ACCA (F5) PERFORMANCE
MANAGEMENT
COMPLETE SUBJECT NOTES
BY VERTEX LEARNING SOLUTIONS
VALID UNTIL DEC 2024
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TABLE OF CONTENTS
CHAPTER
TOPIC
PAGE NO.
A1
Costing - Absorption Costing
4
A2
Costing - Absorption and Marginal Costing
7
A3
Costing - Under-Over Absorption of Overheads
9
A5
Costing - Target Costing
10
A6
Costing – Life Cycle Costing
15
A7
Costing - Throughput Accounting
18
B1
Decision Making - CVP Analysis
24
B2
Decision Making - Limiting Factors
35
B3
Decision Making - Shadow Pricing
36
B4
Decision Making - Make or Buy Decision
40
B5
Decision Making - Linear Programming
43
B6
Decision Making - Pricing Decisions
46
B7
Decision Making - Pricing Methods
51
B8
Decision Making - Relevant Costing
57
B9
Decision Making - Shutdown Decision
63
B10
Decision Making - Risk & Uncertainty Introduction
65
B11
Decision Making - Decision Trees
68
B12
Decision Making - Sensitivity Analysis
70
C1
Budgeting - Introduction to Budgeting I
72
C2
Budgeting – Introduction to Budgeting II
79
C3
Budgeting - Quantitative Analysis in Budgeting (High-
84
Low Method)
C4
Budgeting - Time Series Analysis, Regression and
86
Correlation
C5
Budgeting - Quantitative Analysis in Budgeting
91
(Learning Curve)
C6
Budgeting - Standard Costing
93
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C7
Budgeting - Implications of Standard Costing
96
C8
Variance Analysis - Material Variances
98
C9
Variance Analysis - Material Yield & Usage Variances
101
C10
Variance Analysis - Sales Mix and Quantity Variances
105
C11
Variance Analysis - Sales Variance
108
C12
Planning and Operational Variances
111
C13
Variances - Labor Variances
114
C14
Variance- Fixed Overheads Variance
119
C15
Variance Analysis - Variances Summary Formulas for
122
revision
D3
Performance Measurement - Balance Scorecard
124
D4
Performance Measurement - Building Block Model
126
D5
Performance Measurement - Divisional Performance
129
Measure
D6
Performance Measurement - Transfer Pricing
132
D7
Performance Measurement - Not for Profit Organization
144
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A1 - Costing - Absorption Costing
1.1
Definition of Absorption Costing
Absorption costing is based on the idea that the cost of a product or a service should
be: Its direct costs (direct materials, direct labor, and sometimes direct expenses)
plus, a share of overhead costs.
Absorption costing is therefore a system of costing in which a share of overhead
costs is added to direct costs, to obtain a full cost. This might be:
a full production cost, or
a full cost of sale.
An absorption costing system might be used to decide the full production cost of
the product so that only a share of production
overheads is added to production costs. Administration overheads and selling and
distribution overheads are simply charged as an expense to the period in which
they occur.
Income Statement: Absorption Costing
$000
$000
Sales
$000
950
Cost of inventory at the beginning of the period
80
Production cost of items manufactured in the period:
Direct materials
280
Direct labor
120
Direct expenses (if any)
Production overhead added to cost (‘absorbed’)
0
240
640
720
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Less: Cost of inventory at the end of the period
(120)
Production cost of items sold
600
Gross profit
350
Administration overhead
100
Selling and distribution overhead
200
300
Net operating profit
50
Inventory valuation is an important feature of absorption costing because the cost of
production in any period depends partly on the valuation of opening and closing
inventory, including work-in-progress and finished goods inventory.
In some costing systems,a share of administration overhead and selling and
distribution overhead might be added to the full production cost, to obtain a full cost
of sale. However, it is not common practice to calculate a full cost of sale, because it
has only limited value as management information.
1.2 The Purpose of Absorption Costing
There are several reasons why absorption costing is sometimes used, and production
overhead costs are added to direct costs to
calculate the full production cost of
products (or services).
•
There is a view that inventory should include a fair share of production overhead
cost.
•
This view is applied in financial accounting and financial reporting.
It can
therefore be argued that inventory should be valued similarly in the cost
accounting system. (However, inventory valuations may differ between the cost
accounts and the financial accounts.)
