16,000) 30 = 30,000 Favourable
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Alternative calculations if standard hours adjusted for expected idle time and not the rate.
Standard cost (2 hours × 10/9) × $18 = $40 per tonne
or 2·222 hours × $18 = $40 per tonne
Rate variance as above = 18,960 Adverse
Idle time: (800 – 1,580) 18 = 14,040 Favourable
Efficiency variance: (15,000 – 16,197.77777*) 18 = 21,560 Favourable
* (standard time allowed less standard idle time)
Standard time is 8,000 tonnes × 2.222 hours = 17,777.777 hours
Standard idle time is 10% of 15,800 = 1,580 hours
Therefore expected working hours is 17,777.777 – 1,580 = 16,197.777 hours
Tutorial note: There are many alternative methods of dealing with this issue, any reasonable
attempt was accepted.
Answer 41 CRUMBLY CAKES
(a)
Performance evaluation
Production manager
Assessing the performance of the two managers is difficult in this situation. In a traditional
sense the production manager has seriously over spent in March following the move to
organic ingredients. He has a net adverse variance against his department of $2,300 in one
month. No adjustment to the standards has been made to allow for the change to organic.
The manager has not only bought organically he has also changed the mix, increasing the
input proportion of the more expensive ingredients. This may have contributed to the
increased sales of cakes.
However, the decision to go organic has seen the sales of the business improve; the taste of
the cakes should be better and customers could perceive a health benefit. However, the
production manager is allocated none of the favourable sales variances that result. Assuming
that the improved sales are entirely as a result of the production manager’s decision to change
the ingredients, then the overall net favourable variance is $7,700.
The production manager did appear to be operating in the original standard in February,
indicating a well performing department. Indeed he will have earned a small bonus in that
month.
Sales manager
A change to organic idea would need to be “sold” to customers. It would presumably require
a change of marketing and proper communication to customers. The sales manager would
probably feel he has done a good job in March. It is debatable, however, whether he is
entirely responsible for all of the favourable variances.
The move to organic certainly helped the sales manager as in February he seems to have
failed to meet his targets.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1083
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Bonus scheme
The problem here is that the variances have to be allocated to one individual. The good sales
variances have been allocated to the sales manager when in truth the production manager’s
decision to go organic appears to have been a good one and the driver of the business success.
Responsibility accounting systems struggle to cope with “joint” success stories, refuting in
general a collective responsibility.
Under the current standards the production manager has seemingly no chance to make a
bonus. The main problems appear to be the out-of-date standards and the fact that all sales
variances are allocated to the sales manager, despite the root cause of the improved
performance being at least in part the production manager’s decision to go organic. The
system does not appear fair.
General comments
It would appear that some sharing of the total variances is appropriate. This would be an
inexact science and some negotiation would be needed.
One problem seems to be that the original standards were not changed following the decision
to go organic. In this sense the variances reported are not really “fair”. Standards should
reflect achievable current targets and this is not the case here.
(b)
Variance calculations
Material price variances
Ingredient
Flour
Eggs
Butter
Sugar
Actual
price/kg
0.13
0.85
1.80
0.60
Standard
price/kg
0.12
0.70
1.70
0.50
Total
Actual (AP – SP) × AQ Adv or Fav
quantity kg Price variance
5,700
57
Adv
6,600
990
Adv
6,600
660
Adv
4,578
458
Adv
––––––
2,165
Adv
––––––
Material mix variance
Ingredient
Flour
Eggs
Butter
Sugar
Totals
Actual
mix
5,700
6,600
6,600
4,578
––––––
23,478
––––––
Standard
mix
5,870
5,870
5,870
5,870
––––––
23,478
––––––
Standard
price
0.12
0.70
1.70
0.50
Variance
Adv or Fav
–20
511
1,241
–646
––––––
1,086
––––––
Adv
Material yield variance
Actual yield
Standard yield (23,478/0.4)
Difference
Standard cost of a cake (W1)
Yield variance (1,305 × 0.302)
1084
60,000 cakes
58,695 cakes
1,305 cakes
$0.302
394 Fav
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Sales price variance
Actual
Price (AP)
0.99
Cake
Standard
price (SP)
0.85
Actual
(AP – SP)
volume (AV)
× AV
60,000
8,400
Adv or Fav
Fav
Sales volume contribution variance
Actual volume
Budget volume
Standard contribution
Variance (60,000 – 50,000) * 0.35 =
60,000 cakes
50,000 cakes
0.35
$3,500 Fav
WORKING
(1)
Standard cost of a cake
Ingredients
Flour
Eggs
Butter
Sugar
Total input
Normal loss (10%)
Kg
0.10
0.10
0.10
0.10
0.40
(0.04)
–––––
Standard weight/cost of a cake 0.36
$
$0.12 per kg
$0.70 per kg
$1.70 per kg
$0.50 per kg
Cost
0.012
0.070
0.170
0.050
0.302
0.302
Answer 42 AVX CO
(a)
Calculation of learning rates
The first step in solving this problem is to calculate the actual cost of output for each period.
This is done by calculating the standard cost, and then deducting favourable efficiency
variances from this to find actual cost.
Standard cost
Batches
of output
Variance
Actual cost
$
$
$
November
1
500
0.00
500.00
December
1
500
170.00
330.00
January
2
1,000
452.20
547.80
February
4
2,000
1089.30
910.70
March
8
4,000
1,711.50
2,288.50
April
16
8,000
3423.00
4,577.00
The next stage is to calculate the cumulative average cost each month (i.e. total costs to date
since the first product was made). Cumulative average cost per unit can also be calculated:
November
December
January
February
March
April
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Cumulative
batches
$
1
2
4
8
16
32
Cumulative
Cumulative
total cost average cost per unit
$
$
500.00
500.00
830.00
415.00
1377.80
344.45
2,288.50
286.06
4,577.00
286.06
9,154.00
286.06
1085
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
The table shows that as cumulative output doubles, from 1 to 2 units, cumulative average cost
per unit falls to 83% of the average cost for the first unit. This is repeated each time
cumulative output doubles until cumulative output reaches 8 batches. After this, cumulative
average cost per unit remains constant, meaning that the learning rate has ceased.
The learning rate was therefore 83% for the period November to February. After this it was
zero.
(b)
Implications of finding for AVX
The main implication for AVX is that the standard for the period from February onwards
needs to be recalculated, to take into account a learning rate. The existing standard of $500
per unit is too easy to achieve.
The second implication is that the variances calculated for the first four months should also be
recalculated based on a learning rate. These revised variances show a more realistic picture to
management of the actual performance.
The difficulty of this approach is that the standards should be based on a reasonable learning
rate that might be expected, based on previous experiences. It would be possible to use the
actual rate achieved, but if this is done, it does not question whether actual performance was
what might have been expected.
(c)
Differences between standard costs and target costs
A standard cost is a predetermined budgeted unit cost of a product or service, under specified
working conditions. These working conditions are normally current actual working
conditions – so the standard cost basically reflects what could be achieved under existing
working conditions.
A target cost, on the other hand is a desired cost. It may not be achievable under current
working conditions, but will require changes in production methods.
The calculation of standard costs is inwardly focussed, and does not consider prices or profits.
Target costing starts with the external selling price for the product and then works backwards
to calculate target cost by deducting required profits.
Standard costs are usually calculated for existing products and services. Target costs may be
calculated for planned products (i.e. products that are in the design phase). This means that
the design process can be changed to help achieve the target cost.
Answer 43 MILBAO CO
(a)
Sales volume variances
1. Budget sales (units)
2. Actual sales (units)
in standard proportions
3. Actual sales (units)
Standard unit valuations:
4. Selling price ($)
5. Contribution ($)
6. Profit ($)
1086
Superb
30,000
Excellent
50,000
Good
20,000
Total
100,000
28,800
36,000
48,000
42,000
19,200
18,000
96,000
96,000
100
60
35
80
55
30
70
48
23
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REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Sales volume variance
On turnover basis
(1 – 3) × 4 ($)
600,000(F)
640,000(A)
140,000(A)
180,000(A)
On contribution basis
(1 – 3) × 5 ($)
360,000(F)
440,000(A)
96,000(A)
176,000(A)
On profit basis
(1 – 3) × 6 ($)
210,000(F)
240,000(A)
46,000(A)
76,000(A)
Fixed cost per unit = $2,500,000/100,000 units = $25
Tutorial note: The presentation style used equates increased sales from budget as negative
or favourable variances (as opposed to increased costs which are negative or adverse
variances).
(b)
Relative merits
The choice of turnover, contribution or net profit as the valuation basis for the sales volume
variance will be affected by a number of factors:
(c)
„
The way in which the information is presented to management will affect the choice
of valuation base (e.g. whether a standard absorption or standard marginal cost
system is in operation).
„
In some circumstances management may prefer to think in terms of market share
expressed as turnover and will wish to monitor changes in sales using turnover as
the measure.
„
It may be argued that as an aid to decision-making the valuation base chosen should
be that which most closely approximates to cash flows. The turnover basis ignores
the impact of variable costs and overstates the impact of any variance. The net
profit basis includes a deduction for fixed costs. This means that the cash flow
impact is understated, since fixed costs are sunk and will remain unaffected by
volume changes. The contribution basis is the closest approximation to the cash
flow effect of a change in sales units.
Total sales quantity and sales mix variances
Sales mix variance
Product
Superb
Excellent
Good
Actual
sales
(units)
36,000
42,000
18,000
–––––––
96,000
–––––––
Actual sales
in budgeted
mix (units)
Difference
(units)
28,800 (30%)
7,200
48,000 (50%) (6,000)
19,200 (20%) (1,200)
–––––––
–––––––
96,000
0
–––––––
–––––––
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Standard Sales mix
contribution variance
$
$
60
55
48
432,000
(330,000)
(57,600)
–––––––
44,400
–––––––
(Fav)
1087
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Sales quantity variance
Actual sales
in budgeted
mix (units)
Product
Excellent
Superb
Good
28,800
48,000
19,200
–––––––
96,000
–––––––
Budgeted
sales
(units)
30,000
50,000
20,000
–––––––
100,000
–––––––
Difference
(units)
(1,200)
(2,000)
(800)
–––––––
(4,000)
–––––––
Standard
margin
$
60
55
48
Sales quantity
variance
$
(72,000)
(110,000)
(38,400)
–––––––
(220,400)
–––––––
(Adv)
Answer 44 SPIKE CO
(a)
Budget revisions
A budget forms the basis of many performance management systems. Once set, it can be
compared to the actual results of an organisation to assess performance. A change to the
budget can be allowed in some circumstances but these must be carefully controlled if abuse
is to be prevented.
Allow budget revisions when something has happened that is beyond the control of the
organisation that renders the original budget inappropriate for use as a performance
management tool.
Senior management who should attempt to take an objective and independent view should
approve these adjustments.
Disallow budget revisions for operational issues. Any item that is in the operational control
of an organisation should not be adjusted.
This type of decision is often complicated and each case should be viewed on its merits.
The direction of any variance (adverse or favourable) is not relevant in this decision.
(b)
Budget revision requests
Materials
Arguments in favour of allowing a revision:
„
The nature of the problem is outside the control of the organisation. The supplier
went in to liquidation; it is doubtful that Spike could have expected this or
prevented it from happening.
„
The buyer, knowing that budget revisions are common, is likely to see the
liquidation as outside his control and hence expect a revision to be allowed. He
may see it as unjust if this is not the case and this can be demoralising.
Arguments against allowing a budget revision:
„
1088
There is evidence that the buyer panicked a little in response to the liquidation. He
may have accepted the first offer that became available (without negotiation) and
therefore incurred more cost than was necessary.
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REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
„
A cheaper, more local supplier may well have been available, so it could be argued
that the extra delivery cost need not have been incurred. This could be said to have
been an operational error.
Conclusion: The cause of this problem (liquidation) is outside the control of the organisation
and is the prime cause of the overspending. Urgent problems need urgent solutions and a
buyer should not be penalised in this case. A budget revision should be allowed.
Labour
Argument in favour of allowing a revision: The board made this decision, not the
departmental manager. It could be argued that the extra cost on the department’s budget is
outside their control.
Arguments against allowing a budget revision:
„
This decision is entirely within the control of the organisation as a whole. As such,
it would fall under the definition of an operational decision. It is not usual to allow
a revision in these circumstances.
„
It is stated in the question that the departmental manager complained in his board
report that the staff level needed improving. It appears that he got his wish and the
board could be said to have merely approved the change.
„
The department will have benefited from the productivity increases that may have
resulted in the change of policy. If the department takes the benefit then perhaps
they should take the increased costs as well.
Conclusion: This is primarily an operational decision that the departmental manager agreed
with and indeed suggested in his board report. No budget revision should be allowed.
