Performance
Management (PM)
Sept/Dec 2021
Examiner’s report
The examining team share their observations from the
marking process to highlight strengths and
weaknesses in candidates’ performance, and to offer
constructive advice for those sitting the exam in the
future.
Contents
General comments .............................................................. 2
Section A ............................................................................. 2
Example 1 ........................................................................ 2
Example 2 ........................................................................ 3
Example 3 ........................................................................ 5
Example 4 ........................................................................ 6
Section B ............................................................................. 7
Question 1 ........................................................................ 9
Question 2 ........................................................................ 9
Question 3 ...................................................................... 10
Question 4 ...................................................................... 11
Question 5 ...................................................................... 12
Section C ........................................................................... 13
Question 1 – Bellahouston Co (Bella)............................ 13
Requirement (a) (i) – 7 marks ........................................ 14
Requirement (b) – 4 marks ............................................ 17
Requirement (c) – 5 marks ............................................ 17
Question 2 – Flag Co......................................................... 18
Requirement (a) - 14 marks ........................................... 19
Examiner’s report
PM September/December
2021 22
Requirement
(b) – 6–marks
............................................
1
General comments
This examiner’s report should be used in conjunction with the published
September/December 2021 sample exam which can be found on the ACCA Practice
Platform.
In this report, the examining team provide constructive guidance on how to answer
the questions whilst sharing their observations from the marking process,
highlighting the strengths and weaknesses of candidates who attempted these
questions. Future candidates can use this examiner’s report as part of their exam
preparation, attempting question practice on the ACCA Practice Platform, reviewing
the published answers alongside this report.
The Performance Management (PM) exam is offered as a computer-based exam
(CBE). The model of delivery for the CBE exam means that candidates do not all
receive the same set of questions. In this report, the examining team offer detailed
debriefs of selected questions from each section of the exam.
•
•
•
Section A objective test questions – we focus on four specific questions that
caused difficulty in the September/December 21 sittings of the exam.
Section B objective test case questions – here we look at one case from section
B in detail.
Section C constructed response questions – here we provide commentary on
two questions, providing guidance on answering these questions and where
exam technique could be improved, including in the use of the CBE functionality
in answering these questions.
Section A
In this section we will look at FOUR Section A questions which proved to be particularly
difficult for candidates.
Example 1
Product C currently sells 8,000 units per year at a price of $50 per unit. Market
research shows that an increase in price of $2 would decrease annual sales by 800
units.
What is the marginal revenue at an output level of 6,000 units (to the nearest
$)?
What does this test?
 The application of the demand function
What is the correct answer?
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 The correct answer is $40
The question requires the calculation of marginal revenue. To answer this question
requires the understanding of the demand function and that at the profit maximising
level, marginal cost = marginal revenue.
The first step is to define the demand function, P = a – bQ, where P is the price, Q is
the quantity, a is calculated as the price at which the demand would be zero, and b is
calculated as the change in price / the change in demand.
Calculate a and b:
b = 2/-800 = -0.0025
a = 50 + (8,000 x 0.0025) = 70
The demand equation can then be stated as: P = 70 - 0.0025Q
Marginal revenue (MR) can be defined as P = a – 2bQ, therefore MR = 70 - (2 x
0.0025)Q or
MR = 70 – 0.005Q.
In this question, we are given the quantity of 6,000, therefore MR can be calculated
as 70 – (0.005 x 6,000) = $40. If we equate marginal revenue (MR) and marginal
cost (MC), we can say that marginal cost is also $40, although this is not required for
this question.
Example 2
A company's actual production figures for a batch of products are as follows:
Material
Labour and overhead
Normal loss 10%
Abnormal loss
Good output
Kg
2,000
2,000
(200)
1,800
(100)
1,700
$
10,000
26,000
36,000
36,000
(2,000)
34,000
In terms of environmental cost categorisations, how would the normal and
abnormal losses be described?
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Options:
A.
Normal loss = Potentially hidden costs
Abnormal loss = Conventional costs
B.
Normal loss = Potentially hidden costs
Abnormal loss = Contingent costs
C.
Normal loss = Conventional costs
Abnormal loss = Contingent costs
D.
