ACCA P5 GTG Question Bank - 2011

P5
ADVANCED PERFORMANCE
MANAGEMENT (INT)
QUESTION BANK
ACCA
A GTG
Get Through Guides
Edition 3,Version 1
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Get Through Guides 2011
P5 - ADVANCED PERFORMANCE MANAGEMENT (INT)
About the paper 1 - vi
Question
number
Topic Name Marks Page Numbers
l
Question
bank
Solution I
bank j
Section A Strategic Planning and Control
1 Strategic Management Accounting 25 1 -1 45-47
2 Zero Based Budgeting
National Electronics
Ltd
20 1 -1 47- 49
3 Beyond Budgeting Model Hope and Fraser 20 2- 2 49- 51
4 Strategic planning Diverse Holdings Pic 20 2- 3 52-53
5 External environment 20 3- 3 54- 56
Section B External Influences on Organisational Performance
6
Ethical issues and Mendelow's
matrix
Toyworld Ptc 20 5 - 6 57- 59
Section C Performance Measurement System and Design
7 Contingency theory. BPR 20 7- 7 61- 63
8
Behavioural aspects in performance
measurement
Astrodome Sports Ltd 20 7- 8 63- 65
9
Internal and external aspects of
performance measurement
Ochilpark Pic 35 8- 9 65- 68
10 Information requirement Moffat Ltd 20 10- 10 68- 70
11
Benchmarking and information
system
IN A Ltd 20 10- 10 71- 73
Section D Strategic Performance and Measurement
12 Mission Statement 20 11 - 11 75- 76
13
Usage of standards in decision-
making
15 11 - 11 77-78
14 Performance analysis Sunflower Hospital 35 11 - 13 78- 80
15 Evaluation of strategies 40 13- 14 80- 85
16
Strategic performance
measurement
Big Bucks Bank Pic 40 14 - 16 85- 88
17 Measures of performance 20
16- 16 88- 91
18 Performance analysis Taliesin Ltd 20
17- 18 91 - 94
19 Strategic performance measurement
Pack and Dispatch
Co
20
18- 19 94- 95
20 Measures of performance Tannadens Division 35
19- 20 95- 97
21 Divisional performance
Galaxy pic and Milky-
way group
25
20- 21 97-101
P5 - ADVANCED PERFORMANCE MANAGEMENT (INT)
Question
number
Topic Name Marks Page Numbers I
Question
bank
Solution bank
SGCtion D Strategic Performance and Measurement -
Continued
22 Divisional performance NAW Group 40 22- 24 102-108
23 Product Vs. Customer profitability NAW Group 20 24- 25 109-112
24 Transfer pricing- Able and Baker 20 25- 26 113-115
25
Transfer pricing - Alpha and Beta
division
6 26- 26 115-117
26 Not-for-profit organisation AVand BW 20 26- 28 117-119
27 Not-for-profit organisation GA and EA 40 28- 30 120-124
28
Behavioural aspects of performance
management
15 30- 30 124-125
29 Performance measurement
Sportstown and
Totaleisure
40 30- 32 126-130
Section E Performance Evaluation and Corporate Failure
30
Balanced scorecard and Building
blocks
20 33- 33 131 - 132
31 Performance measurement systems 15 33- 33 132-134
32 Key performance indicators
The Eatwell
Restaurant
20 33- 34 134-135
33 Performance measurement BLA Ltd 20 34- 35 136-139
34 Performance measurement Compuaid Ltd 35 35- 36 140-145
35 Performance measurement Mack-King 20 37- 38 145-149
36 Performance measurement
The Dental Health
Partnership
20 38 - 39 149-153
37 Performance measurement Alisha Pic 40 40- 41 153-157
38 Corporate failure Fashion Plus 25 41 - 42 157-159
q a- p Current Developments and Emerging Issues in Performance
oeciion r Management
39
Contemporary management
accounting techniques
20 43- 43 161-164
40
Traditional vis-a-vis modern
management accounting
15 44- 44 164-165
Appendix
I Present Value Table 1 - 1
[Annuity Table 1 - 1
| Total Page Count:176|
Examination structure
The examination will be a three hour paper in two sections:
Section A
Section A will comprise two compulsory questions comprising between 50 and 70 marks in total. Each question
will comprise of between 25 and 40 marks
Section B
In section B candidates will be asked to answer two from three questions comprising of between 15 and 25
marks each
Total 100 marks
Reading and planning time
For all three hour examination papers. ACCA has introduced 15 minutes reading and planning time.
This additional time is allowed at the beginning of each three-hour examination to allow candidates to read the
questions and to begin planning their answers before they start writing in their answer books. This time should
be used to ensure that all the information and exam requirements are properly read and understood.
Dunng reading and planning time candidates may only annotate their question paper. They may not write
anything in their answer booklets until told to do so by the invigilator.
Effective time management - a key to success
Remember you have 1.8 minutes per mark.
Aim to solve a 20 marks question in 36 minutes.
About the GTG Question Bank
This Question Bank of 40 questions covers all important topics of the syllabus.
The Solution Bank has the following features, in addition to solutions to the questions:
Strategy to help you tackle the question
Callouts and tips to give you additional guidance
Score More
where students lose marks even when they have the required
knowledge and notes how to avoid these mistakes
Answer plan to help you plan the answers for longer questions
QUESTION BANK

J L
Z
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STRATEGIC PLANNING AND
MX
Z
o
p
o
CONTROL
Ui
(O
1. Strategic management accounting
(a) Identify and discuss the circumstances that have brought about the proposition that traditional management
accounting control systems have lost their 'relevance' to today's manufacturing and organisational
environment.
(10 marks)
(b) Evaluate strategic cost management initiatives which may be used in order to restore the 'relevance' of
management accounting control systems in today's manufacturing and organisational environment.
(15 marks)
(25 marks)
(Adapted from J une 2004)
2. Zero Base Budgeting - National Electronics Ltd
National Electronics Ltd manufactures and markets a range of electronic office equipment. The company
currently has a turnover of $50 million per annum. The company has a functional structure and currently
operates an incremental budgeting system. The company has a budget committee that is comprised entirely of
members of the senior management team.
No other personnel are involved in the budget-setting process.
Each member of the senior management team has enjoyed an annual bonus of between 12% and 24% of their
annual salary for each of the past five years. The annual bonuses are calculated by comparing the actual costs
attributed to a particular function with budgeted costs for that function during the twelve month period ended
31 December in each year.
A new Finance Director, who previously held a senior management position in a "not for profit' health
organisation, has recently been appointed. Whilst employed by the health service organisation, the new Finance
Director had been the manager responsible for the implementation of a zero-based budgeting system which
proved highly successful.
Required:
(a) As the new Finance Director, prepare a memorandum to the senior management team of National
Electronics Ltd which identifies and discusses:
(i) factors to be considered when implementing a system of zero-based budgeting within National Electronics
Ltd;
(10 marks)
(ii) the behavioural problems that the management of National Electronics Ltd might encounter in implementing
a system of zero-based budgeting, recommending how best to address such problems in order that they are
overcome.
(6 marks)
(b) Explain how the implementation of a zero-based budgeting system in National Electronics Ltd may differ
from the implementation of such a system in a "not for profit' health organisation.
(4 marks)
(20 marks)
2: Strategic Planning and Control C.TG
3. Beyond Budgeting Model
Better budgeting in recent years may have been seen as a movement from 'incremental budgeting' to
alternative budgeting approaches.
However, academic studies (e.g. Beyond Budgeting - Hope & Fraser) argue that the annual budget model may
be seen as
(i) having a number of inherent weaknesses and
(ii) acting as a barrier to the effective implementation of alternative models for use in the accomplishment of
strategic change.
Required:
0)
(b) Identify and comment on FIVE inherent weaknesses of the annual budget model irrespective of the
budgeting approach that is applied.
(8 marks)
(c) Discuss ways in wtiich the traditional budgeting process may be seen as a barrier to the achievement of the
aims of EACH of the following models for the implementation of strategic change:
(i) benchmarking;
(ii) balanced scorecard; and
(iii) activity-based models.
(12 marks)
(20 marks)
(J une 2005)
4. Strategic planning - Diverse Holdings Pic
Diverse Holdings Pic has five wholly-owned subsidiary companies.
These are:
(i) Organic Foods Ltd (OFL) which is involved in the production and sale of organically grown fruit and
vegetables. OFL has built up a very good reputation as a supplier of quality produce,
(ii) Haul-Trans Ltd (HTL) which was acquired on 1 December 2005 and is involved in transporting a range of
products on behalf of third parties,
(iii) Kitchen Appliances Ltd (KAL) which is involved in the manufacture and sale of small, manually-operated
kitchen appliances. KAL has recently suffered from squeezed margins as a consequence of competition
from low cost imports.
(iv) Paper Supplies Ltd (PSL) which manufactures and sells a narrow range of stationery products to two
distributors,
(v) Office Products Ltd (OPL) which manufactures and sells computer workstations with unique design features
which are highly regarded by health and safety experts.
The management accountant of Diverse Holdings Pic has gathered the following actual and forecast information
relating to the five subsidiaries:
Year ending 30 November
2003 2004 2005 2006 2007
Actual Actual Actual Forecast Forecast
(OFL)
Market size (Sm) 100.00 120.00 150.00 180.00 225.00
Turnover (SSm) 5.00 8.00 10.0 13.50 18.00
Operating Profit ($m) 1.00 1.80 2.50 3.00 3.60
(HTL)
Market size (Sm) Unknown Unknown Unknown Unknown Unknown
Turnover (Sm) 40.00 40.00 41.00 42.00 42.00
Operating Profit (Sm) 4.00 4.00 4.00 5.00 5.60
(KAL)
Market size (Sm) 252.00 250.00 245.00 242.00 240.00
Turnover (Sm) 37.50 37.50 35.50 32.00 29.00
Operating Profit/(loss) Sm) 1.50 1.10 0.70 0.30 (0.20)
(PSL)
Market size (Sm) 60.00 65.00 70.00 77.00 84.00
C.TG Question Rank: 3
Turnover (Sm) 2.00 2.00 2.00 2.00 2.10
(OPL)
Market size ($m) 200.00 220.00 240.00 260.00 280.00
Turnover ($m) 15.00 16.00 16.50 17.00 17.50
The management accountant has also collated the following information relating to the market share held at 30
November 2005 by the market leader in those markets in which each subsidiary operates:
Subsidiary Market
Market share (%) held
by market leader
Organic Foods Ltd Food Production 6.66
Haul-Trans Ltd Transport Unknown
Kitchen Appliances Ltd Kitchen appliances 16
Paper Supplies Ltd Stationery 35
Office Products Ltd
Workstations 25
The management has decided not to undertake any further acquisitions during the next two years due to a
shortage of funds.
Required:
(a) Identify and comment on FOUR advantages that may be gained as a result of the adoption of a formal
system of strategic planning.
(4 marks)
(b) Explain how the use of SWOT analysis may be of assistance to the management of Diverse Holdings Pic.
(3 marks)
(c)
(i) Using ONLY the above information, assess the competitive position of Diverse Holdings Pic.
(7 marks)
(ii) Explain THREE strategies that might be adopted in order to improve the future prospects of Diverse
Holdings Pic.
(6 marks)
(20 marks)
(December 2005)
5. External environment
You are responsible for managing the preparation of all revenue and cost budgets for a motor
component manufacturer. You are aware that the external environment has a significant impact on the
business activity and financial performance of your company and that the current information systems are
underdeveloped and ineffective in this respect.
Required:
(a) Identify which aspects of the external environment you are likely to consider and give reasons for your choice.
(10 marks)
(b) Identify where you might find the relevant sources of information.
(5 marks)
(c) Suggest how an external environment information system could be introduced into your company.
(5 marks)
(20 marks)
(December 2002)
4: Strategic Planning and Control f.TG
QUESTION BANK
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EXTERNAL INFLUENCES ON
ORGANISATIONAL
B
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111
(0
PERFORMANCE
6. Ethical issues and Mendelow's matrix - Toyworld pic
Toyworld Pic is a private company which has been manufacturing plastic toys for the last three years. Its factory
is located in a city called Farland. It sells goods worldwide. In spite of having many competitors, the company
has been making good profits since its first year of operation. Toyworld's strategy is to keep its costs at a
minimum and compete on the basis of price.
Grace has recently been appointed as the CEO of Toyworld after retiring as the CEO of a very successful toy
making company. In Toyworld, she has observed the following:
^ A substandard material is used in making the toys. This material may be dangerous to health if children put
the toys in their mouths. However, the company has not given any warning on the packaging of the toys.
Rather, Toyworld products are advertised as being safe and are claimed to improve children's memory and
motor skills at a faster rate than the toys manufactured by other companies (which has not been
scientifically proven).
> All the workers (including child labourers) are required to work for more than 100 hours a week which is far
above the maximum working hours prescribed through legislation. Since unemployment is high in Farland.
people staying there are prepared to work for lower wage rates. Toyworld is successful in keeping its costs
at a minimum by employing people in Farland at minimum cost (without paying fair wages or bonuses).
> Every year Toyworld donates 525,000 to a political party whose leader is Robert. This is because Robert is
also the chairman of Easy-money, a financing company, which provides finance to Toyworld at low interest
rates.
Furthermore, the company has recently received adverse publicity through a local newspaper which reported
that the emissions from the factory are polluting the environment of Farland. There is no emission treatment
plant in Toyworld. In addition, the material used by Toyworld is bad for the environment. The newspaper has
also highlighted, and published photographic evidence of, the poor hygiene conditions in Toyworld and the fact
that female workers who have young children are allowed to bring their children inside the factory, which could
be dangerous.
After becoming aware of all the above facts and reading the newspaper, Grace immediately called a board
meeting and communicated her view that "our dream is for the company to grow by leaps and bounds and
become a market leader. However, this can only be achieved by incurring some cost in the short term and
therefore we should stamp out all unethical practices."
However, Tony, the finance director disagreed, stating that "we are running the business for profit. If we give up
all these practices, our costs will increase and will directly affect our performance. In addition, although we are
asking workers to work for more than the maximum working hours, this helps them to earn more money, without
which they might not be able to provide for their families."
About 80% of the shares in Toyworld are held by the directors (excluding Grace) and the remaining 20% of the
shares are held by people outside Toyworld. There is no substantial holding by any shareholder: rather many
people each hold a few shares. As a result, the directors are in a dominant position when it comes to taking
strategic decisions (the external shareholders are dormant).
ft: E c o n o m i c , Fiscal and Environmental F a c to r s GTG
Required:
(i) Discuss the ethical issues with reference to the case given above and their impact on the performance of
Toyworld (long-term as well as short-term).
(10 marks)
(ii) Using Mendelow's matrix, map the following stakeholders of Toyworld:
> employees
> customers
> directors of Toyworld
> shareholders (other than directors)
> the government
(10 marks)
(20 marks)
QUESTION BANK
C
7. Contingency theory, BPR
(a) Explain the contingency theory of management accounting and expand on ways in which its components
highlight and allow explanations of differences in management accounting control systems.
(10 marks)
(b)
(i) Explain the term 'Business process re-engineering' and how its application might enable overall
business performance to be improved.
(7 marks)
(ii) Briefly discuss potential problems which may be encountered in the implementation of a business re-
engineenng programme.
(3 marks)
(20 marks)
(December 2004)
8. Behavioural aspects in performance measurement - Astrodome sports Ltd
Astrodome Sports Ltd was formed in December 2000 by seven engineers who comprise the board of directors
of the company. The seven engineers previously worked together for Telstar", a satellite navigation company.
In conjunction with one of the three largest construction companies within their country they constructed the
'365 Sports Complex' which has a roof that opens and uses revolutionary satellite technology to maintain grass
surfaces within the complex. The complex facilities, which are available for use on each day of the year, include
two tennis courts, a cricket pitch, an equestrian centre and six bowling greens. The tennis courts and cncket
pitch are suitable for use as venues for national competitions. The equestrian centre offers horse-riding lessons
to the general public and is also a suitable venue for show-jumping competitions. The equestrian centre and
bowling greens have increased in popularity as a consequence of regular television coverage of equestrian and
bowling events.
In spite of the high standard of the grass surfaces within the sports complex, the directors are concerned by
reduced profit levels as a consequence of both falling revenues and increasing costs. The area in which the
"365 Sports Complex' is located has high unemployment but is served by all public transport services.
The directors of Astrodome Sports Ltd have different views about the course of action that should be taken to
provide a strategy for the future improvement in the performance of the complex. Each director's view is based
on his/her individual perception as to the interpretation of the information contained in the performance
measurement system of the complex. These are as follows:
Director
(a) 'There is no pcwnt whatsoever in encouraging staff to focus on interaction with customers in efforts to create
a 'user friendly' environment. What we need is to maintain the quality of our grass surfaces at all costs since
that is the distinguishing feature of our business.'
(b) 'Buy more equipment which can be hired out to users of our facilities. This will improve our utilisation ratios
which will lead to increased profits.'
(c) 'We should focus our attention on maximising the opening hours of our facilities. Everything else will take
care of itself.'
8: Performance Measurement System and Design > fiTfi
(d) 'Recent analysis of customer feedback forms indicates that most of our customers are satisfied with the
facilities.ln fact, the only complaints are from three customers - the LCA University which uses the cricket
pitch for matches, the National Youth Training Academy which held training sessions on the tennis courts,
and a local bowling team.'
(e) 'We should reduce the buildings maintenance budget by 25% and spend the money on increased
advertising of our facilities which will surely attract more customers.'
(f) 'We should hold back on our efforts to overcome the shortage of bowling equipment for hire. Recent
rumours are that the National Bowling Association is likely to offer large financial grants next year to sports
complexes who can show they have a demand for the sport but have deficiencies in availability of
equipment.'
(g) 'Why change our performance management system? Our current areas of focus provide us with all the
information we need to ensure that we remain a profitable and effective business.'
As management accountant of Astrodome Sports Ltd you have recently read an article which discussed the
following performance measurement problems:
(i) Tunnel vision
(ii) Sub-optimisation
(iii) Misinterpretation
(iv) Myopia
(v) Measure fixation
(vi) Misrepresentation
(vii) Gaming
(viii) Ossification
Required:
(a) Explain FOUR of the above-mentioned performance measurement problems (i-viii) and discuss which of the
views of the directors (a-g) illustrate its application in each case.
(12 marks)
(b) Discuss the relevance of each of the following actions as steps in trying to remedy performance
measurement problems relating to the '365 Sports Complex' and suggest examples of specific problem
classifications that may be reduced or eliminated by each action:
(i) Focusing on and improving the measurement of customer satisfaction.
(ii) Involving staff at all levels in the development and implementation of performance measures.
(iii) Being flexible in the extent to which formal performance measures are relied on.
(iv) Giving consideration to the auditing of the performance measurement system.
(8 marks)
(20 marks)
(December 2005)
9. Internal and external aspects of performance measurement - Ochilpark Pic
Ochilpark Pic has identified and defined a market in which it wishes to operate. This will provide a 'millennium'
focus for an existing product range. Ochilpark Pic has identified a number of key competitors and intends to
focus on close co-operation with its customers in providing products to meet their specific design and quality
requirements. Efforts will be made to improve the effectiveness of all aspects of the cycle from product design to
after sales service to customers. This will require inputs from a number of departments in the achievement of
the specific goals of the 'millennium' product range. Efforts will be made to improve productivity in conjunction
with increased flexibility of methods.
An analysis of financial and non-financial data relating to the 'millennium' proposal is shown in Schedule 3.1.
C.TG Question Bank :*)
Required:
(a)
(i) Prepare a table (Sm) of the total costs for the 'millennium' proposal for each of years 2000, 2001 and 2002
(as shown in Schedule 3.1), detailing target costs, internal and external failure costs, appraisal costs and
prevention costs. The following information should be used in the preparation of the analysis:
2000 2001 2002
Target costs - variable (as % of sales) 40% 40% 40%
- fixed (total) S2m S2m S2.5m
Internal failure costs (% of total target cost) 20% 10% 5%
External failure costs (% of total target cost) 25% 12% 5%
Appraisal costs S0.5m S0.5m S0.5m
Prevention costs S2m 51m S0.5m
(4 marks)
(ii) Explain the meaning of each of the cost classifications in (i) above and comment on their trend and inter-
relationship. You should provide examples of each classification.
(8 marks)
(b) Prepare an analysis (both discursive and quantitative) of the 'millennium' proposal for the period 2000 to
2002. The analysis should use the information provided in the question, together with the data in Schedule
3.1. The analysis should contain the following:
(i) A definition of corporate 'vision or mission' and consideration of how the millennium proposal may be
seen as identifying and illustrating a specific sub-set of this 'vision or mission'.
(5 marks)
(ii) Discussion and quantification of the proposal in both marketing and financial terms.
(6 marks)
(iii) Discussion of the external effectiveness of the proposal in the context of ways in which I. Quality and 2.
Delivery are expected to affect customer satisfaction and hence the marketing of the product.
(4 marks)
(iv) Discussion of the internal efficiency of the proposal in the context of ways in which the management of I.
Cycle Time and 2. Waste are expected to affect productivity and hence the financial aspects of the
proposal.
(4 marks)
(v) Discussion of the links between internal and external aspects of the expected trends in performance.
(4 marks)
(35 marks)
(December 1999)
Schedule 3.1.
2000 2001 2002
Total market size (Sm) 120 125 130
Ochilpark Pic sales (Sm) 15 18 20
Ochilpark Pic - total costs (Sm) 14.1 12.72 12.55
Ochilpark Pic sundry statistics:
Production achieving design quality standards (%) 95% 97% 98%
Returns from customers as unsuitable (% of deliveries) 3.0% 1.5% 0.5%
Cost of after sales service (Sm) 1.5 1.25 1
Sales meeting planned delivery dates (%) 90% 95% 99%
Average cycle time (customer enquiry to delivery) (weeks) 6 5.5 5
Components scrapped in production (%) 7.5% 5.0% 2.5%
Idle machine capacity (%) 10% 6% 2%
10: Performance Measurement System and Design &fT(i
10. Information requirement - Moffat Ltd
Moffat Ltd. which commenced trading on 1 December 2002, supplies and fits tyres and exhaust pipes and
services motor vehicles at thirty locations. The directors and middle management are base-d at the Head Office
of Moffat Ltd. Each location has a manager who is responsible for day-to-day operations and is supported by an
administrative assistant. All other staff at each location are involved in fitting and servicing operations.
The directors of Moffat Ltd are currently preparing a financial evaluation of an investment of S2 million in a new
IT system for submission to its bank. They are concerned that sub-optimal decisions are being made because
the current system does not provide appropriate information throughout the organisation. They are also aware
that not all of the benefits from the proposed investment will be quantitative in nature.
Required:
(a) Explain the characteristics of THREE types of information required to assist in deasion-making at different
levels of management and on diffenng timescales within Moffat Ltd. providing TWO examples of information
that would be appropriate to each level.
(10 marks)
(b) Identify and explain THREE approaches that the directors of Moffat Ltd might apply in assessing the
QUALITATIVE benefits of the proposed investment in a new IT system.
(6 marks)
(c) Identify TWO QUALITATIVE benefits that might arise as a consequence of the investment in a new IT
system and explain how you would attempt to assess them.
(4 marks)
(20 marks)
(Dec 2005)
11. Benchmarking & information system - INA Ltd
INA Ltd manufactures and distributes generic paper-based products and currently has an annual turnover of
$100 million.
At present, the management of INA Ltd are uncertain whether the purchasing department is maximising its
potential in terms of purchasing efficiency and effectiveness.
The management are currently considering the introduction of a system of benchmarking to measure the
performance of the purchasing department.
Required:
(a) Explain the term benchmarking' and briefly discuss the potential benefits that can be obtained as a result of
undertaking a successful programme of benchmarking.
(6 marks)
(b) Descnbe how a system of benchmarking could be introduced to measure the performance of the purchasing
department.
(8 marks)
(c) Discuss the problems that the management of INA Ltd might encounter in implementing a system of
benchmarking and recommend how such problems should be successfully addressed.
(6 marks)
(20 marks)
(Dec 2003)
QUESTION BANK
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STRATEGIC PERFORMANCE
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AND MEASUREMENT
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12. Mission Statement
(a) Explain the role and content of a Mission Statement.
(5 marks)
(b) Explain how a Mission Statement could contnbute towards the planning and performance measurement
process.
(9 marks)
(c) Identify the potential problems arising from using a Mission Statement to manage performance.
(6 marks)
(20 marks)
(December 2002)
13. Usage of standards in decision-making
(a) Discuss ways in which standards may be seen as useful aids in management accounting decision-making.
(6 marks)
(b) Suggest ways in which the use of standards may be seen as having a dysfunctional effect in relation to
decision making about each of materials, labour and overhead cost.
(9 marks)
(15 marks)
(J une 2001)
14. Performance analysis - Sunflower Hospital
Sunflower Hospital is partially government-funded. It specialises in the provision of orthopaedic surgery and
physiotherapy treatments. It is well-known for providing high quality services to all of its patients, who include
both private fee-paying patients and government funded patients.
Some statistics regarding Sunflower Hospital for the year ended 30 J une 2007 are as follows:
1. Budgeted operations
Orthopaedic surgery (25% of which are major surgeries)
Physiotherapy treatments
60%
40%
2. Fees payable by each patient who received treatment from the hospital (40% of the fees are funded by the
government on behalf of patients)
Fees payable by government Fees payable by private patients
Type of service
Orthopaedic minor surgery
Orthopaedic major surgery
Physiotherapy treatments
Amount S
1,000
2,200
3.500
Amount $
1,600
3,000
4,500
12:
3.
20: Strategic Performance and Measurement
Total yearly costs according to budget for Sunflower Hospital
> fiTG
Costs Amount $'000 Fixed costs Variable costs
Surgical costs 40,000 80% 20%
Nursing costs 10,000 65% 35%
Depreciation on equipment & operation accessories 2,500 100% -
Administration costs 5,000 100% -
Miscellaneous costs 6,000 50% 50%
Total yearly costs according to actual results for Sunflower Hospital
Costs Amount S'000 Fixed costs Variable costs
Surgical costs 42,000 32,000 10,000
Nursing costs 10,500 6.500 4.000
Depreciation on equipment & operation accessones 2,500 2.500 -
Administration costs 5,800 5,800 -
Miscellaneous costs 6.300 3,500 2.800
5. Sunflower Hospital did not receive any grant, donation or loan during the year.
6. Variable budgeted surgical costs include a total amount of S1,250,000 related to emergency operations
undertaken.