An alternative view is that the board made the final decision and as such the policy change
was outside the direct control of the departmental manager. In this case a budget revision
would be allowed.
(c)
Sales
(i)
Total sales variances
Sales price variance
= (Actual SP – Standard SP) × Actual sales volume
= (16.40 – 17.00) × 176,000
= $105,600 (Adverse)
Sales volume variance
= (Actual sales volume – Budget sales volume) × Std contribution
= (176,000 – 180,000) × 7
= $28,000 (Adverse)
(ii)
Market size and share variances
Market size variance
= (Revised sales volume – budget sales volume) × Std contribution
= (160,000 – 180,000) × 7
= $140,000 (Adverse)
Market share variance
= (Actual sales volume – revised sales volume) × Std contribution
= (176,000 – 160,000) × 7
= $112,000 (Favourable)
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1089
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
(iii)
Comment on sales performance
Sales price: The biggest issue seems to be the decision to reduce the sales price from $17.00
down to $16.40. This “lost” $105,600 of revenue on sales made compared to the standard
price.
It seems likely that the business is under pressure on sales due to the increased popularity of
electronic diaries. As such, they may have felt that they had to reduce prices to sustain sales
at even the level they achieved.
Volume: The analysis of sales volume into market size and share shows the usefulness of
planning and operational variances. Overall, the sales level of the business is down by 4,000
units, losing the business $28,000 of contribution or profit. This calculation does not in itself
explain how the sales department of the business has performed.
In the face of a shrinking market they seem to have performed well. The revised level of
sales (allowing for the shrinking market) is 160,000 units and the business managed to beat
this level comfortably by selling 176,000 units in the period.
As mentioned above, the reducing price could have contributed to the maintenance of the
sales level. Additionally, the improved quality of support staff may have helped maintain the
sales level. Equally the actions of competitors are relevant to how the business has
performed. If competitors have been active then merely maintaining sales could be seen as an
achievement.
Spike should be concerned that its market is shrinking.
Answer 45 SECURE NET
(a)
Material total variances
Total price variance = ($5.25 – $4) × 3,500kg =
Total usage variance = (3,500 – 4,000) × 4 =
Total
(b)
$4,375 Adverse
$2,000 Favourable
$2,375 Adverse
Planning and operational variances
The planning variances are calculated by comparing the original budget and the revised
standards after adjustment for factors outside the control of the organisation.
On this basis the revised standards would be a price of $4·80 per kg with revised usage at 42g
per card.
Planning price variance = ($4.80 – $4)4,200 =
Planning usage variance = (4,200 – 4,000) × $4 =
Total planning error (variance) is
$3,360 Adverse
$800 Adverse
$4,160 Adverse
The operational variances compare the actual spend with the revised budget figures.
Operational price variance = ($5.25 – $4.80) × 3,500kg =
Operational usage variance = (3,500 – 4,200) × $4.80 =
Total operational variance is
$1,575 Adverse
$3,360 Favourable
$1,785 Favourable
The method above is in line with the article previously written by the examiner and published
in the ACCA student newsletter. Other methods applied consistently would score full marks.
1090
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REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
(c)
Production manager performance
The production manager is subject to external pressures which appear beyond his control.
The size of the security card has to fit the reader of that card and if the industry specification
changes there is nothing that he can do about that. This is, then, a “planning” error and
should not form part of any assessment of his performance.
Equally if world-wide oil prices increase (and hence plastic prices) then the production
manager cannot control that. This would be allocated as a planning error and ignored in an
assessment of his performance.
The performance of the production manager should be based on the operational variances
(and any relevant qualitative factors). The decision to use a new supplier “cost” an extra
$1,575 in price terms. On the face of it this is, at least potentially, a poor performance.
However, the manager seems to have agreed to the higher price on the promise of better
quality and reliability. If this promise was delivered then this could be seen as a good
decision (and performance). The savings in waste (partly represented by the usage variance)
amount to $3,360 favourable. This would seem to suggest better quality. The fact that the
production level jumped from 60,000 to 100,000 also suggests that suppliers’ reliability was
good (in that they were able to deliver so much). The net variance position is relevant at a
saving of $1,785.
It is also possible that such a large increase in volume of sales and production should have
yielded a volume based discount from suppliers. This should also be reflected in any
performance assessment in that if this has not been secured it could be seen as a poor
performance.
This is backed up by the lack of obvious quality problems since 100,000 cards were produced
and sold in the period; a huge increase on budget. The ability of a production manager to
react and be flexible can often form a part of a performance assessment.
In conclusion the manager could be said to have performed well.
Answer 46 OLIVER
(a)
Average price
The average price for hairdressing per client is as follows:
20X0: Female clients paid $200,000 for 8,000 visits. This is an average price per visit of
$200,000/8,000 = $25.
In 20X1 the female hairdressing prices did not increase and the mix of sales did not change so
of the total revenue $170,000 (6,800 × $25) was from female clients. This means that the
balance of $68,500 ($238,500 – $170,000) was from male clients at an average price of $20
per visit ($68,500/3,425).
(b)
Financial performance assessment
Hairdressing sales growth: Oliver’s Salon has grown significantly during the two years,
with an increase of 19.25% (W1). This is impressive in a mature industry like hairdressing.
The increase has come from the launch of the new male hairdressing with a significant
contraction in the core female business – down 15% (W1).
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1091
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Hairdressing gross margin: Oliver’s hairdressing overall gross margin has reduced
significantly, down from 53% to 47.2% in 20X1 (W2).
There has been an increase in staff numbers for the female part of the business and this,
combined with the fall in the volume of sales from female clients, has significantly damaged
margins from that customer type, with a fall from 53% to 40.5% (W2).
The margin from male clients in 20X1 is 63.5%, which is better than that achieved in 20X0
from the female clients. This is probably mainly due to faster throughput, so that despite the
lower average prices charged the overall margin was still quite good.
Staff costs: The staffing levels have had to increase to accommodate the new male market
and the extra levels of business. The new hairdresser for the male clients is being paid
slightly more than the previously employed staff (W3). This might encourage dissatisfaction.
The addition of a junior will clearly reduce the overall average wage bill but increases costs
overall whilst the volume of female clients is shrinking.
Advertising spend: This has increased by 150% in the year ($5,000/$2,000). This is
probably nothing to worry about, as it is likely that the launching of the new product range
(males!) will have required advertising. Indeed, given the increase in sales of male hair
services it is fair to say that the money was well spent.
Rent is clearly a fixed cost and administrative expenses have gone up a mere 5.5%; these
costs appear under control given the overall volume of clients is well up on 20X0.
Electricity costs have jumped 14.3%, which seems a lot but is probably a cost that Oliver
would find hard to control. Energy companies are often very large organisations where
competition is rarely significant. Small businesses have little choice but to pay the going rate
for energy.
Net Profit: Overall net profit has worsened to 33.5% from 39% (W6). This is primarily due
to the weakening gross margin and extra costs incurred for advertising. The advertising cost
may not recur and so the net margin might improve next year.
Overall it is understandable that Oliver is disappointed with the financial results. With a
19.25% increase in overall sales he might have expected more net profit.
(c)
Non-financial performance
Quality: The number of complaints is up by 283% (W4) and is proportionately more
frequent. This seems to be due to two main reasons. Firstly the switch away from a single
gender salon has upset the existing customer base. It is possible that by trying to appeal to
more customer types Oliver is failing to meet the needs of at least one group. It may be that
the quality of hair services has not worsened but that the complaints are regarding the change
towards a multi-gender business.
Secondly the wage rates paid to the new junior staff seem to be well below the wage rates of
the existing staff (W3). This implies that they are in training and could be of poorer quality.
It is stated that they are in a supporting role but if not properly supervised then mistakes could
easily occur. This can easily lead to complaints from dissatisfied customers.
Resource utilisation: The main resources that Oliver has are the staff and the rented
property. As far as the property is concerned the asset is being used to a much higher degree
with 27.8% more clients being serviced in the year (10,225/8,000).
1092
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REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
However, as the overall margins are lower one might argue that just focusing solely on
volume misses the point on asset utilisation.
As far as the staff usage is concerned it is a mixed scene. The female specialists are
producing less per member of staff than in 20X0 after the recruitment of one more staff
member and a fall in volume of female clients. Each specialist served 2,000 female clients in
20X0 and only 1,360 in 20X1 (W7). Oliver may have been concerned with the complaints
coming in and decided to do something about service levels by increasing resources for the
female clients.
The specialist dealing with male clients has produced far more treatments than those serving
the females. This is probably not unusual; the male customer requires only a simple service.
Without comparative data it is not possible to conclude whether or not 3,425 customers per
year is good. This specialist cannot be said to be doing “better” than the others. Cutting
men’s hair is quicker to do, so more output is inevitable.
WORKINGS
(1)
Sales growth overall is $238,500/$200,000 or +19.25%. The female hairdressing sales has
though fallen by 15% ($200,000 – $170,000)/$200,000. This is entirely reflected in volume,
as there was no price increase in 20X1 for female clients.
(2)
Gross margin overall is $106,000/$200,000 or 53% in 20X0 and $112,500/238,500 or 47.2%
in 20X1.
This can be analysed between the female and male clients:
20X0
Female
$
200,000
Sales
Less cost of sales:
Hairdressing staff costs (W3) (65,000)
Hair products – female
(29,000)
Hair products – male
––––––––
Gross profit
106,000
––––––––
GP%
53%
20X1
Female
$
170,000
Male
$
68,500
(74,000)
(27,000)
(17,000)
(8,000)
–––––––
–––––––
69,000
43,500
–––––––
–––––––
40.5%
63.5%
(3)
Staff cost growth is $91,000/$65,000 or +40%. In absolute terms average staff costs were
$65,000/4 = $16,250 in 20X0.
Additional staff cost $26,000 ($91,000 – $65,000) in total for two people. The junior was
paid $9,000 and so the new specialist for the male customers must have been paid $17,000
(4)
Number of complaints up by 46/12 or 283%. Complaints per customer visit up from 12/8,000
or 0.15% to 46/10,225 or 0.44%
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1093
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
(5)
Number of female clients per specialist is 8,000/4 or 2,000 in 20X0 and 6,800/5 or 1,360 in
20X1. Number of male clients per specialist is 3,425 in 20X1.
(6)
Net profit is $78,000/200,000 or 39% in 20X0 and $80,000/238,500 or 33.5% in 20X1.
Answer 47 THATCHER INTERNATIONAL PARK
(a)
Financial performance
TIPs Financial performance can be assessed in a number of ways:
Sales growth
Sales are up about 1.3% (W1) which is a little above the rate of inflation and therefore a move
in the right direction. However, with average admission prices jumping about 8.6% (W2) and
numbers of visitors falling there are clearly problems. Large increases in admission prices
reduce the value proposition for the customer; it is unlikely that the rate of increase is
sustainable or even justifiable. Indeed with volumes falling (down by 6.7%, (W6)) it appears
that some customers are being put off and price could be one of the reasons.
Maintenance and repairs
There appears to be a continuing drift away from routine maintenance with management
preferring to repair equipment as required. This does not appear to be saving any money as
the combined cost of maintenance and repair is higher in 2009 than in 2008 (possible risks are
dealt with in part (b)).
Directors pay
Absolute salary levels are up 6.7% (W3), well above the modest inflation rate. It appears that
the shareholders are happy with the financial performance of the business and are prepared to
reward the directors accordingly. Bonus levels are also well up. It may be that the directors
have some form of profit related pay scheme and are being rewarded for the improved profit
performance. The directors are likely to be very pleased with the increases to pay.
Wages
Wages are down by 12% (W5). This may partly reflect the loss of customers (down by 6.7%
(W6), assuming that at least part of the wages cost is variable. It could also be that the
directors are reducing staff levels beyond the fall in the level of customers to enhance shortterm profit and personal bonus. Customer service and indeed safety could be compromised
here.
Net profit
Net profit is up a huge 31.3% (W7) and most shareholders would be pleased with that. Net
profit is a very traditional measure of performance and most would say this was a sign of
good performance.
1094
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REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Return on assets
The profitability can be measured relative to the asset base that is being used to generate it.
This is sometimes referred to as ROI or return on investment. The return on assets is up
considerably to 11.4% from 8% (W8). This is partly due to the significant rise in profit and
partly due to the fall in asset value. TIP has cut back on new development so the fall in asset
value is probably due to depreciation being charged with little being spent during the year on
assets. In this regard it is inevitable that return on assets is up but it is more questionable
whether this is a good performance. A theme park (and thrill rides in particular) must be
updated to keep customers coming back. The directors on TIP are risking the future of the
park.
(b)
Quality provision
Reliability of the rides
The hours lost has increased significantly. Equally the % of capacity lost due to breakdowns
is now approaching 17.8% (W9). This would appear to be a very high number of hours lost.