Normal loss = Conventional costs
Abnormal loss = Contingent costs
What does this test?
 The understanding of environmental cost categorisations
What is the correct answer?
 The correct answer is A Normal loss = Potentially hidden costs, Abnormal
loss = Conventional costs
Performance management candidates should be aware that there are different
environmental cost categorisations. One set of definitions provided by the US
Environmental Protection Agency made a distinction depending on how an
organisation intended to use the information. They identified four types of costs:
•
conventional costs: raw material and energy costs having environmental
relevance
•
potentially hidden costs: costs captured by accounting systems but then losing
their identity in ‘general overheads’
•
contingent costs: costs to be incurred at a future date – for example, clean-up
costs
•
image and relationship costs: costs that, by their nature, are intangible, for
example, the costs of preparing environmental reports.
In this example, normal loss costs are spread over good units of production
thus losing their identity and being lost and potentially hidden. Abnormal losses are
reported separately in results so are like conventional costs of material, energy etc.
The numbers given in the question are for illustration only and are not required to
answer the question.
Candidates should read the PM technical article on Environmental management
accounting which can be found on the study resources section of the ACCA website.
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Example 3
Which TWO of the following statements about forecasting based on simple
linear regression are correct?
Options:
A.
It can account for the effect of multiple independent variables
B.
It assumes that historical data is a reliable guide to the future
C.
It is not suitable when the variables show strong negative correlation
D.
Cost forecasts using extrapolation are less accurate than those using
interpolation
What does this test?
 The understanding of the assumptions of linear regression
What is the correct answer?
 The correct answer is B. It assumes that historical data is a reliable guide to
the future and D. Costs forecast using extrapolation are less accurate than
those using interpolation
One assumption of simple linear regression is that the dependent variable is only
affected by one independent variable. Therefore 'It can account for the effect of
multiple independent variables' is incorrect.
Another assumption is that what happened in the past will continue into the future.
Therefore ‘It assumes that historical data is a reliable guide to the future’ is correct.
Simple linear regression is suitable when there is correlation between two variables.
It can be positive or negative correlation. Therefore ‘It is not suitable when the
variables show strong negative correlation’ is incorrect.
Interpolation means forecasting within the range of the original data whereas
extrapolation means forecasting outside the range of the original data. Forecasting
within the range is more reliable because there is data to back up the forecast. It is
more difficult to be sure what the results will be if they are outside the range
recorded in the past. ‘Cost forecasts using extrapolation are less accurate than those
using interpolation’ is therefore correct.
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Example 4
Core Care Trust is a public sector 'health and care' home providing care for the
elderly. Income is received on a contract basis from the local government authority.
Care workers are mainly full-time staff but occasionally temporary staff from a local
employment agency must be brought in, at great expense, to fill staff rota gaps.
There is a regulatory body monitoring the work done by care homes known as
CHQC which sets targets for the standard of care expected.
It is generally regarded that residents spend a much happier time whilst in a care
home if they are able to establish long-lasting relationships with care home staff
providing their direct care.
The six performance measures below are used by the management of Core Care
Trust to monitor performance as part of the value for money framework.
Match the performance measures to the elements of the value for money
framework which they are measuring.
Measures
Economy
Direct staff cost as a percentage of
contract income
Temporary staff usage (hours) as a
percentage of total staff hours
Food cost per meal served to
residents
Efficiency
Achieving the CHQC’s designated
standard of care for the elderly
Number of voids (the number of
empty beds as a percentage of total
Staff turnover
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Effectiveness
6
What does this test?
 The application of the value for money (3Es) framework
What is the correct answer?
 The correct answer is: Economy – direct staff as a percentage of contract
income and food cost per meal served to residents. Efficiency – temporary
staff usage (hours) as a percentage of total staff hours and number of
voids. Effectiveness – achieving the CHQC’s designated standard of care
for the elderly and staff turnover.
Economy is an input measure and considers whether the resources used are being
acquired at the required quality for the cheapest price. Efficiency links inputs and
outputs and considers whether the maximum outputs are being achieved given the
level of inputs. Effectiveness measures outputs and considers if the overall
objectives are being met.