7. Variable actual surgical costs of emergency operations undertaken were $1,300,000.
8. The proportion of emergency operations as a percentage of total operations was according to budget.
9. Other statistics relating to Sunflower Hospital
Capacity utilisation (%) 90%
Patient mix for each type of operation and treatments:
Privately-funded patients 30%
Government funded patients 70%
Operation mix:
Orthopaedic surgery (40% of which are major surgeries) 55%
Physiotherapy treatments 45%
Additional:
Moonlight Hospital is privately owned and also specialises in the provision of orthopaedic surgery and
physiotherapy treatments. (Assume that it does not carry out emergency operations).
Summary of income statement of Moonlight Hospital:
Amount
$'000
Fees earned 45,000
Less: Costs
Surgery 12,000
Nursing 18.000
Depreciation 4.000
Interest on loan 600
Management 5,000
Sundry 1,000
Net profit 4.400
Each hospital comprises 20 wards, each of which can accommodate 6 patients. The average patient stay in
both hospitals was 2 days. Each hospital is open for 365 days per annum.
C.TG Question Bank :I3
Required:
(a) Prepare a statement which shows comparative analysis of actual and budgeted results for Sunflower
Hospital for the year ended 30 J une 2007.
(14 marks)
(b) State four performance measures to assess the quality of surgical treatments provided by a hospital,
indicating how each measure may be assessed.
(6 marks)
(c) Give your suggestions to Sunflower Hospital regarding the ethical issues which may arise as a result of
considering patient mix as a key determinant of profitability.
(3 marks)
(d) Is it appropriate to make a direct companson of the financial performance of Sunflower Hospital and
Moonlight Hospital? Explain four reasons for your view.
(6 marks)
(e) Using only information contained in the question, make three adjustments to the income statements you
have prepared in your solution to (a) that you consider would assist in the development of a more
appropriate comparison of the financial performance of both hospitals.
(6 marks)
(35 marks)
(Adapted from Pilot Paper)
15. Evaluation of strategies
A motor car manufacturer has been specialising in the production and sale of one model of car. The model is
somewhat dated, and the current sales forecast indicates that the sales will decline from the current level (2003)
of 170,000 cars per annum to 150,000 in 2004, 130.000 in 2005 and 110,000 in 2006. The company supplies to
order and no stocks are held. Carbon monoxide emission regulations will prevent the model being manufactured
and sold after December 2006.
The compan/s current estimates of the selling price and costs in 2004 are as follows:
Per car $
Selling Price 9,500
Production costs:
Material and labour (vary with production volume) 3.600
Assembly* 4,000
*75% of the assembly costs are fixed and the remainder vary with production volume. In addition, the company
estimates that it will incur the following non-production costs:
Marketing costs of $60 million. 50% of these vary with sales volume. Delivery costs of $75 million. 20% of these
vary with sales volume. The Administration costs of S10 million are fixed.
The selling price, variable costs per car and total fixed costs are expected to remain constant throughout the
period from 2004 to 2006.
The compan/s Managing Director is unhappy with the current annual profit forecasts for 2004-2006 based upon
the information above and believes that the company has the potential to increase the profit to $280m in each of
the years 2004 to 2006. The Managing Director has undertaken a strategic review and developed the following
strategies:
Strategy 1
A marketing proposal will enable the company to enter a new overseas market with the result that the total
(including the overseas market) sales level will be stabilised at 160,000 cars per annum from 2004 to 2006. The
market entry costs will be S30 million for each of the three years.
Strategy 2
A re-design of the car will enhance its sales appeal and will permit the company to increase its selling price to
$10,000. The re-design costs are $30 million and are to be amortised over three years on a straight line basis.
14: Strategic Performance and Measurement > fiTG
Strategy 3
A radical cost reduction programme will improve efficiency and lower all variable costs by 20%. This will add
$70 million to the annual fixed overheads each year from 2004 to 2006.
Required:
(a) Prepare a financial analysis showing the current annual forecast of costs, revenues and profits for each of
the years 2004 to 2006 and briefly comment on the figures. Ignore inflation.
(6 marks)
(b) Estimate the profit in 2004 if:
(i) Strategy 1 was implemented;
(2 marks)
(ii) Strategy 2 was implemented;
(2 marks)
(iii) Strategy 3 was implemented.
(2 marks)
(c) Estimate the profit in 2004 if all three strategies were implemented.
(4 marks)
(d) Explain why the total of the increase in profit arising from the three strategies implemented separately in (b)
is different from the total profit calculated in (c). Illustrate your answer with a numerical reconciliation of the
differences in the two profit figures.
(5 marks)
(e) Explain how "Gap Analysis' can be used to assist a company to plan the achievement of its strategic profit
objective. Illustrate your answer with a diagram which quantifies the effect of your calculations in (a), (b), (c)
and(d)above.
(7 marks)
(')
(i) Explain how sensitivity analysis could be used in conjunction with the profit estimates that you have
made for the company and illustrate your answer with reference to each of the strategies;
(ii) Calculate and comment on the percentage change in the key variable in each of strategies 1, 2 and 3
from its original forecast level in order that the desired profit level of 280m for 2004 will be achieved in
each case
(8 marks)
(g) What major external environmental factors need to be considered in assessing the success of the three
strategies?
(4 marks)
(40 marks)
(J une 2003)
16. Strategic performance measurement - Big Bucks Bank Pic
Big Bucks Bank Pic (the Bank) is a clearing bank in the UK. It has 2,000 retail branches. It classifies its business
into retail and corporate banking. Each type of business currently accounts for more or less half of the Bank's
turnover.
Big Bucks Bank Pic's retail banking business provides banking facilities for retail customers and small businesses
to which it does not lend in excess of $2,000,000 in any one year. On the other hand, the Bank defines 'corporate
business' as "....where lending (both domestic and international) would exceed $2,000,000 in any one year."
Corporate lending is traditionally the most profitable business for the Bank, contributing 70% of the profit before
taxation. Corporate lending operations comprise eight regional offices and a department at the head office in
London. The London office is also responsible for international lending. There are 250 staff employed in
corporate lending.
C.TG Question Bank :I5
On the other hand, the retail and small business customer strength ranges from 1,000 to 15,000 per branch, mean
customer numbers being 7,500.
The Bank has the following mission statement for its retail banking:
"To deliver a high-quality service to customers based on our managers' personal knowledge of customers'
affairs."
The policy of the Bank is to cross-subsidise its retail banking operations (since this is a less profitable venture
than corporate banking) in the hope that some retail customers will become corporate ones. The Bank has
assigned its branch managers the responsibility of assisting in this process because of their financing expertise
and deep knowledge of their customers.
Each branch of the Bank operates as a cost centre. The managers of each branch need to record and compare
committed expenditure and budgeted expenditure on a quarterly basis. The Bank does not follow an accrual
accounting system as regards branch expenditures for these quarterly reports. However, year-end adjustments
reconcile committed, actual and budgeted expenditures. These accounting activities are performed by
management accounting staff based at head office.
The managers' remit is to operate within their expenditure budgets. Moreover, they are set targets (e.g. number
of new accounts opened, amount of holiday insurance sold, level of bad debts).
The managers are not consulted about the size of their budgets or their targets. These are imposed by head
office.
Proposals for change
The Bank is reviewing its corporate attitude. Its corporate lending business has shown a dedining trend in
profitability as a result of problems with international debt and movements in foreign exchange rates. The Bank
has also become concerned about the attitudes which it believes have become dominant in its retail banking
business. Most of its managers have found their targets relatively easy to achieve. They have been criticised for a
lack of entrepreneurial awareness and for not taking sufficient account of environmental forces. The managers
have defended their behaviour by arguing that, as soon as a retail customer becomes a corporate customer, they
lose their business. Therefore there is no incentive for them to convert retail customers into corporate customers.
Due to these factors, the Bank has decided upon the following changes:
Retail banking must, in future, contribute 50% of the Bank's profit before taxation.
^ A programme of branch rationalisation will be entered into in which half the branches will close.
> A new type of branch, referred to as "superbranches", will be introduced. These will be at the centre of a
network of 4 to 6 existing branches. The superbranch manager will make all major decisions for the network
of branches. He will be assisted in this by two assistant managers who will probably be drawn from the
existing managers in the network.
> Each superbranch will be designated an investment centre and must earn a return of 15%.
No target has been set for residual income, although the Bank intends to set such targets after
it has gained some experience of the superbranches' operations.
r An expenditure budget has been allotted to each superbranch. The budgets are set based on the cumulative
total spent by the superbranch's network branches in the previous year. No extra funds have been allocated
for the establishment of the superbranches. The manager of the superbranch has the power to decide where
the superbranch will be located. This could be inside an existing branch or in new premises.
> The manager of the superbranch will be responsible for the design and operation of all of the
network's information systems. They will be accountable to the head office. The head office will continue to
draw up the statutory accounts.
^ The manager of the superbranch will be responsible for deciding the number of employees working in the
network. If there are to be any redundancies, head office will negotiate nationally to determine the terms for
redundant staff. The superbranch will need to bear the costs, if any, of redundancies in its network.
The CMD of the Bank has described the new philosophy for retail banking thus: "We are operating in a very
competitive environment. In order to survive, we must change. We must never forget that earning profit is our
ultimate objective. Retail banking has been subsidised for a long time and as a result, has become inefficient.
Our proposed steps will enable us to deliver an efficient, low-cost service. However, I arn afraid the days of the
bank manager being a personal friend and adviser are over"
Required:
(a) Explain the implications of the new philosophy for retail banking for the staff, customers and
shareholders of the Bank. You should contrast the new philosophy with the mission statement of the
organisation.
(12 marks)
(b) Discuss the advantages and disadvantages of the proposal to make superb ranches investment
centres.
(8 marks)
(c)
(i) Describe the reports you believe will be necessary for the manager of a superbranch to manage
successfully. Your answer should include the reasons for your suggestions.
(12 marks)
(ii) Suggest, and fully justify, THREE qualitative performance indicators you consider would be of assistance
to a superbranch manager.
(8 marks)
(40 marks)
17. Measures of performance
A large conglomerate with diverse business activities is currently considering whether it should commence a
project and has gathered the following data:
Project data
An initial investment of S60 million will be required on 1 J anuary, year 1. The project has a three-year life with a
nil residual value. Depreciation is calculated on a straight line basis.
The project is expected to generate annual revenue flows of S90m in year 1. S100m in year 2 and S110m in
year 3. These values may vary by 5%.
The incremental costs will be $60m in year 1, $70m in year 2 and $80m in year 3. These may also vary by 5%.
The most likely cost of capital is 12%.This may vary from 10% to 14% for the life of the project.
Additional information:
Assume that all cash flows other than the initial investment take place at the end of each year.
Use the written down value of the asset at the start of each year to represent the value of the asset for the year.
Note: Ignore taxation
Required:
(a) Prepare two tables showing net profit, residual income and return on investment for each year of the project
and also net present value (NPV) for:
(i) the best outcome;
(ii)the worst outcome.
(8 marks)
(b) Explain the distinctive features of residual income, return on investment and net present value in measuring
financial performance.
Your answer should include a critique of the strengths and weaknesses of each measure.
(8 marks)
(c) What broader issues are likely to be considered when deciding whether the company should proceed with a
particular project?
(4 marks)
(20 marks)
C.TG Qupsilon Bank :l<)
18. Performance analysis - Taliesin Ltd
Taliesin Ltd manufactures a range of ice-cream based confectionery products, which it sells to national
supermarket chains which market the products under their own brand labels. The board of directors is
committed to a policy of achieving growth. However because the company is a relatively small player within the
industry the board of directors is focused solely upon internal development as opposed to growth by acquisition
and has further agreed that it wishes to confine operations to the home market.
Summary financial statements for the year ended 31 May 2005 together with prior year comparative figures are
as follows:
Profit and Loss Account
2005 2004
$'000 $'000
Sales (note 1) 48,000 40,000
Cost of sales (note 2) 28,800 24.000
Gross Profit 19,200 16.000
Operating expenses 10,200 8.000
Interest 1,000 0
Depreciation 4,000 4,000
Net Profit 4.000 4.000
Balance Sheet
Fixed Assets (net book value)
Net Current Assets
2005
$'000
42,000
24.000
2004
$'000
40,000
12,000
Total Assets less Current Liabilities
Loan Finance
66,000
10.000
52,000
Net Assets 56,000 52,000
Capital Employed:
Ordinary Share Capital (1 each)
Retained Earnings
30,000
26.000
30,000
22,000
Capital Employed
56.000 52.000
Other information relating to Taliesin Ltd is as follows:
(1) Sales information in respect of the years ended 31 May 2005 and 2004 is as follows:
2005 2004
Sales revenue $000 $'000
1 J une-30 November 33,300 26,000
1 December-31 May 14,700 14,000
(2) Cost of sales information:
2005 2004
$'000 $000
Materials 9.360 7.800
Labour 4.620 4.200
Manufacturing overheads 14.820 12.000
Cost of sales 28.800 24.000
18: Strategic Performance and Measurement
(3) Other Information:
> fiTG
2005 2004
Number of employees:
Permanent 204 200
Temporary 288 240
Number of customers 5 6
Number of new 6 5
(i) Temporary employees are hired on a full-time basis between 1 J une and 30 November in each year. They
were paid at the same rate as permanent employees.
(ii) Six new product lines were launched during the year ended 31 May 2005. The manufacture of each new
product line required an investment in capital equipment of $1 million.
Required:
(a) Using the above information, appraise the performance of Taliesin Ltd during the year ended 31 May 2005
and evaluate the extent to which the objective of growth has been achieved.
(11 marks)
(b) Explain the major benefits of pursuing a policy of internal development.
(4 marks)
(c) Explain how the use of activity-based techniques may benefit Taliesin Ltd.
(5 marks)
(20 marks)
(J une 2005)
19. Strategic performance measurement - Pack and Dispatch Co
Pack and Dispatch Co (PADC) is a well-known company in food products packaging. The management of
PADC is currently considering whether to enter the fast food market. On average, fast food packs make up
between 3% and 5% of the total cost of the purchaser's finished product.
The following information has been gathered by senior management:
(1) The machines used to manufacture fast food packs would differ on the basis of size as well as efficiency.
The lowest cost machine is priced at S70.000 and requires only one operator. A one-day training course is
required in order that an unskilled person can then operate such a machine in an efficient and effective
manner.
(2) Fast food packs are made from high quality plastic which has been in short supply during recent years.
(3) The cardboard packs are made from specially formulated paper which, during recent years, has
occasionally been in short supply.
(4) Currently, the six major manufacturers of fast food packs have an aggregate market share of about 75%.
Among them, the current market leader has a 25% market share. The remaining five major manufacturers'
market shares are equal in size. The product ranges offered by them are similar in terms of quality, size and
price. In recent years, the market has grown by 2.8% per annum (approx.)
(5) There is an assumption in the present market that a foreign-based multinational company will expand its
operations by opening a packaging division overseas. The company possesses large-scale automated
machinery for manufacturing fast food packs of various sizes.
(6) Another company. Soft Packaging, produces cardboard packs for regular household products. Soft
Packaging is increasing its goodwill in the market more quickly than any other company. However, Soft
Packaging's prices are comparatively expensive. In fact, its prices are 25% higher than equivalent sized
plastic packs available in the market.
Required:
(a) Using Porter's five forces model, assess the attractiveness of the option to enter the market for fast food
packs as a performance improvement strategy for PADC.
(10 marks)
A rival company was the market leader with a share of 29% three years ago. The managing director of that
company stated at a recent meeting of the board of directors that: "our loss of market share during the last three
years might lead to the end of this organisation and therefore we must address this issue immediately".
Required:
(b) Discuss the statement of the managing director of the nval company and discuss six performance
indicators, other than decreasing market share, which might indicate that the rival company will fail as a
corporate entity.
(10 marks)
(20 marks)
(Adapted from Dec 2007)
20. Measures of performance - Tannadens Division
Tannadens Division is considering an investment in a quality improvement programme for a specific product
group which has an estimated life of four years. It is estimated that the quality improvement programme will
increase saleable output capacity and provide an improved level of customer demand due to the enhanced
reliability of the product group.
Forecast information about the programme in order that it may be evaluated at each of best, most likely and
worst scenario levels are as follows:
(i) There will be an initial investment of S4.000.000 on 1 J anuary, year 1, with a programme life of four years
and nil residual value. Depreciation will be calculated on a straight line basis.
(ii) Additional costs of staff training, consultancy fees and the salary of the programme manager are estimated
at a most likely level of $100,000 per annum for each year of the proposal. This may vary by it 2.5%. This is
the only relevant fixed cost of the proposal.
(iii) The most likely additional output capacity which will be sold is 1,000 standard hours in year I with further
increases in years 2, 3 and 4 of 300. 400 and 300 standard hours respectively. These values may vary by
5%.
(iv) The most likely contribution per standard hour of extra capacity is S1,200. This may vary by 10%.
(v) The most likely cost of capital is 10%. This may vary from 8% to 12%.
Assume that cash flows other than the initial investment take place at the end of each year. Ignore taxation.
Required:
(a) Present a table (including details of relevant workings) showing the net profit, residual income and return on
investment for each of years 1 to 4 and also the net present value (NPV) for the BEST OUTCOME situation
of the programme.
(10 marks)
Using the information provided above, the net profit, residual income (Rl), and return on investment (ROI) for
each year of the programme have been calculated for the most likely outcome and the worst outcome as
follows:
Most likely outcome: Year 1 Year 2 Year 3 Year 4
Net profit (S) 100,000 460,000 940,000 1,300,000
Residual income ($) 300.000 160.000 740.000 1,200,000
Return on investment 2.5% 15.3% 47.0% 130.0%
Worst outcome: Year 1 Year 2 Year 3 Year 4
Net profit (S) (-76.500) 231.300 641,700 949,500
Residual income (S) (-556.500) (-128,700) 401.700 629,500
Return on investment (-1.9%) 7.7% 32.10% 95.0%
In addition, the net present value (NPV) of the programme has been calculated as most likely outcome:
$1,233,700 and worst outcome: $214,804.
It has been decided that the programme manager will be paid a bonus in addition to the annual salary of
$40,000 (assume that this salary applies to the best, most likely and worst scenarios).The bonus will be paid on
ONE of the following bases:
(A) Calculated and paid each year at 1.5% of any profit in excess of $250,000 for the year.
(B) Calculated and paid each year at 5% of annual salary for each $100,000 of residual income in excess of
$250,000.
(C) Calculated and paid at 15% of annual salary in each year in which a positive ROI (%) is reported.
(D) Calculated and paid at the end of year 4 as 2.5% of the NPV of the programme.
Required:
(b) Prepare a table showing the bonus to be paid in each of years 1 to 4 and in total for each of methods (A) to
(D) above, where the MOST LIKELY outcome situation applies.
(9 marks)
(c) Discuss which of the bonus methods is likely to be favoured by the programme manager at Tannadens
Division. You should refer to your calculations in (b) above as appropriate. You should also consider the
total bonus figures for the best outcome and worst outcome situations which are as follow:
Total Bonus
Best Worst
outcome outcome
$ $
Net profit basis 43,890 16.368
Residual income basis 48,150 14,624
ROI basis 24,000 18,000
NPV basis 60,323 5,370
(11 marks)
(d) The achievement of the quality improvement programme will be influenced by the programme manager's:
(i) level of effort
(ii) attitude to risk and
(iii)personal expectations from the programme'.
Discuss this statement.
(5 marks)
(35 marks)
(December 1999)
21. Divisional performance - Galaxy pic and Milky-way group
Galaxy Pic is considering measurement of divisional management performance and divisional economic
performance. It considers the following performance measures for evaluation:
(i) Contribution margin =Sales - Variable costs
(ii) Controllable profit =Contribution margin - Controllable fixed costs
(iii) Divisional profit =Controllable profit - Non-controllable avoidable costs
Required:
(a) Discuss the relevance of all the measures mentioned above.
(9 marks)
Note: The following can be considered in the discussion of the measures:
r internal transfers to the other divisions of Galaxy Group
> costs fixed in short term such as labour costs
> depreciation on non-current assets
finance costs not directly related to the division
C.TG Question Bank :21
Sun and Moon are the different divisions of Galaxy Group. The managers of Sun and Moon are considering two
different projects, S and M. The following information is related to the projects:
Project S Project M
Average annual profit (before interest & tax) 550,000 S35.000
Average investment (assets employed) $300,000 $300,000
Profit given is calculated after considering the depreciation on assets employed.
The cost of capital to Galaxy is 15%. The current ROI of Sun division is 20% and of Moon division is 11%.
(b) Evaluate the projects considering the ROI and comment on the decisions the divisional managers are likely
to take regarding the projects and the impact of these decisions on the overall performance of the
organisation.
(8 marks)
Note: Remember. Galaxy Pic gives bonuses to the divisional managers based on the year's divisional
performance.
The following information is related to Milky-way Group (another group):
20X6 20X7
Sm Sm
Sales 492 557
Profit before interest and tax 112.5 137.5
Interest 7.5 7.5
Profit before tax 105.0 130.0
Income tax 31.5 39.0
Profit after tax 73.5 91.0
Dividend 30.0 35.0
Retained earnings 43.5 56.0
20X6 20X7
Sm Sm
Non-current assets 190 171
Current assets 205 289
395 460
Equity 300 350
Long-term debt 95 110
395 460
Additional information
^ Capital employed at the beginning of 20X6 was S311 m.
r- Milky-way amortises $5m every year including 20X6 and 20X7. Accumulated amortised goodwill (during the
years prior to 20X6) amounted to S60m.
> Cost of equity for the year 20X6 is 15% and for 20X7 is 17%.
> Cost of debt (before tax) is 10%.
> Target capital structure is 60% debt and 40% equity.
> Tax rate is estimated as 30%.
> Accounting and economic depreciation are the same.
^ Other non-cash expenses amounted to S14m in 20X6 and $15 in 20X7.
(c) Measure the performance of Milky-way Group for the years 20X6 and 20X7 using EVA as a measure.
(8 marks)
(25 marks)
(Adapted from December 2007)
22. Divisional performance - NAW group
The NAW Group manufactures healthcare products which it markets both under its own brand and in unbranded
packs. The group has adopted a divisional structure. Division O. which is based in a country called Homeland,
manufactures three pharmaceutical products for sale in the domestic market. Budgeted information in respect of
Division O for the year ending 31 May 2005 is as follows:
Product 'Painfree' 'Digestisalve' 'Awaysafe'
Sales packs (000's) NAW Brand 5.000 5,000 15,000
Unbranded 15,000 20,000
-
Selling price per pack ($) NAW Brand 2-40 4-80 800
Unbranded 1-20 3-60 -
Cost of sales information
Variable manufacturing
costs per pack
Material and
conversion cost
Packaging
cost
Variable manufacturing
costs per pack
$ $
Painfree'
NAW Brand 0-85 0-15
Unbranded 0-85 005
'Digestisalve'
NAW Brand 1 85 0-25
Unbranded 1 85 0-15
'Awaysafe'
NAW Brand 2-80 0-40
Other relevant information is as follows:
1. Each of the three products is only sold in tablet form in a single pack-size which contains 12 tablets. During
the year to 31 May 2005 it is estimated that a maximum of 780 million tablets could be manufactured. All
three products are manufactured by the same process therefore management have the flexibility to alter the
product mix. Management expect that sales volume will increase by 10% in the year ending 31 May 2006.
2. Advertising expenditure has been committed to under a fixed term contract with a leading consultancy and
is therefore regarded as a fixed cost by management. Advertising expenditure in respect of the turnover of
branded products in the year ending 31 May 2005 is apportioned as follows
Product Advertising
expenditure as a %
of turnover
Painfree 5%
Digestisalve 10%
Awaysafe 12%
3. The average capital employed in the year to 31 May 2005 is estimated to be $120 million. The company's
cost of capital is 10%.
4. The management of the NAW Group use both Return on Investment (ROI) and Residual Income (Rl) to
assess divisional performance.
5. Budgeted fixed overheads (excluding advertising) for Division O during the year ended 31 May 2005
amount to S81.558.000.
6. There is no planned change in manufacturing capacity between the years ended 31 May 2005 and 31 May
2006.
7. Ignore taxation for all calculations other than those in part (c).
Required:
(a)
(i) Prepare a statement of budgeted profit in respect of Division O for the year ending 31 May 2005. Your
answer should show the annual budgeted contribution of each branded and unbranded product.
Calculate BOTH the residual income (Rl) and Return on Investment (ROI) for Division O.
(7 marks)
(ii) Name and comment on THREE factors, other than profit maximisation, that the management of the
NAW Group ought to consider when deciding upon the product mix strategy for he year ending 31 May
2006.
(3 marks)
(iii) Suggest THREE reasons why the management of the NAW Group may have chosen to use Residual
Income (Rl) in addition to Return on Investment (ROI) in order to assess divisional performance.
(3 marks)
Division L of the NAW Group is based in Farland. The management of Division L purchases products from
vanous sources, including other divisions of the group, for subsequent resale. The manager of Division L has
requested two alternative quotations from Division O in respect of the year ended 31 May 2005:
1. Quotation 1 - Purchasing five million packs of 'Awaysafe'.
2. Quotation 2 - Purchasing nine million packs of 'Awaysafe'.
The management of the NAW Group has made a decision that a minimum of 15 million packs of 'Awaysafe'
must be reserved for Homeland customers in order to ensure that customer demand can be satisfied and the
producfs competitive position is further established in the Homeland market.
The management of the NAW Group is willing, if necessary, to reduce the budgeted sales quantities of other
products in order to satisfy the requirements of Division L. They wish, however, to minimise the loss of
contribution to the group.
The management of Division L is aware of the availability of another product that competes with 'Awaysafe'
which could be purchased at a local currency price that is equivalent to 5-50 per pack. The NAW Group's
policy is that all divisions are allowed the autonomy to set transfer prices and purchase from whatever sources
they choose. The management of Division O intend to use market price less 30% as the basis for each of the
quotations.
Required:
(b)
(i) From the viewpoint of the NAW Group, comment on the appropriateness of the decision by the
management of Division O to use an adjusted market price as a basis for the preparation of Quotations
1 and 2, and the implications of the likely decision by the management of Division L.
(3 marks)
(ii) Recommend the prices that should be quoted by Division O for 'Awaysafe'. in respect of Quotations 1
and 2, which will ensure that the profitability of the NAW Group as a whole is not adversely affected by
the decision of the management of Division L.
(3 marks)
(iii) Discuss the proposition that transfer pnces should be based on opportunity costs.