This would surely increase the risk that customers are disappointed being unable to ride.
Given the fixed admission price system this is bound to irritate some customers as they have
effectively paid to ride already.
Average queuing time
Queuing will be seen by customers as dead time. They may see some waiting as inevitable
and hence acceptable. However TIP should be careful to maintain waiting times at a
minimum. An increase of 10 minutes (or 50%) is likely to be noticeable by customers and is
unlikely to enhance the quality of the TIP experience for them. The increase in waiting times
is probably due to the high number of hours lost due to breakdown with customers being
forced to queue for a fewer number of ride options.
Safety
The clear reduction in maintenance could easily damage the safety record of the park and is
an obvious quality issue.
Risks
If TIP continues with current policies then they will expose themselves to the following risks:
„
The lack of routine maintenance could easily lead to an accident or injury to a
customer. This could lead to compensation being paid or reputational damage
„
Increased competition. The continuous raising of admission prices increases the
likelihood of a new competitor entering the market, although there are significant
barriers to entry in this market (e.g. capital cost, land, and so on).
„
Loss of customers. The value for money that customers see when coming to TIP is
clearly reducing (higher prices, less reliability of rides and longer queues).
Regardless of the existence of competition customers could simply chose not to
come, substituting another leisure activity instead
„
Profit fall. In the end if customers’ numbers fall then so will profit. The
shareholders, although well rewarded at the moment could suffer a loss of dividend.
Directors’ job security could then be threatened
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1095
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
WORKINGS
(1)
Sales growth is $5,320,000/$5,250,000 = 1.01333 or 1.3%
(2)
Average admission prices were:
2008: $5,250,000/150,000 = $35 per person
2009: $5,320,000/140,000 = $38 per person
An increase of $38/$35 = 1.0857 or 8.57%
(3)
Directors pay up by $160,000/$150,000 = 1.0667 or 6.7%
(4)
Directors bonuses levels up from $15,000/$150,000 or 10% to $18,000/$160,000 or
12.5% of turnover. This is an increase of 3/15 or 20%
(5)
Wages are down by (1 – $2,200,000/$2,500,000) or 12%
(6)
Loss of customers is (1 – 140,000/150,000) or 6.7%
(7)
Profits up by $1,372,000/$1,045,000 = 1.3129 or 31.3%
(8)
Return on assets:
2008: $1,045,000/$13,000,000 = 1.0803 or 8.03%
2009: $1,372,000/$12,000,000 = 1.114 or 11.4%
(9)
Capacity of rides in hours is 360 days × 50 rides × 10 hours per day = 180,000
2008 lost capacity is 9,000/180,000 = 0.05 or 5%
2009 lost capacity is 32,000/180,000 = 0.177 or 17.8%
Answer 48 EATWELL RESTAURANT
(a)
Overall business performance
The performance can be categorised into the following key areas: financial, competitiveness,
resource utilisation, quality of service and innovation/flexibility.
Financial
„
„
„
„
Continuous turnover growth with a 123% increase over the period.
Annual compound growth rate.
An even faster growth in profit – approximate fivefold increase.
Profits growing faster than revenue creates an increasing net profit margin from
14% in 201W to 30.9% in 201Z. This may have arisen from improved resource
utilisation (see below) resulting in a gradual decrease in the ratio of fixed costs to
revenues.
Competitiveness
This is concerned with market share and growing new business areas.
Market share is measured by the rate of restaurant turnover to the turnover of all restaurants in
the locality. This commences with 9.2% in 201W and continually increases to 17.5% in
201Z. There is also a rapid growth in the proposals submitted for new events (10 to 38), and
even more significantly, is the faster growth in contracts won. The success rate increases
from 20% in 201W to 66% in 201Z. The restaurant is therefore competing increasingly
successfully in this developing business area. The restaurant is becoming increasingly price
competitive.
1096
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REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Quality of service
The increasing number of regular customers would suggest that many customers are satisfied
with the total package that the restaurant offers. This may be partly due to service quality or
other factors such as price competitiveness. The growth in complaints, complimentary letters,
reported cases of food poisoning and the service delivery data would suggest rather a mixed
situation. It is difficult to provide a definitive comment regarding the quality of service over
the period, especially as the number of customers nearly doubled over the period. Even
additional calculations, such as those involving key service quality data per 100 customers
would not provide the basis for an overall conclusive comment.
Innovation/Flexibility
The restaurant has fared quite well in this respect considering:
„
„
„
the increase in the number of dishes on offer;
the introduction of theme evenings;
the development of the catering activities for special events.
The restaurant is prepared to try new dishes although the extent of its experimentation varies
considerably from year to year. Also, the fluctuating and somewhat unsatisfactory service
delays suggest that they are not managing to flex their resources adequately to meet peak
demand levels.
Resource utilisation
The business activity level continually increased over the period (meals served) with a decline
in non-productive time and the hours of operation with no customers. All these suggest an
improvement in resource utilisation. We do not know whether the increase in seating
capacity in 201Y arose from extending the floor area available or from the provision of more
seating within a constant space. Although this capacity increase permitted more customers to
be fed at peak times, it did result in a fluctuation in the annual number of meals served at each
seat, 150 (201W), 204 (201X), 155 (201Y), 167 (201Z). A brief attempt was made in 201Y
to extend the opening hours and increase the hourly utilisation of the premises.
(b)
Additional information to assess performance
Financial
„
The value of assets required to generate the profits – to calculate the ROCE.
„
Details of cost categories (e.g. labour, food overheads – to assess comparative
financial ratios).
„
Did the increase in capacity in 201Y require additional capital investment – to
assess the marginal returns.
„
The level of business risk inherent in alternative business and the associated
expected return.
Competitiveness
„
„
National trends in restaurant attendance and revenues provide broader comparisons.
Data on/customer surveys of restaurants in targeted customer groups.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1097
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Quality of service
„
To assess various intangible factors (e.g. politeness of staff, atmosphere and décor,
responsiveness to customer requests).
„
Food writers or expert ratings.
Innovation/Flexibility
„
Staff training and the potential for multi-skilled activities to provide greater
operational flexibility.
„
The ability to cope with non-standard requests (e.g. special dietary needs and
respond to customer needs).
Resource utilisation
„
Data on employee numbers would facilitate the calculation of business activity per
employee.
„
Data on floor area per customer.
Answer 49 BALANCED SCORECARD
Robert Kaplan and David Norton carried out studies in several companies in the early 1990’s. The
studies aimed at investigating the need to balance short-term financial performance with the drivers of
long-term growth opportunities. A number of advantages of the balanced scorecard over the traditional
major focus on financial performance may be suggested. These include:
„
Traditional measures tend to be dominated by financial accounting requirements. For
example the need for inventory valuation, including WIP for Statement of financial position
(Balance Sheet) purposes. Also the focus on short-term profit and ROI in order to ensure that
short-term financial reporting was favourably received by stakeholders. The balanced
scorecard is more broadly based. It argues that no single measure can provide a clear
performance target or focus attention on critical areas of the business.
„
Traditional measures are mainly inward looking. The balanced scorecard is more broadly
based. It is more outward looking and focuses on comparisons with competitors in order to
establish best practice and ensure that change is implemented in order to achieve it. It
requires a balanced presentation of both financial and non-financial measures and goals.
„
The balanced scorecard focuses to a greater extent than traditional measures on strategic
planning for the longer term. It attempts to identify the needs and concerns of customers and
the identification of new products and markets.
„
The balanced scorecard attempts to overcome the over-emphasis of traditional measures on
the quantifiable aspects of the internal operations of a company expressed in financial terms.
It also considers a range of non-financial and qualitative measures.
The balanced scorecard views the business from four different perspectives that are internal business,
innovation and learning, customer and financial perspectives. The questions asked in relation to these
perspectives are:
„
„
„
„
1098
What processes must we excel at to achieve our customer and financial objectives?
Can we continue to improve and create value?
What do existing and new customers value from us?
How do we create value for shareholders?
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
The balanced scorecard establishes goals for each of the four perspectives and provides measures that
should assist in movement towards these goals. Its focus is both internal and external. Examples of
measures that could be used are:
„
Internal business perspective: cycle time, unit cost analysis including cost trends and
VA/NVA analysis, engineering efficiency,
„
Innovation and learning perspective: Time to market for new products; number of new
products introduced.
„
Customer perspective: % sales from new products, % on time deliveries, % orders from
enquiries, customer survey analysis.
„
Financial perspective: overall measures such as profit, sales growth, ROI; liquidity measures
such as cash flow analysis; evaluation of new investment opportunities.
(Alternative relevant points and discussion would be accepted)
Answer 50 BLA CO
(a)
Business performance indicators
The Fitzgerald et al framework proposes six dimensions of performance that are controlled by
service industries. Their propositions include that two of these, namely financial performance
and competitiveness are the “results” of actions previously taken and reflect the success of the
chosen strategy. The remaining four dimensions of quality, flexibility, resource utilisation
and innovation are factors that determine competitive success now and in the future. The
performance of BLA Co can now be analysed under this framework.
(i)
Financial performance
Summary income statement for the year ended 31 October 201X
Fee income
Costs:
Consultants’ salaries
Bonus
Other operating costs
Subcontract payments
Net profit
Budget
$000
6,075
Actual
$000
6,300
2,025
2,025
90
2,805
18
4,938
–––––
1,362
–––––
2,550
4,575
–––––
1,500
–––––
It is clear that BLA has not performed as well as expected during the year to 31 October
201X. Whilst client income is above budget, other operating expenses reached a level that is
more than 10% higher than the budget for the year, and thus it would be extremely useful to
have a more detailed breakdown of other operating expenses for the year. Consultants have
earned an aggregate bonus of $90,000 (42,000 – 40,500) × $150 × 40% in respect of activity
above budgeted levels. Payments to subcontractors amounted to $18,000. Actual profit
amounts to $1,362,000 against a budget of $1,500,000.
It would be extremely useful to see the results of the previous two years in order to assess
whether there are any discernible trends in revenues and costs. The budget for the following
year should be reviewed in the light of the actual performance of this year with particular
reference to checking the footing of the assumptions on which it has been prepared.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1099
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
(ii)
Competitiveness
Competitiveness may be measured in terms of market share or sales growth and the relative
success in obtaining business from enquiries made by customers. The revenue of BLA Co for
the year to 31 October 201X is above budget.
Again it is desirable to see the results of recent years since it might well be the case that BLA
Co has achieved steady growth which is indicative of a high level of competitiveness in future
years. BLA provided 1,200 consultations on a no-fee basis with a view to gaining new
business. Also, during the year BLA consultants provided 405 non-chargeable “remedial”
consultations. Both of these non-chargeable activities might be viewed as initiatives to
increase future levels of competitiveness.
It is useful to look at the extent to which BLA Co were successful in converting the enquiries
received from both existing and new client enquiries into new business. The percentages are
as follows:
Budget
Actual
Conversion rate from enquiries
New clients
36.0%
26.7%
Repeat clients
50.0%
70.0%
70% of enquiries from the existing client base resulted in additional consultancy work for
BLA Co. This is indicative of strong customer loyalty indicating that existing clients are
satisfied with the service provided. However, the company was unable to fare as well with
regard to enquiries from potential “first time” customers, only achieving a conversion ratio of
26.7%, which is approximately 74% of the intended number of “first time” clients that were
budgeted for. This indicates that there is probably room for improvement in the ways in
which BLA Co deals with enquiries from prospective clients. The company should review its
marketing strategies with a view to improving its conversion ratio.
In absolute terms new business was approximately 7.8% below budget whereas repeat
business was 21.0% above budget.
As regards the nature of the chargeable activities undertaken by the consultants it can be seen
that Exterior design is 14.6% below budget, whereas Interior design and Garden design are
6.4% and 35.1% above budget.
(iii)
Service quality
Quality of service is the totality of features and characteristics of the service package that bear
upon its ability to satisfy client needs. Flexibility and innovation in service provision may be
key determinants of service quality. To some extent the increase in the number of complaints
and non-chargeable consultations associated with the remedying of those complaints is
indicative of a quality problem that must be addressed. This problem needs to be
investigated. BLA Co only provides advice to clients and only recommends contractors when
asked to do so by clients. It would be interesting to see how many of the complaints related
to recommendations made by BLA Co. Assuming consultants could have otherwise
undertaken chargeable work, the revenue foregone as a consequence of the remedial
consultations was $60,750. Client complaints received during the year were nearly double the
budgeted level.
1100
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Also the number of remedial consultations was 405 against a budgeted level of only 45,
which is exactly nine times higher than budget! Perhaps BLA Co should review and, if
necessary, limit the amount of remedial consultancy provided to any one particular client.