So, staff costs and food costs should be measured against the budgets set and are
economy measures. The use of temporary staff and having empty beds are
efficiency measures as they measure how well resources are being used. Finally,
providing good quality care to meet the regulator's requirements is a measure of
effectiveness. As relationships are key to providing good care then low staff turnover
will facilitate that.
Section B
In this section we will look in detail at a case covering target costing from syllabus
area B – Specialist cost and management accounting techniques.
Darask Co
Darask Co is a global consumer electronics manufacturer. It sells its own brand of
smartphones, computers and personal entertainment devices. It uses target costing.
D-Paad - Feasibility study results
The board of Darask Co has conducted a feasibility study in order to decide whether
or not to launch a new device, the D-Paad, in 20X9. The D-Paad will have a threeyear life cycle, over which a total of 80 million units will be sold.
The variable manufacturing and selling cost of the D-Paad is currently estimated at
$123 per unit. The total fixed product cost, including investment and overheads, is
budgeted to be $3,360m over the whole life cycle.
The initial estimate of the selling price included in the feasibility study for the D-Paad
was calculated to ensure a profit mark-up of 60%.
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D-Paad - Market research analysis
The board decided to commission some market research to determine the price
customers would be willing to pay for the D-Paad. Sales volumes and sales prices
were estimated for the various stages of the D-Paad’s product life cycle as follows:
Introduction
Growth
Maturity
Decline
Sales volume
(millions)
Sales price
($/unit)
8
14
56
2
425
300
220
120
Based on the market analysis, the board has approved the development of the DPaad as long as the total product cost, including manufacturing, investment and
overheads, does not exceed $13,000m.
Retail outlets
The board of Darask Co is also considering the opening of some retail outlets which
will be located in major cities around the world. The outlets, as well as selling Darask
Co's products, will also hold free-of-charge surgeries where the product users can
seek help on how to use their devices and have their devices repaired.
The board has been discussing whether it is possible to use target costing in relation
to the retail outlets. The following statements have been made:
Director X
Target costing cannot be used because it is difficult to
estimate target selling prices for services
Director Y
Target costing is most useful when what is being
developed has a high degree of variability such as
developing new services
Director Z
Target costing when developing new services is difficult
because services are intangible and measuring a unit of
service is not always possible
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Question 1
Which of the following statements about the use of target costing at Darask Co
is/are correct?
(1) It relies on just-in-time processes in order to work
(2) It can be used alongside life cycle costing and planning
Options:
A.
1 only
B.
2 only
C.
Both 1 and 2
D.
Neither 1 nor 2
The correct answer is B. 2 only
Statement 1 is incorrect as, although just-in-time (JIT) is often associated with cost
reduction and performance improvement, there is no prerequisite that JIT must be in
operation for target costing to be useful, as long as there is scope to reduce costs
sustainably in other ways.
Statement 2 is correct, but some candidates will believe that target costing, life cycle
costing and planning are alternatives to each other.
Question 2
What was the initial selling price of the D-Paad from the feasibility study
results (to the nearest whole $)?
$___________
The correct answer is $264
Variable cost ($123 x 80m)
Fixed cost (given)
Mark-up
$m
9,840
3,360
13,200
x 1.6
21,120
£21,120m ÷ 80m units = $264
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Question 3
Based on the market research analysis, what is the total cost gap of the DPaad, if Darask Co wants to achieve a target profit margin of 45%?
Options:
A.
$3,928m
B.
$1,912m
C.
$9,072m
D.
$11,088m
The correct answer is B. $1,912m.
Target profit
Introduction
Growth
Maturity
Decline
Target revenue
Target cost (Balance)
Target profit (45% x
$20,160m)
Sales units Sales price
(millions)
($)
8
14
56
2
80
425
300
220
120
Revenue
($m)
3,400
4,200
12,320
240
20,160
(11,088)
9,072
Cost gap = $13,000m less $11,088m = $1,912m
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Question 4
The following proposals have been made in order to close the cost gap of the DPaad:
(1) Introduce 24-hour working in the factories where the D-Paad is made in order to
increase production and build inventory
Incorporate quality assurance inspections into the manufacturing processes to
(2)
reduce faulty units
Increase the sales and marketing spend in order to boost the sales volumes of the D(3)
Paad
Which of these proposals is/are likely to reduce the cost gap?