(4 marks)
(c)
(i) After much internal discussion concerning Quotation 2 by the management of the NAW Group. Division
O is not prepared to supply nine million packs of 'Awaysafe' to Division L at a price lower than market
price less 30%. All profits earned in Farland are subject to taxation at a rate of 20%. Division O pays tax
in Homeland at a rate of 40% on all profits.
Advise the management of the NAW Group whether the management of Division L should be directed
to purchase 'Awaysafe' from Division O, or purchase a similar product from a local supplier. Supporting
calculations should be provided.
(6 marks)
(ii) Identify and comment on the major issues that can arise with regard to transfer pricing in a multinational
organisation.
(5 marks)
(d) Evaluate the extent to which the management of the NAW Group could make use of the product life cycle
model in the determination of its product pricing strategy.
(6 marks)
(40 marks)
(J une 2004)
23. Product vs. Customer profitability - NAW Group
Candidates are advised that information contained in Question 24 is also relevant to this question.
The management of the NAW Group has divided the customers of Division O into four customer groups: large
pharmaceutical stores, independent specialist pharmacies, supermarkets and other retail outlets (such as petrol
stations, newsagents, etc). The management accountant of the NAW Group has reviewed internal records
relating to customer ordering, shipping and distribution patterns and also extracted information from the budget
file for the year ended 31 May 2005.
Budgeted sales statistics (% of sales volume)
Customer group
Large
Pharmaceutical
stores
Independent
Specialist
pharmacies
Supermarkets
Other
retail
outlets
Product
'Painfree'
NAW Brand 60 20 10 10
Unbranded 30 - 70 -
'Digestisalve'
NAW Brand 40 30 20 10
Unbranded 30 70 -
'Awaysafe'
NAW Brand 40 30 20 10
Other budgeted statistics
Customer group
Large
Pharmaceutical
stores
Independent
Specialist
pharmacies
Supermarkets Other
retail
outlets
No. of delivenes 400 2,400 800 3,000
No. of purchase orders 100 300 100 1,000
Promotion and exhibition events 4 - - -
Average kilometres per delivery
No. of times delivery
requirements were changed
300
30
150 400
10
150
The following information is available:
(1) The review of internal records undertaken by the management accountant has revealed new information. It
has been established that S33.558.000 of the total of $81,558,000 costs which were categorised as fixed
overheads in Question 1, do in fact vary with activities.
Note: Candidates need only consider this new information with regard to their answers to Question 2.
(2) The budgeted overheads of 33,558,000 for the year ending 31 May 2005 may be charged to the four
customer groups using the following costs per unit of activity:
Activity Cost
Delivery $6-40 per kilometre
Changed delivery requirements $20000 per change
Order processing $2000 per order
Promotion and exhibition $27,500 per event
(3) NAW Group pays a retrospective rebate based on annual sales revenue to each customer group as follows:
% rebate
Customer groups based on
sales value
Large pharmaceutical stores 10
Independent specialist pharmacies 5
Supermarkets 15
Other retail outlets
Required:
(a) Prepare a statement of budgeted customer profitability for the year ending 31 May 2005 which shows the
profit before fixed overheads for each of the four customer groups. Your answer should be based on the
original budgeted sales volumes i.e. excluding Quotations 1 and 2.
(9 marks)
(b)
(i) Discuss the proposition that 'customer profitability is as critical as product profitability.'
(5 marks)
(ii) Discuss the initiatives that managers should consider in order to improve customer profitability.
(6 marks)
(20 marks)
(J une 2004)
24. Transfer pricing - Able and Baker
(a) The transfer pricing system operated by a divisional company has the potential to make a significant
contribution towards the achievement of corporate financial objectives.
Required:
Explain the potential benefits of operating a transfer pricing system within a divisionalised company.
(6 marks)
(b) A company operates two divisions, Able and Baker. Able manufactures two products X and Y. Product X is
sold to external customers for S42 per unit. The only outlet for product Y is Baker.
Baker supplies an external market and can obtain its semi finished supplies (product Y) from either Able or an
external source. Baker currently has the opportunity to purchase product Y from an external supplier for $38 per
unit. The capacity of division Able is measured in units of output, irrespective of whether product X. Y or a
combination of both are being manufactured. The associated product costs are as follows:
X Y
Variable costs per unit 32 35
Fixed overheads per unit 5 5
Total unit costs 37 40
Required:
Using the above information, provide advice on the determination of an appropriate transfer price for the sale of
product Y from division Able to division Baker under the following conditions:
(i) when division Able has spare capacity and limited external demand for product X:
(3 marks)
(ii) when division Able is operating at full capacity with unsatisfied external demand for product X.
(4 marks)
(c) The design of an information system to support transfer pncing decision making necessitates the inclusion
of specific data.
Identify the data that needs to be collected and how you would expect it to be used.
(7 marks)
(20 marks)
(December 2001, Pilot paper)
25. Transfer pricing - Alpha and Beta division
(a) Alpha division has an external market for product A which fully utilises its production capacity.
(i) Explain the principle which would suggest that Alpha division should transfer product A to Beta division
of
(ii) Explain the circumstances in which Alpha division may offer to transfer product A to Beta division at less
than the external market price and yet report the same total profit.
(4 marks)
(b) The transfer pricing method to be used for an intermediate product between two divisions in a group is
under debate.
The supplying division wishes to use actual cost plus a 25% profit mark-up. The receiving division suggests
the use of standard cost plus a 25% profit mark-up. A suggested compromise is to use revised standard
cost plus 25% profit mark-up.
The revised standard cost is arrived at after taking into account the appropriate elements of a planning and
operational variance analysis at the supplying division.
Discuss the impact of EACH of the above transfer pncing methods and their acceptability to the supplying
and receiving divisions.
(6 marks)
(Dec 1999)
26. Not-for-profit organisation - AV & BW
AV is a charitable organisation, the primary objective of which is to meet the accommodation needs of persons
within its locality.
BW is a profit-seeking organisation which provides rented accommodation to the public.
Income and Expenditure accounts for the year ended 31 May 2004 were as follows:
AV BW
$ $
Rents received 2.386,852 2,500,000
Less:
Staff and management costs 450.000 620.000
Major repairs and planned maintenance 682.400 202.200
Day-to-day repairs 478,320 127,600
Sundry operating costs 305.500 235,000
Net interest payable and other similar charges 526,222 750.000
Total costs 2.442,442 1,934,800
Operating (deficit) / surplus (55,590) 565,200
>GTG Quesilon Bank :27
Operating information in respect of the year ended 31 May 2004 was as follows:
(1) Property and rental information:
Size of
Property
Number
of
Properties
AV
Rent
payable
per week
S
Number
of
Properties
BV
1 bedroom 80 40 40
2 bedrooms 160 45 80
3 bedrooms 500 50 280
4 bedrooms 160 70 nil
AV had certain properties that were unoccupied during part of the year. The rents lost as a consequence of
unoccupied properties amounted to S36.348. BW did not have any unoccupied properties at any time during the
year.
(2) Staff salaries were paid as follows:
AV BW
Number of Salary per Number of Salary per
staff staff member staff staff member
($) per annum (S) per annum
2 35.000 3 50,000
2 25,000 2 35,000
3 20,000 20 20,000
18 15,000 - -
(3) Planned maintenance and major repairs undertaken:
Nature of work
AV BV
Number of Cost per Number of Cost per
properties property properties property
$ $
Miscellaneous construction work 20 1,250
- -
Fitted kitchen replacements (all are the same
size)
90 2,610 10 5.220
Heating upgrades/replacements
Replacement sets of windows and doors for
15 1,500 - -
3-bedroomed properties 100 4,000 25 6,000
(4) Day-to-day repairs information:
Classification
of repair
Number of
repairs
Undertaken AV
Total cost
Number of
repairs
Undertaken BW
Emergency 960 5134.400 320
Urgent 1,880 5225,600 752
Non-urgent 1.020 S118.320 204
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 its service provision
during the year ended 31 May 2004.
(7 marks)
(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 year ended 31 May 2004 with that of the previous year:
>Flexibility
>Service quality
(2 marks)
(ii) 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)
(c) 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 year ended 31 May 2004.
(5 marks)
(20 marks)
(J une 2004)
27. Not-for-profit organisation - GA and EA
General Airways (GA) is a US-based company in which the US government is a substantial shareholder both
directly as well as indirectly through investments by government-run pension funds. Its operations are spread all
over the world. GA is divided into four divisions according to the nature of operations namely Domestic,
International, Cargo services and Helicopter services.
Excellent Airways (EA) is a pnvate company which provides all the services that GA provides except for the
helicopter services.
The following is a summary of the financial performance of General Airways and Excellent Airways for the year
ended 31 December 20X6 and 20X7.
GA EA
20X6 20X7 20X7 20X6 20X7 20X7
Actual Actual Budget Actual Actual Budget
$'000 $'000 $'000 $'000 $'000 $'000
Revenue
Domestic 4,730,880 4,300,800 5,160,960 4,386,816 5,849,088 5,483,520
International 6.481.280 6.451.200 6.200.960 4,386.816 5.849.088 5.483.520
Helicopter
services 716,800 645,120 750,320 - - -
Cargo 3.541.160 3,221.600 3.810,720 3.290.112 3.886.816 3.612.640
Total revenue 15,470.120 14,618.720 15.922.960 12,063,744 15,584,992 14,579,680
Costs
Variable costs
Domestic 2.071.700 2.057.920 1,214.937 1,523.200
International 2,727,656 2,709.504 1,457,924 1,827,840
Helicopter
services 757.681 752,640
Cargo 1.503.443 1,493.440 911.203 1,142.400
Total variable
costs 7,060,480 7,013,504 7,040,000 3,584,064 4,493,440 4,480,000
Salaries 3,430.000 3,470,000 3,500,000 3,472,000 4,000,000 3,500.000
Repairs and
maintenance 285,000 348,000 306,000 112,000 112,000 117,600
Depreciation 96.000 96.000 96.000 700,000 700,000 700,000
Other operating
costs 672,000 698.400 682,000 784,000 940,000 896.000
Loan interest 200,000 200,000 200.000
Total costs 11,543,480 11,625,904 11,624,000 8,852,064 10,445,440 9,893,600
Net profit 3,926,640 2,992,816 4,298,960 3,211,680 5,139,552 4,686,080
Route Domestic International
Helicopter
services Car
P
GA EA GA EA GA EA GA EA
Capacity utilisation per aircraft (%)
year 2006 55 60 65 57 85 - 50 60
Capacity utilisation per aircraft (%)
year 2007 48 67 60 70 82 - 50 75
Additional information for the year ended 31 December 2007:
^ From time to time, EA announces various schemes offering reductions in domestic airfares. However, GA
cannot offer similar schemes (because these schemes require government approval) and therefore the
fares charged by EA are usually lower than those charged by GA. For international and cargo services. GA
fares are 10% lower than EA fares.
> GA works for 325 days and EA works for 345 days a year.
> A 50% concession is provided by GA to senior citizens using its domestic services. No such concession is
provided by EA. Dunng both the year's l.e.20X6 & 20X7, about 10% of the aircraft capacity is occupied by
senior citizens.
^ The actual average variable costs of operating the aircraft service during the year ended 31 December 2007
amounted to S52 per km for GA and $50 per km for EA. Only these costs can be avoided if any service or
route is discontinued.
> GA, being more concerned about its social responsibility, has taken higher insurance cover for the
passengers and on board staff.
^ The managing director of GA is of the opinion that the helicopter service should not be discontinued.
^ The wntten down values of non-current assets are as follows:
2006 2007
$m $m
Aircrafts
GA 1,280 1,152
EA 4,620 4,158
Other
GA 960 864
EA 2,380 2,142
Neither company acquired / disposed of assets during the year.
> The budgeted occupancy rates for all buses on all routes in operation, for the year ended 30 November
2007, were as follows:
Company Budgeted occupancy rate %
Passengers Helicopters Cargo
GA 58 85 50
EA 65 - 70
Required:
(a) Evaluate the operating performance and financial performance of GA and EA for the years ended
31 December 2006 and 2007.
(17 marks)
(b)
(i) Give reasons why GA and EA cannot be compared.
(5 marks)
(ii) Give any five items of additional information that would have helped in assessing the operating and
financial performance of GA and EA and explain how these items would have helped in assessing
performance.
(5 marks)
(iii) Identify the decisions taken by GA which indicate that GA is concerned about its corporate social
responsibility and discuss the impact of such decisions on its short-term financial performance.
(5 marks)
(c) Explain the importance of qualitative information in assessing the performance of GA and EA.
(8 marks)
(40 marks)
(Adapted from December 2007)
28. Behavioural aspects of performance management
To focus on specific performance measures may lead employees or managers to take action which is not in the
best interests of the organisation. Examples of problems which may occur are:
(i) Over-emphasis on the short term
(ii) Over-emphasis on the achievement of specific measures
(iii) Over-simplification of the meaning of specific measures
(iv) Deliberate distortion
Required:
(a) Expand briefly on each of the above problems, giving a specific example to illustrate how each may occur.
(10 marks)
(b) Name and comment on any FOUR actions which may be implemented in order to overcome problems in the
operation of a performance measurement system.
(5 marks)
(15 marks)
(December 1999)
29. Performance measurement - Sportstown and Totaleisure
J ohn Wizard has recently won a contract to act as a financial consultant to Sportstown, a publicly owned
organisation that provides a range of community services to its inhabitants. Wizard's first brief is to prepare a
report on the Operating Efficiency and Financial Performance' of the leisure centre that is owned and managed
by the public body. The governing body of Sportstown has become increasingly concerned by the growing
financial subsidy that it has to provide to its leisure centre. Sportstown onginally owned and operated two
identical leisure centres, but sold one of them in 19X5 to a private leisure company. Totaleisure, who continue to
manage a successful leisure business. Totaleisure have kindly provided Wizard with recent operating and
financial data to permit a comparative study to be undertaken. The two leisure centres both offer the same four
sporting activities: squash, swimming, gym and badminton. The following data and information is available for
the Sportstown leisure centre and for Totaleisure.
Data categorised by leisure activity for 20X1
Squash
Swimmin
9
Gym
Badmint
on
S T S T S T S T
Number of hours per day that the facility is open 12 13 10 15 12 15 6 8
% utilisation of facility*
Day time 50 20 70 40 15 25 50 40
Evening 80 85 70 80 50 85 50 60
The average number of people attending per hour who pay 6 n/a 29 n/a 20 n/a 6 n/a
Pnce per person per hour S4 n/a $2 n/a S3 n/a $4 n/a
Annual cost savings if activity is discontinued ($000) 21 25 120 105 51 60 60 52
S =Sportstown
T =Totaleisure
* =includes free access customers
Cost data ($'000)
Actual Budget
20X0 20X1 20X1
S T S T S T
Salaries 450 350 500 400 550 350
Maintenance contract 150 75 200 100 200 90
Depreciation 25 50 25 50 25 50
Other costs 125 100 75 150 125 150
Loan interest None 200 None 200 None 200
S =Sportstown
T =Totaleisure
Additional Information
(1) Both leisure centres are open for 350 days per year.
(2) The income of Totaleisure is derived from an annual membership fee of $500 per person in both 20X0 and
20X1. No additional charges are made for using the facilities.
(3) The membership of Totaleisure has risen from 1,700 to 2,000 between 20X0 and 20X1. The management
has budgeted for membership to rise from 1,700 to 1,900 during this period.
(4) Sportstown compels its centre to offer free access to all facilities to local schools to encourage sports
development and to those over 60 years of age to promote healthy living styles. It is estimated that 60% of
those provided with free access would continue to use the facilities if they had to pay the standard charges
to use the facilities. The remaining 40% would not use the facilities if free access were to be withdrawn. The
free access users comprise 30% of all users.
(5) Although both centres are identical in terms of the capacity, range and quality of facilities provided, the
Sportstown building is five years older than the Totaleisure premises. The realisable values of both buildings
are equal to their market values which are:
20X0 20X1
Sportstown centre
Totaleisure
$400,000
$800,000
$375,000
$750,000
(6) The annual subsidy to the Sportstown centre equals its financial deficit (loss) for the year.
(7) The Sportstown opening hours and hourly charges remained the same during 20X0 and 20X1.
(8) The average hourly attendance during 20X0 and budgeted for 20X1 for the Sportstown centre was as
follows:
20X0 20X1
Squash 9 8
Swimming 31 37
Gym 23 25
Badminton 5 10
(9) With the exception of the avoidable costs identified i.e. the annual costs savings if an activity is
discontinued, all costs are general fixed overheads.
(10)The Sportstown centre had all its long-term debt repaid in full by the local authority in 19X8. It has no
outstanding debts.
Required:
(a) Compare the operational and financial performance of the Sportstown centre with Totaleisure.
(18 marks)
(b) Assess the validity of appraising their relative performance from the data made available to you.
(5 marks)
(c) Make any necessary adjustments to the data used to appraise performance above in section (a) to develop
an alternative and more appropriate comparison of their financial performance.
(6 marks)
(d) What additional information would you require to provide a more appropriate and comprehensive
comparison of the financial performance of the two centres?
(4 marks)
(e) Traditional financial measures of performance have been criticised for not providing a broad enough basis
for the assessment of organisational performance.
Identify a range of appropriate Non Financial Performance Indicators for the leisure centres which, when taken
in conjunction with traditional financial indicators, would provide a comprehensive assessment of performance.
(7 marks)
(40 marks)
(December 2001)
QUESTION BANK
S
E
C
T
I
O
N

E

PERFORMANCE EVALUATION
AND CORPORATE FAILURE
E
30. Balanced scorecard and Building blocks
(a) Discuss the advantages which 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)
(J une 1999)
(b) Explain rewards for performance' as relevant elements of performance measurement systems.
Note: your answer should consider clarity, motivation and controllability.
(5 marks)
(20 marks)
31. Performance measurement systems
Discuss ways in which each of the following may be viewed as relevant elements of performance measurement
systems, explaining each of the terms emphasised.
(i) Dimensions of performance will comprise the results and the determinants of such results.
(ii) Standards of performance must consider the ownership, achievability and equity of the standards set.
(iii) Rewards for performance must consider issues of clarity, motivation and controllability.
(15 marks)
32. Key performance indicators - The Eatwell Restaurant
The owners of The Eatwell Restaurant have diversified business interests and operate in a wide range of
commercial areas. Since buying the restaurant in 1997 they have carefully recorded the data below.
Recorded Data for the Eatwell Restaurant (1998 - 2001)
1998 1999 2000 2001
Total meals served 3,750 5,100 6,200 6,700
Regular customers attending weekly 5 11 15 26
Number of items on offer per day 4 4 7 9
Reported cases of food poisoning 4 5 7 7
Special theme evenings introduced 0 3 9 13
Annual operating hours with no customers 380 307 187 126
Proposals submitted to cater for special
10 17 29 38
events
10 17 29 38
Contracts won to cater for special events 2 5 15 25
Complimentary letters from satisfied
0
4 3 6
customers
0 V
Average number of customers at peak times 18 23 37 39
Average service delay at peak times (mins) 32 47 15 35
Maximum seating capacity 25 25 40 40
Weekly opening hours 36 36 40 36
Written complaints received 8 12 14 14
Idle time 570 540 465 187
New meals introduced during the year 16 8 27 11
34: Performance Evaluation and corporate. Failure GTG
Financial Data $
$ $ $
Average customer spend on wine
Total Turnover
3
83,000
4 4 7
124.500 137,000 185,000
Turnover from special events
Profit
Value of food wasted in preparation
2,000
11,600
1,700
13,0001 25.000 55.000
21,400 43,700 57,200
1.900 3.600 1.450
Total turnover of all restaurants in 895,000 1,234,000 980,000 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
The Eatwell Restaurant in comparison with another restaurant. Give reasons for your selection and explain
how they would relate to the key performance area categones used in (a).
33. Performance measurement - BLA ltd
BLA Ltd is a design consultancy that provides advice to clients regarding property maintenance and
improvements. Three types of consultant are employed by BLA Ltd. These are:
(1) Architectural consultants who provide advice with regard to exterior building improvements.
(2) Interior design consultants who provide advice regarding intenor design, and
(3) Landscape consultants who provide advice regarding landscaping of properties and garden design
improvements.
BLA Ltd 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 dients.
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 Ltd 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 2003. The actual amount incurred in respect of the year to 31 October 2003 was
S2.805.000. which exdudes 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 Ltd.
(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 2002. BLA Ltd 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 within BLA Ltd.
(vii) BLA Ltd has a policy of maintaining staff at a level of 45 consultants on an ongoing basis, irrespective of
fluctuations in the level of demand. Also. BLA Ltd 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
within a particular category are fully utilised. During the year ended 31 October 2003 subcontractors only
undertook non-chargeable client consultations.
(6 marks)
(20 marks)
(J une 2002)
BLA Ltd
Sundry statistics for year ended 31 October 2003
Budget Actual
Number of consultants by category
Exterior designer 18 15
Interior designer 18 18
Landscape and garden design 9 12
Total client enquiries
New business 67.500 84,000
Repeat business 32.400 28,000
Number of chargeable client consultations
New business 24.300 22.400
Repeat business 16.200 19,600
Mix of chargeable client consultations
Exterior designer 16,200 13,830
Interior designer 16,200 17,226
Landscape and garden design 8,100 10,944
Number of non-chargeable client consultations
undertaken by BLA consultants:
Number of business development consultations 1,035 1,200
Number of remedial consultations 45 405
Number of non-chargeable client consultations
undertaken by subcontractors 120 -
Other statistics:
Number of complaints 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, comment on the
performance of BLA Ltd.
{15 marks)
(b) Briefly discuss THREE factors that should be considered in the determination of expected standards in a
performance measurement system.
(5 marks)
(20 marks)
(Dec 2003)
34. Performance measurement - Compuaid Ltd
Compuaid Ltd provides advisory services to home computer customers. Three types of advisor are employed
offering advice by telephone, wntten/e-mail replies and home visits respectively.
Appendix 1.1 shows sundry statistics for the past 12 month penod for Compuaid Ltd and also for two competitor
companies A and B.
Additional information relating to Compuaid Ltd for the past 12 month period is as follows:
(i) Home visit travel and remedial work hours are not charged directly to customers.
(ii) All service workers incur some 'idle time' which is not charged directly to customers.
(iii) A number of customers pay a fixed annual fee of $100 for the advisory service. This entitles them to 24 hour
priority access to the service and a maximum of five hours of advice without further charge. Appendix 1.1
shows the total hours of advice (both budget and actual) taken up by customers. Assume that no customer
requires more than the five hours allowable.
(iv) All other time for the advisory service and home visits is billed to customers at S20 per hour.
(v) The budgeted wage rate per hour for advisory service staff is S8.This was also the actual rate paid.
(vi) Sundry operating expenses (other than advisor wages) were budgeted at S950.000. Actual operating
expenses incurred were $1,000,000.
Actual information for the penod under review for competitor companies A and B is as follows:
(i) Similar policies to those used by Compuaid Ltd are operated with regard to idle time, home visit travel and
remedial hours.
(ii) Fixed annual fee advisory service schemes, similar to that of Compuaid Ltd. are operated. The annual fee
charged per customer by company A and company B is $75 and 100 respectively.
(iii) Other revenue and cost information is as follows:
Company A
$
Company B
$
Total revenue (excluding annual fee income)
Enquiry advice 756.180 1.266.000
Home visits 87,500 810.000
Total wage costs 720.000 1,099.000
Sundry operating expenses 650.000 1,250.000
Required:
(a)
(i) Prepare budgeted and actual profit and loss accounts for the 12 month period under review for
Compuaid Ltd and also actual profit and loss accounts for companies A and B.
(8 marks)
(ii) Discuss the financial performance of Compuaid Ltd. incorporating details of relative customer billing
rates, company service wage rates and annual agreement advice 'level of uptake' in your answer.
(12 marks)
(b) Comment on the performance of Compuaid Ltd, incorporating relevant percentage and ratio statistics in the
context of each of the following:
(i) Competitiveness;
(ii) Quality;
(iii) Resource utilisation.
(15 marks)
(35 marks)
(December 2000)
>GTG Question Bank :37
Appendix 1.1
Sundry Statistics for the previous 12 month period
Compuaid
Budget
Compuaid
Actual
Competitor
Compuaid
Budget
Compuaid
Actual
A
Actual
B
Actual
Number of service employees:
Telephone advisor 22 27 25 44
Written/e-mail advisors 15 17 8 10
Home visit staff 12 14 2 21
Service employee hours analysis:
Home visit travel hours 2,500 4,800 390 4,500
Idle time - home visit staff 2,000 2,600 2,800 6,000
- advisors 4.000 4.800 1.000 7,000
Remedial work for home visits 500 2.000 600 5,200
Annual agreement advisor call uptake 14,600 15.300 29.700 35,000
Advisor time billed to customers 58.400 72.100 42.010 63.300
Home visits billed to customers 22.000 23.200 3.500 36.000
Total hours 104.000 124.800 80.000 157,000
Number of home visit enquiries received 15.000 16.000 2.000 24,000
Number of home visits obtained/completed 10.000 8.000 1.400 15,000
Number of home visits requiring remedial
work 300 1,200 400 3,400
Number of customer complaints- home visits 100 160 70 225
Number of customer complaints- advisors 73 131 35 196
Number of annual agreement customers 5.840 7.650 6.600 10,000
35. Performance measurement - Mack-King
Mack-King, a long established UK fast food chain expanded its operations abroad for the first time in 1999 in
Coja. Although the UK business is much larger than the new operation in Coja, they both operate as semi-
autonomous business divisions with their own performance targets. Compared with the UK. the Coja business
environment is characterised by significant political uncertainty and limited general awareness of Mack-King
products and outlet locations.
Financial Data for Mack-King
('000)
2000 ACTUALS 2001 ACTUALS
UK COJ A TOTAL UK COJ A
TOTA
L
Turnover 780 70 850 845 106 951
Less:
Labour 200 10 210 216 12 228
Materials 150 20 170 165 24 189
Other operating costs 80 5 85 85 5 90
430 35 465 466 41 507
Marketing 60 30 90 70 70 140
Interest (Group) - - 14 - - 41
Depreciation and amortisation 100 8 108 100 16 116
160 38 212 170 86 297
Total Costs 590 73 677 636 127 804
Profit 190 (3) 173 209 (21) 147
NBV of Fixed Assets (year end) 520 40 560 520 90 610
(includes capital expenditure in the
in the year)
Capital expenditure in year 90 30 120 100 66 166
Long-Term Debt (Group) - - 140 - - 340
Capital and Reserve 600 744
Required:
(a) Provide an assessment of the total corporate financial performance of Mack-King and of the contribution
made towards it by each of the two divisions between 2000 and 2001.