The business development consultations can be viewed as an innovative measure with a view
to gaining additional business. It is noticeable that during the year ended 31st October 201X
retired consultants working on a subcontract basis undertook 120 consultations, each of which
was of a non-chargeable nature. It is highly unlikely that the work undertaken by the retired
consultants was in nature of Business Development Activity as such work would invariably
be undertaken by the consultants employed on a full-time basis by BLA Co. Moreover, given
that the actual number of complaints during the year totalled 630 and that BLA consultants
themselves undertook 405 remedial consultations, it would be reasonable to assume that the
retired consultants undertook further remedial consultations and/or work that related to
complaints from clients.
It would be extremely useful to have a detailed analysis of the client complaints. The
scenario states that BLA only recommends contractors that undertake the three types of work
when requested to do so by clients. In this regard it is important to recognise that a potential
problem often exists where one party provides advice and another party is engaged to perform
duties which relate to the provision of that advice.
(iv)
Flexibility
Flexibility may relate to the company being able to cope with flexibility of volume, delivery
speed or job specification. Hence, flexibility might be substantiated by looking at the mix of
work undertaken by the consultants during the year. The following table gives a comparison
of actual and budgeted consultations by category of consultant.
Consultations by category of consultancy service
Budget %
Exterior Design
Interior Design
Garden Design
40.0
40.0
20.0
Actual %
32.9%
41.0%
26.1%
Increase/
(decrease)
(7.1%)
1.0%
6.1%
It is a deliberate policy of BLA Co to retain 45 consultants thereby maintaining flexibility to
meet increasing demand. The delivery speed will be increased as a consequence of the
retention of consultants. It would appear that a change has occurred in the mix of consultants,
which may well be a response to changing market requirements. Again, it would be useful to
see recent year’s statistics in order to consider trends but notably garden design looks to be a
growth area hence the three new consultants recruited during the year. The mix of consultants
should be such that BLA Co can cope with a range of job specifications. The fact that links
have been retained with retired consultants will give an added dimension of flexibility in
times of very heavy demand on its consultants.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1101
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
(v)
Resource utilisation
Resource utilisation measures the ratio of output achieved from those resources input. In this
scenario the mean number of consultations per consultant may be used as a guide.
Average consultations per consultant
Exterior Design
Interior Design
Garden Design
Budget
900
900
900
Actual
922
957
912
Increase/(decrease)
2.4%
6.3%
1.3%
It is interesting to note that all categories of consultant are being utilised above budgeted
levels. Consequently an aggregate bonus amounting to $90,000 was paid in respect of the
year ended 31 October 201X. There are potential problems if the quality of the service
provision is falling. In this regard it would be useful to have more detailed analysis of the
client complaints in order to ascertain whether a large proportion relate to any one category of
consultancy and/or contractor. BLA Co has adopted an innovative approach that requires
consultants to undertake non-chargeable business development consultations that have at their
heart the intention of generating new business. Hence in the immediate sense there is a tradeoff between resource utilisation and innovation.
(vi)
Innovation
Innovation should be viewed in terms of its impact on financial performance,
competitiveness, service-quality, flexibility and resource utilisation in the short, medium and
long term. Certainly the non-chargeable activity in terms of “business development” is an
innovative feature in the business of BLA Co, as is the non-chargeable remedial consultancy
provided to clients who experience problems at the commencement of building works. The
acquisition of “state of the art” business software is by its very nature innovative. The result
of its use is reflected in the significant increase of 35.1% above budget achieved in garden
design consultations. This has probably enabled BLA Co to differentiate its services from
those of its competitors and enhance its reputation. Certainly the management of BLA Co
will be hoping for a similar increase in business as a consequence of the use of the software
by its external and interior design consultants. The management should ensure the
introduction of the software has not caused the increase in the number of complaints received.
(b)
Determination of expected standards
In establishing targets, the importance of individuals taking ownership of the standards has
long been established: this is often facilitated by the adoption of a budgetary system based on
employee participation. This is also considered to be beneficial to the organisation since it
alleviates, or at the very least reduces, many of the dysfunctional consequences associated
with particular control models. In particular, managers who participate in the standard-setting
process are more likely to accept the standards set, feel less job-related tension and have
better relationships with their superiors and colleagues. Participation does, however, provide
opportunities for the introduction of budgetary slack in order that any subsequent monitoring
of activities presents a favourable outcome.
Budgets need to be realistic enough to encourage employees to perform, but not set at levels
so high that they are demodulated. The challenge to management lies in finding the balance
between what the company views as achievable and what the employee views as achievable
as this often proves to be a source of organisational conflict.
1102
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
It is important that the standards of performance measurement chosen by management
facilitate a fair comparison across all similar business units and that equity is seen to prevail
in measuring the performance of those units. There may be circumstances where some
business units have an inherent advantage unconnected with their own deliberate initiatives.
For example, some business units will be subject to higher levels of environmental
uncertainty than others. In situations where higher levels of uncertainty exist, there will be a
need for greater reliance to be placed on subjective judgment in appraising performance, with
consequently less reliance being placed on objective, financial data. It would be inappropriate
and inequitable to measure the performance of two completely different business contexts in
an identical manner.
Answer 51 AV
(a)
The value of money
The term “value for money” is often used to refer to economy, efficiency and effectiveness.
Value for money audits can be undertaken in order to assess whether value for money has in
fact been achieved. In order for such an audit to be effective the objectives of AV would need
to be clearly understood by those undertaking the audit.
The management of AV could attempt to measure the value for money of its operating
activities in terms of economy, efficiency and effectiveness. Economy is only concerned with
inputs acquired by AV, and is achieved by obtaining those inputs at the lowest acceptable
cost. For example, the prices at which with the replacement fitted kitchens are purchased
($2,610) could be compared with those obtainable from other vendors in order to assess
whether the lowest acceptable cost is being achieved for the required level of quality. It is
important that the management of AV realise that economy is measured by reference to
quality of resource inputs. They need to recognise that the purchase of poor quality materials
and inferior services represents “false economy”.
Efficiency is focussed on output, for example, maximising output for a given level of input.
For example with regard to the replacement fitted kitchens, AV could use the tendering
process in an attempt to maximise the number of fitted kitchens that would be installed for a
given amount of money by the contractor awarded the tender. Efficiency is measured by the
ratio of output to input. The ratio is not used in an absolute sense but in a relative sense and
can be improved in four ways:
„
„
„
„
By increasing output for the same input;
By increasing output by a greater proportion than the proportionate increase in
input;
By decreasing input for the same output; and
By decreasing input by a greater proportion than the decrease in output.
The denominator (input) is often measured in monetary terms whilst the numerator (output)
can be measured in either monetary amounts or physical units (e.g. per property).
Effectiveness is focussed on the achievement of objectives. A not for profit organisation will
invariably have a number of objectives. For example AV may have the following objectives:
„
„
„
„
„
To meet housing needs;
To provide quality well-managed homes;
To provide the services that clients want;
To provide an effective care and repair service;
To support the communities in which it operates.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1103
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
The management of AV should be mindful that the three performance measures require
individual consideration since for example, the degree to which effectiveness is achieved
gives no indication about how much was spent to achieve it.
The management of AV should also recognise that these performance measures may conflict
with one another. For example, during the year AV incurred expenditure amounting to
$234,900 in respect of 90 replacement fitted kitchens. If AV had purchased the same
replacement kitchen units as BW, then AV would only have been able to refit 45 properties
($234,900/$5,220). Hence, the efficiency ratio of inputs to outputs would have been halved.
However, the purchase of replacement kitchen units at a cost of $5,220 might have resulted in
a higher level of effectiveness being achieved through factors such as the longer life of the
replacement kitchen units, higher quality fixtures and fittings, and enhanced aesthetic
“appeal” to residents.
The management of AV should also give consideration to benchmarking against other similar
charities whose primary objective is the provision of accommodation to the communities in
which they operate. Benchmarking is probably the most significant recent development in
measuring the performance of not-for-profit organisations. The management of charities such
as AV would be far more willing to share information about performance with similar
organisations for their mutual benefit, than the management of many profit-seeking
organisations who often view the sharing of information as a commercial threat. For
example, the management of AV could attempt to establish whether $2,610 is the “norm” in
respect of the cost of a replacement fitted kitchen incurred by similar non-profit-seeking
organisations.
(b)
Performance Measures
(i)
Performance measures for flexibility and service quality
Service quality.
The time required in order to undertake repairs of an emergency nature, after notification of
the requirement by a tenant.
The friendliness of staff employed by AV could be measured via the completion of
questionnaires by tenants.
Flexibility.
Mean waiting time for a house to become available to a tenant.
Mean waiting time to re-house a tenant in a different sized house after receipt of a request
from a tenant.
(ii)
Cost and efficiency measures
The management of AV could use the following performance measures:
Cost and efficiency
(1)
(2)
(3)
1104
AV
$9.61
––––––
The mean cost per week, per house on general repairs. $10.22
––––––
Percentage of rent available that was collected.
98.5%
––––––
The mean cost, per week per house on management.
BW
$29.81
––––––
$6.13
––––––
100%
––––––
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Notes/comments
(1)
The mean cost per week per house is calculated by dividing the amount of staff and
management costs by the number of properties held by each of the respective
organisations. Although the same number of staff, 25, are employed by each
organisation, staff costs incurred by BW are 37.7% higher than those of AV. This
could result from different pay structures and management policies regarding
remuneration that are likely to be employed in a profit-seeking organisation such as
BW.
(2)
AV currently pays, on average, $140 for each emergency repair, $120 for each
urgent repair and $116 for each non-urgent repair. BW has benefited from the fact t
that each repair undertaken by BW costs the same (i.e. $100), irrespective of the
classification of repair. This might be a result of a contractual arrangement with a
subcontractor that each repair undertaken is charged at the same fee in return for
guaranteed business volumes for the subcontractor. If this were the case, then AV
would benefit from entering into such an arrangement for the supply of repair
services.
(3)
BW did not have any unoccupied properties at any time during the year. This
would seemingly indicate a high level of demand for its properties. AV had
potential gross rents receivable during the year of $2,423,200. Unoccupied
properties resulted in lost revenues of $36,348, which amounted to 1.5% of gross
rents receivable. Further information is required to in order to assess whether the
lost revenue is attributable to “void periods” (i.e. properties becoming vacant or
perhaps due to tenants who have defaulted).
Tutorial note: Other ratios and relevant comments would have been acceptable.
(c)
Comparison of operating and financial performance
The primary objective of any commercial organisation such as BW is to maximise profit.
Management may take a short or long-term view regarding the ways in which they seek to
achieve this objective. Management may have to choose between available options, each of
which might help them to achieve this objective. However, whilst many decisions may have
to be made, the objective remains clear and identifiable.
The management of BW will most probably be concerned with the provision of high quality
accommodation in order to generate higher revenues and profits. The management of BW are
probably trying to appeal to those who are willing to pay high rents for high quality
accommodation. The fact that replacement fitted kitchens and replacement windows and
doors purchased by BW cost 100% and 50% respectively, more than those purchased by AV
may be an indication of this.
The objectives of not-for-profit organisations such as AV can vary significantly. AV’s
primary objective is “to meet the accommodation needs of persons in its locality”. This might
distil down to ensuring that any person, who is in need of accommodation, is in fact provided
for. The absence of a profit measure makes it more difficult to measure whether objectives
are in fact being achieved. It is difficult to judge whether non-quantitative objectives such as
meeting accommodation needs of people have been met. This does not mean however, that
such an assessment should be placed on the “too difficult pile” and left unattended. A number
of suitable measures need to be devised by the management accountant in order to assess the
extent to which non-quantitative objectives have been met.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1105
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
The management of AV would probably be better served in comparing the performance of
their organisation with a similar non-profit seeking organisation that provides accommodation
to meet the needs of society.
Additional information that would assist in appraising the performance of BW during the year
includes the following:
„
Estimates of the financial effects of changes in demand for different levels of rents
charged.
„
Estimates of the financial effects of changes in demand for different costs/quality
levels of accommodation provision.
„
A detailed analysis of net interest payable – $750,000.
„
A detailed analysis of sundry operating costs – $235,000.
„
Management accounts for the current and prior years.
„
Budget information for the year and the two following years, if available.
It would also be useful to have details regarding the location of the properties held by BW. It
is quite conceivable that the houses held by BW are situated in a sought after area.
Benchmarking with a “best practice” organisation from the private sector would be of much
assistance in the appraisal of the operating and financial performance of BW.
Answer 52 BRIDGEWATER CO
(a)
Financial performance
The divisions of Bridgewater Co have been given very specific targets to meet it is reasonable
to assume that performance will be assessed relative to them.