Options:
A.
1 and 2
B.
2 and 3
C.
2 only
D.
1 and 3
The correct answer is C. 2 only.
Increasing capacity and building inventory are non-value adding activities unless the
additional production can be sold.
Boosting marketing spend to sell more units may be tempting but it does not address
the cost gap.
Quality assurance inspections eliminate waste and reduces cost so is the only
potential option to reduce the cost gap.
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Question 5
In relation to the use of target costing for the retail outlets, which of the
directors' statements is/are correct?
Options:
A.
X, Y and Z
B.
Y and Z only
C.
X and Y only
D.
Z only
Director X is wrong as it is possible to estimate target selling prices for services
(many organisations do) even if target costs may be more difficult to establish.
Director Y is wrong because a high degree of variability makes it difficult to
determine a target that can be achieved through cost reduction. Designing costs out
of a new mobile phone can be done because it is a standardised product so once it
is designed the cost reduction can be realised. If a service is so variable then it is
less obvious as to what is required to fulfil each customer’s needs so a target cost
can be difficult to meet.
Director Z is correct as services are intangible and determining a service unit is not
always possible.
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Section C
In this section we will look in detail at TWO constructed response questions from
different syllabus areas. The full questions and solutions have been published and
are available on the ACCA Practice Platform.
Question 1 – Bellahouston Co (Bella)
Bella is from the Decision-Making area of the syllabus (syllabus area C), specifically
limiting factors. This is one of the more technically demanding areas of the syllabus,
which can lead to low scores if candidates are not fully prepared and have not studied
this area in depth. Conversely, it is possible to score very high marks if you have a
good understanding of these techniques.
Bella is a sport shoe manufacturer, manufacturing three types of shoe. Bella has
been approached by a major retailer for a special order of 200 pairs of each type of
shoe for a discounted price. Bella is keen to fulfil the order as it could lead to a
regular supply contract, however Bella has insufficient resources to meet the
production level required to fulfil both the special order and normal levels of demand.
Information from the scenario should allow candidates to establish that during March,
there is a single limiting factor, but during April there are multiple limiting factors.
Part (a)(i) involves the calculation of the optimum production plan and total
contribution assuming the special order is fulfilled for 7 marks, followed in (a)(ii) by a
calculation of the financial penalty that could be incurred if the special order cannot
be completed for 4 marks. Part (b) is the only discussion aspect of the question for 4
marks, which asks for a discussion as to whether Bella should complete the special
order. The final requirement introduces multiple limiting factors and involves defining
the variables and formulating the linear programming model for the remaining 5
marks.
Approaching this type of question can be a bit daunting – there are several
requirements and a lot of detail in the scenario. It is a good approach to have a
quick look at each requirement first to identify what syllabus areas are involved and
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any important information that will be needed from the scenario. Then, take each
requirement in turn and read the scenario in detail. This also highlights why
practising past exam questions as part of your revision is crucial – it allows you to
become much more familiar with how questions are phrased and narrow down
what’s being asked. On this question, key terms jumping out are:
Part (a) – Calculate the optimum production plan – questions asking for this are
most likely to be single limiting factor questions (if it’s multiple limiting factors that will
be very clear).
Part (b) – Discuss... Runwild’s order. Not a lot to go on there, but I need to find out
what Runwild is.
Part (c) – Define... linear programming model. This clearly involves multiple
limiting factors – defining the linear programming model is the first part of this.
Remember this is nothing more than a quick scan, but from this it is clear that the
question is about limiting factor analysis.
How to perform well in this question
Requirement (a) (i) – 7 marks
(a) (i) Calculate the optimum production plan and the resulting total
contribution earned for March, assuming that the order with RunWild is
supplied in full.
(7 marks)
Requirements often include more than one task, and it’s a good idea to break it up
and decide what needs doing. This also ensures that no parts of the requirement are
missed.