•
There is also a view that to assess the profitability of products or services,
it is appropriate to charge products and services with a fair share of overhead
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costs. Unless products contribute sufficiently to covering indirect costs, their
‘profitability’ might be too low, and the business might not be profitable.
1.3 Criticisms of Absorption Costing
There are criticisms of absorption costing. The main criticisms are as follows:
•
Absorption costing does not provide reliable information about profitability.
Methods of charging overhead costs to products, as we shall see, are not
‘scientific’, and rely on arbitrary assumptions.
•
There are better methods of measuring profitability, such as marginal costing.
There are also better ways of providing cost information to help managers make
decisions (relevant costs). Marginal costing and relevant costs are explained in
later chapters.
When absorption costing was first used in manufacturing, well over 100 years ago, total
overhead costs were fairly small compared with direct costs. Manufacturing was laborintensive, and direct labor costs were a significant proportion of total costs. Adding a
share of overheads to product costs, usually in proportion to the cost of direct labor or
direct labor time, was therefore a reasonable method of dealing with overhead costs.
In a modern manufacturing environment, however, direct labor is a small proportion of
total costs. Most work in production now consists of the ‘support’ activities of indirect
labor employees, and the cost of this labor is an overhead cost. Overhead costs are high
compared to direct labor costs. Therefore, it is often argued that a costing system
should use a different approach to overhead costing and try to present overhead costs
in a way that is more useful to management for information purposes.
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A2 - Costing - Absorption and Marginal Costing
2.1 Overview of Absorption and Variable Costing
Absorption
Marginal/Variable
Costing
Costing
Direct Material
Product
Direct Material
Cost
Variable Manufacturing Overhead
Product Cost
Fixed Manufacturing Overhead
Period
Variable Non-Manufacturing Overhead
Cost
Fixed Non-Manufacturing Overhead
•
Marginal Costing is good for decision making.
•
Absorption is for reporting.
Period Cost
2.2 Marginal Cost and Marginal Costing
•
Marginal Costing – it is an alternative to absorption costing method.
•
Only variable costs are charged as a cost of sale and a contribution is calculated.
(sales revenue minus the variable cost of sales)
•
Closing inventories of WIP or finished goods are valued at marginal production
cost (variable cost)
•
Fixed costs are treated as a period cost and are charged in full to the profit and
loss account.
2.3 Absorption Versus Marginal Costing Profit Statements
Absorption costing allows you to add overheads in the inventory, and if any units are
unsold then units are transferred to the next period, and they also take their fixed
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overheads to the next period. Fixed cost in unsold units is transferred to the next
period.
Marginal costing on the other hand says that fixed costs are period costs and cannot be
transferred to next period. Whether you sell full years fixed costs for the period must
be deducted in full of the income statement.
2.4 Absorption Versus Marginal Costing
•
Absorption costing is used for routine profit reporting and must be used for
financial accounting purposes under IAS 2 Inventories
•
Marginal costing provides better management information for planning and
decision making and is used for internal reporting and decision making.
•
Reported profit figures using the two different approaches will differ if there is
a change in the level of inventories in the period
•
If inventory level increases, absorption costing will report higher profits
•
If inventory level decreases, absorption costing will report lower profits.
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A3- Costing – Under/Over Absorption of
Overheads
Under-Absorption
•
If the amount absorbed is less than the amount incurred, the difference denotes
under-absorption.
•
It is also termed as “Under Recovery”.
•
It may be due:
▪
Actual expenses exceeding the estimate
▪
Output or the hours worked may be less than the estimate.
Over-Absorption
•
If the amount absorbed is more than the amount incurred, the difference denotes
over-absorption.
•
Over-absorption is also formed as “Over Recovery”.
•
It may be due to:
•
Expenses being less than estimate; and/or
•
Output or hours worked may be exceeding the estimate.
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A5 - Costing - Target Costing
Target Costing for Pm Acca
1 Introduction of Target Costing:
This involves setting a target cost by subtracting a desired profit margin from the selling
price. It is the system of strategic profit planning and cost management that determine
the life cycle cost that each product must achieve to enhance organizational desired
level of profit together with the product anticipated selling price. With target costing
it is often easier to reduce costs of a product at the design stage rather than after it
has entered production.