Sales growth
The northwest division suffers from a slow start to the year, with falls in sales from quarter 1
to quarter 2. Overall sales growth looks better with an average growth of 14% achieved.
There are no quarterly budget sales to compare to but the low growth in budget profit suggests
that much slower sales growth than that actually achieved was expected. Overall the sales
budget has been exceeded, with big increases in sales in the last two quarters
The manager’s promotion could be damaged by the slow start. The “good news” of better
sales growth comes after the promotion decision is taken.
Cost control – trainer costs
The division spends slightly more (as a % of sales) than budgeted on trainers. It is spending
20% as opposed to 18% on trainers. Given the manager’s attitude towards quality it appears
he is trying to employ better trainers in the hope of more satisfied customers. This should,
logically, build customer loyalty and improve local and brand reputation. This could possibly
explain the better growth in the later quarters.
Again the problem for the promotion-seeking manager, investing in the future in this way
damages short-term performance measures, in this case cost targets.
1106
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REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Cost control – room hire costs
The divisional manager is also spending more on room hire. He is spending 10% as opposed
to the budgeted 9% of sales. He could be buying poorly, hence wasting money. Alternatively
he could be hiring better quality rooms to improve the learning environment and enhance the
training experience.
Again his focus on quality may be undermining his short-term promotional prospects.
Profit
Annually, the divisional manager is beating the targets laid down for profit. His problem as
far as his promotion is concerned is the profit targets laid down for the first two quarters are
not met.
The promotion decision comes too early for his employers to see the benefit of a quality focus
made earlier in the year.
Overall, promotional prospects do not look good. The manager has not met any of his targets
in the first two quarters. His only hope is that his bosses look at future forecasts and take
them in to consideration when making the decision.
(b)
Proposed changes
(i)
Revised forecasts
Sales
Less:
Trainers
Room hire
Staff training
Other costs
Software
Forecast Net profit
Original Budget profit
Q1
$000
42.5
Q2
$000
38.5
Q3
$000
62.5
Q4
$000
74.5
Total
$000
218.0
8.0
4.0
1.5
3.0
1.8
–––––
24.2
–––––
25.0
7.2
3.6
1.5
1.7
12.0
6.0
1.0
6.0
14.4
7.2
1.0
7.0
–––––
24.5
–––––
26.0
–––––
37.5
–––––
27.0
–––––
44.9
–––––
28.0
41.6
20.8
5.0
17.7
1.8
–––––
131.1
–––––
106.0
Q1
$000
Q2
$000
Q3
$000
Q4
$000
Total
$000
2.5
2.5
2.5
10.0
2.5
12.0
10.0
22.0
2.0
1.0
2.4
1.2
+9.5
+10.9
4.4
2.2
1.0
1.8
+22.6
Incremental effects (as a working)
Extra sales
Voucher sales
Software sales
Extra costs
Trainers
Room hire
Staff training
Software
Change in forecast Net profit
0.5
1.8
+0.2
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
0.5
+2.0
1107
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
(ii)
Evaluation of proposed steps
Voucher scheme
At first glance of it the voucher scheme looks a good one. The manager is confident of a
reasonable volume of sales and given that all the attendees will go on existing courses there
will be no additional costs. The scheme seems to generate $10,000 of extra sales revenue in
the year. One should question the assumption that no extra costs are incurred.
One potential concern would be that existing customers might object to the price reduction,
particularly if they have already paid a higher price for a future course. However, most
customers will probably not be aware of the price difference or will not bother complaining,
those that do complain can be dealt with individually. It is common with promotions that the
offer clearly states the terms and conditions that apply. In this way the manager can protect
existing sales by excluding existing sales from the new offer.
From a promotion point of view the extra revenue and profit helps a little. If the revenue is
spread evenly (as suggested) there will be $2,500 of extra revenue and profit in each of
quarter 1 and 2. Unfortunately, in both cases the manager will still fall short of the target
profit and the growth between quarter 1 and 2 will still be negative. He would need the take
up rate of the sessions to be quicker to help his promotion prospects. Manipulation of the
accounting figures should be resisted
Software upgrade
A software training company must stay in touch with modern software developments. From
that point of view you could argue that this development is essential. Financially the proposal
looks sound. The extra courses will generate a profit of $12,600 in this year alone, with,
presumably, more courses to follow. A slower than expected take-up rate for the new course
would reduce this year’s effect.
The promotional aspects are not as good. The extra costs occur in quarter 1 and 2 but the
revenue does not come in until after the promotion decision is made. Integrity is an issue
here. Personal promotional prospects must come second to sound business decisions. The
manager should show the revised forecasts to his bosses and hope this sways the decision.
Delayed payment to trainers
This is a poor idea. This will not affect profit, costs or any of the performance measures in
question. It will affect cash flow in a positive manner. However, to delay payment without
agreement can damage the relationships with the trainers, upon which he depends on for the
quality of their presentations.
Overall the three proposals do improve the performance of the division. However most of the
benefits accrue after quarter 2 and might therefore come too late for the promotion decision.
(iii)
Two improvements
To encourage a longer-term view more emphasis should be placed on non-financial measures
of performance.
This business is dependent amongst other things on the quality of its course provision. As a
result an improvement could be to set targets for the quality of presentations given. Attendees
could be asked to grade all trainers (or facilities) at the end of sessions. This would prevent
cheap but weak presenters (and poor quality rooms) being employed by managers.
1108
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Equally, the senior managers have to take account of longer periods when assessing
performance. Viewing a single quarter is too narrow and looking at the whole year is
advisable. Wider issues should also be taken into consideration when making promotional
decisions. Repurchase rates could be measured for client companies for example.
Answer 53 OSBORNE CO
(a)
Performance targets
(i)
Divisional return on investment
Traceable profit
Traceable capital employed
Traceable profit
= 8.5m – 5.3m – 1.7m – 0.95m = 0.55m
Capital employed = 2m + 1.2m + 0.3m + 0.8m + 0.5m + 0.1m – 0.4m – 0.2m = 4.3m
Therefore ROI
(ii)
=
0.55
4.3
= 12.8%
Divisional residual income (assuming an imputed interest rate of 12%)
$m
0.550
(0.516)
———
0.034
———
Traceable profit
Imputed interest (12% × 4.3m)
Thus both targets have been achieved.
(b)
Mr Iommi
Given that Mr Iommi is due to retire after the project’s first year, he will only consider the
effect on ROI and RI for the first year.
The effect during year 1 on the company’s profit and capital is as follows:
Profit
Cash flow from project
Depreciation (840,000 ÷ 3)
Increase in profit
Capital employed after one-year increase in capital employed will be
the NBV of the investment = 840,000 – 280,000
New ROI
0.55 + 0.02
4.3 + 0.56
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
$
300,000
(280,000)
——–—
20,000
——–—
560,000
——–—
11.7%
1109
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
New RI
$m
0.570
(0.583)
———
(0.013)
———
Traceable profit (0.55 + 0.02)
Imputed interest (12% × 4.86)
Hence neither target is achieved nor would Mr Iommi not receive his bonus for 2000
Over the whole life of the project average net profit is
⅓ × [(300,000 + 600,000 + 700,000) – 840,000] = $253,333
Thus ROI for the project calculated as
Average annual profit
Net assets at end of first year
and RI for the project in global terms
=
253,333
× 100% = 45.2%
560,000
= 253,333 – (12% × 840,000) = $152,533
If the project were considered over its entire life it would be acceptable under both appraisal
measures.
Consequently, Mr Iommi is acting dysfunctionally by not accepting the project. However,
this is understandable given that Mr Iommi is concerned with short-term results rather than
long-term, due to his intention to retire in a year. What has caused the difference in attitudes
towards the project is the fact that the high profits occur after the first year of the project’s
life.
Answer 54 RESPONSIBILITY CENTRE
(a)
Responsibility centres
A responsibility centre is part of an organisation for whose activities a manager is deemed to
be responsible. The type of responsibility centre depends on the type of activities for which
responsibility is carried.
Cost centre
A cost centre or expense centre can be defined as a responsibility centre where a manager is
accountable only for costs that are under his control. It is a production or service location for
which costs can be identified or accumulated prior to allocation to cost units. Cost centres
may be either standard cost centres, where output can be measured and the input needed for a
given output can be specified, or discretionary cost centres, where output cannot be measured
easily and the relationship between inputs and outputs cannot be specified1. An example of a
standard cost centre is a production unit in a factory, while an example of a discretionary cost
centre is a health and safety department in a university. A cost centre manager is responsible
for the cost of inputs to the organisation. The performance of the manager of a cost centre
can be assessed by comparing actual performance with budgeted targets for price, usage and
efficiency.
1
1110
Drury, C. (2004) Management and Cost Accounting, 6th edition, pp.653–4
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Revenue centre
A revenue centre is a responsibility centre where a manager is accountable solely for the
revenue generation that is under his control. An example would be a sales team with a target
geographical area that is under the control of a sales manager. The manager would have no
responsibility for the production cost of the items his team is selling, but has responsibility for
meeting sales targets in terms of sales volume, sales revenue or market share. A revenue
centre manager has responsibility for the revenue generated by outputs from the organisation.
The performance of the manager of a revenue centre can be assessed by comparing actual
performance with budgeted targets for price, mix and volume.
Profit centre
A profit centre is a combination of a cost centre and a revenue centre where a manager has
responsibility for both production costs and revenue generation. The degree of responsibility
carried by a manager can be higher with a profit centre than with a cost centre or a revenue
centre, and the manager may be responsible for purchasing, production planning, product mix
and pricing decisions. The performance of the manager of a profit centre is unlikely to be
assessed on the fine detail of cost and revenue data but by the extent to which agreed targets
for overall cost, revenue and profit have been achieved.
Investment centre
With an investment centre, the manager of a profit centre is given additional responsibility for
investment decisions regarding working capital and the purchase and replacement of fixed
assets. The manager of an investment centre is likely to be assessed with an aggregate
measure that links periodic profit to the assets employed in the period to generate that profit.
An example of such an aggregate measure is return on capital employed.
Controllable and non-controllable factors
It is a cardinal principle of responsibility accounting that managers can only be assessed on
the cash flows that are under their control. If a manager has no control over a cash flow he
cannot influence its size or timing and so cannot be held responsible if either of these values
changes. The performance of the manager of a cost centre can thus only be assessed on the
controllable costs over which he exercises control. In the case of a production cost centre, the
manager may be able to control material usage but could have no influence over the price at
which materials are bought by the purchasing department. For the production cost centre
manager, material usage is a controllable factor whereas material purchase price is not.
With a revenue centre, a sales manager can be held responsible for generating revenue against
agreed sales volume targets but may have no control over the selling price of his products as
this is determined by market conditions. In this case sales volume is a controllable factor
whereas selling price is not.
The manager of a profit centre will have control of operating costs but will not be able to
influence the financing costs arising from investment decisions. The manager may thus have
responsibility for operating profit but his performance should not be assessed on profit before
tax since interest charges are outside of his control.
The manager of an investment centre could have his performance assessed on profit before
tax, but the profit on which he is assessed should exclude non-controllable elements such as
overhead costs that he cannot influence, for example allocated head office charges.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1111
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
(b)
Assessing managerial performance
While it is possible to assess the performance of an investment centre such as a division in a
company on the basis of the profit it generates, considering profit alone and taking no account
of the assets used to generate the profit will provide an incomplete picture of performance.
Comparing profit between profit centres is also misleading if assets employed are ignored.
Assessment of the performance of an investment centre will usually therefore include a
performance measure that relates profit to assets employed. Two such measures are return on
investment (ROI) and residual income (RI).
Return on investment expresses controllable profit as a percentage of capital employed. It is
thus a relative, rather than an absolute, performance measure and is both widely used and
understood. Controllable profit means that non-controllable factors are excluded as far as
possible from the profit used in calculating ROI since these will diminish the usefulness of the
calculated measure in assessing managerial performance.
Because ROI is a relative measure, it can be used to compare performance between
investment centres. ROI also offers a way of assessing the past investment decisions made by
an investment centre, since it is measured after these investment decisions have been made. It
can thus be used to check that the performance predicted by investment appraisal decisions is
in fact being achieved post implementation.
Since ROI assesses investment centre managerial performance on the basis of controllable
profit generated, managers will be keen to maximise this as far as possible. The desire to
maximise controllable profit can be assisted by the use of performance related pay and similar
incentive schemes. But if performance is assessed using ROI, investment centre managers
will be as keen to minimise capital employed, as they will be to maximise controllable profit.
While this can encourage managers to dispose of obsolete equipment and minimise working
capital, it can also lead to sub-optimal decisions for the company as a whole.
If managers are assessed using ROI, there will be a disincentive to invest in projects with a
ROI that is less than the current ROI of the investment centre. However, these projects
should be accepted if the project ROI is greater than the company’s cost of capital. In this
case, the decision not to invest will not be consistent with the overall objective of maximising
shareholder wealth.