Calculate the optimum production plan
Verbs are very important in requirements – this one is clear; we need to perform a
calculation. ‘Optimum’ means best. In the context of our syllabus, it’s used in a few
situations, but means ‘Profit maximising’. However, in almost every case, if we
maximise contribution, we’ll also maximise profit, as fixed costs will not change in the
short term. Finally, production plan means how many of each product to make.
So, in summary, I need to work out how many of each product to make in order to
maximise contribution. This already tells me that I need to identify what products the
business makes, and their respective contributions.
and the resulting total contribution earned for March
This is the next part of the requirement, so I also need to calculate the contribution
my production plan earns. This should be straightforward – my production plan will
tell me how many of each product to make, and I will already have the contribution
that each unit earns, so total contribution is just units x contribution/unit for each
product.
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Note that it doesn’t matter if your production plan is ‘wrong’. As long as you take your
final plan and multiply it by contribution/unit, you will get credit for calculating total
contribution correctly. That’s why it is so important to keep going – there are easy
marks here for a final contribution, so make sure you get to this part of the
requirement. Unfortunately, many candidates didn’t attempt this part of the
requirement.
assuming that the order with RunWild is supplied in full
We have no idea what this means at this point, but what it tells us is that when we do
read the scenario to find out what RunWild is, and make sure we include it.
We can now look in detail at the scenario. Reading through the scenario gives the
following vital information:
Products - We need to know what products they make in order to come up with a
production plan, and this is given straight away – Road, Spikes and Trail. Note that
each unit equates to a pair of shoes.
Contribution – We’re trying to maximise contribution, and the first table clearly gives
selling prices and costs for each shoe, to allow us to calculate the contribution per
shoe.
Important points – two common mistakes made in this question were to either use
profit per shoe or throughput per shoe. You cannot use profit per shoe as this
includes fixed cost per shoe. Remember that we are changing the number of each
shoe we produce – this will change the fixed cost per shoe. Overall fixed costs don’t
change, so we use contribution per shoe, and then profit can be calculated as total
contribution less total fixed costs.
Throughput should only be used if we are specifically told that the business uses
throughput accounting
Demand/Runwild – we’re given details of maximum demand – we will need that to
help with the production plan. Importantly, we are also told about the RunWild order.
This is for 200 of each shoe, but we are told two important details – firstly that the
selling price is $8 lower than normal and secondly that the 200 shoes are NOT
included in the demand figures given.
Resource Availability – finally, we’re told that there are restrictions on resource
availability in March and April. Check the requirements quickly – parts (a) and (b)
refer to March and (c) refers to April.
Now we have all the information, we can attempt the question. As with many
technical areas in PM, there are set steps to follow in order to find the optimum
production plan. These steps are:
Examiner’s report – PM September/December 2021
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1) Identify the limiting factor
2) Calculate contribution/unit
3) Calculate contribution per unit of limiting factor
4) Rank products in order of contribution per unit of limiting factor
5) Make products in order of rank until resource is exhausted
It is vitally important to know these steps. If you look at the model answer, this is
exactly what has been done (step 2 is missed out but needs to be done in order to
work out step 3).
The most common mistake is to rank products using contribution/unit. This cannot
work as it does not allow for the fact that some products use more resource than
others.
The other common mistake on these questions is not to include the minimum order.
It was pleasing to see that in this case, most candidates did include the RunWild
order as instructed.
Once you have got your optimum plan, it’s important to get the easy part of the
question – work out the total contribution your plan will earn.
Requirement (a)(ii) – 4 marks
(a)(i) Calculate the maximum financial penalty Bellahouston Co would be
prepared to accept from RunWild, if it does not complete RunWild’s order in
full.
(4 marks)
The financial penalty was mentioned in the scenario – Bella will have to pay a financial
penalty if they do not complete the RunWild order in full. The key thing here is to
understand Bella’s position. The RunWild order is less profitable than normal
production – each shoe earns $8 less contribution than normal. Since machine hours
are in short supply, Bella cannot fulfil maximum demand for its normal production.
Therefore, it would be more profitable if they gave up on some of the RunWild order
and met demand for regular production.