1.1 Target Costing Process
It is how a target cost and selling price is derived in a manufacturing company
(industry). Target costing begins with taking the price which the market will pay for
the product for a given market. From that, the required profit margin is deducted to
arrive at a target cost. The difference between the Current estimated cost for the
product and the target cost is the cost gap. Where the estimated costs exceed the
target cost, steps are taken to reduce the cost gap. The product can then be sold at a
price which the market will accept, and which generates an acceptable profit margin.
The cost Gap need to be closed before the product is launch.
1.2 Levels Where Target Costing Is Appropriate
1. Where we are designing an entirely new product
2. Where we are introducing new product into an existing value stream
3. To dive our existing improvement
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1.3 Steps Involve in Target Costing Process
1) Customer Identification & Product Development
2) Setting of Selling Price:
3) Calculation of Target (Desired) Operating Profit Margin
4) Calculation of Target cost:
5) Calculate the estimated Actual cost of the product based on
6) Determination Of Cost Gap:
7) Close/ Remove the cost gap:
8) Negotiation with Customer Whether to Go Ahead or abandon or redesign the product
Computation of Desire Profit
Note:
Desire profit could be calculated using =
i.
Profit =Sales amount X Profit margin %
ii.
Profit = (Sales) x (Mark-up % / (100%+Mark-up %)) = xx used for
converting Margin to margin
iii.
iii. Profit = (Sales) x (Margin % / (100% - Margin %)) = XX Used for
converting Margin to mark – up
Steps to Reduce a Cost Gap
In deciding what costs to eliminate, the company will have to consider the effect of
these on the quality and perception of the final product.
•
Cut down non- value - adding activities
•
Redesign the workflow or manning i.e., Team approach to allow discussion of
methods to reduce costs, Open discussion and brainstorming are useful
approaches here
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•
Review the whole supplier chain
•
Reduce the number of components inside without making the customer to less
value the product
•
Standardize the component as against specialized or customized component to
enjoy economy of scale.
•
Look into the cost log:
a) Materials - Use of cheaper material (Reduce costs without compromising
perceived value):
b) Labor - Use of cheaper labor grate (Reduce costs without compromising
perceived value):
c) Training staff in more efficient techniques to improve labor efficiency to
reduce the cost of our labor
d) Overheads - Increase in productivity to spread fixed overheads: Productivity
increases would also help here by spreading fixed overheads over a greater
number of units. Equally Activity based costing approach to its overhead
allocation; this may reveal more favorable cost allocations or ideas for reducing
costs in the business.
•
Assembly workers - changing working practices: Productivity gains may be
possible by changing working practices or by de-skilling the process.
•
Acquire new more efficient technology or invert new and efficient technology
to achieve the same thing at a lower cost.
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Benefits Of Adopting Target Costing
•
Early external focus as against cost plus approach:
•
Only those features that are of value to customers will be included in the product
design.
•
Cost control will begin much earlier in the process
•
Costs per unit are often lower under a target costing environment.
•
It is often argued that target costing reduces the time taken to get a product to
market.
Target Costing in A Service Organization
A service is an activity that is largely intangible that brings about value (i.e., an activity
which is of benefit to that individual) which can be transfer/ render to one person or /
to the other but does not need transfer of ownership.
Four Characteristics of Services
•
Spontaneity (Inseparability or simultaneity): unlike goods, a service is
consumed at the exact same time as it is made available. No service exists until
it is being experienced by the consumer.
•
Heterogeneity/variability (No standardization): services involve people and,
because people are all different, the service received may vary depending on
which person who performs it. Standardization is expected by the customer, but
it is difficult to maintain.
•
Intangibility: unlike goods, services cannot be physically touched.
•
Perishability: unused capacity cannot be stored for future use.
•
No transfer of ownership takes place when a service is provided’ and ‘service
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Difficulties for a Service Company in Using Target Costing
•
It is difficult to find a precise definition for some of the services
•
It is difficult to decide on the correct target cost for services
•
It would be difficult to use target costing for new services
•
Heterogeneity: Being heterogeneous the price will also be changing.
•
Intangibility: intangibility make it difficult to apply the target costing because it
hinders a survey, it is difficult to say the type of service that customers like
most.
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