A similar problem arises with asset disposal decisions. Here, a manager assessed using ROI
may choose to retain assets with a low written down value since these assets will generate a
higher ROI than new, more expensive assets that could be more economical and efficient.
This problem highlights the way in which short-term concerns can outweigh longer-term
interests when ROI is used to assess managerial performance. It should be noted that ROI
could simply increase due to ageing assets rather than from the actions of managers charged
with increasing it.
Residual income has been suggested as a way of overcoming some of the perceived
shortcomings of ROI as a managerial performance measure. Residual income (RI) is defined
as controllable profit less a cost of capital charge on controllable investment. RI is therefore
an absolute, rather than a relative, performance measure, which means that comparisons
between investment centres cannot be made directly.
1112
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
The advantage of RI as a performance measure is that the cost of capital charge (or imputed
interest charge) is made by reference to the company’s cost of capital, so that a positive
residual income arises if an existing or proposed investment generates a return greater than
the required minimum. Investment centre managers assessed on the basis of RI will therefore
choose to accept all projects with a positive RI, increasing the company’s overall return. Suboptimal investment decisions should therefore be reduced or eliminated using RI. Investment
centre managers will also be discouraged from retaining ageing and inefficient assets, since
replacing such assets by more efficient ones is likely to lead to an increase in residual income.
Overall, it is felt that return on investment is an unsatisfactory way of assessing managerial
performance as far as an investment centre is concerned, and that residual income should be
used instead. Despite this, ROI appears in practice to be preferred to RI1.
Answer 55 PACE CO
(a)
Performance statistics
ROI
Bonus paid?
Sales Growth
Gross margin
Overheads
Net profit % on Sales
20X8
13%
No
–
40%
$67,000
6.5%
20X9
17.5%
Yes
0%
35%
$56,000
7%
20Z0
16.7%
Yes
–10%
35%
$53,000
5.6%
20Z1
20%
Yes
–5.6%
30%
$43,000
4.7%
The performance of store W can be assessed in various ways:
Sales growth
Sales revenue growth is most unimpressive. The market in which PC operates is steadily
growing and yet store W has shrunk in terms of sales over the last four years. This could be
poor volumes or poor prices achieved. Given the reducing gross margin (see below), then a
reducing sales price is likely. It is possible that W is subject to higher than normal levels of
competition.
Gross margin
The gross margins have also shrunk. Reducing margins can result from sales price pressure
or increases in the cost of sales levels being incurred. Suppliers might have increased prices
or labour could have got more expensive. The level of margin has only reached the normal
level once in the last four years. Clearly W is under performing.
Overhead control
The one area that is impressive is the apparent ability of the business to reduce overheads as
sales and margin have shrunk. This is often difficult to do. It is possible that reducing these
overheads could have contributed to the poor sales performance, if (for example) quality has
been affected, or one could say it reflects flexible management.
Net margin
The net margin has also fallen, primarily due to falling gross margins as overheads have
reduced. Clearly, this is a disappointing performance.
1
Drury, C. (2004) Management and Cost Accounting, 6th edition, p.847
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1113
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
ROI
The ROI has improved in most years and has exceeded the 15% target in all but one year
20X8. This is simply due to the reducing asset base as the stores assets have gradually been
depreciated. Net profit levels have fallen overall and yet ROI has increased.
It is hard to argue that the ROI figures properly reflect the performance of the store. The ROI
will tend to increase as assets get older and this will distort the financial performance picture.
In a period of falling sales and weaker margins the manager of W has been awarded bonuses
in three out of four years. This is hard to justify.
(b)
Manipulation of financial results
The unethical manager would have needed to move profits out of 20X9 and in to 20X8. One
immediate problem here is having the information in good time to respond. The manager
would have to be able to anticipate the 20X8 poor results and the improvement in 20X9. It is
likely that such a manager would have to gamble at the end of 20X8 and make an adjustment
in the hope of a better year in 20X9.
The manager need only move $2,000 of profit from 20X9 to 20X8 to achieve a 15% return in
both years.
Possible methods of adjustment include:
Accelerate revenue: Sales made early in 20X9 could be wrongly included in 20X8. He
could, for example, raise an invoice before it is normal, perhaps on the receipt of an order and
before actual delivery. The invoice itself would not have to be sent to the customer, merely
filed until the second year had begun and delivery made.
Delay the recording of 20X8 costs: A supplier’s invoice could be left unrecorded at the end
of 20X8, including it in 20X9 expenses instead.
Understate a provision or accrual in 20X8: This has the effect of moving cost from 20X8
to 20X9 (assuming that by the end of 20X9 the provision is correctly stated).
Manipulate accounting policy: Inventory values (for example) are easy targets for the
unethical manager. If inventory in 20X8 could be overstated this would have the effect of
increasing 20X8 profits at the expense 20X9 profits.
(c)
Store S
(i)
Financial forecast
Sales
Gross profit
Overheads
Net profit
Investment
ROI
1114
(W1)
(W2)
Year 1
$
216,000
86,400
70,000
16,400
100,000
16.4%
Year 2
$
237,600
95,040
70,000
25,040
75,000
33.39%
Year 3
$
248,292
91,476
80,000
11,476
50,000
22.95%
Year 4
$
235,877
79,061
80,000
(939)
25,000
–3.8%
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
WORKINGS
(1)
Sales
Sales volume (units)
Sales price ($)
Revenue ($)
Year 1
18,000
12·00
216,000
Year 2
19,800a
12·00
237,600
Year 3
Year 4
b
21,780
21,780
11·40c
10·83d
248,292
235,877
a:
18,000 (1.1) = 19,800
19,800 (1.1) = 21,780
c:
12.00 (0.95) = 11.40
d:
11.40 (0.95) = 10.83
b:
(2)
Gross profit
Year 1
Year 2
Year 3
40% (given).
Total gross profit = $216,000 × 0.4 = $86,400
40% (given).
Total gross profit = $237,600 × 0.4 = $95,040
(40 – 5)/(100 × 0·95) = 36.8421052%
Total gross profit = $248,292 × 0.368421052 = $91,476
(40 – 5 – 4·75)/(100 × 0.952) = 33.5180055%
Total gross profit = $235,877 × 0.335180055 = $79,061
Year 4
Alternatively, given that variable costs are said to be constant over the four years, you could
calculate the variable cost in year one and hold for the four years. Gross profit is then simply
sales revenue less variable costs.
Variable costs in year one:
$216,000 – (18,000 × unit VC) = $86,400
VC per unit = $7.20
So year two’s gross profit will be:
$237,600 – 19,800 × 7.2 = $95,040
(ii)
Minimum sales volume
In order for a bonus to be paid in year four a ROI of 15% is needed. This implies a net profit
of $25,000 × 15% = $3,750.
Adding overheads of $80,000 to this net profit means that $83,750 of gross profit is needed.
At a gross profit % of 33.518% this implies sales of $249,866.
At a price of $10.83, this suggests sales volume of 23,072 units.
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1115
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Answer 56 BUSINESS SOLUTIONS
(a)
Optimal daily cross charge
(i)
Spare capacity
If North uses the external consultant, the daily contribution to the company is $1,200 – $500
= $700. If North uses a consultant from South the daily contribution to the company is
$1,200 – $100 = $1,100. Therefore the cross charge rate should be set on a level where both
North and South will perceive that they will benefit – above $100 and below $500 – say $300.
(ii)
Full capacity – $400 a day
If North uses the external consultant, the total contribution for one day’s consultancy in both
North and South divisions would be:
Income
1,200
400
–––––
1,600
North
South
Variable cost
500
100
–––––
–
600 =
$1,000
––––––
If the South consultant goes to North, then the total contribution would be:
$1200 – $100 = $1,100
Therefore it is best if North employs the South consultant – by setting the cross charge above
$400 and below $500, say $450, both parties will benefit and agree to the transaction.
(iii)
Full capacity – $700 a day
If the North uses the South Consultant, the total contribution will be:
$1200 – $100 = $1,100
If North employs the external consultant, the total contribution will be:
North
South
Income
1,200
700
–––––
1,900
Variable cost
500
100
–––––
–
600 =
$1,300
––––––
The lost contribution of the work in South ($600) exceeds the incremental cost ($400) of the
external consultant undertaking the work.
The company therefore needs to set a cross charge that discourages a consultant going North
(i.e. above $500 but below $700).
1116
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)
Assumptions
(b)
„
The objective of the company is to maximise contribution in the short run (not long
run considerations)
„
The long term business consequences of rejecting work in the South (Scenario ii)
can be ignored
„
The divisional managers’ behaviour and responses determined only by short-term
sectional (divisional) financial performance measurement.
„
Access to all the decision-making data that the separate divisions use.
Reasons for re-organisation
„
The need to have local knowledge applied specifically to local decisions
„
A divisional company offers the opportunity to make decentralised speedy decisions
– especially with a rapidly changing environment
„
It permits senior managers to concentrate on global strategic issues – detailed
operational activities are dealt with separately by those most suitable
„
It permits junior managers to experience broader decision making and can be used
as part of their development programme
„
Local semi-autonomous decision making is likely to be a motivating factor for
managers (less central control)
„
A divisional structure may reduce the complexity and cost of the communication
systems in an unitary hierarchical structure
Suggested problems
„
The senior management may have difficulty in “letting go” – permitting decision to
be made locally
„
Senior management may become involved in resolving disputes between the
divisions
„
The divisions might eventually compete against each other to the detriment of the
entire company
„
Some divisional decisions may not be in the best interests of the entire company
(problems of local optimality v global optimality) – ensuring goal congruence
„
The potential waste from the duplication of functions
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
1117
PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK
Answer 57 MANUCO CO
The general rule of transfer pricing to assist in profit maximising decisions is to set transfer price equal
to marginal cost plus net opportunity cost to the group.
Applying this rule to the three situations:
(i)
External market
Since Helpco Co has an external market, which is the opportunity foregone, the relevant transfer price
would be the external selling price of $15 per kg. This will be adjusted to allow for the $1.50 per kg
avoided on internal transfers due to packing costs not required:
The transfer price should be $15 – $ 1.50 = $13.50 per kg.
(ii)
No external market
In this situation Helpco Co has no alternative opportunity for 3,000kg of its production of special
ingredient Z. It should, therefore, offer to transfer this quantity at marginal cost. This is variable cost
less packing costs avoided = $9 – $1.50 = $7.50 per kg.
Total cost = $15 × 80% = $12 Variable cost = $12 × 75%= $9)
The remaining amount of special ingredient Z should be offered to Manuco Co at the adjusted selling
price of $13.50 per kg as in (i) above.
(iii)
Alternative use for some production capacity
Helpco Co has an alternative use for some of its production capacity that will yield a contribution
equivalent to $3 per kg of special ingredient Z ($6,000/2,000kg). The balance of its spare capacity
(1,000kg) has no opportunity cost and should still be offered at marginal cost.
Helpco Co should offer to transfer:
2,000kg at $7.50 + $3 = $10.50 per kg; 1,000kg at $7.50 per kg; and the balance of requirements at
$13.50 per kg.
1118
©2012 DeVry/Becker Educational Development Corp. All rights reserved.
Performance
Management
Time allowed
Reading and planning:
Writing:
15 minutes
3 hours
ALL FOUR questions are compulsory and MUST be attempted.
Do NOT open this paper until instructed by the supervisor.
During reading and planning time only the question paper may
be annotated. You must NOT write in your answer booklet until
instructed by the supervisor.
This question paper must not be removed from the examination hall.
The Association of Chartered Certified Accountants
Paper F5
Fundamentals Pilot Paper – Skills module
Answer ALL FOUR questions
1
Triple Limited makes three types of gold watch – the Diva (D), the Classic (C) and the Poser (P). A traditional product
costing system is used at present; although an activity based costing (ABC) system is being considered. Details of the
three products for a typical period are:
Product D
Product C
Product P
Hours per unit Labour hours Machine hours ½
1½
1½
1
1
3
Materials Production
Cost per unit ($) Units
20
1,750
12
1,250
25
7,000
Direct labour costs $6 per hour and production overheads are absorbed on a machine hour basis. The overhead
absorption rate for the period is $28 per machine hour.
Required:
(a) Calculate the cost per unit for each product using traditional methods, absorbing overheads on the basis of
machine hours.
(3 marks)
Total production overheads are $654,500 and further analysis shows that the total production overheads can be
divided as follows:
Costs relating to set-ups
Costs relating to machinery
Costs relating to materials handling
Costs relating to inspection
Total production overhead
%
35
20
15
30
100
The following total activity volumes are associated with each product line for the period as a whole:
Product D
Product C
Product P
Number of
Set ups
175
115
480
Number of movements
of materials
112
121
187
Number of
inspections
1,150
1,180
1,670
670
120
1,000
Required:
(b) Calculate the cost per unit for each product using ABC principles (work to two decimal places).