To answer this question, we need to work out what the contribution would be if we did
not do the RunWild order first. As the model answer explains, there are two ways to
do this. The first is perhaps more straightforward – really, it’s just a repeat of (a)(i), but
now we have 6 products. If you rank those 6 products in order of contribution/hr, the
lowest ranked is the RunWild Road shoes, so we can make everything else, and 20
of the Road special order, giving a contribution $1200 higher than in (a)(i).
The second approach is quicker and involves just looking at the changes. From (i), we
can see that we would like to make another 150 Road shoes. In order to do that we
need to free up enough hours to make them. As the RunWild Road shoes are the
worst ranked product in terms of contribution/hr, if we give up on 150 of those, that will
Examiner’s report – PM September/December 2021
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free up enough hours to sell 150 Road shoes at full price. The only difference is the
$8 price discount, so selling the shoes at full price will give an extra $8*150=$1200.
As mentioned before, this does depend on your answer to (i) – remember if that was
wrong, you would still get follow through marks if your method was correct for (ii).
The most common mistake here was that many candidates didn’t realise that they
could part fulfil the RunWild order, so looked at what would happen if they didn’t do
the order at all. Some credit can still be earned, but careful reading of the requirement
would show that part fulfilment was an option.
Requirement (b) – 4 marks
(b) Discuss whether Bellahouston Co should fulfil RunWild's order in full in
March.
(4 marks)
We should be aware of the situation now – Bella can either fulfil the order in full, or
part fulfil and accept the fine. Most candidates focussed on this, however this question
is worth four marks, so needs more. Other factors were hinted at in the scenario, and
good answers picked up on this – the question was really about non-financial factors.
Happily, most candidates also identified that not completing the order would have a
negative reputational impact, and could affect future orders
Requirement (c) – 5 marks
(c) Define the variables and formulate the constraints and objective function to
be used in a linear programming model to determine the optimum usage of
resources in April.
(5 marks)
This requirement is separate to (a) and (b) – as mentioned earlier they were
regarding March, while (c) asks about April. This is quite a long requirement, so
breaking it down:
Define the variables
Standard requirement for linear programming questions – the variables are ‘the things
we can change’, i.e. how many of each product to make.
Formulate the constraints
Again, it’s essential you know the steps for formulating a linear programming problem
– the constraints are the limiting factors, which we are already quite familiar with.
Objective function
Our objective is to maximise contribution, the objective function will tell us how to work
out contribution depending on our variables.
Examiner’s report – PM September/December 2021
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to be used in a linear programming model to determine the optimum usage of
resources in April
This should be a straightforward requirement – look at the model answer and see how
it ties in with the requirement. The fact that there are three variables is irrelevant –
examples in textbooks may only have two variables – this is because you can’t solve
a problem with more than two variables graphically. However, we are not being asked
to solve this, but to simply formulate the problem.
Those candidates that allowed for three variables did score all or most of the marks
here. The most common omissions were the demand constraints and the objective
function. The former can be put down to time pressure, the latter is more disappointing
as it’s clearly asked for.
Performance of September/December 2021 candidates:
Overall answers to this question were disappointing. Hopefully reading this in
conjunction with the model answer will show that learning and applying the methods
from the syllabus would allow you to score well on this type of question.
Question 2 – Flag Co
Flag Co is from the Performance measurement and control area of the syllabus
(syllabus area E). The focus of this question was measuring the performance of a
private sector organisation.
This is a typical ‘traditional’ performance management question, in which candidates
are required to perform some fairly routine calculations and analysis, focussing on
both financial and non-financial performance indicators. The balance of these two
types of performance indicators will vary depending on the scenario given and
whether the context is private sector or public sector/not for profit sector. Historically,
‘traditional’ performance management questions like these do not include a template
for the candidates’ answers. However, as in the case of Flag Co, headings are
sometimes given for candidates to use to structure their answer, so that they are
clear about the main areas they need to discuss. In a private sector organisation like
Examiner’s report – PM September/December 2021
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Flag Co, it was appropriate to use ‘profitability’, ‘liquidity’ and ‘risk’ as the main areas
to focus on.
Flag Co had two requirements, (a) for 14 marks requiring an analysis of Flag Co and
a rival company’s financial performance and (b) for 6 marks asking for an
explanation of Fitzgerald and Moon’s building block model.