(8 marks)
(b) Identify and explain the purpose of any additional information that would be required to provide a more
complete assessment of Mack-King's financial performance.
(4 marks)
(c) Explain the problems that may arise in endeavouring to assess the comparative financial performance of the
management in the two divisions. Suggest any allowances/adjustments that could be made to improve the
validity of any comparisons between managers operating in different countnes.
(4 marks)
(d) Suggest two separate measures of performance that would be appropriate for a fast food chain, for each of
the following areas:
> Service quality
> Marketing effectiveness
> Personnel
> Food preparation
{4 marks)
(20 marks)
(Dec 2002)
36. Performance measurement - The Dental health partnership
The Dental Health Partnership was established in 1992 and provides dentistry and other related services to the
population of Blaintopia, a country in which the public health service is partially funded by the Government.
Additional information relating to the Dental Health Partnership for the year ended 31 May 2005 is as follows:
(1) The partnership was open for five days per week during 48 weeks of the year.
(2) Each dentist treated 20 patients per day. The maximum number of patients that could have been treated by
a dentist on any working day was 24 patients.
(3)
(i) The partnership received a payment from the government each time any patient was consulted as
shown in the following table:
Category of treatment Payments from Government
$
No treatment required 12
Minor treatment 50
Major treatment 100
(ii) In addition, adult patients paid a fee for each consultation which was equal to the amount of the
payment shown per category of treatment in the above table. Children and Senior Citizens were not
required to pay a fee for any dental consultations.
GTG
Question Bank
(4) The partnership received an annual fee of $20,800 from a well-known manufacturer of dental products
under a fixed-term contract of three years' duration. The contract commenced on 1 J une 2004 and relates to
the promotion of the products of the manufacturer.
(5) The total of material and consumable costs (which are 100% variable) during the year ended 31 May 2005
amounted to $446,400.
(6) Staff costs were paid as follows:
Category of Employee
Salary per annum, per employee
$
Dentist
Dental Assistant
Administrator
60.000
20,000
16.000
Note: A fixed bonus payment amounting to 4% of their basic salary was paid to each Dental Assistant and
Administrator.
(7) Establishment costs and other operating costs amounted to 85,000 and S75.775 respectively for the year
ended 31 May 2005.
(8) All costs other than materials and consumables costs incurred by the Dental Health Partnership are subject
to contracts and are therefore to be treated as fixed costs.
(9) A table of non-financial information relating to the Dental Health Partnership for the year ended 31 May
2005 is as follows:
Number of Dentists 6
Dental Assistants 7
Administrators 2
Patient 'Mix'
Adults 50%
Children 40%
Senior Citizens 10%
Mix of patient appointments (%)
No treatment required 70%
Minor treatment 20%
Major treatment 10%
Required:
(a) Prepare a summary Profit and Loss Account of the Dental Health Partnership for the year ended 31 May
2005 and calculate the percentage of maximum capacity that was required to be utilised in order to break
even in the year ended 31 May 2005.
(12 marks)
(b) Discuss FOUR factors that distinguish service from manufacturing organisations and explain how each of
these factors relates to the services provided by the Dental Health Partnership.
(5 marks)
(c) Excluding the number of complaints by patients, identify and briefly explain THREE quantitative non-
financial performance measures that could be used to assess the "quality of service' provided by the Dental
Health Partnership.
(3 marks)
(20 marks)
(J une 2005)
37. Performance measurement-Alisha Pic
Alisha Pic has been running a naturopathy centre for the last fifteen years. The naturopathy treatment is a 30
day course. It is conducted in batches, each batch having a capacity of 1.000 patients. The naturopathy
treatment offered by Alisha is famous all over the world. The occupancy rate is 100% and it is necessary to book
the course in advance. 10 batches of naturopathy treatment are conducted per year.
The company has also been conducting 10 day meditation courses for the last three years. Each batch for the
meditation course has a capacity of 2.000 people and two batches can undergo the course at the same time.
The occupancy rate for meditation classes is 80%. In a year, 70 classes of meditation can be conducted.
Alisha Pic is situated on a hill called Sify (near Wonderland city). The only way to travel between Wonderland
and Sify is using vehicles owned by Alisha Pic, as there is no public transport to this area from the city and
private vehicles are not allowed. Once a patient / visitor enrol himself on a course, he has to stay at the centre
until the completion of the course.
The following information is available in respect of the year ended 31 December 2006 and the year ended 31
December 2007.
(1) Admission fees per visitor were as follows:
Category Naturopathy centre Meditation classes for the first time
$ $
Adults 4,000 500
Children (only above 12 years) 5,000 500
Senior citizens 6,500 650
A 10% discount is given to customers who take the medication course more than once. Around 20% of
attendees re-enrol on the meditation course.
(2) The patients / visitors 'mix' was as follows:
Naturopathy Meditation
Adults 40% 60%
Children 5% 10%
Senior citizens 55% 30%
(3) In addition to any admission fees payable. $2.5 per person one way is charged as a transportation fee for
the journey to and from Sify Hill.
(4) The management of Alisha Pic categorises all operating costs, including accommodation, catering and the
operating cost of vehicles as fixed costs. The allocation of the fixed cost is as follows:
Naturopathy centre Meditation classes
$50m $40m
Meditation classes
$50m
(5) Alisha Pic received an annual fee of $3 million from Sanjivini Group under a fixed-term five-year contract.
The contract commenced on 1 J anuary 2005 and relates to the nghts to advertise programmes which were
filmed in the naturopathy and meditation centre. Therefore the fee should be equally allocated to the
naturopathy and to the meditation centre.
(6) Admission fees to the naturopathy centre and meditation classes will increase by 10% and 5% respectively
with effect from 1 J anuary 2006. Transport fees will increase by 4%.
(7) All operating costs will increase by 7% per annum during the year ended 31 December 2007.
(8) Assume that the number of visitors and the visitor mix remain constant during the year ended 31 December
2007.
GTG
Question Bank :41
Required:
(a) Prepare the following for Alisha Pic:
> actual statement of comprehensive income for the year ended 31 December 2006
> budgeted statement of comprehensive income for the year ending 31 December 2007
(17 marks)
(b) The management of Alisha is considering discontinuing the practice of giving a 10% discount for repeat
business. Determine the impact on the profitability of meditation centre if a 10% discount is not provided for
repeat business. Assume that 95% of repeat visitors will attend the class even if the 10% discount is not
offered.
(4 marks)
(c) Calculate the percentage of maximum capacity at which the meditation course will break even during the
year ended 31 December 2007.
Note: use the original information.
(7 marks)
(d) Explain the importance of qualitative information for assessing the performance of Alisha and suggest five
dimensions which could be used to assess the service quality.
(7 marks)
(e) Briefly discuss six initiatives that management might consider in order to enhance profitability.
(5 marks)
(40 marks)
Note: ignore taxation in all your calculations.
(Adapted from Dec 2006)
38. Corporate failure - Fashion Plus
Fashion Plus is a manufacturer of leather bags. It is a well known brand in the market. Robin was appointed as
the CEO of Fashion Plus four years ago (after the death of his father who was the previous CEO). He has a
dominant and arrogant style of working and does not take into consideration the ideas suggested by other
board members.
Waterman, a newly appointed director of Fashion Plus, wonders why Fashion Plus has not come up with any
new product over the last three years and also has no projects under consideration. In his opinion, in this
competitive era, the company should try to give something innovative to the customer. At the same time,
diversification could also help Fashion Plus to remain in competition. Therefore. Waterman suggests that, along
with manufacturing leather bags, Fashion Plus should start manufacturing leather shoes. However, Robin does
not like the idea. In addition, Waterman expects that other members of the board will not support him because
they appear to him to be passive.
With the growth in retail chains (where many varieties are available), Fashion Plus is facing tough competition.
The sales of Fashion Plus have been showing a decreasing trend over the last two years, as have the profits.
In addition, the market share of Fashion Plus has declined from 33% to 17% over the last four years.
The financial information of Fashion Plus is as follows:
Statement of financial position
31 March 20X7
$ million
31 March 20X6
$ million
Non-current assets
Land and buildings (net)
PPE (net)
216.00
249.75 465.75
195.75
237.60 433.35
Current assets
Inventory
Receivables
Cash & bank
162.00
46.50
0.75 209.25
135.00
37.10
2.05 174.15
675.00 607.50
Shareholders' funds
Ordinary shares (50 cents par share )
Reserves
67.50
145.80 213.30
67.50
141.75 209.25
Loan funds
15% debenture ($100 par)
Term loans
152.55
94.50 247.05
152.55
60.75 213.30
Current liabilities
Dividend payable
Tax payable
Payables
12.15
6.75
195.75 214.65
12.15
10.80
162.00 184.95
675.00 607.50
Extracts from statement of comprehensive income
20X7
$m
20X6
$m
Sales 586.80 633.60
Earnings before interest and taxes 56.70 66.50
Interest 27.00 23.50
Earnings before taxes 29.70 43.00
Taxation @ 30% 8.91 12.90
Available to shareholders 20.79 30.10
Dividend 19.00 19.00
Retained earnings 1.79 11.10
The share price in the market is currently 52 cents.
Required:
(a) Calculate the Z score for Fashion Plus and comment on the probability of the failure of Fashion Plus.
(10 marks)
(b) Identify the qualitative information which indicates that Fashion Plus might fail.
(5 marks)
(c) Recommend the performance improvement strategies that may be adopted by Fashion Plus
(10 marks)
(25 marks)
QUE STI ON BANK
u.
CURRENT DEVELOVEMENTS
Z
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AND EMERGING ISSUES IN
c
p
o
UJ
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PERFORMANCE MANAGEMENT

39. Contemporary management accounting techniques
Performance through Quality' has been a theme adopted by many successful organisations that operate in
highly competitive business environments. The diagram below entitled Costs and Quality illustrates the
alternative paths (as depicted by the arrows) that a business can take from a starting point A.
Costs and Quality
qualify
Required:
(a) Briefly explain the probable business consequences of pursuing the alternative paths available and arriving at
points B to F. Identify the path that is most likely to bnng business success.
(5 marks)
Traditional management accounting activities have had their original scope broadened by the development of a
variety of techniques that incorporate a growing recognition of the cost and quality issue in the management
decision making process.
Required:
(b) Explain how contemporary management accounting/management techniques such as Total Quality
Management, J ust In Time, Value Analysis, Activity Based Costing and The Balanced Scorecard could
contnbute towards the analysis of the relationship between costs and quality.
(15 marks)
(20 marks)
(J une 2002)
44: Current Development and emerging Issues In Performance Management GTG
40. Traditional vis-a-vis modern management accounting
A traditional view of the environment in which goods are manufactured and sold is where stocks of materials
and components are held. Such stocks are then used to manufacture products to agreed standard
specifications, aiming at maximising the use of production capacity. Finished goods are held in stock to satisfy
steady demand for the product range at agreed prices.
Required:
(a) Discuss aspects of the operation of the management accounting function which are likely to apply
in the above system.
(5 marks)
(b) Describe an alternative sequence from purchasing to the satisfaction of customer demand, which
may be more applicable in the current business environment. Your answer should refer to the
current 'techniques or philosophies' which are likely to be in use.
(5 marks)
(c) Name specific ways in which changes suggested in (b) will affect the operation of the management
accounting function.
(5 marks)
(15 marks)
(J une 1999)
SOLUTION
BANK
1
El j? < E I
SOLUTION BANK
A
1. Strategic management accounting
This question deals with issues such as the shortcomings of traditional management accounting
systems and how strategic management accounting has restored the 'relevance' of management
accounting in the modern manufactunng environment.
Your answer to part (a) of the question should be brief, justifying the marks allotted. However, the
answer given below is comparatively large as it is intended to give you a complete overview of the
topic.
Your answer to part (b) should be elaborate but specific to the requirements of the question.
In the 1980s, advanced manufacturing technologies such as computer-aided manufacturing and just-in-time
(J IT) manufacturing techniques dramatically changed the production processes in many organisations. In order
to compete successfully, it was necessary to produce innovative products of high quality at a relatively low cost
and also to provide the best possible customer service. Many companies responded to these competitive
demands by investing in advanced manufactunng technologies, implementing J IT manufacturing philosophies
and emphasising their corporate objectives such as quality, delivery innovation and a flexibility to meet
customers' needs.
Some organisations have found that their existing cost systems have hindered, rather than helped, the
introduction of the required changes. This has resulted in ciaims by some writers that traditional management
accounting techniques are obsolete and that a radical change in management accounting is required to match
the revolution in manufacturing technology. There is a growing consensus that traditional cost control and
performance management systems do not provide the appropriate information to control the activities of
companies which operate in an advanced manufacturing environment.
Investment in advanced management technology has dramatically changed cost behaviour patterns. Computer
engineers, software programmers and technocrats are replacing direct labour and vanable costs tend to consist
of only direct materials and energy costs to operate the machinery. More of the firm's costs are becoming fixed
and direct labour costs are becoming only a small proportion of the total manufacturing costs. Overhead costs
are a much higher percentage of total manufacturing costs and consequently need to be understood and
controlled much more carefully than in the past.
The main reasons why traditional management accounting systems have lost their "relevance' in a rapidly
changing business environment are as follows:
> Competitive pressures
Most significant was the application of flexible manufactunng technologies by the J apanese to produce a greater
diversity of high-quality, low-priced products more quickly. Specific modes of work organisation, production
systems and motivational incentives were seen to differ radically from those used traditionally.
> Emergence of new technologies
The adoption of flexible technologies in manufacturing and service-oriented enterprises including manufacturing
and enterprise resource planning systems, computer-aided design and computer-aided manufacturing (CAD
and CAM), robotics and other features of computer integrated manufacturing (CIM) led to questioning of the
conventional accounting methods for cost allocation. Management accounting techniques are therefore seen to
be outdated given the new manufacturing environment. Similar problems have been raised about cost
accounting techniques in service industries.
46: Strategic Planning And control C.TG
> Dominance of financial accounting
From the post-first world war period, progress in management accounting was seen as virtually ceasing,
principally as a result of the growing importance of external reporting priorities. Some critics of traditional
management accounting therefore assert that management accounting has. for over seventy years, been
subordinated to the requirements of financial statements preparation for external parties.
> The diverse role of management accounting
Critics have questioned the usefulness of complex methods of organisational costing and pricing in the face of
the belief that the price of a product must ultimately meet the expectations of the marketplace rather than
reflecting the procedures involved in its manufacture. Others have given weight to the argument that
management accounting has for too long remained isolated and divorced from other enterprise functions.
Conventional accounting practices have installed, within the organisation, channels for information flow and
routes for data-exchange which have rendered some organisations static, inflexible and excessively structured,
especially in the case of organisations operating in dynamic and fast-moving markets.
(b)
The strategic cost management initiatives suggest several ways to restore the 'relevance' of management
accounting control systems in today's manufacturing and organisational environment.
The fundamental objective of strategic management accounting is to use management accounting information
for strategy implementation, management planning and control in organisations. The distinguishing feature of
strategic management accounting (SMA) is that it considers the relationship of the organisation with its
external business environment. It focuses attention on suppliers, customers and competitive rivals. Information
may be quantitative or qualitative in nature, and some information will be of a non-financial nature.
The basic features of strategic management accounting include external onentation (I.e. competitor information,
suppliers and customers) and long-term process. These features are described below, along with other
important features of strategic management accounting:
Features of SMA
(a) External orientation
(i) Competitor information: (related to cost, pnces. market share etc.) in developing and monitoring the
business strategy.
(ii) Suppliers and customers: they should be considered from a value chain perspective. Several authors
have widely demonstrated that external information is useful in that it enables organisations to develop
a relationship with suppliers as well as customers that can be exploited in the business's interest.
Ultimately "external" refers to the "market"; it means focusing on the product's on offer to satisfy customers'
needs while taking into account the cost of adding new product features.
(b) Long-term process
SMA is a long-term process only which focuses on utilising qualitative and quantitative information (both internal
and external to an organisation) in the strategy formulation of a business.
(c) Forward-looking
SMA provides information about potential changes in the market, competition, consumer preference, supplier
profile etc.
(d) Holistic approach
SMA does not confine itself to collecting external information. Rather, it involves collecting any relevant
information that may have an impact on the business from all spheres of the business, including the internal
sources of the organisation.
Major techniques used in strategic management accounting are activity-based costing, benchmarking,
competitive position monitoring, life-cycle costing, target costing, value chain analysis, strategic pricing, etc.
Since virtually all organisations are subject to environmental change, one of the prime objectives of strategic
planning and control is to gain a sustainable competitive advantage. This process is aided by the information
gathered within a strategic management accounting system.
GTG
Solution Bank : 47
Moreover, it is critical that all aspects of a business are monitored so that a holistic approach is taken when
strategic plans are being developed. The strategic management accounting system is capable of coping with
changes that can and will inevitably occur in a dynamic business environment. Hence it identifies changes such
as the emergence of a new competitor or the emergence of new market areas and ensures that these are
detected and reflected within strategic plans at the earliest opportunity.
A strategic management accounting system provides information that is relevant and reliable thereby enabling
management to make correct decisions. This is critical to any business, given that decisions of a strategic
nature affect the entire organisation and are irreversible in the short term and often the long term.
Strategic cost management promotes the need to revitalise management accounting by extending cost
estimates over the entire life cycle of a product, a practice that many J apanese organisations have adopted for
many years.
The development of strategic management accounting initiatives can be viewed as management accounting's
attempt to regain relevance and maintain a focus on upon matters of strategic importance and long-term
effectiveness.
2. Zero Base Budgeting - National Electronics Ltd
no hucoiivii deals with the different aspects of the implementation of zero-base budgeting in an
organisation.
> Your answer should be specific to the question and should make reference to the case of
National Electronics Ltd.
> Remember that answering the question without referring to the given case will reduce your
prospect to earn high marks.
(i) Memorandum
To: Board of Directors
From: Finance Director
Date: 12 J une 20X8
Re: The implementation of zero-based budgeting in National Electronics Ltd
During recent years, the management of National Electronics Ltd has used the traditional approach of
incremental budgeting.
Incremental budgeting involves preparing a budget on the basis of the previous year's budget with some
additions and deletions for the forthcoming budget penod. Incremental budgets are suitable for all kinds of
organisations. They are widely used by organisations since they are easy to prepare.
However, incremental budgets are cnticised for not justifying the cost elements for inclusion in the budgets. This
approach can lead to inefficiencies since the previous year's budget is rolled forward to the next year's budget
purely by virtue of the fact that the previous year's budget is the starting point for the construction of the new
budget.
The implementation of a system of zero-based budgeting will require consideration of the following:
> the need for major input by management
^ the fact that it will prove extremely time consuming
> the need for a very high level of data capture and processing
> the subjective judgement inherent in its application
> the fact that it might be perceived as a threat by staff
whether its adoption may encourage a greater focus upon the short-term to the detriment of longer-term
Zero-based budgeting was developed to overcome the shortcomings of the technique of incremental budgeting.
The implementation of zero-based budgeting will effectively require each manager within National Electronics
Ltd to start with a blank sheet of paper and a budget allowance of zero. The managers will be required to defend
each of their budget proposals at the beginning of each and every year. Accordingly, the entire planning
process for coming up with budget proposals will have to be reconsidered.
(a)
planning
The development and implementation of the zero-based budgeting model will require managers and others in
the organisation to engage in major planning, analysis and decision-making. National Electronics Ltd has
already established mission and goal statements. However, taking into account the major changes that have
occurred in the internal and external environment of our business, I feel it is prudent to redefine the mission and
goal statements of our company.
It is worth mentioning here that zero-based budgeting can be made successful in National Electronics Ltd if we,
the senior management team, can ensure the following:
> Objectives are more sharply defined and alternative means are explicitly considered.
Managers become more heavily involved in a well-structured budget process that fosters communication
and consensus.
> Priorities among activities are pinpointed.
> Knowledge and understanding of inputs and outputs are enhanced and moreover inputs can be linked
clearly with the output as far as practicable.
^ Resources are reallocated more effectively and efficiently.
A zero-based budgeting decision unit is an operating division for which decision packages (described below) are
to be developed and analysed. It can also be described as a cost or a budget centre.
The manager responsible for each cost centre within National Electronics Ltd will be responsible for developing
a description of each programme to be taken up for operation in the next budget year. In the context of zero-
based budgeting, such programmes are referred to as decision packages and each decision package will
usually have three or more alternative ways of achieving its objectives. Accordingly, each decision package
alternative must contain, as a minimum, objectives, activities, resources and their associated costs.
Each decision package should contain a description of how it will contribute to the attainment of the mission and
goals of the organisation. Each manager within National Electronics Ltd will be required to evaluate each
alternative decision package in order to assess and justify its operation. National Electronics Ltd will have to
establish a mechanism in the organisation that estimates the workload and performance of each decision
package effectively. Based on the merit of each decision package and its importance to the organisation, the
decision packages will be ranked in order of priority for resource allocation. Sometimes, the senior levels of
management may ask the managers of the decision packages to revise and resubmit their decision packages
for additional review and analysis.
The company's budget will be prepared following the acceptance and approval of the decision packages. As
soon as the company's budget has been approved, the managers of the decision units will put into operation all
approved decision packages during the budget year.
The last major process of zero-based budgeting is monitoring and evaluation. The processes of planning,
analysing, selecting and budgeting for decision packages will prepare the company for operation during the next
year.
(ii) In a bid to implement a zero-based budgeting system, the senior managers of National Electronics Ltd
need to keep in mind possible behavioural issues that may anse. Successful implementation of the new
budgetary system will largely depend on how successfully the company can address these issues.
The budgetary process entails the setting of goals. If the budget is overemphasised or viewed as a rigid monitor
of performance, managers and employees are often induced toward behaviour that is not in line with the goals
of the organisation as a whole.
For example, managers in industry are often disindined to reduce costs because they feel that cost cutting may
lead to temporary praise or rewards but, in the long run, will make the job tougher because the future budget will
not be as easy to attain.
In National Electronics Ltd. a fragile balance needs to be struck between careful definition of responsibility, on
the one hand, and a too rigid division of responsibility amongst the managers, on the other hand. Passing the
buck is a pervasive tendency that is supposedly minimised when responsibility is fixed unequivocally.
All these behavioural issues relating to budgeting can be overcome by successful implementation of zero-based
budgeting. Successful implementation of zero-based budgeting will require a major planning effort by National
Electronics Ltd's personnel. It is through the planning process that important guidelines and directions are
provided for the development and ranking of the decision packages.
The zero-based budgeting process addresses and supports comprehensive planning, shared decision-making,
the development and application of strategies and resource allocation as means of achieving established goals.
In addition, zero-based budgeting supports the processes of monitoring and evaluation.
GTG
Solution Bank : 49
Zero-based budgeting, when properly implemented, has the potential to assist the personnel of an organisation
to plan and make decisions about the most efficient and effective ways to use their available resources to
achieve their defined mission and objectives.
As a consequence of the adoption of zero-based budgeting, the managers of National Electronics Ltd should be
able to make decisions on the basis of an improved reporting system. It is quite possible that zero-based
budgeting will help to identify and eliminate any budget bias or 'budget slack' that may be present. Budgetary
slack is 'a universal behavioural problem' whereby managers intentionally create slack as a protective device.
Slack involves intentionally overstating cost budgets and/or understating revenue budgets to allow some
padding in actual performance. Zero-based budgeting can reduce the possibility of the presence of slack in the
budget since greater justification is needed for a manager to get his decision package approved for resource
allocation.
It is important to assure the managers of National Electronics Ltd that the reason for implementing a zero-based
budgeting system in the organisation is to bhng in a culture of justifying expenditure before it is spent. Moreover,
any sort of blame-culture will be discouraged. Finally, it needs to be emphasised to the senior management that
the zero-based budgeting process will not yield the desired results without the support and active involvement of
the senior managers.
Signed: Finance Director
(b) The basic differences between the implementation of a zero-based budgeting (ZBB) system in National
Electronics Ltd (a profit seeking, manufacturing organisation) and the implementation of ZBB in a 'not for
profit' health organisation are descnbed below:
ZBB is implemented in profit seeking, manufacturing organisations primarily as a management tool in planning
for and controlling the staff and support functions. Typically, a ZBB review is conducted for a relatively small
portion of a manufacturing company's total budget. ZBB has proved to be most useful in managing discretionary
fixed costs. Direct costs that incur more or less in proportion to the output volume can be better planned through
the traditional approach to budgeting. On the other hand, for a not for profit' organisation. ZBB is used as the
main system of budget justification (and, in most cases, presentation) for all functions within an organisation.
Accordingly, the finance director of National Electronics Ltd is probably aware that the application of zero-based
budgeting within National Electronics Ltd might prove most fruitful in the management of discretionary costs
where it is difficult to establish standards of efficiency and where such costs can increase rapidly due to the
absence of such standards. Direct production and service costs incurred in National Electronics Ltd which
change according to production volume can be planned and accordingly resources can be allocated more
appropriately following traditional budgeting methods utilising standard costs. Since the major costs incurred by
a 'not for profit' health organisation will be of a discretionary nature, one might conclude that the application of
zero-based budgeting techniques is more appropriate for service organisations such as the not for profit' health
organisation than for a profit-seeking manufacturer of electronic office equipment. A further difference lies in the
fact that the ranking of decision packages is likely to prove less difficult (sometimes a decision package may not
have any alternative) within an organisation such as National Electronics Ltd which is only involved in the
manufacture and marketing of electronic office equipment. In contrast, there is likely to be a much greater
number of decision packages of a dissimilar nature, competing for allocation of the available resources within a
'not for profit' health organisation.
3. Beyond Budgeting Model
Part (a) of the answer should be divided into points. A critical approach towards budgeting systems
is expected in the answer.
Although the answer contains several relevant points related to the weaknesses of budget model,
you should confine your answer to five such points, as asked for.
Part (b) of the question contains three questions each of which is worth 4 marks. In order to get high
marks make your answer brief and to the point.
(a) Advocates of beyond budgeting have criticised conventional budgeting processes on several counts.
Inherent weaknesses of the annual budget model irrespective of the budgeting approach that is applied are
enumerated below. It is argued that budgets:
> cannot cope with a fast-changing environment and that they are often out-of-date before the start of the
budget period
> focus too much management attention on the achievement of short-term financial targets. Instead,
managers should focus more on the things that create value for the business (e.g. innovation, building
brand loyalty and responding quickly to competitive threats)
^ reinforce a command and control' structure that prevents junior managers from exercising autonomy. This
may be particularly true where a top-down approach, that allocates budgets to managers, is being used.