(12 marks)
(c) Explain why costs per unit calculated under ABC are often very different to costs per unit calculated under
more traditional methods. Use the information from Triple Limited to illustrate.
(4 marks)
(d) Discuss the implications of a switch to ABC on pricing and profitability.
(6 marks)
(25 marks)
2
Simply Soup Limited manufactures and sells soups in a JIT environment. Soup is made in a manufacturing process
by mixing liquidised vegetables, melted butter and stock (stock in this context is a liquid used in making soups). They
operate a standard costing and variances system to control its manufacturing processes. At the beginning of the current
financial year they employed a new production manager to oversee the manufacturing process and to work alongside
the purchasing manager. The production manager will be rewarded by a salary and a bonus based on the directly
attributable variances involved in the manufacturing process
After three months of work there is doubt about the performance of the new production manager. On the one hand, the
cost variances look on the whole favourable, but the sales director has indicated that sales are significantly down and
the overall profitability is decreasing.
The table below shows the variance analysis results for the first three months of the manager’s work.
Table 1
F = Favourable. A = Adverse
Material Price Variance
Material Mix Variance
Material Yield Variance
Total Variance
Month 1 $300 (F)
$1,800 (F)
$2,126 (F)
$4,226 (F)
Month 2 $900 (A)
$2,253 (F)
$5,844 (F)
$7,197 (F)
Month 3
$2,200 (A)
$2,800 (F)
$9,752 (F)
$10,352 (F)
The actual level of activity was broadly the same in each month and the standard monthly material total cost was
approximately $145,000.
The standard cost card is as follows for the period under review
$
0.90 litres of liquidised vegetables @ $0.80/ltr =
0.72
0.05 litres of melted butter @$4/ltr
0.20
1.10 litres of stock @ $0.50/ltr
0.55
Total cost to produce 1 litre of soup
1.47
Required:
(a) Using the information in table 1:
(i)
Explain the meaning of each type of variances above (price, mix and yield but excluding the total variance)
and briefly discuss to what extent each type of variance is controllable by the production manager.
(6 marks)
(ii) Evaluate the performance of the production manager considering both the cost variance results above
and the sales director’s comments.
(6 marks)
(iii) Outline two suggestions how the performance management system might be changed to better reflect the
performance of the production manager.
(4 marks)
(b) The board has asked that the variances be calculated for Month 4. In Month 4 the production department data
is as follows:
Actual results for Month 4
Liquidised vegetables:
Melted butter:
Stock:
Actual production was 112,000 litres of soup
Required:
Bought
Bought
Bought
82,000 litres
4,900 litres
122,000 litres
costing $69,700
costing $21,070
costing $58,560
Calculate the material price, mix and yield variances for Month 4. You are not required to comment on the
performance that the calculations imply. Round variances to the nearest $.
(9 marks)
(25 marks)
3
BFG Limited is investigating the financial viability of a new product the S-pro. The S-pro is a short-life product for which
a market has been identified at an agreed design specification. The product will only have a life of 12 months.
The following estimated information is available in respect of S-pro:
1.
Sales should be 120,000 in the year in batches of 100 units. An average selling price of $1,050 per batch of 100
units is expected. All sales are for cash.
2.
An 80% learning curve will apply for the first 700 batches after which a steady state production time will apply,
with the labour time per batch after the first 700 batches being equal to the time for the 700th batch. The cost of
the first batch was measured at $2,500. This was for 500 hours at $5 per hour.
3.
Variable overhead is estimated at $2 per labour hour.
4.
Direct material will be $500 per batch of S-pro for the first 200 batches produced. The second 200 batches will
cost 90% of the cost per batch of the first 200 batches. All batches from then on will cost 90% of the batch cost
for each of the second 200 batches. All purchases are made for cash
5.
S-pro will require additional space to be rented. These directly attributable fixed costs will be $15,000 per
month.
A target net cash flow of $130,000 is required in order for this project to be acceptable.
Note: The learning curve formula is given on the formulae sheet. At the learning rate of 0.8 (80%), the learning
factor (b) is equal to -0.3219.
Required:
(a) Prepare detailed calculations to show whether product S-pro will provide the target net cash flow. (12 marks)
(b) Calculate what length of time then second batch will take if the actual rate of learning is:
(i) 80%;
(ii) 90%.
Explain which rate shows the faster learning.
(5 marks)
(c) Suggest specific actions that BFG could take to improve the net cash flow calculated above.
(8 marks)
(25 marks)
4
The following information relates to Preston Financial Services, an accounting practice. The business specialises in
providing accounting and taxation work for dentists and doctors. In the main the clients are wealthy, self-employed and
have an average age of 52.
The business was founded by and is wholly owned by Richard Preston, a dominant and aggressive sole practitioner.
He feels that promotion of new products to his clients would be likely to upset the conservative nature of his dentists
and doctors and, as a result, the business has been managed with similar products year on year.
You have been provided with financial information relating to the practice in appendix 1. In appendix 2, you have been
provided with non-financial information which is based on the balanced scorecard format.
Appendix 1: Financial information
Turnover ($’000)
Net profit ($’000)
Average cash balances ($’000)
Average debtor / trade receivables days (industry average 30 days)
Inflation rate (%)
Current year
945
187
21
18 days
3
Previous year
900
180
20
22 days
3
Current year
16%
7 weeks
Previous year
10%
10 weeks
Current year
1220
775
14%
Previous year
1500
600
20%
Current year
4%
Previous year
5%
30%
60%
25%
80%
Appendix 2: Balanced Scorecard (extract)
Internal Business Processes
Error rates in jobs done
Average job completion time
Customer Knowledge
Number of customers
Average fee levels ($)
Market Share
Learning and Growth
Percentage of revenue from non-core work
Industry average of the proportion of revenue from non-core work
in accounting practices
Employee retention rate.
Notes
1.
Error rates measure the number of jobs with mistakes made by staff as a proportion of the number of clients
serviced
2.
Core work is defined as being accountancy and taxation. Non-core work is defined primarily as pension advice and
business consultancy. Non core work is traditionally high margin work
Required:
(a) Using the information in appendix 1 only, comment on the financial performance of the business (briefly
consider growth, profitability, liquidity and credit management).
(8 marks)
(b) Explain why non financial information, such as the type shown in appendix 2, is likely to give a better
indication of the likely future success of the business than the financial information given in appendix 1.
(5 marks)
(c) Using the data given in appendix 2 comment on the performance of the business. Include comments on
internal business processes, customer knowledge and learning/growth, separately, and provide a concluding
comment on the overall performance of the business.
(12 marks)
(25 marks)
End of Question paper
Formulae Sheet
Learning curve
Y = axb
Where y =
a=
x=
b=
LR =
average cost per batch
cost of first batch
total number of batches produced
learning factor (log LR/log 2)
the learning rate as a decimal
Regression analysis
y=a+bx
b=
n∑xy-∑x∑y
n∑x2 -(∑x)2
a=
∑y b∑x
n
n
r=
n∑xy-∑x∑y
n∑x2 -(∑x)2 )(n∑y 2 -(∑y)2 )
Demand curve
P = a – bQ
b = change in price
change in quantity
a = price when Q = 0
Pilot Paper F5
Performance Management
1
Answers
TRIPLE Limited
(a)
Traditional cost per unit
Material
Labour ($6/hour)
Direct costs
Production overhead
($28/machine hour)
Total production cost /unit
(b)
D
$
20
3
23
C
$
12
9
21
P
$
25
6
31
42
28
84
65
49
115
ABC cost per unit
Examiners note: Each step required has been given its own sub-heading to make the procedure clear. The basic principle is
to find an overhead cost per unit of activity for each element of overhead cost. In some cases it might then be possible to find
an overhead cost per unit directly; here it is probably easier to split overheads between each product type first and then find a
cost per unit as shown.
(i)
Total overheads
These were given at $654,500
Total machine hours (needed as the driver for machining overhead)
(ii)
Product Hours/unit Production units 1,750
D
1½
C
1
1,250
P
3
7,000
Total machine hours
23,375
(iii) Analysis of total overheads and cost per unit of activity
Type of overhead Driver Set-ups
Machining
Materials handling
Inspection
Number of set ups
Machine hours
Material movements
Number of inspections
Total hours
21,125
21,250
21,000
%
35
20
15
30
100
Total overhead
$ 229,075
130,900
98,175
196,350
654,500
Level of
driver activity 670
23,375
120
1,000
Cost/driver
341.90
5.60
818.13
196.35
(iv) Total overheads by product and per unit
Product D Product C Product P Total
Overhead Activity $ Cost Activity $ Cost Activity $ Cost Activity $ Cost
Set-ups
75 25,643
115 39,319
480 164,113
670 229,075
Machining
1,125
6,300
1,250
7,000
21,000 117,600
23,375 130,900
Material Handling
12
9,817
21 17,181
87 71,177
120 98,175
Inspection
150 29,453
180 35,343
670 131,554
1,000 196,350
Total overhead cost
77,213 98,843 484,444 654,500
Units produced
Costs per unit
Cost per unit
(v)
Direct costs (from (a))
Overheads (from (iv))
750
$94.95
D $ 23.00
94.95
117.95
C $ 21.00
79.07
100.07
1,250 $79.07
P
$
31.00
69.21
100.21
7,000
$69.21
(c)
Comment
The overhead costs per unit are summarised below together with volume of production.
Product
Volume
Conventional overheads
ABC overheads
D 750
$42
$95
C 1,250
$28
$79
P
7,000
$84
$69
The result of the change to Activity Based Costing is clear, the overhead cost of D and C have risen whilst that of P has
fallen.
This is in line with the comments of many who feel that ABC provides a fairer unit cost better reflecting the effort required to
make different products. This is illustrated here with product P which may take longer to make than D or C, but once production
has started the process is simple to administer. This may be due to having much longer production lines.
(d)
Products D and C are relatively minor volume products but still require a fair amount of administrative time by the production
department; ie they involve a fair amount of `hassle`. This is explained by the following table of `activities per 1,000 units
produced`.
Set-ups Materials
Inspections
movements
D
100
16
200
C
92
17
144
P
69
12
96
This table highlights the problem.
–
Product P has fewer set-ups, material movements and inspections per 1,000 units than or C
–
As a consequence product P’s overhead cost per unit for these three elements has fallen
–
The machining overhead cost per unit for P is still two or three times greater than for products D or C, but because this
overhead only accounts for 20% of the total overhead this has a small effect on total cost.
–
The overall result is P’s fall in production overhead cost per unit and the rise in those figures for D and C
Pricing and Profitability
Switching to ABC can, as in this case, substantially change the costs per unit calculations. Consequently if an organisation’s
selling prices are determined by a version of cost-plus pricing then the selling prices would alter.
In this case the selling price of D and C would rise significantly, and the selling price of P would fall. This, at first glance may
be appealing however:
–
Will the markets for D and C tolerate a price rise? There could be competition to consider. Will customers be willing to pay
more for a product simply because Triple Ltd has changed its cost allocation methods?
–
Product P is a high volume product. Reducing its selling price will have a dramatic effect on revenue and contribution.
One would have to question whether such a reduction would be compensated for by increased volumes.
Alternatively, one could take the view that prices are determined by the market and therefore if Triple Ltd switches to ABC, it is
not the price that would change but the profit or margin per unit that would change.
This can change attitudes within the business. Previously high margin products (under a traditional overhead absorption
system) would be shown as less profitable. Salesmen (possibly profit motivated) can begin to push the sales of different
products seeking higher personal rewards. (Assuming commission based on profits per unit sold)
It must always be remembered that if overheads are essentially fixed then they should be ignored in business decision making.
Switching to ABC can change reported profits per unit but it is contribution per unit that is perhaps more important.
2
(a)
SIMPLY SOUP Limited
(i)
Meaning and Controllability of the variances
Material Price Variance
Indicates whether Simply Soup has paid more (adverse) or less (favourable) for its input materials than the standard
prices set for the period. For example, if a new supplier had to be found and the price paid was more than the standard
price then Simply Soup would incur an extra cost. This extra cost is the price variance.
Price variances are controllable to the extent that Simply Soup can choose its suppliers. On the other hand, vegetables
are a seasonal and weather dependent crop and therefore factors outside Simply Soups control can influence prices in
the market. The key issue is that the production manager will not control the price paid that is the job of the Purchasing
Manager.
Material Mix Variance
Considers the cost of a change in the mix of the ingredients to make soup. For example adding less butter (which is
expensive) and more stock (which is cheaper) will be a cheaper mix than the standard mix. A cheaper mix will result in
a favourable variance.