The context set was that Flag Co was the country’s national airline and had been
government owned until ten years previously. Its mission was to be ‘the airline of
choice for long distance travellers’. It charged premium fares, focussed on long haul
flights and had an ageing fleet of aircraft. The comparative company, Budget Co,
was a recent entrant to the market, founded by a wealthy entrepreneur, focussing on
the short haul, budget market. Whereas Flag Co’s customers were mainly business
travellers, a market sensitive to economic conditions, Budget Co’s were mainly
holiday makers, a less sensitive market (per the scenario).
Various financial information was provided for both companies to help candidates
assess and compare performance.
How to perform well on this question
Requirement (a) - 14 marks
(a) Analyse the financial performance of the two airlines, including reasons for
the differences in the two businesses' performance.
Note: Use the headings profitability, liquidity and risk to structure your answer. There
are up to six marks available for calculations.
(14 marks)
There were up to six marks available for calculations and candidates had to make
sure that they performed calculations which enabled them to discuss performance in
the three areas outlined in the requirement: profitability, liquidity and risk. Each
calculation performed scored half a mark, provided it was one that added value to
the discussion. There were more calculations relevant to some headings than others,
for example, ‘Profitability’ compared to ‘Liquidity’.
I. Profitability
This was the area where there was the most scope for discussion in this question
and it was important to recognise this and spend more time on it. Never assume that
equal time must be given to each area, this is not necessarily the case. Instead,
assess the level of information given when planning an answer and identify whether
there is more or less to say for some areas. Equally, never ignore one area all
together as there will always be a marking scheme that prevents full marks from
being obtained if one area is ignored altogether.
A good starting point for discussing profitability was the calculation of three key
ratios: return on capital employed (ROCE), operating profit margin and asset
turnover. Additional information could also be obtained by calculating revenue per
kilometre (km), available seat kms per litre (l) of fuel (fuel efficiency) and seat
occupancy rate. Candidates did not need to calculate all of these ratios in order to
discuss profitability and score full marks. Indeed, if they had done so, they would
have used all of their marks available for calculations on profitability alone, which
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was not intended. The important thing is that having performed the calculations, their
meaning is then discussed in the context of all of the information given in the
scenario and the links between performance indicators are recognised. When
answering these types of questions, candidates must keep asking themselves: ‘So
what? What does that mean?’
An example of this is given below, together with some of the key calculations
performed:
Profitability
ROCE
Operating margin
Asset turnover
Flag Co
12.8%
10.93%
1.17
Budget Co
13.7%
6.07%
2.26
It can be seen from the calculations that Budget Co’s ROCE is almost one percentage
point higher than Flag Co’s, despite the fact that its operating margin is almost five
percentage points lower. Making this observation alone is not enough to earn a
candidate discussion marks. The candidate must ask: ‘Why is this?’ One of the
reasons is that, as seen by the asset turnover, Budget Co is generating $2.26 for every
$ of capital employed compared to Flag Co’s $1.17. So, despite Budget Co’s low
fare/low margin approach, the fact that it also has a newer aircraft fleet (amongst other
factors), mean that it is still managing to outperform Flag Co on ROCE.
If candidates had gone on to analyse seat occupancy rate or fuel efficiency (available
seat km per l of fuel) they would have observed that Budget Co’s seat occupancy rate
was 95% (Flag Co: 66.29%) and their available seat km per l of fuel was 12,001 (Flag
Co: 8,802). So, Budget Co’s low fares are leading to much higher seat occupancy and
much higher fuel efficiency, each of which is impacting asset turnover and ROCE. It
is this ability to perform calculations, link them and analyse them in the context of the
scenario which scores maximum marks in these questions.
II Liquidity
There was less to discuss in the area of liquidity. As regards calculations, the main
ones were the current ratio and the quick ratio. However, it should be noted that there
was no value in calculating both ratios for each company because the inventory levels
in this type of business are extremely low. So, by taking inventory out of current assets
to calculate the quick ratio, there would have been no effect on the ratio at all. It would
have remained at 0.60 for Flag Co and 0.79 for Budget Co.