Where managers feel constrained, attempts to retain and recruit able managers can be difficult.
> take up an enormous amount of management time that could be better used. In practice, budgeting can be
a lengthy process that may involve much negotiation, reworking and updating. However, this may add little
to the achievement of business objectives.
> are based around business functions (e.g. sales, marketing and production). However, to achieve the
business's objectives, the focus should be on business processes that cut across functional boundaries and
reflect the needs of the customer.
> encourage incremental thinking by employing a "last year figure plus a certain per cent' approach to
planning. This can inhibit the development of break out' strategies that may be necessary in a fast-changing
environment.
can protect costs rather than lower costs. In some cases, a fixed budget for an activity, such as research
and development, is allocated to a manager. If the amount is not spent, the budget may be taken away and
in future periods, the budget for this activity may be either reduced or eliminated. Such a response to
unused budget allocations can encourage managers to spend the whole of the budget, irrespective of need,
in order to protect the allocations they receive.
^ promote a negative mentality amongst managers. In order to meet budget targets, managers may try to
negotiate lower sales targets or higher cost allocations than they feel is really necessary. This helps them to
build some slack' into the budgets and so meeting the budget becomes easier.
> Moreover, one of the biggest problems with budgets is that they tend to promote an inward-looking, short-
term culture that focuses on achieving a budget figure, rather than on implementing business strategy and
creating shareholder value over the medium to long term.
(b)
(i) Benchmarking
Benchmarking is a process for improving performance by constantly identifying, understanding and adapting
best practices and processes followed inside and outside the company and implementing the results. The main
emphasis of benchmarking is on improving a given business operation or process by exploiting best practices'.
The prime objective of benchmarking is to assess an organisation's strategic capability in relative terms since it
concerns the ability to meet and beat the performance of competitors. There are different ways in which relative
performance might be understood. In order to understand the relative performance of an organisation,
organisations are compared with each other in terms of their overall strategic characteristics and in terms of how
customers perceive them.
In simple terms, benchmarking is an approach which involves setting goals and measuring productivity based
on best industry practices. It developed out of the need to have information against which performances can be
measured.
Traditional budgeting processes focus on the achievement of short-term targets and accordingly the targets set
in the budgeting process do not consider the adoption of 'best practices' since this may require significant
change in the work process which is not feasible in the short term.
Since the budget is perceived to be predominantly a control exercise, managers feel that there is very little real
incentive to seek out benchmarks which may be used to raise budgeted performance targets. Benchmarking
may sometimes invite behavioural issues. The managers may view benchmarking as an attempt by top
management to impose impossible targets upon operational managers.
Moreover, organisations which do not measure their success relative to their competition do not resort to
benchmarking and remain happy with favourable performance based on budgetary targets.
GTG
Solution Bank : 51
(ii) Balanced scorecard
Realising the need for a balanced measurement system. Robert S. Kaplan and D.P. Norton developed a new
measurement system called the balanced scorecard. The balanced scorecard links the short-term operational
goals of an organisation to its long-term objectives and strategy by forcing it to monitor and control day to day
operations. It defines the entire road map for achieving the goals and constantly reveals what is happening in an
organisation.
The balanced scorecard starts by defining the mission, outlining the strategies to achieve the mission,
understanding the core customer requirements, defining the internal business process and assessing the
organisational infrastructure needed to achieve the objectives. This continually tests the theories underlying
management's strategy. The emphasis of the balanced scorecard is on progress and improvement rather than
on meeting any specific standards.
A useful approach for a complete, strategic performance evaluation is to include both financial and non-financial
factors for an organisation, using the balanced scorecard. The balanced scorecard measures an organisation's
performance in four key areas:
> customer satisfaction
> financial performance
^ internal business process
> learning and growth
The main concept of the balanced scorecard is that no one measure can properly evaluate the organisation's
progress to strategic success. Rather, multiple measures typically grouped in the four key areas, provide the
desired comprehensive evaluation of the organisation's performance. Moreover, by attending directly to the
firm's critical success factors, the balanced scorecard effectively links the performance measurement /
evaluation to the organisation's strategy. Unfortunately, any shift from a traditional budgeting approach might
lead to dysfunctional behaviour at every level of the organisation.
The balanced scorecard is often misperceived as a consequence of the failure by top management to ensure
that it is implemented effectively within the organisation. Accordingly, it may be viewed as the addition of a few
non-financial measures to the traditional budget targets. In order to overcome this incorrect perception, many
organisations now establish a reward system based upon the achievement of scorecard targets for the
forthcoming budget period.
Even in situations where the scorecard has been well-designed and well-implemented, it is difficult for it to gain
widespread acceptance. This is because managers often like to maintain an organisational culture which places
high importance upon the achievement of the fixed annual targets in order to avoid the loss of status,
recognition and rewards.
The balanced scorecard approach contains a mix of long-term and short-term measures and therefore dnves
the company in the direction of medium-term strategic goals which are supported by cross-functional initiatives.
On the other hand, the focus of the budgeting process is on the achievement of short-term financial goals
supported by the initiatives of individual departments. Budgets can also act as a hindrance to the acceptance of
responsibility by local managers for the achievement of the scorecard targets. This is often the case in situations
where a continued emphasis exists on meeting short-term, e.g. quarterly, targets.
(iii) Activity-based models
Traditional budgets consider the costs of functions and departments (e.g. staff costs and establishment costs)
instead of activity costs (e.g. receipt of goods inwards and processing and dispatch of orders). Accordingly,
managers do not focus on identifying the real 'cost drivers' of their business. Moreover, it is probable that a
traditional budget contains a significant amount of non-value-added costs that are not apparent and accordingly
steps are not taken to eliminate the activities that give rise to non-value-added costs. The annual budgets are
prepared considering a fixed capacity level for the forthcoming budget period thereby undermining the potential
of activity-based management (ABM) analysis to determine the required capacity from a customer demand
perspective.
52: Strategic Planning And conirol C.TG
4. Strategic planning - Diverse Holdings Pic
Jr PfffTHny
> The question relates to strategic planning and SWOT analysis as a tool for strategic planning.
> Your answer should be with reference to the case discussed in the question.
Remember that your examiner will prefer a point-by-point answer and therefore you should
present your answer in this manner as far as possible in order to get high marks.
Strategic planning is an organisation's process of defining its strategy, or direction, and making decisions on
how to allocate its resources to achieve its corporate objectives, including its capital and people. Various
business analysis techniques can be used in strategic planning induding SWOT analysis and PEST analysis
(analysis of the influence of the political, economic, social and technological components of the organisation's
external environment).
There are a variety of perspectives, models and approaches used in strategic planning. The way that a strategic
plan is developed depends on the nature of the organisation's leadership, the culture of the organisation, the
complexity of the organisation's environment, the size of the organisation, the expertise of the planners and so
on.
The following are some of the advantages that may be gained as a consequence of the adoption of a formal
system of strategic planning:
(i) Strategic planning determines the future course of action of an organisation. The focus of a strategic plan is
usually on the entire organisation, while the focus of a business plan is usually on a particular product,
service or programme.
(ii) Strategic planning identifies business risks and accordingly equips an organisation to run its business
smoothly and effectively.
(iii) A strategic plan draws management attention to the need to give due consideration to the ever-changing
environment and to the threats from competition. A strategic plan considers potential change and guides an
organisation to cope with changes to ensure long-term sustainability.
(iv) Strategic planning ensures that planning and controlling activities are consistent with the organisation's
long-term, medium-term and short-term objectives. Strategic planning also helps to identify whether the
business objectives are leading an organisation in the right direction or whether they require re-assessment.
(b)
SWOT analysis is a technique used in strategic planning to evaluate the Strengths, Weaknesses. Opportunities
and Threats that might affect business strategy. It involves specifying the objective of the business venture or
project and identifying the internal and external factors that are favourable and unfavourable to achieving that
objective. The aim is to identify the extent to which the current strengths and weaknesses are relevant to. and
capable of, dealing with the threats or capitalising on the opportunities in the business environment.
Senior managers in an organisation might have their own opinion about the strengths and weaknesses of the
organisation, but a management information system should be in place to provide measured and reliable
information about strengths or weaknesses.
The use of SWOT analysis will focus management attention on the current strengths and weaknesses of each
subsidiary company which, in turn, will assist in the formulation of the business strategy of Diverse Holdings Pic.
It will also enable management to monitor trends and developments (which may present opportunities or
threats) in the constantly changing environments of their subsidiaries. Management will accordingly assess the
feasibility of the actions required in order that the organisation may take advantage of the opportunities whilst
eliminating or minimising the effect of any threats.
GTG
Solution Rank : 53
(c)
(i) The competitive positions of all the constituents of Diverse Holdings Ltd are analysed below:
Organic Foods Ltd (OFL) had a market share of 6.66% and was the market leader at 30 November 2005.
According to the forecast, it will have a market share of 8% by the end of 2007. Operating profits appear to be
reasonably good and moreover OFL has built up a very good reputation as a supplier of quality produce.
Accordingly, therefore it seems reasonable to regard OFL as a current 'strength' of Diverse Holdings Pic.
Haul-Trans Ltd (HTL) was acquired on 1 December 2005 and has a record of reasonable profitability. The
turnover and profit of the company have remained more or less static over the last few years. However, it has
an optimistic profit forecast. The total market size of the transport market segment is unknown and accordingly it
is not possible to identify the market share of HTL or any other company. Therefore it is not possible to compare
the performance of HTL with that of the market leader. Management may have identified avenues through which
to achieve significant cost savings or may have been able to attract more profitable customers while
discontinuing its service to less profitable customers.
The information collected by the management accountant of Diverse Holdings Pic suggests that the turnover
and operating profit of Kitchen Appliances Ltd (KAL) is gradually decreasing and, more alarmingly, its market
share is decreasing at an even faster rate. At 30 November 2005, KAL had a market share very close to the
market leader. Since then. KAL has developed into a weakness of Diverse Holding Pic. According to the
forecast, it will enter into the loss region during the year ended 30 November 2007. KAL has suffered from
reduced margins as a consequence of competition from low cost imports. The situation may worsen as
competition from abroad intensifies.
The available information shows that the sales (and profit) of Paper Supplies Ltd (PSL) have not changed at all
although the market size of the products it manufactures has expanded over time. The market for the stationery
items that PSL manufactures is dominated by a single manufacturer (holding a 35% market share). PSL
appears to be struggling to achieve any growth in turnover, profits and therefore cash flow. It is not a feasible
proposition for PSL to continue to compete with a narrow range of products and only two customers.
Office Products Ltd (OPL) is growing slowly in terms of turnover and the operating profit of the company has
continually increased in exact proportion to the turnover (the operating profit ratio being 10%). It is alarming to
note that, despite operating in a rapidly growing market, the company could not boost its sales and increase its
market share in spite of the fact that its products are highly regarded by health and safety experts.
(ii) The forecast situation of Diverse Holdings PIc indicates some problems (in particular, in regard to the
performances of KAL, PSL and OPL). KAL and OPL require the immediate attention of management.
Continuation of the business of KAL is in question since the forecast predicts that the company will
gradually enter into loss territory.
Any one of the following strategies may be adopted by Diverse Holdings PIc:
> outsource the manufacture of kitchen appliances
> set up a manufacturing operation overseas in order to cut costs
> withdraw from the market
Each alternative must be assessed. Whatever decision is taken, it is unlikely to affect the other four subsidianes.
PSL is also independent of the other subsidiaries. A strategic decision to increase its range of products and
outlets will surely improve its turnover and profit position. In an expanding market, it will not be difficult for
management to find new markets for its products, which are separate and distinct from those markets served by
its appointed distributors.
In order to improve the prospects of OPL. management needs to put more emphasis on market promotion
strategies since, in spite of operating in a high growth market, the company could not capture a reasonable
market share.
Management should endeavour to develop a strategy to integrate its subsidianes further so that they can benefit
from each other and also derive as much synergy as possible from the acquisition of HTL.
It is of paramount importance that management ensure that sufficient funds are channelled into expanding OFL
and HTL, which are both showing an upward trend in profitability. The group has exhausted its cash reserves,
mainly due to the purchase of HTL. In order to make good its cash position. Diverse Holdings PIc may consider
divestment of KAL, which has shown a consistent downwards trend.
5. External environment
(a)
J In this question you are asked to assess the external environment. Whenever it comes to external
environment, you should consider both the micro as well as the macro-environment and, when
considering the macro-environment, try to remember PESTEL. Then it will be very easy to
answer this question.
You will earn 2 marks for identifying each area and explaining it, up to a maximum of 10 marks.
Here, all related areas are identified but you should not mention all of these in the exam. This is
because you will be given a maximum of 10 marks for this part of the question and too long an
answer will eat up your valuable time.
The external environment, being influential factors outside the organisation, is beyond the control of the
organisation. It is necessary to. study the external environment since it has an impact on the organisation, its
strategies and its performance. The areas in which the external environment affects the organisation include the
following:
financial performance
activity level (volume of production / sale)
costs
product quality and features
business strategies
survival and growth of the business
The external environment consists of the micro-environment and the macro-environment. Competitors,
customers, suppliers etc. come under the micro-environment. The macro-environment is made up of PESTEL
i.e.
(i) Political;
(ii) Economic:
(iii) Socio-cultural;
(iv) Technological;
(v) Environmental; And
(vi) Legal Factors.
The components of external environment, information related to them and
the way in which they influence the organisation are presented in the
following table:
Presenting your answer in
tabular format will save time
and also highlight the
important points.
Components Related information Influence / Reason
Competitors
^ identifying the competitors
> information related to marketing and pricing
strategies
> performance
> market share
> market share
> market trend
> pricing policy
> product line / features
Suppliers
> availability
> quality
/ financial viability
> pricing policy
> quality of product and after sales service
^ quality of the final product
r price of the product
> production schedule
Customers
> expectations and preferences
> financial capability
> liking / demand for a particular product
> market share
> market trend
> pricing strategies
GTG
Solution Rank : 55
Political
> stability of government
> composition of government
> governmental rules and regulations
> involvement of government in trade agreements
> production methods
> pricing policy
Economic
> inflation rate
> interest rate
> foreign exchange rate
> business cycle
> taxation
level of export and import
> level of production
Socio-cultural
> demographic patterns
> consumer tastes and preferences
> overall societal trends
^ beliefs and customs in the society
> market share
> market trend
> pricing strategies
> product line
Technological
> technological developments
> new innovations
> product development
> product line / features
Environmental &
legal
> related laws and regulations
> compliance requirements
> costs
(b) Sources of Information
i
Here, the information provided' column is additional. In order to manage your time in the exam, you
should write only succinct, specific answers without including extra information. Identifying each
source will earn you one mark therefore do not write more than 5 sources.
The information about the external environment (the components mentioned above) can be gathered from the
following sources:
Sources Information provided
Government (statistics given by
government in vanous reports,
journals etc. published by it)
> industry trends and statistics
> government policies (fiscal, monetary)
> demographic statistics
> economic growth, GDP
> economic indicators (such as inflation rates and interest rates.)
> consumer spending statistics
> import / export statistics
International agencies
e.g. World Bank and IMF
(global information is provided)
> industry trends
> consumer spending statistics
> import / export statistics
> economic indicators
> technological developments in any industry
> other industry statistics
Market research and focus group
studies
> tastes and preferences of customers
> suggestions from customers
> expectations about prices of products
Newspapers, television and other
media
Trade journals
> industry trends and statistics
> competitors, suppliers, customers
> share prices
> market conditions
> technological developments
Suppliers' pnce list and brochures
> product prices
> features / quality of products
> various products and substitutes available
> product launching
Customers' feedback / consumer
association
> customers' tastes and preferences
> customers' suggestions
Encyclopaedia / the internet
Almost all kinds of information are available from the internet (paid /
unpaid)
(c) Development and implementation of the system
Answering this question is very easy. Think what you would do if you wanted to develop a system.
Consider the requirements of the system and. accordingly, start writing the answer.
The development and implementation of a system includes the following:
> Data capture: identifying various sources of information and gathering relevant data is the basic
requirement for any system.
> Data process: all the gathered data are to be converted into meaningful information. Who will require what
kind of data should be decided in advance and the data should be processed accordingly.
Data categorising: categorising the data according to the requirements of the different levels such as
strategic, tactical and operational.
In addition, the frequency of the requirement of information should be identified and information should be made
available accordingly.
> Monitoring & controlling the system: the system should be monitored to assess whether it is working
according to the requirement.
> Distribution of Information on a need to know basis: whether or not the information is distributed to the
people who require it and is in the required format.
Once the requirements are specified, the next job is to assign the duties to the personnel involved in the
implementation of the system.
1
4
SOLUTION BANK
B
6. Ethical issues and Mendelow's matrix- Toyworld pic
(a)
While answering this part of the question, you are expected to point out all the unethical practices
adopted by Toyworld. Therefore, if you note down the points while reading the question, it will save
you time.
In addition, do not forget to discuss the impact of the unethical practices on Toyworld's long-term
and short-term performance.
Previously, it was assumed that organisations were responsible only to their shareholders and their
responsibility was to maximise the wealth of the shareholders by earning more and more profit. Later on. this
view changed and nowadays organisations also have an ethical responsibility towards their various other
stakeholders, including the society at large.
Organisations are expected not to take dedsions or engage in activities that will hurt the interests of any of
these groups. However, being ethical has a cost in the short term which affects an organisation's short-term
performance.
It is clear from the following examples that the company has adopted unethical practices.
Use of substandard material
The use of substandard material saves cost but is unethical. Although it is known that the material could be
dangerous to children's health. Toyworld has not stopped using it. This means that the company has put profit
before the health of the children who play with its toys.
Although Toyworld has performed well until now. in the long term, customers will become aware that the
material is dangerous to children's health and stop purchasing Toyworld's products. As a result. Toyworld's
long-term performance will be affected.
Unethical labour practices
Vanous issues related to employees have been ignored by Toyworld such as its responsibility to enforce
maximum working hours and provide good working conditions and fair pay to its employees. Toyworld has
employed many unethical practices such as:
> employing children, which is prohibited by law
> not paying fair wages to its employees
> making it compulsory to work for more than the maximum working hours
> not providing a creche facility for young children of its employees
By adopting these practices. Toyworld is saving costs, but is ignoring its ethical responsibility.
Since its workers are in need of employment and money, they will not take any action against these unethical
practices. However, they are likely to come to the attention of the public. This will affect the reputation as well as
the performance of Toyworld in the long term. This is because people prefer to deal with ethical companies.
58: Economic, Fiscal and Environmental Factors >f.T(i
False advertising I marketing
The company is aware that the material it uses is dangerous to children's health (if they put the toys in their
mouths, as children are likely to do!). In such a case, it is the ethical responsibility of the company to display a
warning on the packaging of the toys. However, no warning is given.
In addition. Toyworld tries to attract customers by falsely advertising that Toyworld's products are safe and by
giving exaggerated statements that Toyworld products are better than the products of other companies and help
to improve children's memory and motor skills.
By adopting these practices, Toyworld may become successful in attracting customers and increasing revenues
in the short term but in the long term, this will affect its reputation and therefore performance.
Environmental issues
As stated in the question, the material used by Toyworld is not environmentally-friendly. In addition, Toyworld
doesn't have a pollution treatment plant. Emissions from the factory are polluting the environment of Farland. An
organisation should not improve its performance at the cost of society. Society as well as the government will
not accept this and legal action may be taken against Toyworld. This will affect the reputation as well as
performance of Toyworld in the long term.
Therefore, although it will be expensive and will affect the short-term performance of Toyworld, the company
should establish a pollution treatment plant and should use environmentally-friendly material.
Unethical practices
Toyworld donates a huge amount to the political party led by Robert. Although this helps Toyworld to obtain
easy finance at low interest rates, this also puts Toyworld's reputation at risk and it may become a target for
legal and political investigations. The donations are a form of bribe and therefore this practice is not only
unethical but also illegal. This is a poor management decision and could create difficulties for Toyworld.
By stamping out this practice, Toyworld may lose its ability to obtain finance at any time (from Easy-money) and
may also have to pay higher interest rates but it will eliminate the risk to its reputation.
From the above discussion, it is clear that Toyworld has adopted several unethical practices. The finance
director argues that stamping out such practices may affect the performance of Toyworld. Although this is true,
adopting ethical practices will help to improve Toyworld's performance in the long term. This is because
although an organisation may "get away with" unethical practices in the short term, they are likely to affect the
organisation adversely when they come to the public's attention.
On the other hand, being ethical improves the performance of an organisation in the long term in the following
ways:
> Employees are more loyal to ethical organisations.
> Customers are willing to buy products from an ethical organisation.
> Suppliers are more willing to maintain and improve relationships with an ethical organisation.
> Potential business collaborators are more willing to associate with an organisation that has an established
reputation for behaving ethically.
(b)
In this part of the question, you are asked to categorise some of Toyworld's stakeholders in
Mendelow's stakeholder mapping matrix. However, do not forget to give your reasons for categorising
a stakeholder in a particular quadrant.
In addition, do not discuss what Mendelow's stakeholder mapping matrix is. Only categorisation is
expected.
GTG
Solution Rank : 59
Mendelow's stakeholder mapping matrix
Employees
In Toyworld, although the employees have a high level of interest in the organisation, they have very little power
to influence the organisation. This is evident from the ways in which Toyworld is exploiting them. The employees
cannot speak out against their exploitation because their livelihood depends on their employment at Toyworld.
Therefore they will be categorised in the high interest- low power quadrant.
Customers
Customers can influence the strategies of Toyworld. This is because there are many competitors in the market
and therefore customers may easily shift to another competitor. In the absence of customers, Toyworld will have
no business. For example, if customers stop buying Toyworld's products because they are not quality products,
Toyworld will have to improve the quality of its products. Therefore customers have influencing power.
However, customers have low interest in Toyworld as they may shift to any other organisation. Therefore
customers should be categorised in the high power - low interest quadrant.
Directors of Toyworld
It is clear from the case that the directors have the power to change Toyworld's strategies as well as having a
high interest in Toyworld. This is because they are the decision makers and hold significant shares in Toyworld.
Therefore they should be categorised in the high power - high interest quadrant.
Shareholders (other than directors)
It is given in the case that, other than the directors, each of the shareholders holds only a few shares and
therefore has little influence over the strategies of Toyworld. However, they may have an interest in Toyworld
since they are the owners. Therefore they should be categonsed in the high interest- low power quadrant.
The government
For any organisation, the government is always in a position to influence the strategies of the organisation.
However the government does not have any interest in Toyworld, (it is not a publicly owned company, utility
business or monopoly) therefore the government will be categorised in the high power- low interest quadrant.
60: Economic, Fiscal and Environmental Factors >f.T(i
SOLUTION BANK
I PERFORMANCE
g MEASUREMENT SYSTEM AND
w DESIGN
C
7. Contingency theory, BPR
t Part (a) of the question deals with the contingency theory of management accounting and part (b)
deals with application of 'Business process re-engineering' and the potential problems which may be
encountered in the implementation of a business re-engineering programme.
Your answer to the question should be brief, justifying the marks allotted. However, the answer given
below is comparatively large as it is intended to give you a complete overview of the related topics.
(a) There are many forms of contingency theory. In a general sense, contingency theories are a class of
behavioural theory that contend that there is no one best way of organising / leading and that an
organisational / leadership style that is effective in some situations may not be successful in others (Fiedler,
1964). In other words, the optimal organisation / leadership style is contingent upon various internal and
external constraints.
Four important ideas of contingency theory are as follows:
(i) There is no universal or one best way to manage.
(ii) The design of an organisation and its subsystems must fit' with the environment.
(iii) Effective organisations not only have a proper 'fit' with the environment but also between their
subsystems.
(iv) The needs of an organisation are better satisfied when it is properly designed and the management
style is appropriate both to the tasks undertaken and the nature of the work group.
The contingency theory of management accounting represents an attempt to identify the most appropriate
accounting control system for a given set of circumstances and to identify the most important contingent
variables and assess their impact on the design of control systems.
Contingent variables will have a definite influence In designing management accounting systems and
associated performance practices. David Otley has identified five sets of contingent variables that impact on
the management accounting of an organisation, namely, the organisation's environment, competitive
strategy, the business unit itself (i.e. size, diversification and structure) and knowledge and observation (of
performance).
Since the purpose of a control system is to assist an organisation in adapting its business environment, then
it would appear reasonable to accept that a management control system is subject to influence from the
external environment in which it operates. A formal accounting control system is only one of a number of
potential controls that could be adopted by an organisation. Whilst it is undeniable that the degree of
sophistication of accounting controls is influenced by the intensity of competition faced by a firm, two other
characteristics from within an organisation's environment, namely dynamism and heterogeneity, have been
shown to affect the design of control systems. Each of these characteristics is associated with an emphasis
on different aspects of accounting control. The view has also been put forward that other major influences
on the design of control systems are the degree of structural complexity of an organisation and the extent to
which 'turbulence' exists in its environment. Increasing structural complexity will lead to an increase in the
number of accounting tools used by an organisation, whereas environmental discontinuity may require new
tools to replace those which have become obsolete.
(>4: Performance Measurement System and Design fiTf.
The nature of a manufacturing process determines the type of costing system that is required and the extent
to which costs can be traced to products. The level of accuracy achieved in job-costing which is used in
conjunction with batch production technology is higher than that which can be achieved in process costing
due to the fact that a greater proportion of the costs are incurred jointly by the range of final products. It
follows that there is a technological constraint on the design of accounting controls due to product
interdependence.
One should also consider the direction of causality. Is it contingent factors that cause the system to be as it
is or might the system itself be a contingent factor which is a cause of change?
(i) Business process re-engineering (BPR)
Business process re-engineering is the fundamental rethinking and redesign of business processes to achieve
dramatic improvements in critical, contemporary measures of performance, such as cost, quality, service and
speed.
A business process consists of a collection of activities that are linked together in a coordinated manner to
achieve a specific objective. Business process re-engineering involves examining business processes and
making substantial changes to how the organisation currentJ y operates. It involves the redesign of how work is
carried out through activities, seeking improvements in cost, quality, service and speed.
For example, material handling might be classified as a business process consisting of separate activities
relating to scheduling production, storing matenals, processing purchase orders, inspecting materials and
paying suppliers.
Applications of business process re-engineering
> BPR draws on the insights of Porter's value chain by viewing the organisation as a set of value-generating
processes rather than as a segmented structure of departments and divisions. Techniques such as activity-
based costing and activity-based management can also support this.