The recipe determines the mix. The recipe is entirely under the control of the production manager.
Material Yield Variance
This shows the productivity of the manufacturing process. If the process produces more soup than expected then the yield
will be good (favourable). At the moment 2.05 litres of input produces 1 litre of soup, if 2.05 litres of input produces more
than 1 litre of soup then the yield is favourable. Greater yield than expected can be a result of operational efficiency or a
change in mix.
The production manager controls the operational process so should be able to control the yield. Poor quality ingredients can
damage yield but the production manager should be in control of quality and reject dubious ingredients. The production
manager is also responsible for things like spillage. Higher spillage can also reduce yield.
(ii)
Production manager’s performance
Cost Efficiency
The production manager has produced significant favourable cost variances. The total favourable variance has risen from
$4,226 to $10,352 in the first three months. This last figure represents approximately 7.1% of the standard monthly
spend.
The prices for materials have been rising but are probably outside the control of the production manager. The rising prices
may have put pressure on the production manager to cheapen the mix.
The mix has become cheaper. This could be seen as a cost efficient step. However, Simply Soup must question the quality
implications of this (see later).
The yield results are the most significant. The manager is getting far more out of the process than is usual. The new mix
is clearly far more productive than before. This could easily be seen as an indicator of good performance as long as the
quality is maintained.
Quality
The concern is that the production manager has sacrificed quality for lower cost and greater quantity. The sales director
has indicated that sales are falling, perhaps an indication that the customers are unhappy with the product when
compared to competitor offers. The greater yield and cheaper mix may well have produced a tasteless soup.
Overall
Overall there has to be concern about the production manager’s performance. Cost control and efficiency are important
but not at the expense of customer satisfaction and quality. We do not have figures for the extent to which sales have been
damaged and small reductions may be acceptable.
(iii) Changes to the performance management system
The performance management system needs to take account of the quality of the soup being produced and the overall
impact a decision has on the business.
Quality targets need to be agreed with the manager. These are difficult to quantify but not impossible. For example soup
consistency (thickness) is measurable. Regular tasting will indicate a fall in quality; tasters could give the soup a mark out
of 10 on taste, colour, smell etc.
The production manager should not be rewarded for producing lots of cheap soup that cannot be sold. The performance
management system should reflect the overall effect that decisions have. If the production manager’s actions have
reduced sales then sales volume variances should be allocated to the production manager as part of the performance
assessment.
(b)
Variance calculations
Material Price Variance
Mixed Vegetables:
$69,700
82,000
– 0.80
Butter:
$21,070
4,900
–4
Stock:
$58,560
122,000
– 0.50
x 82,000 = $4,100 (A)
x 4,900 = $1,470 (A)
x 122,000 = $2,440 (F)
10
Material Mix Variance
Mixed Vegetables: (82,000 – 91,712.2*) x 0.80
= $7,770 (F)
Butter:
(4,900 – 5,095.1) x 4
= $780 (F)
Stock:
(122,000 – 112,092.7) x 0.50 = $4,954 (A)
Total Mix Variance
Note: it is only the total mix variance that is a valid variance here
Total input volume = (82,000 + 4,900 + 122,000) = 208,900
* Standard mix for mixed vegetables is = $91,712.2
Note: alternate approaches are acceptable.
Material Yield Variance
[112,000 – 101,902.4] x 1.47
= $3,596 (F)
= $14,843(F)
The standard inputs add up to 2.05 units (0.9+0.5+1.1). This produces 1ltr of soup. The actual inputs were 208,900 litres
and therefore the standard expected output should be
1
= 101,902.4 litres
208,900
2.05
3
BFG Limited
(a) Sales
Sales Revenue
Costs:
Direct materials (W1)
Direct Labour (W2)
Variable overhead
Rent
Net cash flow
Target cash flow
120,000 units
$1,260,000
$514,000
$315,423
$126,169
$180,000
$124,408
$130,000
The target cash flow will not be achieved
Workings:
(1) Direct material: Batches
First 200 @ $500
Second 200 @$450
Remaining 800 @$405
Total
$
100,000
90,000
324,000
514,000
(2) Direct labour
For first seven hundred batches
y = axb
y = 2,500 x 700 –0.3219
y = $303.461045
Total cost for first 700 batches = $303.461045 x 700 = $212,423
All batches after the first 700 will have the same cost as the 700th batch. To calculate the cost of the 700th batch we
need to take the cost of 699 batches from the cost of 700 batches.
For 699 batches
y=axb
y = 2,500 x 699 –0.3219
y = $303.600726
Total cost for first 699 batches = $303.600726 x 699 = $212,217
Cost of 700th batch is $212,423 - $212,217 = $206
Total cost for the 12 months of production
$212,423 + ($206 x 500) = $315,423
(3) Variable overhead is $2 per hour or 40% of direct labour
11
(b)
To calculate the learning factor BFG will have had to measure the time taken to make the first batch (500 hours) and then the
time taken to make the second batch. The learning rate measures the relationship between the average time taken between
two points as production doubles. The easiest way to measure the learning rate is when the production doubles between the
first and second batches.
At 80%
Time for first batch
Average time for two batches @80% 500 x 0.8
Total time for two batches
2 x 400
Time for second batch
800 – 500
At 90%
Time for first batch
Average time for two batches @90% 500 x 0.9
Total time for two batches
2 x 450
Time for second batch
900 – 500
500
= 400
= 800
= 300
500
= 450
= 900
= 400
The 80% learning rate reduces the time taken for the two successive batches above by a greater amount (or faster). Hence the
80% learning rate is the faster learning.
(c)
4
Possible actions to improve the net cash flows are:
–
Increase the price charged. The question states that an agreed specification has been reached, however further research
may reveal that a higher price could be tolerated by the market. Equally a form of price skimming may be possible to
improve short term net cash flow.
–
Reduce the labour cost per batch by removing unnecessary operations or processes. It may be possible to simplify the
design without damaging the ability to achieve the price stated.
–
Improve the learning rate. This may involve improving the training or the quality of people involved in the production
process. This does takes time and costs money in the short run.
–
Consider substitute materials (without damaging the product specification). Also look for new suppliers to reduce the input
cost.
–
Consider ways to reduce the level of variable overhead incurred by the product.
–
Investigate whether the production of product X could take place in existing space and hence avoid the extra rent charge.
Re-negotiate the rent charge with the landlord.
Preston Financial Services
(a)
Financial analysis
There are various financial observations that can be made from the data.
–
–
–
–
–
Turnover is up 5% – this is not very high but is at least higher than the rate of inflation indicating real growth. This is
encouraging and a sign of a growing business.
The main weakness identified in the financial results is that the net profit margin has fallen from 20% to 19.8%
suggesting that cost control may be getting worse or fee levels are being competed away.
Profit is up 3.9%. In absolute terms profits are impressive given that Richard Preston is the sole partner owning 100% of
the business.
Average cash balances are up 5% – indicating improved liquidity. Positive cash balances are always welcome in a
business.
Average debtors days are down by 3 days – indicating improved efficiency in chasing up outstanding debts. It is noticeable
that Preston’s days are lower than the industry average indicating strong working capital management. The only possible
concern may be that Richard is being particularly aggressive in chasing up outstanding debts.
Overall, with a possible concern about margins and low growth, the business looks in good shape and would appear to have
a healthy future.
(b)
Financial performance indicators will generally only give a measure of the past success of a business. There is no guarantee
that a good past financial performance will lead to a good future financial performance. Clients may leave and costs may
escalate turning past profits to losses in what can be a very short time period.
Non financial measures are often termed “indicators of future performance”. Good results in these measures can lead to a good
financial performance. For example if a business delivers good quality to its customers then this could lead to more custom at
higher prices in the future.
Specifically the information is appendix 2 relates to the non financial measures within the balanced scorecard.
Internal business processes are a measure of internal efficiency. Interestingly these measures can indicate current cost efficiency
as much as any future result
12
Customer knowledge measure how well the business is dealing with its external customers. A good performance here is very
likely to lead to more custom in the future.
Innovation and learning measures that way the business develops. New products would be reflected here along with indicators
of staff retention. Again this is much more focused on the future than the present.
Measuring performance by way of non-financial means is much more likely to give an indication of the future success of a
business.
(c)
The extra non-financial information gives much greater insight into key operational issues within the business and paints a
bleaker picture for the future.
Internal business processes
Error rates
Error rates for jobs done are up from 10% to 16%, probably a result of reducing turnaround times to improve delivery on time
percentages. This is critical as users expect the accounts to be correct. Errors could lead to problems for clients with the Inland
Revenue, bankers, etc. What is worse, Richard could be sued if clients lose out because of such errors. One could say that
errors are unlikely to be revealed to clients. Businesses rarely advertise mistakes that have been made. They should of course
put mistakes right immediately.
Customer Knowledge
Client retention
The number of clients has fallen dramatically – this is alarming and indicates a high level of customer dissatisfaction. In an
accountancy practice one would normally expect a high level of repeat work – for example, tax computations will need to be
done every year. Clearly existing clients are not happy with the service provided.
Average fees
It would appear that the increase in revenue is thus due to a large increase in average fees rather than extra clients – average
fee is up from $600 to $775, an increase of 29%! This could explain the loss of clients in itself, however there could be other
reasons.
Market share
The result of the above two factors is a fall in market share from 20% to 14%. Looking at revenue figures one can estimate
the size of the market as having grown from $4.5m to $6.75m, an increase of 50%. Compared to this, Preston’s figures are
particularly worrying. The firm should be doing much better and looks to being left behind by competitors.
Learning and Growth
Non-core services
The main weakness of the firm seems to be is its lack of non-core services offered. The industry average revenue from non-core
work has increased from 25% to 30% but Richard’s figures have dropped from 5% to 4%. It would appear that most clients
are looking for their accountants to provide a wider range of products but Richard is ignoring this trend.
Employee retention
Employee turnover is up indicating that the staff are dissatisfied. Continuity of staff at a client is important to ensure a quality
product. Conservative clients may resent revealing personal financial details to a variety of different people each year. Staff
turnover is possibly a result of extra pressure to complete jobs more quickly without the satisfaction of a job well done. Also
staff may realise that the lack of range of services offered by the firm will limit their own experience and career paths
Conclusion
In conclusion, the financial results do not show the full picture. The firm has fundamental weaknesses that need to be
addressed if it is to grow into the future. At present it is being left behind by a changing industry and changing competition. It
is vital that Richard reassesses his attitude and ensures that the firm has a better fit with its business environment.
In particular he should seek to develop complementary services and reduce errors on existing work.
13
Pilot Paper F5 Performance Management
Marking Scheme
1
(a)
For each product
1 mark
Total 3 marks
(b)
Total machine hours
2 marks
Cost per driver calculation
3 marks
Overheads split by product table
4 marks
Cost per unit calculation
3 marks
Total 12 marks
(c)
Explanation
(d)
Comment on pricing, markets, customers and profitability
Total
4 marks
6 marks
25 marks
2
(a)
For each variance
Explanation of meaning of variance
Brief discussion of controllability
1 mark
1 mark
(b)
Comment on cost variance
Price:
Outside Production Managers Control
Rising prices pressures
1 mark
1 mark
Mix
Cheaper mix and comment
1 mark
Yield
High yield results and comment
1 mark
Quality
Comment on quality implications
1 mark
Overall summary
1 mark
6 marks
(c)
Improvements to performance measurement system
For each sensible suggestion 2 marks
4 marks
(d)
Variance calculations
Price: 1 mark for each ingredient
3 marks
Mix: 3 marks
Yield: 3 marks
Method marks should be awarded as appropriate
Total
9 marks
25 marks
3
(a) Sales 1 marks
Direct material
2 marks
Direct labour first seven months
3 marks
last five months
3 marks
Variable overhead
1 marks
Rent
1 marks
Decision
1 marks
Total for part (a)
12 marks
(b) Second batch times 80%
2 marks
90%
2 marks
Comment on faster learning
1 marks
Total for part (b)
5 marks
(c)
Actions to improve net cash flow
(2 marks per explained idea)
Total for part (c)
Total
14
6 marks
8 marks
25 marks
4
(a)
Financial commentary
Turnover growth
2 marks
Profitability
2 marks
Cash position
2 marks
Debtor management
2 marks
Total
8 marks
(b)
Future performance
General explanation with example
2 marks
Comment on each area
3 marks
Total
5 marks
(c)
Assessment of future prospects.
Internal business processes
Error rates
3 marks
Not revealed to clients
1 marks
Customer Knowledge
Retention
1 marks
Fee levels
2 marks
Market share/size
1 marks
Learning and growth
Lack of product range
2 marks
Employee retention
2 marks
Total
Total
12 marks
25 marks
15
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