To score marks for discussion here, it was important to note that these were both
service companies carrying little inventory, so the ‘textbook norm’ of 2:1, which is often
used (in very broad terms) to identify a healthy current ratio, could not be applied. In
addition, there was no ‘norm’ for the airline industry given in the scenario. So, all that
could really be observed was that Budget Co’s was higher (and therefore a little
healthier) than Flag Co’s, but that the reasons for this were not really known nor likely
to be significant, because of the nature of the industry.
III Risk
This area gave rise to more potential discussion than ‘Liquidity’, although not as much
as ‘Profitability’. The main calculations to be performed were:
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Risk
Capital gearing (debt:equity)
Interest cover
Operating gearing
Flag Co
110.44%
4.96 times
950%
Budget Co
51.47%
8.08 times
820%
Gearing could alternatively have been calculated in terms of ‘debt: debt and equity’,
giving a figure of 52.5% for Flag Co and 34% for Budget Co. It did not matter which of
the two methods was used to calculate gearing, but it would have added no value to
perform the calculation both ways, so time was wasted if candidates did this.
In terms of the discussion, again, the important thing is to keep asking ‘Why does this
matter?’ when discussing the figures, making links both between the figures and the
scenario and the figures with each other. Flag Co clearly has much higher capital
gearing than Budget Co, meaning that it has much higher relative debt than Budget
Co. This makes it higher risk as debt needs to be serviced. Strong candidates would
then go on to explain that with an interest cover of almost 5, Flag Co seems to be able
to comfortably service its debts. However, when you see how high its operating
gearing is, it identifies a concern; at 950%, it means that if sales volumes fell by 10%,
PBIT would fall by 95%, which would then leave it unable to service its borrowing.
There was more discussion that could have taken place here, as this has only covered
Flag Co, but it is clear to see that there were lots of points that could be made and
candidates do not need to make all of them in order to score full marks. Indeed, in the
time available, they would not have been able to. The important point is that discussion
adds value and does not focus on just writing the calculations out in words and saying
that one is higher or lower than the other; this does not add value.
Performance of September/December 2021 candidates on requirement (a):
Since there were six marks available and lots of calculations to choose from, there
was plenty of scope to earn all six of these marks, yet most candidates did not gain
them. Often this was because candidates were calculating absolute figures instead of
percentages. For example, there is no value in stating that Flag Co’s revenue was
$4,679 million higher than Budget Co’s as it is clear from all the extracts provided that
Flag Co was a substantially larger company. Similarly, candidates sometimes created
ratios that were meaningless, such as ‘non-operating costs as a percentage of
operating profit’. It really is worth taking a little time at the beginning to think about
what the meaningful calculations might be, rather than panicking and just writing
anything down. It is very difficult to give any meaningful discussion if the calculations
performed are themselves meaningless.
As regards the discussion, many candidates failed to give an analysis of performance,
with many simply stating the increase/decrease in their figures and saying whether
each company’s figures were better or worse than the other company. As already
discussed, to gain marks, a reason, impact or link to other measures/the scenario
needed to be provided. A notable number of candidates were able to link the differing
objectives of the two organisations to their discussion about the differences in their
figures, but limited marks were scored unless a good explanation was given to analyse
the specific area of performance.
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Requirement (b) – 6 marks
(b) Briefly explain how Fitzgerald and Moon's building block model could be
used to manage the performance of a service business.
(6 marks)
This part of the question was a straightforward six marks for pure knowledge,
explaining how the building block model could be used to manage performance in a
service business. Given that none of the dimensions, standards or rewards were given
in the question, there were some marks available for simply saying what these were.
However, given that the requirement said, ‘briefly explain…..to manage performance
of a service business’, answers needed to go further than this to score full marks.
Performance of September/December 2021 candidates on requirement (b):
A good number of candidates were able to recall the building blocks model and its
components, but merely stating these was not enough to score full marks. Few
candidates were able to explain HOW it could be used to manage performance in a
service industry, which was the requirement. Disappointingly, the balanced scorecard
model was explained by some candidates rather than the building block model.
Hopefully reading this guide in conjunction with the model answer will show how to
score well on this type of question.
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