> BPR normally supports the marketing onentation since it re-engineers the business on the basis of the
benefits sought by the customers.
> BPR has a role in furthering the network organisation. If it can be shown that outside suppliers can deliver
certain benefits in comparison to managing the process in-house. then the conclusion should be to extend
the network.
> BPR can be assisted by benchmarking. Management may direct BPR to those processes where relative
performance is poor. In addition, benchmarking is a useful technique for measuring the improvements
yielded by the BPR programme.
'r BPR also indicates the relationship of the firm with its suppliers. Re-engineering an organisation to provide
streamlined performance is pointless if the organisation is held back by the inefficiencies of its suppliers and
partners.
(ii) Potential problems which may be encountered in the implementation of a business re-engineering
programme are:
> Often used as the pretext for staff reductions: for example, Ezzamel et al. (1995) concluded that
much of the impetus for organisational change came from the cost-cutting potential and less from
considerations of business effectiveness. Some writers (e.g. Willmott. 1995) present BPR merely as an
excuse for senior management to assert their power over middle management and staff through
increasing workload and cutting headcount. If true, this makes BPR entirely opposed to many of the
modern 'trust-based' approaches to management.
> Conflicts with human resource-based approaches to business improvement: several of the new
wave' management approaches, such as teamworking, TQM and empowerment, emphasise the value
of unlocking human potential to make the firm more responsive and innovative. BPR suggests
empowering the end-users and making them more responsive and innovative. However, it does not
appear to accept that staff should determine the structure in which they work, nor that these structures
should adapt through time. Instead. BPR envisages a group of specialists imposing their understanding
on the business and designing a better process. The result will be that members of staff are still
constrained within a new framework of operation that they did not design.
C.TG Solution Bank :<>)
> Overlooks the impact on human resources: advocates of BPR overlook the enormous implications of
a BPR exercise for the staff involved. These changes will involve learning new patterns of work, the
break-up of traditional workgroups, the loss of enriching parts of the job and redundancies. The firm will
incur visible costs such as training and redundancies, but also less visible ones such as the loss of
goodwill and uncontrolled staff losses.
> Increase stress of staff: a common outcome of BPR has been the reduction in staff numbers at middle
and line management levels. The result of this is an overload on the remaining staff thereby reducing
effectiveness.
^ Does not focus on business effectiveness: it is apprehended that BPR causes the loss of key
competitive assets, namely the knowledge and creativity of middle management. Critics accuse BPR
(and benchmarking) of focusing too much on improving the existing business rather than developing
new and better lines of business.
> May destroy existing controls within the organisation: management control is exerted in a variety of
ways. Widely used internal control measures are segregation of duties, management supervision, the
quality of personnel and the accounting procedures used. BPR threatens these by combining tasks,
stripping away levels of management and allowing the firm to use lower grade staff.
8. Behavioural aspects in performance measurement - Astrodome sports Ltd
(i) Tunnel vision
Tunnel vision is about focusing on performance measures in isolation without taking into consideration the other
aspects of management. The first director's view i.e. 'There is no point whatsoever in encouraging staff
to focus on interaction with customers in efforts to create a 'user friendly' environment. What we
need is to maintain the quality of our grass surfaces at all costs since that is the distinguishing feature of
our business' is an example of this problem; the director is focusing only on increasing the quality of the
grass and ignoring other aspects, such as customer satisfaction and the ambience of the complex, which
have an impact on the demand for the facilities.
(II) Sub-optimisation
Sub-optimisation occurs when managers concentrate on one area of management in order to achieve better
results and overlook the other aspects which ultimately affect the overall profitability of an organisation. 'We
should focus our attention on maximising the opening hours of our facilities. Everything else will take
care of itself' is an example of sub-optimisation where other important issues such as the possible need to
increase the availability of horse-riding and bowling equipment for hire (since these sports are becoming
increasingly popular) are ignored.
(iii) Misinterpretation
Misinterpretation is when a performance measure is interpreted incorrectly or in an over-simplified way.
Performance might be a result of several complex and overlapping factors but management may attribute the
success or failure to one or two specific factors, which is over-simplistic. In the given scenario, the director's
view that 'we should reduce the buildings maintenance budget by 25% and spend the money on
increased advertising of our facilities which will surely attract more customers' shows that the director
has attributed the success of Astrodome Sports Ltd to its marketing strategy i.e. advertising. In reality,
several complex factors, such as unemployment in the local area, have led to the fall in revenue. This is a
serious factor. As a result of unemployment, the economy may slow down and result in falling demand for
the facilities of Astrodome Sports Ltd.
In this question you are asked to discuss only four problems. Therefore, even though more than
four problems are discussed in the answer below (to aid your understanding) in the exam you
should not mention more than four problems. Instead, spend your valuable time on improving your
answers to other questions.
(a)
(iv) Myopia
This is short-sightedness. In the context of performance management, it means concentrating on short-term
performance measures which may lead to the neglect of longer term considerations. An example of myopia is
the director's view that 'we should reduce the buildings maintenance budget by 25% and spend the
money on increased advertising of our facilities which will surely attract more customers.' Asset
maintenance, even if does not provide any direct and short-term benefit, is needed in the long term.
Short-term decisions should not be taken at the cost of long-term benefits.
(v) Measure fixation
Measure fixation involves taking action to ensure that specific performance targets are reached without
considering the probable consequences. An example of measure fixation is the director's opinion that 'we
should buy more equipment which can be hired out to users of our facilities. This will improve our utilisation
ratios which will lead to increased profits'. This strategy will not provide any additional benefit. This is because
there have been no complaints from customers; on the contrary, they are satisfied. Therefore it can be assumed
that the fall in revenue is because of unemployment in the town. In such a case, buying more equipment will
only increase the burden and will not otherwise be helpful.
(vi) Misrepresentation
Misrepresentation is the tendency to give a false but satisfying picture of performance by suppressing the actual
results i.e. creative reporting or window dressing. The information given should be complete so that the facts
can be analysed. In this case, incomplete information is provided by the director's statement that 'recent
analysis of customer feedback forms indicates that most of our customers are satisfied with the facilities.
In fact, the only complaints are from three customers - the LCA University which uses the cricket pitch
for matches, the National Youth Training Academy which held training sessions on the tennis courts, and
a local bowling team.'
In order to analyse this fact, additional information about how much business the company receives from
these customers is needed. If these customers constitute a major portion of the business, their
dissatisfaction may be harmful to Astrodome Sports Ltd.
(vii)Gaming
Gaming is a deliberate attempt to distort performance targets so that the subsequent results appear better than
they actually are.
(viii)Ossification
Ossification is management's unwillingness to introduce new performance measures in place of outdated and
ineffective measures that are in use.
(b)
(i) Trying to focus on and improve the measurement of customer satisfaction
Customer satisfaction is very important for an organisation. One satisfied customer can bring 4 new customers
and, similarly, one dissatisfied customer can discourage 4 potential customers Therefore satisfying customers is
very important. Management should not focus on only one aspect (tunnel vision) such as improving the quality
of grass but should also consider the other aspects such as creating a customer-friendly atmosphere.
In addition, care should be taken to avoid taking sub-optimal decisions. All the decisions should be taken only
after evaluating their impact on the organisation as a whole.
Instead of interpreting the measures in an over-simplified way (misinterpretation), the actual cause should be
identified and all the complexities in the environment should be considered. For example, advertising may not
be the proper solution for decreasing revenue and therefore an increase in advertising may not result in an
increase in demand. Instead, emphasis should be placed on those measures that will result in an increase in
customer satisfaction.
Focusing on short-term factors (myopia) at the cost of long-term benefits should be avoided. Customer
satisfaction is a long-term measure which should not be sacrificed for short-term benefits.
(ii) Involving staff at all levels in the development and implementation of performance measures
The dimensions of the building block model required that the standards should be owned by individuals. This
means that the individuals who are ultimately responsible for completing the task should be involved in the
process of setting the standards and deciding the performance measurement criteria.
Involving staff in the process of developing and implementing performance measures motivates them. The
involvement of all the employees of the organisation in performance measurement will help to reduce gaming
i.e. deliberate distortion of target. In the given case, directors have made an attempt to understate the potential
benefit of maintaining the buildings so that the funds available for maintaining buildings can be used for
advertising. Management should understand that advertising alone will not be sufficient; the state of the facilities
is also important.
In addition, the involvement of staff will also help management to understand the importance of creating a
customer-friendly atmosphere. The staffs know the ground level difficulties and therefore they can contnbute to
deciding attainable targets.
(iii) Being flexible in the extent to which formal performance measures are relied on
A 1994 study by Wyatt focused on identifying recent trends and best practices in performance management by
examining the systems of a select group of 37 companies, recognised for financial success and innovative
research programmes. As a result, a set of best practices that can help focus the process of designing,
implementing and monitoring performance management emerged. Flexibility is one of those best practices.
The performance measurement system should be flexible. Management should be flexible while deciding the
extent to which the system should be emphasised upon. This is because a notion given by a measure in short-
term may be true in the long -term e.g. by cutting down marketing expenses (which are taken to increase the
demand in long-term) may show increased profitability in short-term. However, this increase may not be long-
term and in long-term the profitability may decrease. Therefore too much emphasis should not be placed on any
performance measure. It should be flexible enough to balance the short-term and long-term performances.
Flexibility helps in reducing measure fixation and misrepresentation. Flexibility in the system will help to avoid
this and encourage management to take good decisions (i.e. any decision will not be taken to show good short-
term performance on account of long-term performance.
In addition, if the system is flexible and too much emphasis is not placed on the performance measures, it will
not force people to misrepresent the information. Instead, the facts will be quoted and then decisions will be
taken to improve the performance.
(iv) Giving consideration to the audit of the performance measurement system
When an independent person evaluates a system and expresses his opinion on its efficiency and effectiveness,
value is always added. This helps in reducing the incidence and impact of measure fixation, misinterpretation
and gaming.
For example, if Astrodome Sports Ltd carried out an audit, it would be drawn to management's attention that the
directors have misinterpreted equipment availability as key to customer volume and high profitability and,
accordingly, have given this factor too much emphasis. In addition, evidence that the benefits of one course of
action have been deliberated understated in order to release funds for an alternative course of action (i.e.
evidence that gaming is taking place) would be provided.
However, the audit should be free from bias and should be conducted by an independent person.
9. Internal and external aspects of performance measurement - Ochilpark Pic
^ Read the question carefully and note down the key requirements before answering the question.
> Be careful not to lose marks by accidentally missing out some of the requirements
^ In the case of numerical part of the answer, it is necessary to think about presentation before you
start writing your answer. Such planning saves time by avoiding repetition of the same information
and moreover planning eliminates any unnecessary information and makes your answer clear.
Before answering this question, keep in mind the following points:
(I) Statement showing the total costs for 'millennium' proposal
2000 2001 2002
Sm Sm $m
Target cost
- variable (W1) 6.000 7.200 8.000
- fixed (W1) 2.000 2.000 2.500
Internal failure cost (W2) 1.600 0.920 0.525
External failure cost (W3) 2.000 1.104 0.525
Appraisal cost 0.500 0.500 0.500
Prevention cost 2.000 1.000 0.500
Total cost 14.100 12.724 12.550
Workings
2000 2001 2002
W1 Target costs - variable
S15m x 40% $18m x 40% S20m x 40%
(as % of sales)
=$6m =$7.2m =$8m
Target costs - fixed
$2m $2m $2m
Total target costs S8m $9.2m $10.5m
W2 Internal failure cost
$8 x 20% $9.2 x 10% $10.5x5%
(% of total target costs) =S1.6m =$0.92m =0.525m
W3 External failure cost
$8m x 25% $9.2m x 12% $10.5m x 5%
=$2m =$1,104 =0.525
Score Mor e
The question does not specify that working will have to be given along with the
statement showing the total costs for millennium' proposal.
Accordingly if the workings are not given in the answer, the answer will not be wrong but will be
considered bad and will earn fewer marks.
(ii) The target cost is that which will provide the required return (target profit) for the 'millennium' proposal given
the sales amount. In order to achieve the target cost, it is likely that Ochilpark PIc will have to make some
improvements over the current expected level of performance. This will include all areas in the cycie from
product design to after-sales service to customers. The target vanable cost is stated as 40% of sales.
The target fixed cost rises in 2002 to S2.5m. This indicates a stepped fixed cost that increased due to
increased activity.
The cost gap between target cost and current expected cost levels may be divided into internal and external
failure costs.
Internal failure costs occur when work fails to meet the design quality standards and the failure is detected
before the product is sold to the customer. Examples will include high levels of production losses or
excessive machine idle time.
External failure costs occur when the product fails to reach design quality standards and failure is not
detected until after the product is sold to the customer. An example is the free replacement of defective
product units returned by the customer.
Internal failure costs are expected to fall from 20% of target cost in 2000 to 5% of target in 2002. External
failure costs are expected to fall from 25% of target cost in 2000 to 5% in 2002. The trend indicates a
gradual improvement in the work process.
Appraisal and prevention costs are incurred in an effort to reduce the incidence of internal and external
failure costs in order that the total cost may be brought closer to the target cost. Appraisal costs are incurred
due to evaluation of the work process and services in the cycle in order to ensure conformance with the
agreed specification. Examples include checks on design and quality negotiation procedures with customers
and checks that machines are performing within the efficiency tolerance limit specified. Prevention costs
originate from the implementation of procedures I actions to ensure that the company reaches the quality
standards for the achievement of target cost. Examples include staff training costs or fees to consultants to
improve operating procedures.
Appraisal costs are expected to remain at the level of S0.5m over the three year period from 2000 to 2002.
Prevention costs are expected to fall from S2m in 2000 to S0.5m in 2002. This may be construed as a
gradual reduction in requirements for staff training or consultancy services as improvements are achieved.
(i) Corporate vision is a short, succinct and inspiring statement of what the organisation intends to become and
to achieve at some point in the future, often stated in competitive terms. Vision refers to the category of
intentions that are broad, all-inclusive and forward-thinking. It is the image that a business must have of its
goals before it sets out to achieve them. It describes aspirations for the future, without specifying the means
that will be used to achieve those desired ends.
Ochilpark Pic has come up with the 'millennium' proposal for one of its product ranges as a specific market
opportunity. It focuses on competing through the identification of key competitors and by close co-operation
with its customers in providing products to meet their specific design and quality standards. The corporate
vision is seen as being achieved through a focus on internal efficiency and external effectiveness. The
'millennium' proposal may be seen as illustrating a specific sub-set of the corporate mission since it:
> has its own distinct business concept and mission - the 'millennium' focus
^ has identified the key competitors
> is a suitable area for the management of its own strategies and close cooperation with customers and
the provision of products to meet customer requirements
(ii) The 'millennium' proposal may be measured in both marketing and financial terms. It is apparent that it has
achieved market growth and improved market share. The projected sales in Schedule 3.1 show growth of
20% in 2001 on year and a further 11% in 2002 on a year to year basis. In addition, market share is
anticipated to improve, which is evident from the market shares of 125%, 144% and 154% in years 2000,
2001 and 2002 respectively.
The net profit to sales ratio is expected to increase each year. The profit increase is partly linked to the
projected fall in quality costs, both costs of conformance and costs of non-conformance. It is partially
attributable to the increase in the volume of business.
(iii) The marketing success of the proposal is linked to the achievement of customer satisfaction. The success
will require an efficient business operating system for all the phases of the life-cycle from product design to
after-sales service to customers. Improved quality and delivery should lead to improved customer
satisfaction. Schedule 3.1 shows a number of quantitative measures.
The percentage of production achieving design quality standards is expected to rise from 95% to 98%
between 2000 and 2002. In the same period, returns from customers for replacement or rectification are
expected to fall from 3% to 0.5% and the cost of after-sales service is expected to fall from 1.5m to 1m.
All these measures are indicative of improvement in the quality of the products.
Delivery efficiency improvement may be measured in terms of the increase in the percentage of goods
achieving the planned delivery date. This percentage rises from 90% in 2000 to 99% in 2002.
(iv) The financial success of the proposal is linked to the achievement of high productivity. This should be
helped through reduced cycle time and decreased levels of waste. Schedule 3.1 shows a number of
quantitative measures of these factors:
The average total cycle time from customer enquiry to delivery should fall from 6 weeks in 2000 to 5 weeks
in 2002. This indicates both internal efficiency and external effectiveness.
Waste in the form of idle machine capacity is expected to fall from 10% to 2% between 2000 and 2002.
Moreover, component production scrap is expected to fall from 7.5% in 2000 to 25% in 2002. These are
measures indicating improved productivity. Both will be linked to the prevention and appraisal costs, which
are intended to reduce the level of internal and external failure costs.
(v) The marketing and financial success of the proposal is linked to the achievement of customer satisfaction
and high productivity.
Increased flexibility of methods is expected to be achieved. This should help in achieving improved
productivity and also in an improved level of customer satisfaction. High quality standards will improve
customer satisfaction and in turn will assist in market retention and growth.
10. Information requirement - Moffat Ltd
Read the question carefully because it asks you to do more than one thing. Identify the three levels
of management with their responsibilities. This will help you to identify the kind of information
required. You are also asked to give two examples of the information required at each stage. These
examples should not be general but should be related to the scenario given in the question.
I
(a) Relevant, reliable and timely information facilitates better execution of controls. In an organisation, controls
are exercised at three levels i.e. the strategic, tactical and operational levels. The information needs tboth
nature and content) are different at these different levels.
(i) Strategic level
This level of management is responsible for setting the strategic direction and long-term objectives of the
organisation. Strategic information should be related to the organisation as a whole and summanse the
main points.
The information required by the management of Moffat Ltd at the strategic level indudes the following:
> What additional I extended service can be given to customers?
> Have there been any technological advances related to the business which could be used by Moffat
Ltd?
4
Score Mor e
Many candidates do not relate their answer to the given scenario. For example, if you write that the external
information required at strategic level includes the following:
> competitors' activities:
^ customer preferences, style:
> economic trends;
> technological advancements: and
> new laws, rulings;
This will not get you many marks because you have not related the information required to the scenario.
Note: Do not forget to relate your answer to the given scenario.
(ii) Tactical level
At this level, the plan for implementation is prepared and various decisions are taken regarding the ways in
which the strategies deaded at the strategic level can be best implemented and the objectives achieved.
External information required at this level includes information on the following:
price changes
changes in demand or supply This is for your information. You do
credit availability during procurement 1
no l n e e d t0 wr i t e thi s i n t he e x a m
credit policy for receivables
need to open a unit / branch
The information required by the management of Moffat Ltd at tactical level includes the following:
If the additional / extended service is provided, what additional resources are required?
> Is there any need to change the pricing policy?
(iii) Operational level
Operational control is normally exercised by the supervisory level (i.e. the team of managers at the base of
the management hierarchy) of an organisation. At the operational level, managers are responsible for
routine, day-to-day decisions and for overseeing the activities of the organisation which do not require much
judgement or discretion.
External information required at this level includes the following:
r sensitive changes affecting material supplies and sales
-- political disturbances causing interruption in normal operations
The information required by the management of Moffat Ltd at operational level includes the following:
^ the number of vehicles serviced and the number of complaints received during a week
^ the way to deal with the unanticipated increase in the demand such as requirement to ask workers to
work overtime
(b)
J
^j g ^X For each approach you mention, you will get a maximum of 2 marks.
The approaches that the management of Moffat Ltd can adopt to assess the qualitative benefits arising from
investment in the IT system include the following:
> ignoring the qualitative benefits
One can evaluate the proposal ignoring the qualitative benefits. However, the drawback of this approach is
that the areas on which quantitative analysis do not provide sufficient information will not be evaluated
properly.
Qualitative information provides additional information over quantitative information. In addition, cost benefit
evaluation will not give the correct results since, although all costs will be considered, only the quantitative
benefits will be ignored and therefore the proposal may not be attractive. Therefore this approach is not
suggested.
> assessing the qualitative benefits by making an attempt to attribute values to those benefits
Under this approach, the cash flows are derived in order to carry out the cost benefit analysis. These cash
flows are based on management estimates which involve various assumptions. However, the problem
associated with this approach is that the various parties involved in the proposal may not agree on the
assumptions. In addition, if the proposal is taken up, the assessment of the results i.e. whether the benefits
are derived as anticipated will be difficult.
> assessing the qualitative benefits in a reasonable manner i.e. a manner acceptable to all the parties
involved
Instead of expressing these benefits in financial terms and making certain assumptions, they can be
assessed in a manner which is acceptable to all the parties involved in the proposal. For example, the time
saved as a result of using the IT system can be assessed without expressing it in monetary terms.
> assessing the qualitative benefits by expressing them in specific terms linked to a hierarchy of
organisational requirements
This is another way of interpreting and analysing qualitative information. The information can be categorised
as being:
* essential to the business
J very useful
* desirable, but not essential
s possible, if funding is available
* doubtful and difficult to justify
The information can then be assessed according to its importance to the business. The qualitative benefits
arising from using the IT system can be assessed in the same way.
(c)
For each benefit you mention, you will get a maximum of 2 marks. Remember that you need to
write how you will assess the qualitative benefits of the new IT system. One mark is for identifying
the benefit and one for assessing the benefit so do not forget to mention the benefit. You are
required to write only two benefits (three benefits are given here for your information) so do not
waste your time by writing too much.
Generally, before taking any decision, a cost-benefit analysis is made. While doing so, one should keep in mind
that all the benefits (both quantitative as well as qualitative) should be considered for better analysis. Some of
the qualitative benefits from the investment in the new IT system are as follows:
(i) Improved service quality
With the help of the new, improved IT system, better service quality can be provided to the customers by
reducing the waiting time. This can be done through scheduling the appointments and improving inventory
management.
This improved service quality can be assessed by obtaining feedback from customers. For example,
customer feedback registers may be kept at several of Moffat's locations and customers asked to give their
views on the quality of the service they received. Alternatively, customers may be asked to fill in
questionnaires containing specific questions on the time taken to service the vehicle, the cleanliness of the
vehicle, the behaviour of staff, the skill and competence of staff etc..
(ii) Improve internal business processes
The new IT system could also help in improving the internal business processes. This can be achieved
through better inventory management, better distribution of the information within the organisation etc.
The improvement to the internal business processes can be assessed by the number of customer
complaints, the reduction in waiting times, the reduction in the cost of inventory management etc.
(iii) Improve customer loyalty I satisfaction
If the customers are provided with a better quality service, they will be satisfied with the services provided
by Moffat and this will help in improving customer loyalty. This will give Moffat a competitive advantage.
At the end of the period, the improvement in customer loyalty / satisfaction can be assessed by the number
of customers who pay for Moffat's services on repeated occasions, the number of customer complaints etc.
11. Benchmarking & information system - INA ltd
(a)
ebbzsqf
This question tests your understanding of benchmarking'. There are two requirements in this part
of the question:
> explain the concept of benchmarking
> explain the benefits of benchmarking
Therefore do not forget to meet both the requirements.
In addition, do not foraet to relate vour answer to the aiven scenario.
Definition of benchmarking
Benchmarking is a process for improving performance by continuously identifying, understanding and adapting
best practices and processes followed inside and outside the company and implementing the results.
The aim of benchmarking is to improve the existing processes / operations using best practices. In
benchmarking, the working process of an organisation is examined and compared with another unit of the same
organisation or with a leading organisation so that the good practices adopted by them can be identified and
implemented. In short, benchmarking involves setting goals and measuring productivity based on best industry
practices.
INA can implement benchmarking in any of the following ways:
^ External benchmarking: benchmarking against other organisations (which may or may not be
competitors).
> Competitive benchmarking: benchmarking against competitors.
^ Internal benchmarking: benchmarking against organisation's own units or branches.
r Functional I process benchmarking: benchmarking against organisations from different business sectors
or areas of activity but which are involved in similar functions or work processes
z' Strategic benchmarking: examining the core competencies, product I service development and innovation
studies of best practice' companies.
However, the greatest difficulty in benchmarking is identifying the peer for comparison purposes. Even if a peer
is identified, it may be difficult to obtain information about them. This is because they may not want to share
their confidential information. Even if such information is obtained, it is difficult to establish its reliability.
Therefore it may be problematic for INA to adopt external benchmarking. Instead, it may choose to adopt
internal benchmarking (although internal benchmarking offers a more limited scope and fewer benefits
compared to external benchmarking).
In such a case, INA may choose an organisation with a similar function, which is not its competitor (perhaps not
from the same industry) and is ready to share information with INA, provided its purchasing department is
efficient and effective.
The ultimate objective of benchmarking is to improve performance through minimising costs and improving
quality. If two organisations mutually agree to share their information, both the organisations will benefit. This is
because both the organisations will then review their policies and procedures and come up with innovations to
define best practices in the purchasing department.
The benefits of benchmarking include the following:
> Benchmarking will highlight any weaknesses in the purchasing department and help to remove those
weaknesses.
^ Benchmarking will help in identifying the areas where there is scope for improvement i.e. the areas where
cost can be reduced or quality can be improved. This will help in improving the overall performance of the
purchasing department.
Along with the practices adopted by the peer, benchmarking also considers innovative ideas from the
employees. Therefore INA should ask the staff of the purchasing department to communicate their
innovative ideas for improving the efficiency and effectiveness of the purchasing department.
In this way. benchmarking provides the basis for establishing targets and accordingly, quantitative and
justifiable targets can be set for the purchasing department.
INA should design its reward system (linked to targets) after considenng the measurable and realistic
targets set using benchmarking. This will motivate the purchasing department team.
(b)
I
Do not make the mistake of discussing common performance measures for the purchasing
department since this is not asked for. You are expected to discuss how benchmarking can be
implemented in the purchasing department of INA.
In addition, do not forget to relate the implementation of benchmarking to the purchasing
department instead of discussing it in general.
There is no standard procedure for implementing benchmarking but the following steps are generally followed
(which could also be used to implement benchmarking in the purchasing department of INA).
^ Identifying the need for benchmarking and defining the objectives
Under this step, the existing practices / processes in the purchasing department are reviewed and assessed,
the existing processes are mapped and the need for benchmarking, the type of benchmarking and the
objectives of benchmarking are established.
This is an important point. You
should discuss this in detail.
> Establishing targets and performance measures
Once the need for and objectives of benchmarking
have been determined, performance measures and quantifiable and
realistic targets should be established for the purchasing department. In order to be effective, benchmarking
requires well-defined and measurable targets. While establishing targets and performance measures, certain
factors such as terms and conditions of supply, annual expenditure and number of orders should be taken into
consideration.
> Identifying best processes I practices and selecting peer
The next step is to identify the best practices which make the purchasing department efficient and effective.
These best practices may be within the organisation or external to the organisation. Moreover, the best
processes / practices may be from a different industry entirely. If an organisation is selected as a best practice
organisation, it should be ensured that this organisation is willing to participate in the benchmarking process and
to share information with INA.
'r Comparing own processes and performance with those of others
The performance of the purchasing department is then compared with the performance of the peer, the
differences are examined and the practices which are performed better by one organisation compared to the
other are identified.
> Designing and implementation
Once the comparison has been made, the next step is to combine the best practices of the two organisations
(considering innovations), design the steps needed for implementation and carry out these steps.
> Evaluation
Once the necessary steps have been earned out, it is necessary to evaluate the results of the benchmarking
process in terms of improvements vis-a-vis objectives and other criteria set for the purpose. In addition,
periodical evaluation and changes in benchmarks may be required in light of changes in the conditions that
affect the performance.
For the successful implementation of benchmarking, the involvement and support of management as well as the
staff of the purchasing department and the cooperation of the peer are necessary.
(c)
A
While answering this part of the question, do not forget to address the behavioural problems which
may arise dunng the implementation of benchmarking, as these problems may be of vital
importance.
In addition, only identifying the problems is not sufficient; you should also recommend how these
problems can be resolved. Identifying problems and giving recommendations are worth equal
marks i.e. 3 marks each.
> Obtaining critical information
Obtaining critical information about an organisation whose purchasing department is working efficiently and
effectively is very difficult.
Recommendation
Therefore, as stated earlier, while selecting the best practice' organisation, it is necessary to obtain the
organisation's consent to the benchmarking and the organisation should also be prepared to share its critical
information with INA. It should be understood that the sharing of information is beneficial to both the
organisations.
Furthermore, it should be remembered that meaningful comparison is possible only when two similar
business functions are compared. This means that the peer should have a similar business function.
> Behavioural problem
The most commonly faced problems during the implementation of benchmarking are behavioural problems.
Therefore INA should be prepared to encounter such problems. For example, the purchasing department
staff may resist the idea of benchmarking. This is because there is the possibility that major changes will be
made in their existing working style, their existing payments and their existing reward systems (especially
those which are linked to performance).
In addition, benchmarking is often wrongly perceived as being adopted only when a unit or organisation is
not performing well. However, in reality, benchmarking is not directly related to performance. It is a process
improvement measure which ultimately results in improving performance. However, as a result of this wrong
perception, additional behaviour problems may emerge. The staff of the purchasing department may feel
that benchmarking has been resorted to because the management of INA feels that the department's
performance is not up to the mark. However, in reality, this may not be true. Benchmarking is a continuous
process of searching for and implementing better practices.
Recommendation
In order to ensure the full cooperation of the staff of the purchasing department, the management of INA
should explain the need for benchmarking to them, listen to their views and obtain their consent to the
process of benchmarking. In short, the management of INA should handle the behavioural problem tactfully.
> Imitation of the practices of peer
It is often the case that, through benchmarking, an organisation ends up adopting the practices of the other
organisation. However, this is not the aim of benchmarking; in addition to adopting the practices followed by
the peer, the organisation should come up with innovative ideas.
Recommendation
Therefore while designing the benchmarking process, the management of INA should keep this in mind and
accordingly should ensure that benchmarking does not involve mere copying of the practices of the peer.
^ Catching-up exercise
Instead of carrying out innovative work to gain a distinct advantage, benchmarking may become a catching-
up' exercise.
Recommendation
The management of INA should remember that, for the successful implementation of benchmarking,
catching-up should be avoided.
74: Performance Measurement System and Design
SOLUTION BANK
12. Mission Statement
This is a straightforward question to answer.
The following requirements about Mission Statement are included in this question:
> Role and content of it
^ How does it contribute towards the planning and performance measurement process
> Drawbacks
Be careful not to lose marks by accidentally missing out some of the requirements. Read the
question carefully and note down the key requirements before answering the question.
A Mission Statement may be described as a published statement that contains the fundamental objective(s) of
an entity expressed in general terms. It sets out the broad directions that the entity should and will attempt to
follow and summarise the reasoning and values on which these are based. It is an enduring statement of
purpose for an organisation that identifies the scope of its operations in product and market terms, and reflects
its values and priorities.
Content of a Mission Statement
(i) A purpose
Why does the business exist? Is it to create wealth for shareholders? Does it exist to satisfy the needs of all
stakeholders (including employees and the society at large)?
(ii) A strategy and strategic scope
A Mission Statement provides the commercial logic for the business and so defines the following:
> the products or services the business offers (its competitive position)
^ the competences through which it tries to succeed and its method of competing
A business' strategic scope defines the boundanes of its operations. These are set by management.
These boundanes may be set in terms of geography, market, business method, product etc. The decisions
management takes regarding strategic scope define the nature of the business.
(iii) Policies and standards of behaviour
A mission needs to be translated into everyday actions. For example, if the business mission includes
delivering outstanding customer service, then policies in line with this mission should be drawn up and
standards should be created to monitor the effectiveness of the policies.
(a)
These might include monitoring the speed with which telephone calls are answered in the sales call centre,
the number of complaints received from customers or the extent of positive customer feedback via
questionnaires.
76: Strategic Performance Measuremenl fi Tf.
(iv) Values and culture
The values of a business are the basic, often unstated, beliefs of the people who work in the business. The
values may be built upon an underlying philosophy. They would include:
> business principles (e.g. social policy, commitments to customers)
> loyalty and commitment (e.g. are employees inspired to sacrifice their personal goals for the good of the
business as a whole? Does the business demonstrate a high level of commitment and loyalty to its
staff?)
> guidance on expected behaviour (a strong sense of mission helps to create a work environment where
there is a common purpose)
(b) The Mission Statement can play an important part in the planning process by:
> providing a basis for consistent planning decisions
> assisting in translating purposes and direction into objectives suitable for assessment and control
> providing a consistent purpose between different interest groups connected to the organisation
> establishing organisational goals and ethics
^ improving understanding and support from key groups outside the organisation
This framework should impact upon both high level strategic plans e.g. which areas of business the
organisation should venture into, and on operational planning decisions such as sources of supply and the
way customers are dealt with by staff.
In terms of the owners, the Mission Statement may incorporate a broad intention to enhance shareholder
wealth. It might provide a broad indication highlighting specific goals such as to provide a specified (say
20%) return on investment.
The Mission Statement will therefore result in the cascading down of increasingly more detailed plans and
targets. These targets will be set for the corporate entity, business sub-units and individuals. The comparison
between these targets and the actual outcomes will provide the basis for performance measurement.
Performance is concerned with assessing the extent to which an objective has been achieved. It is a matter
of a comparative judgement. To what extent has the organisation achieved what it set out to achieve?
(c) Potential problems arising from using a Mission Statement to manage performance are as follows:
^ the expression of the statement may be rather vague and abstract and therefore provide limited
assistance in developing strategies.
> the content of the statement may provide management with incongruent goals. For example,
maximising shareholder wealth may conflict with any ethical statements made in the mission. Some of
the targets in the Mission Statement may be quantified and others may be non-quantifiable, leading to
complications in the assessment of managerial performance.
> there is potential for inconsistent goal setting between departments or diffenng managerial levels.
> the Mission Statement is occasionally regarded by employees as a 'window dressing' exercise which
does not, in their view, reflect actual company strategy and the actions of management. Consequently,
this may result in dysfunctional behaviour.
r the Mission Statement does not normally stipulate a time horizon for the achievement of the corporate
objectives. This leads to problems in assessing how well the organisation is performing.
C.TG Solution Rank:77
13. Usage of standards in decision-making
This question relates to usage of standards in management accounting decision-making and
behavioural aspects of setting standards.
> The answer to the question should be elaborate but specific to the requirements of the question.
> Remember to read the question carefully and note down the key information before start
answering.
(a) Standard cost systems have lost their importance in modern business systems. However, setting standards
(such as production targets and cost standards) is becoming increasingly important in measunng
performance and accordingly in taking a dedsion on the future course of action. Existing standards may be
used as the starting point to estimate the costs for a proposed new product. In a target costing situation,
where the product price, market size and required return have been identified, target costs may be
estimated. The target cost may then be compared with a current standard in order to identify the quantum of
any cost gap which might exist. This gap may then be investigated with a view to its reduction or elimination
through the application of techniques such as value engineering.
Decisions about the need for actions for improvement and change may be aided through the monitoring of
variance trends through time. For improvement and change to take place, new standards are set or existing
standards are improved, taking into consideration both internal and external factors Trends in a business
(such as customer tastes and preferences) may be monitored in order to identify situations in which the
existing standard (of product quality) may need to be improved with a view to improving and changing
product design, production methods etc.
(b) A standard cost system provides guidance and criteria for operations and performance evaluations.
Variance analysis is stricUy a tool for controlling and improving operations; it should never be used to find a
scapegoat. Research into organisational behaviour has shown that successful operations are often the
result of proper rewards. The focus in using a standard cost system should be on influencing behaviour
through positive support and appropnate motivation. Long-term success is seldom achieved by means of
penalties and punishments.
Managers and employees' perception of a standard costing system affects its success or failure. A negative
perception or motivation is often the result of unreasonable standards, lack of transparency in setting
standards, authoritarian control procedures, poor communication or absence of communication, inflexibility,
uneven reward systems or over-emphasis on profits. These situations can turn a good standard cost system
into a failure. Managers or employees with highly negative perceptions may feel discouraged and adopt
protective or defensive behaviour, or even sabotage the system. These tactics include cushioning in the
budgets, subtle attempts to beat the system, decreased initiative and divulging trade secrets. On the other
hand, managers and other employees who like a standard cost system, show enthusiasm, creativity, and
productivity.
Examples of the possible dysfunctional effects on decision-making are as follows:
Undue focus on material price and the need to achieve a predetermined standard may be a detrimental
decision strategy.
It may detract from other factors such as loyalty to suppliers, fostering relationships with suppliers with
regard to quality and just in time deliveries of materials. Such problems could, for example, disrupt
manufacturing and alienate customers with adverse effects on future profit.
78: Slrafeglc Performance Measuremeni 6TC
The achievement of a labour efficiency standard may lead to the achievement of a pre-determined ratio of
output and input as the major decision focus. Efforts to achieve the standard may lead to the decision to
increase batch sizes and hence reduce overall set-up and idle time (or to resort to a continuous production
system, if it is feasible). Such decisions could be dysfunctional in that they lead to increased work-in-
progress. They may also lead to reduced responsiveness to customer needs and the loss of future orders
and hence profit.
Overhead standards will encourage a focus on absorption of the costs by product units. Increased
throughput will be seen as the decision strategy to ensure that absorption of overhead cost per unit
becomes favourable. This is likely to lead to an increase in the production of goods which remain in stock
incurring holding costs and will run the risk of items of materials becoming obsolete (for the products which
have very short life-cycles) if they are not sold within a short span of time. It also detracts from management
efforts to focus on the root causes of overhead expenditure and action to reduce costs, possibly through
quality improvement initiatives.
14. Performance analysis - Sunflower Hospital
Since this is a numerical question, it is necessary to think about the presentation before you start
writing your answer.
When planning your answer, note down the salient points of the case while reading the question
itself since the question is long. Keep in mind the time available for writing the answer.
Your answer should be with reference to the case discussed in the question.
(a) Income statement of Sunflower Hospital
Budget Actual Variance
amount amount amount
$'000 $000 $'000
Revenue received (W1)
Government funded patients (budget 40% patients
whereas actual 70% patients)
^ Orthopaedic major surgeries 1.182.60 3,035.34 1,852.74
" Orthopaedic minor surgeries 7.805.16 10,016.62 2,211.46
> Physiotherapy treatments 11.037.60 21,730.28 10,692.68
Private patients ( budget 60% patients whereas
actual 30% patients)
^ Orthopaedic major surgeries 2.838.24 2,081.38 (756.86)
> Orthopaedic minor surgeries 15,965.10 5,853.87 (10,111.23)
> Physiotherapy treatments 21,286.80 11,973.83 (9,312.97)
Total revenue 60.115.50 54.691.32 (5,424.18)
Less: Vanable costs
Surgical costs 7,200.00 10,000.00 (2.800.00)
Nursing costs 3,150.00 4,000.00 (850.00)
Miscellaneous costs 2,700.00 2,800.00 (100.00)
Total variable costs 13,050.00 16.800.00 (3,750.00)
Contribution 47,065.50 37,891.32 9,174.18
Less: Fixed costs
Surgical costs 32,000.00 32.000.00 0.00
Nursing costs 6,500.00 6,500.00 0.00
Miscellaneous costs 3,000.00 2,800.00 200.00
Depreciation on equipment & operation accessories 2,500.00 2,500.00 0.00
Administration costs 5,000.00 5,800.00 (800.00)
Total fixed costs 49,000.00 49,600.00 (600.00)
Net profit / (Net loss) (1,934.50) (11,708.68) 9,774.18
C.TG Solution Rank:79
Note that fixed costs remain unchanged if capacity is not fully realised, whereas variable costs
vary in accordance with production capacity utilisation. In this case, only 90% of capacity is utilised
during a year. Hence, only 90% of variable costs will be considered.
W1 Revenue received
W1 Revenue received
Major surgery
For budget: government funded
21.900 patients x 40% government funded x 60% x 25% major x 90% capacity x S1.000 fees
Minor surgery 21.900 patients x 40% government funded x 60% x 75% minor x 90% capacity x S2.200 fees
Physiotherapy 21,900 patients x 40% government funded x 40% x 90% capacity x $3,500 fees
For actual: government funded
Major surgery 21.900 patients x 70% government funded x 55% x 40% major x 90% capacity x S1.000 fees
Minor surgery
Physiotherapy
21,900 patients x 70% government funded x 55% x 60% minor x 90% capacity x S2.200 fees
21.900 patients x 70% government funded x 45% x 90% capacity x S3.500 fees
For budget: private
I Major surgery 21,900 patients x 60% private funded x 60% x 25% major x 90% capacity x $1,600 fees
Minor surgery 21,900 patients x 60% private funded x 60% x 75% minor x 90% capacity x $3,000 fees
Physiotherapy 21,900 patients x 60% private funded x 40% x 90% capacity x $4,500 fees
Major surgery
For actual: private
21.900 patients x 30% private funded x 55% x 40% major x 90% capacity x $1,600 fees
Minor surgery 21.900 patients x 30% private funded x 55% x 60% minor x 90% capacity x $3,000 fees
Physiotherapy 21,900 patients x 30% government funded x 45% x 90% capacity x $4,500 fees
Note:
Number of patients per year:
23125612
(b)
20 wards x 6 patients x 365 annual days
Average 2 days
=21,900 patients
Performance measures that could be used to assess the quality of service provided by the management of a
hospital are as follows:
number of successful operations as a percentage of total operations / surgeries performed
> the percentage of total operations / surgeries actually performed compared to agreed / pre-planned
schedule, which could be measured by reference to committed operation schedules and their rescheduling
> responsiveness of hospital staff to requests of patients, which could be measured via a patient survey
> availability of medicines and other facilities on time
r waiting time for non-emergency operations which could be measured by considering the time elapsed from
the date when an operation was deemed necessary until it was actually performed
^ tidiness and hygiene standards
A
Score Mor e
The above answer will be treated as inappropriate answer if the performance measures are not
discussed in the context of the hospital and moreover the performance measures are not
discussed point-by-point.
SO: Slrafeglc Performance Measuremeni 6TC
(c)
Since private patients pay more than government-funded patients, the mix of government-funded to private
patients is the key determinant of profitability. Therefore, if ethical issues are ignored and, in the next year,
demands for total operations exceed their available capacity, the hospital should give priority to private fee-
paying patients as they receive more fees from these patients for each type of treatment and surgery.
However, the following ethical issues must also be taken into account while deciding on the correct mix of
patients:
> Government-funded patients also require medical treatment. This fact should be taken into consideration,
especially as Sunflower Hospital is a partially government-funded hospital.
> Finally, Sunflower Hospital is a not-for-profit organisation committed to providing high quality service to all
kinds of patients: hence it should not give prionty to private, fee-paying patients.
(d)
It is not appropriate to make a direct comparison of the financial performance of the two hospitals, because:
r Sunflower Hospital is partially government funded whereas Moonlight Hospital is privately owned.
> Sunflower does not paying any interest on its loan while Moonlight does.
> Sunflower gives preference to emergency cases by providing treatments on-time. On the other hand.
Moonlight does not undertake operations on an emergency basis.
r- The hospitals have differing objectives: one is a not-for-profit organisation and the other is a profit-oriented
organisation.
The fees structure charged to patients may be different in Sunflower and Moonlight.
> The level of operating costs differs as evidenced by the fact that the annual depreciation in Moonlight is
60% greater than that of Sunflower.
Required adjustments in the income statement
Sunflower
(2007)
budget
($ 000)
Sunflower
(2007)
actual
($'000)
Moonlight
(2007)
actual
($'000)
Original profit / loss
Attributable income to subsidised operations (W2)
Cost of emergency operations
Loan interest adjustment
Operating profit / loss after effects of adjustments
(1,934.50)
9,855.00
1,250.00
(11,708.69)
17.936.10
1,300.00
4,400.00
600.00
Original profit / loss
Attributable income to subsidised operations (W2)
Cost of emergency operations
Loan interest adjustment
Operating profit / loss after effects of adjustments (684.50) (7,527.41) 5,000.00
W2 Attributable income
Budgeted:
21.900 patients x 90% capadty x 40% government funded x $1,250 budgeted surgical costs =S9.855.000
Actual:
21.900 patients x 90% capacity x 70% government funded x $1,300 actual surgical costs =S17.936.100
15. Evaluation of strategies
i
r This question is designed to test your knowledge and understanding on the concept of strategic
analysis of a business induding sensitivity analysis and gap analysis.
^ In order to secure better marks, present the numerical parts of the answer in tabular form.
> Your answer should contain workings, since workings are integral part of the solution.
>GTG Solution Rank:8l
(a) Statement showing forecasted revenues, costs and profitability for each of the years 2004 to
2006
2004 2005 2006
Sales units 150,000 130,000 110,000
$m $m $m
Revenues 1,425 1,235 1,045
Less: Vanable costs
- Materials and labour (W1) 540 468 396
- Assembly (W2) 150 130 110
- Marketing (W3)
30 26 22
- Delivery (W4) 15 13 11
Total variable costs 735 637 539
Contnbution 690 598 506
Less: Fixed costs
- Assembly (W2) 450 450 450
- Marketing (W3) 30 30 30
- Delivery (W4) 60 60 60
- Administration 10 10 10
Total fixed costs 550 550 550
Profit
140 48 (44)
Workings:
W1 Materials and labour costs
$3,600 per unit of production and sales x Sales units in respective years
(e.g. for 2004, $3,600 x 150,000 units =$540m)
W2 Assembly cost
25% of assembly cost is variable i.e. $1,000 (25% of 4.000) per unit of sales / production is vanable.
Therefore, variable assembly cost =assembly cost/unit x no. of units produced and sales in the respective
years.
Fixed assembly cost =75% of $4,000 per unit x number of units produced and sold in 2004.
(Since fixed assembly cost per unit is calculated based on costs in 2004).
W3 Marketing costs
Variable costs
For 2004, 50% of $60 million i.e. $30m
For 2005. ($30m x 130.000)/150.000 =$26m
For 2006, ($30m x 110.000)/150.000 =S22m
Fixed marketing costs =50% of $60 million =$30 million
W4 Delivering costs
Variable costs
For 2004. 20% of S75 million i.e. $15m
For 2005, (S15m x 130,000)/150,000 =$13m
For 2006, ($15mx 110,000)/150,000 =$11m
Fixed delivery costs =80% of $75 million i.e.$60 million.
Comment: the forecast reveals that the contribution will continue to decline with the decrease in sales
volume. Accordingly, the company will sustain a loss in the year 2006.
(b) Statement showing profit estimates in 2004 based on original forecast and if each of the strategies
is implemented
Original Strategy Strategy Strategy
forecast 1 2 3
Volume 150.000 160.000 150,000 150.000
Selling pnce S9.500 S9.500 S10.000 S9.500
Sm Sm Sm Sm
Revenues 1,425 1,520 1,500 1,425
Less: Variable costs
- Materials and labour 540 576 540 432
- Assembly 150 160 150 120
- Marketing 30 32 30 24
- Delivery 15 16 15 12
Total variable costs 735 784 735 588
Contribution 690 736 765 837
Less: Fixed overheads
- Assembly 450
- Marketing 30 550 550 550
- Delivery 60
- Administration 10
- Strategy 1 30
- Strategy 2 10
- Strategy 3 70
Total fixed overheads 550 580 560 620
Profit 140 156 205 217
(c) Statement showing profit estimates in 2004 if all three strategies are implemented
Year 2004
Selling price S10,000.0
Volume 160.000.0
Sm
Revenue 1,600.0
Less: Variable costs:
- Materials and labour 460-8
- Assembly 128 0
- Marketing 256
- Delivery 12 8
Total variable costs 627-2
Contribution 972-8
Less: Fixed overheads
- Assembly 450.0
- Marketing 30.0
- Deliver
1
/ 60.0
Administration 10.0
Strategy 1 30.0
Strategy 2 10.0
Strategy 3 70.0
Total fixed overheads 660.0
Profit 312.8
GTG
Solution Rank :83
(d) Increase in profit from separate strategies:
Strategy 1
Increase in contribution as a result of increased sales
CdCm
volume ($690m x 10,000 units)/150,000 units
ftOIII
Less: Market entry costs $30m
Net increase in profit S16m
Strategy 2
Increase in contribution
<t7C
m
(@ $500 per unit x 150,000 units)
2>/om
Less: Redesign costs (as amortised) $10m
Net increase in profit $65m
Strategy 3
Savings by reduction in all variable costs by 20% (i.e. S735 x 20%) $147m
Less: Additional fixed overheads $70rn
Net increase in profit $77rn
Total increase in profit from the three strategies $158rn
The increase in profit from the implementation of 3 strategies simultaneously =S312.8 - S140 =5172.8m
The increase in profit is S14.8m greater when the strategies are applied together. There is a synergy between
the three strategies that provides a contribution greater than the sum of the increased profits when each of the
strategies is applied in isolation.
Numerical recoodliation of additional profit increase when all the three strategies are applied simultaneously with
total increase in profit when the strategies are applied in isolation:
Strategy 1 increases sates volume by 10,000 units
Strategy 2 increases contribution by $500 per unit (since sales price is increased by $500 per unit)
Total variable cost/unit =$735m/150.000 units =$4,900
Strategy 3 increases contribution per unit by $980 (since 20% of the variable costs are saved)
Therefore, the combined impact (increase) on profit is 1,000 units x ($500 +$980) =$14.8 million.
Gap analysis is concerned with the gap between the forecast position from continuing with the current activities
and the position that the organisation expects to achieve. It is not the gap between the current position and the
forecast position. The Managing Director is unhappy with the current profit / (loss) forecast of $140 million in
2004, $48 million in 2005 and S44) million in 2006. The strategies developed will enable a profit of $312.8m to
be achieved in 2004.
Each strategy contributes towards filling in the gap ($312.8m - $140m) =$172.8m
The company envisages that it has potential to achieve a profit level of S280 million in 2004 and to
maintain this level in each of the years thereafter. Gap analysis can be illustrated with the following
diagram.
84: Strategic Performance Measuremenl
m Profir
fi Tf.
3 I 2.8m
298m
Desired
outcome
280m
Current
forecast
140m
Year 2003 Year 2004
(i) Sensitivity analysis is a technique that permits options to be tested for their sensitivity / responsiveness
to changes in specified key variables such as sales volume, price and material costs. The strategies
outlined above generate other predicted outcomes from specified changes in particular variables.
Strategy 3 Strategy 3 offers a 20% reduction in vanable costs in return for spending $70m on a cost
reduction programme. What if the S70m cost reduction programme only reduced costs by 15% - is it still
worthwhile? How sensitive is the success of the strategy on the original estimates?
Strategy 1 What additional profits would result from strategy 1 if the sales rose by only 1,000 units?
Strategy 2 What if a re-design enables the company to fetch a price of $10,200 instead of $10,000?
Sensitivity analysis can be used to assess the robustness of a strategy i.e. whether it will continue to
deliver its major benefits in spite of some changes in key variables.
Therefore sensitivity analysis provides management with more information than a single point estimate of
an outcome. It considers a range of estimated outcomes depending upon the behaviour of key variables. It
considers risk and uncertainty by offering alternative scenarios - increasing realism and complexity.
(ii) Percentage changes / sensitivity data:
Strategy 1 (% change in volume)
Contribution required =$580m +$280m =S860m
Original forecast contribution =$690m
Therefore, percentage increase in volume required =($860m - $690m)/S690m =24.6%
Strategy 2 (% increase in selling price from re-design)
Additional profit required =$280m - S205m =$75m
Therefore the revenue required =$1,500m +$75m =$1,575m
This requires a selling price of $1,575m/150,000 =$10,500 per car
Therefore the % increase in selling price =($10,500 -$9.500VS9.500 =10.5%
For example:
GTG
Solution Bank:85
Strategy 3 (% reduction in variable cost from cost reduction programme)
Additional profit required =S280m - $217m =S63m
The variable costs required =S588m - S63m =S525m
Therefore, the % reduction in variable costs required =(S735m - $525m)/$735m =28.6%
This indicates that a much greater percentage change from the current forecast is required in the key
variable(s) for strategies 1 and 3 if the desired outcome is to be achieved as compared to the percentage
change required for strategy 2.
(g)
The financial performance of the company may be influenced by the political, economic, social and
technological changes in the environment within which it operates. These external variables are beyond the
control of the company in most cases. Therefore, in order to assess the efficacy of the strategies, the
influence of these factors needs to be considered carefully.
For example, an organisation needs to consider whether the overall economic activity is undergoing a boom
or a recession. Local economic factors such as the availability of skilled manpower might be a matter for
consideration by the organisation.Interest rate movements and the company's debt structure are other
factors that may need to be considered. During a period of rising interest rates, a heavily indebted company
will be operating in a particularly difficult financial environment.
The success of strategy 1 in the given case depends upon the company's success in entering a new
overseas market. The condition of the overseas economy and exchange rate movements will be vital to the
success of this strategy. Government policy towards car ownership may have a significant influence on the
performance of the company as factors such as taxation, safety norms, environmental legislation and
government policy on traffic congestion all have a potential impact on car sales.
The strategies adopted by competitors are also exogenous variables which are likely to affect the success
of the companies' strategies. The competitors are unlikely to be passive and will take counter-measures to
maintain their market share in response to the strategies applied by the company.
16. Strategic performance measurement - Big Buck Bank PIc
t my?Tffiy"
^ The question discusses issues such as mission of a business, evaluation of strategies and
identification of appropriate performance measures (both quantitative and qualitative).
The question contains 40 marks and should therefore be allocated a large amount of time for
answering.
When planning your answer, note down the salient points of the case while reading the question
itself. Since the question is long, keep in mind the time available for writing the answer to that part
(0.6 minute per mark should be allowed for careful reading of the question and planning the
answer and 1.2 minutes per mark for writing the answer).
(a) The mission of retail banking was to provide a high quality service to customers, by developing a close
relationship between the bank managers and their customers. The new philosophy of the Bank emphasises
profitability through rendering an efficient yet low-cost service. It is expected that the proposed change will
bring in significant change in the operational system. This change in the philosophy of retail banking will have
an impact on the Bank's staff, customers and shareholders.
As a result of the closure of around 1.000 retail branches, a large number of employees will become
redundant. However, some additional managenal posts will be created in the superbranches.
Approximately 130 superbranches will be formed and accordingly new employment opportunities will be
created for about 400 existing managers. At the same time however, about 50% of the existing staff and 600
managers will be declared redundant. Although the redundant staff will be compensated, this will inevitably
have an effect on employee morale within the whole organisation. This, in turn, might adversely affect the
efficiency and motivation of the employees, in particular, during the transitional period.
86: SiralegIc Performance Measurement 6TC
Moreover, the creation of the superbranches will substantially change the job profile for many of the staff.
Most of the jobs within the branches will not require professional skills. This may lead to decreased job
satisfaction and fewer opportunities for staff development.
The newly adopted policy of using profitability as a performance measure may also have an adverse impact
on managers' behaviour.
The new performance measurement system will assign less importance to aspects such as customer
satisfaction or expansion through the opening of new accounts.
It appears that assigning importance to the profitability criterion and ignoring criteria such as customer
satisfaction is overly focused on short-term gains. There are reasons for apprehension that the focus on
short-termism may be at the expense of the Bank's growth in the future.
It is clear that many customers depend on the managers' advice and assistance. Therefore, management
should focus on the activities that establish a relationship of trust between bank managers and their
customers.
It is essential for the Bank to reconsider its policy of not focusing on increasing the number of customers and
not encouraging managers to advise customers about their businesses. In fact, the Bank should assess the
impact of its change in philosophy on its customers. Predicting customer reaction to the change is important
because the loss of a large number of existing customers will be detrimental to the Bank. Moreover, it is
important that the sites of the superbranches are chosen carefully because if the superbranches are not
conveniently located for most of their customers, customers might decide to move their accounts to another
bank which is more conveniently located.
Basically, it is essential for the Bank to estimate the effect of the changed philosophy on its customers. This
may be particularly significant if the Bank's competitors are still providing personalised service to its
customers. In addition, the attitude of the customers to the "efficient yet low-cost service" must be predicted,
as the loss of a large number of existing customers will be detrimental for the Bank. It is possible that the
superbranches will not be conveniently located for many of the customers, and they may decide to move
their accounts to a bank that has a branch that is more convenient. It is also possible that customers, who
use many of the services offered by the Bank, will find that their total bank charges increase as a result of
the changes at Big Bucks Bank Pic.
The shareholders will be primarily interested in the enhanced profits generated by the changed policy. If costs
are reduced and profitable customers can be retained, it is likely that the profits will increase. However, the
additional cost of the superbranches may reduce the profits to some extent. Moreover, the cost impacts of
the one-off payments to the employees who are made redundant need to be considered in the calculation of
profitability.
Finally, the effect of the changes in the branches may also influence the corporate banking business. This is
an aspect of the proposed changes which will be difficult to predict, but could be important when evaluating
the consequences of the decision to increase the Bank's efficiency through reducing costs.
(b) Previously, all branches were treated as cost centres. The decision to make the superbranches investment
centres requires attention to be paid to both the profitability of and capital employed in each superbranch.
This new approach to performance measurement indicates that the management of each unit will enjoy
more autonomy to take decisions regarding the best utilisation of the resources available, since the
performance of the unit will be evaluated in terms of profitability.
Moreover, managers will have a greater degree of freedom and authority to undertake projects which are
expected to meet the organisation's performance criteria. This will increase the managers' motivation and
experience. In addition, it will enable senior management to compare the performance of each superbranch
and accordingly this may encourage improved performance through generating inter-branch competition.
A possible disadvantage of using profitability as a performance measure is that it may lead to short-termism
since the managers will take decisions that enhance current profit (even at the cost of the long-term growth
and progress of the company). An example of this problem is the reduction in public relations expenditure
and promotional expenditure in order to improve the profit in a particular accounting period. This will affect the
future organisational growth. Moreover, concentrating only on projects which do not require large amounts of
capital may result in the avoidance of capital intensive projects, since these projects will not meet the short-
term profitability targets.
Another possible problem area is the bank managers' lack of experience of using profitability as a
performance measure. Inappropriate targets may be set and this may affect the managers' motivation and
behaviour.
GTG
Solution Bank:87
(c)
(i) The branch managers, the superbranch managers and the senior management of Big Bucks Bank Pic will
need reports to assess the performance of each branch. In order to be useful, the relevant reports will be
needed to be generated at regular intervals (e.g. monthly, quarterly, and annually).
It is prudent to use residual income and return on capital employed as performance measures for the
branches and superbranches. In order to calculate these performance measures, the managers should be
provided with regular reports on the profit generated by each branch, the amount invested by each branch
and details of other important factors. Moreover, a report on incremental profit attributable to the number of
new accounts opened might be useful in justifying the opening of new accounts. The reports should provide
information to both the superbranch managers and senior management within the Bank. This will enable
appropriate action to be taken, if needed, and allow for companson of the performance of the different
superbranches.
The annual budget should indude details of both the expected revenue from the different activities of the
Bank and a forecast of the total expenses and their justification. The staff costs will be significant and
therefore both staff strength and costs should be explicitly reported. The capital investment budget is another
important aspect which should be reported, along with justification of the budgeted expenditure.
The monthly reports will contain details of the revenues, expenses and details of staffing for the current
month and also for the year to date. Finally, the profit of the superbranch. the return on investment and the
residual income will be shown in order to ensure that each manager is aware of the performance of each
superbranch.
Details of the level of sales for each of the financial products will be needed regularly (at least on a monthly
basis, if not more frequently). However, as a substantial part of the expenses of each branch is expected to
be fixed (and therefore less controllable), a monthly report is likely to be adequate for the purpose of
controlling these expenses. Since travel, advertising and entertainment costs are also likely to be substantial,
management will need to monitor the monthly details of these expenses in order to control them.
Finally, the managers will need various ad hoc reports to provide information about the profitability of different
categones of customer, services or products offered by the Bank.
(ii) The following non-financial measures will help the Bank to monitor the performance of the branches:
There are a number of non-financial areas which should be monitored continuously by the managers of the
superbranches. These include:
> staffing levels
> the number of new customer accounts opened
^ the quality of service offered to customers, especially in comparison with the service provided by the
Bank's competitors
The number of staff employed per branch or superbranch will be a good basis for measuring the
performance of the branch / superbranch. Moreover, employee cost is one of the major costs of all the
branches. Accordingly, it is essential that this is monitored. However, length of service, experience and
training are qualitative indicators that should be available to management in respect of individual staff
members. In particular, the level of staff competence in IT is an area which should be monitored, as the
retail Bank's operations use computers extensively.
In order to monitor the Bank's growth, details should be provided of the number of new customers. This
information, if provided on a regular basis, will reflect the growth of the business. Details of the different
types of customer will be an important aspect in monitoring the success of the activities in attracting new
customers and also in assessing the needs of the public.
As the Bank aims to offer an "efficient yet low-cost service", it is essential that management is aware of
customers' opinions regarding the quality of service offered to them. This information may be difficult to
measure accurately, but some possible qualitative measures are waiting times in branches, the number of
mistakes in customers' accounts and the number of complaints lodged by the public. In addition, surveys
could be conducted regularly to measure the reactions of the Bank's customers. A matter that should be of
major concern to the management of the Bank is the nature and frequency of complaints that are received
from the public. This information should be recorded to indicate the areas which need to be improved. This
type of indicator will be crudal in a period of cost-cutting to ensure that the customers are not dissatisfied
with the changes.
Another area which should be considered by the management of each superbranch is the activities of
competitors. Within the Bank it will be possible to compare the performance of each superbranch. This
information will be relatively easy to obtain and will allow the performances of the superbranches to be
compared. However, it will be necessary to take into account differences between the superbranches in
terms of the profile of their customers and the nature of their services. Although the performance of other
banks is difficult to measure, appropriate measures should be devised in order to assess the relative
performance of Big Bucks Bank Pic.
17. Measures of performance
I In the case of part (a) (being a numerical question), it is necessary to think about the presentation
before you start writing your answer. This is because:
Planning the presentation saves time by avoiding repetition of the same information
> Good presentation provides better readability
^ Planning eliminates any unnecessary information and makes your answer clear, simple and
concise
For part (b) and part (c), remember that your examiner will prefer a point-by-point answer and
therefore you should present your answer in this manner in order to get high marks.
Highest possible revenue, lowest possible costs and lowest
possible cost of capital (10%) are taken into consideration
(i) If revenue increases by~5% ana costs aecrease Dy ov: 7 ^
BEST OUTCOME / ^ ^
Year 1
$m
2
Sm
3
$m
Revenues 94.5 105 115.5
Less: Direct costs 570 66-5 76.0
Net cash flow 37-5 38.5 39.5
Less: Depreciation 20 20 20
Profit 17.5 18.5 19.5
Less: Imputed interest (10% on net book value) 6.00 4.00 2.00
Residual income 11.50 14.50 17.50
Net book value (=initial investments -
accumulated depreciation at the beginning of the 60 40 20
year)
ROI 17.5'60 x 100
18.5'40x
100
19.5-20 x
100
=29.17% =46.25% =97.50%
Year Cash flow ($m)
Discount factor
(10%) DCF (Sm)
0 (60.0) 1.000 (60.00)
1 37.5 0.909 34.09
2 38.5 0.826 31.80
3 39.5 0.751 29.66
Net Present Value 35.55
Lowest possible revenue, highest possible costs and highest
possible cost of capital (14%) are taken into consideration
(ii) If revenue decreases by 5% and costs increase by 5%:
WORST OUTCOME
Year 1 2 3
Sm Sm Sm
Revenues 85.5 95.0 104.5
Less: Direct costs 63.0 73.5 84.0
Net cash flow 22.5 21.5 20.5
Less: Depreciation 20.00 20.00 20.0
Profit 2.50 1.50 0.5
GTG
Solution Bank:89
Less: Imputed interest (14% on net book value) 8.40 5.60 2.8
Residual income (5.90) (4.10) (2.3)
Net book value (=initial investments -
accumulated depreciation at the beginning of the
year)
60.00 40.00 20.0
ROI
2.5/60 x
100
=4.17%
1.5/40 x 100
=3.75%
0.5/20 x 100
=2.5%
Year Cash flow Discount factor (14%) DCF
0 (60.0) 1.000 (60.00)
1 22.5 0.877 19.73
2 21.5 0.769 16.53
3 20.5 0.675 13.84
Net Present Value (9.90)
Comment: the best outcome and the worst outcome are two extremes and in real life the outcome is expected
to be somewhere in between.
(I) Residual income (Rl)
Rl is the net income earned after deducting a charge for the funds invested in the division or investment unit.
The charge is determined by taking the organisation's desired minimum rate of return and multiplying it by the
amount of the investment. It is calculated as follows:
Rl =Income - Charge on investment
Charge on investment =(Investment x Desired rate of return)
In contrast to ROI, which is expressed as a percentage, residual income is expressed in absolute terms (i.e. as
a dollar amount).
Strengths
Rl gives project sponsors an idea of the finance costs involved in a project. Rl can be used to discriminate
between projects that generate returns above and below the cost of capital. It is a flexible tool as projects
carrying differing risks can be attributed separate rates of interest.
Limitations
The major limitation of this method is that, because residual income is not expressed as a percentage, it is not
useful for comparing units of significantly different sizes. It favours larger units that would be expected to have
larger residual income, even with relatively poor performance.
It is difficult to decide what should be the desired rate of return. Considering a wrong rate of return may
misguide the decision-maker.
(ii) Return on investment (ROI)
ROI is the ratio of profit to investment in operational assets. It is normally expressed as a percentage, and the
larger the percentage, the better the ROI.
ROI is normally interchangeable with ROCE as a measure of profitability. ROI is normally used for divisional or
investment centre performance appraisal. ROI is calculated as follows:
ROI =Return on sales x Operating asset turnover
EBIT Sales
x
Sales Operatinga ssetemploy ed
ROI indicates the profit earned for each dollar invested in the operating assets of a business. It is a measure
which takes into consideration the revenues, costs and investments, by combining these factors into a single
percentage. ROIs for successful firms range from 10 to more than 50 per cent, although each firm's ROI must
be evaluated in the light of the industry average ROI and the economic factors facing that particular entity or
strategic business unit.
Strengths
It is directly related to the standard accounting process and is widely understood.
^ It appeals to investors who are interested in assessing the percentage return on an investment.
^ It permits comparison between projects that differ in their absolute size.
> It permits the performance of semi-autonomous business units to be compared with each other and with an
aggregated figure.
Limitations of ROI
ROI may be a better alternative to profit as a performance measure for divisions or investment projects.
However. ROI also has certain shortcomings that limit its use as a performance evaluation critenon. These
shortcomings are:
> Ignores time value of money
ROI ignores the time value of money. The concept of the time value of money is that the value of money
changes over time i.e. the value of a dollar / pound today is different from the value of a dollar / pound tomorrow
and accordingly the purchasing power of the same unit of money undergoes a change.
^ Ignores risk associated with the project
ROI also ignores the risks associated with the project. While taking a decision regarding projects with different
levels of risk, using ROI may result in ignoring a good project which has lower risk and accepting a project which
offers a high return but with correspondingly high risks.
> Flexibility
It is an advantage that ROI can be modified to fit the situation. However, this advantage may turn into a
disadvantage if this flexibility is used to manipulate the results by expressing them in a different way.
> Inconsistency
The terms income and investment can be interpreted in various ways. Income is sometimes taken as before
interest and tax; sometimes as after interest and tax. Likewise, investment also sometimes considers net assets
and, sometimes, the gross value of assets.
> Short-term analysis
The calculation of ROI only takes into consideration short-term investments. Long-term costs such as
maintenance and software upgrades are ignored. Therefore, projects with heavy long-term costs may show a
high return on investment in the initial period.
> Variation in calculations
If the methods of calculating depreciation are different for the different units, it is difficult to compare their
performances.
(iii) Net present value (NPV)
The net present value (NPV) of an investment (project) is the difference between the amount of initial
investment and the sum of the discounted cash flows which the investment is predicted to generate.
The value of money depends upon the timing of the cash flows. The same amount of money received or paid at
different times has different values. To make the cash flows at different dates comparable, their present values
are calculated. The net present values are calculated as:
GTG
Solution Rank:0l
NPV =Present value of cash inflows - Present value of cash outflows
These present values can be either positive (cash inflow greater than outflow), negative (cash outflow greater
than inflow) or zero (cash outflow and inflow exactly equal). The rule is to accept all the independent projects
with a positive net present value or. for competing projects, the project with the highest NPV.
The discounted value depends on the date of expected cash flows. Some assumptions relating to NPV
calculations include the following:
^ The initial cash outlay is incurred at the beginning of the first period, i.e. the year is taken as 0. The present
value of this initial investment is the same as the amount of investment; it is not required to be discounted
since the time is now'. The discount factor for year 0 is 1.000.
> Any transaction during a penod is assumed to occur at the end of the period. E.g. receipts dunng year 2 are
assumed to have taken place at the end of year 2.
^ Cash flows occurring at the beginning of a period will be assumed to have occurred in the previous period
for discounting purposes only.
Strengths
The biggest strength of NPV is that it recognises the time value of money. The emphasis on cash flows is
particularly appealing to shareholders who are seeking short and long-term cash returns. The use of cash flows
is subject to less manipulation and fewer subjective decisions than the use of profits based on accruals
accounting. It considers the opportunity cost of not holding money. Risks can be considered by using different
costs of capital for different money market situations.
Weaknesses
NPV estimates incorporate a number of assumptions concerning decision critical variables such as the duration
of the cash flows. It is very difficult to predict the timing of the cash flows within the life of the project.
Determining the appropriate cost of capital to apply to the project is difficult and moreover it is even more
difficult to estimate whether or this should remain constant over the life of the project. This is especially difficult
when the organisation is not able or is unwilling to arrange long-term fixed interest funding. The heavy reliance
on estimates and subjective decision-making permits and encourages project sponsors and other interested
parties to submit optimistic projections that cannot be easily refuted.
(c)
The broader issues that should be considered when deciding whether the company should proceed with a
particular project are as follows:
> The anticipated project nsk - can it be measured reliably?
^ Is the project an integral part of a larger and longer term business plan? Is it the first step in a series of
dependent projects? If the project is an integral part of a large business plan, the performance of the project
should not be considered in isolation.
> The synergy and relationship between different projects- it may so happen that the combined outcome of
the projects in an overall business plan will be greater than the sum of the outcomes of the projects in
isolation.
> The potential for an individual project to alter the overall risk of a company's business activities. For
example, a single project may have the potential, if combined with certain other projects, to lower the overall
risk, and consequently the corporate cost of capital.
The time of commencement of a project. This might be a vital issue as it may so happen that a project will
lose its relevance it is not taken up on time.
18. Performance analysis - Taliesin Ltd
titiLty
For case study based questions, read the question carefully and note down the key information
before start answering.
If the key information are noted down well in advance you can keep track of your answer and
make sure that you have answered all the requirements. This will save you time and prevent
you from losing marks.
Moreover, your answer should be specific to the question and should make reference to the
case of Taliesin Ltd.
Remember that answering the question without referring to the given case will reduce your
prospect to earn high marks.
4
(a) The overall performance of Taliesin Ltd during the years ended 31 May 2004 and 31 May 2005 can be
measured by its return on capital employed (ROCE) as follows:
2005 2004
Profit before interest 5,000 4,000
Total assets less current liabilities 66,000 52,000
7.58% 7.69%
Performance analysis
An ROCE of 7.58% Is not good, especially when Taliesin Ltd has borrowed money at 10% with the intention of
improving its activity in order to grow further. The ROCE for 2005 is slightly lower than that for 2004. Since this
information was available at the start of the 2005 financial year, the directors should have reconsidered their
growth target.
Sales have increased by 20% over the previous year. There is a considerable vanation in the sales achieved by
Taliesin Ltd in the different halves of their accounting year which is mainly attributable to seasonal variations in
demand. In order to cope with the additional demand for the period 1 J une - 30 November during each financial
year, temporary workforce is hired during these periods. Most of the growth in sales revenue occurred during
the first half of the year ended 31 May 2005.
The cost of sales has remained constant at 60% of sales. It is interesting to note that the composition of cost of
sales has changed during the year and management attention should be focused on this in order to ascertain
the reasons for this change. The material costs as a percentage of cost of sales have remained unaltered
whereas labour cost (in percentage terms) has decreased. Manufacturing overheads have increased slightly in
2005 compared to the preceding year. It may be noted that the cost of sales in 2005 (51.5%) mostly comprises
manufactunng overheads. This is an increase of 1.5% over 2004.
2005 2004
% of cost of % of cost of
sales: sales:
Materials 32-5 32-5
Labour 160 17 5
Overheads 51-5 500
1000 1000
Score Mor e
Instead of presenting the information in tabular form, one could present the information in the
following manner:
In 2004. materials, labour and overheads constitute 32.5%. 17% and 50% of cost of sales.
Such presentation will not make the answer wrong. However, tabular presentation of numerical
information provides better readability and makes the answer clear, simple and concise.
Whilst the gross profit percentage has remained constant at 40% in 2005 (compared to 2004), the net profit
percentage has reduced from 10% to 8.33% during the same period. However, Taliesin Ltd has earned the
same profit in absolute terms during the year ended 31 May 2005 as it did in the previous year.
Operating costs have risen by 27.5% over the previous year's level. The company has also paid 1 million as
interest on a loan in order to finance the infrastructure required to manufacture the six new products.
Details of the composition of net current assets are required in order to ascertain the liquidity position of Taliesin
Pic and thereby obtain a broader view of the financial position of Taliesin Ltd.
GTG
Solution RanK:<)3
From the information provided, it appears that Taliesin Ltd has lost a customer during the year ended 31 May
2005. It can be construed that this only happened towards the end of the year and therefore the income
statement might not fully reflect the financial consequences of the lost customer. The loss of the customer could
well be highly significant since the company had only six customers at the start of the year. It is highly probable;
therefore, that each of the six customers, being supermarkets, purchased in relatively large volumes and
accordingly significant turnover may have been lost. In order to make good the loss, Taliesin Ltd should attempt
to attract a new customer as soon as possible, in order to replace the lost customer.
Growth may only have been achieved by introducing new products. There may be a limit to the number of times
that this can be done effectively. It has already been noted that the six new products have led to a loan, the cost
of which exceeds the return generated by Taliesin Ltd. It is essential, accordingly, to focus on growth of the
customer base.
(b) The major benefits of pursuing a policy of internal development that may accrue to Taliesin Ltd are as
follows:
By confining its activities to its internal environment, the company avoids the need to manage the
integration of businesses which would have been necessary had the company opted for an acquisition.
Management teams, when considering the acquisition of another organisation, very often underestimate
the costs of integration.
> There is no need for the board of directors of Taliesin Ltd to make itself acquainted with different
organisational and national cultures, values etc., thereby avoiding many potential problems.
^ The board of directors of Taliesin Ltd considered it to be prudent to control the activities of the business.
It was felt that going for more complex supply chains and strategic alliances with foreign organisations
would be unnecessary.
> All investments in tangible capital assets are made at market price whereas if the board of directors had
attempted to acquire another business then significant outlays would probably have been required in
respect of purchased goodwill.
> As the organisation develops and expands, staff are provided with development and learning activities
that may give them the impetus to increase the level of their commitment to the organisation.
(c) Use of activity-based techniques in Taliesin Ltd
(i) For pricing
Switching to ABC can substantially change the costs per unit calculations. Consequently, if an organisation's
selling pnces are determined by cost-plus pricing then the selling prices will be altered. Specifically, the prices of
the products assigned a higher amount of overheads will go up whereas the prices of the products allocated a
lower amount of overheads will go down.
This may result in the non-acceptance of the price of a product (whose price has gone up) by the market or loss
of revenue due to a decrease in the pnce of a product.
Keeping in mind the above consequences, Taliesin Ltd might prefer prices to be market driven and accordingly
might not make any change to the price due to a change in the method of overhead absorption. Only the profit
per unit would change. Nevertheless, even when the pnces are market driven, management may come to know
about the real profitability of products by switching to ABC.
(ii) For sales strategy
There is a likelihood of attitudinal change within the organisation due to the changed profitability of the products.
After switching over to ABC from a traditional system, the allocation of overheads to the products will change
and, accordingly, the profitability of the products will change if the prices are market driven. The focus of the
marketing team will be redirected into rescheduling the sales target, aiming at higher profitability.
(iii) For performance management
ABC points out the fact that activities give rise to costs i.e. a greater number of activities would mean greater
costs. Therefore, costs can be controlled only if activities are controlled. The management of Taliesin Ltd needs
to consider that organisations implementing the ABC system mainly use it to plan and manage activities i.e. as
an aid to performance management.
(iv) For decision-making
In order to make the correct decisions, one needs to have accurate information about costs. The ABC system
can provide the accurate costs of the products by refining the method of overhead cost allocation. Management
decisions regarding making or outsourcing', 'adding or dropping any new product', 'alternative design choices to
improve efficiency and reduce non value-added costs', etc. can be perfected through using activity-based
costing.
19. Strategic performance measurement - Pack and Dispatch Co
i
This Question relates to Strategic Management Accounting model (Porter's Five Forces model) and
different performance indicators.
Your answer should be with reference to the case discussed in the question.
In order to get high marks make your answer brief and to the point. However, the answer given
below is comparatively large as it is intended to give you a complete overview of the topic.
(a) In order to assess the attractiveness of the option to enter the market for fast food packs, the directors of
PADC could make use of Michael Porter's 'five forces model' in order to make a qualitative evaluation of the
firm's strategic position. The five forces that determine an organisation's strategic position are the threat of
substitute products, the threat of the entry of new competitors, the intensity of competitive rivalry, the
bargaining power of customers and the bargaining power of suppliers.
In applying this model to the given scenario, one might conclude that the relatively low cost of the machine
together with the fact that an unskilled person would only require one day's training in order to be able to
operate a machine, constitute relatively low costs of entry to the market. Therefore one might reasonably
condude that there is no entry barrier i.e. the threat of the entry of new competitors might be high.
Products are usually purchased in very large quantities by customers. Moreover, there is little real difference
between the products of alternative suppliers. Under these circumstances, customer (buyer) power is likely
to be very high. The fact that the paper packs, on average, make up only between 3% and 5% of the total
cost of the purchaser's finished product, also suggests that buyer power might be very high.
The specially formulated paper from which the packs are made is sometimes in short supply. Accordingly,
the bargaining power of suppliers will also be very high. Hence suppliers might increase their prices with a
consequential reduction in the gross margin of the firms in the marketplace.
The threat from competitive rivals will be strong as the six major players in the market are of similar size and
the market is a slow growing market. The market leader currently has 25% of the market and the remaining
five nearest competitors each hold approximately 10% of the market.
The fact that Soft Packaging produces a narrow range of cardboard packs constitutes a threat from a
substitute product. This threat will increase if the product range of the company is extended and the price of
cardboard packs is reduced.
The fact that a foreign-based multinational company is considering entering this market represents a
significant threat from a potential new entrant as it would appear that the multinational company might be
able to leverage economies of scale from large scale automated machinery and has manufacturing
flexibility.
Low capital barriers to entry might appeal to PADC but they would also appeal to other potential entrants.
The low growth market, the ease of entry, the existence of established competitors, a credible threat of
backward vertical integration by suppliers, the possible entry by a multi-national, a struggling established
competitor and the difficulty of differentiating an industrial commodity should call into question the potential
of PADC to achieve any sort of competitive advantage.
Entry into such a market will be considered to be a good move only if PADC can achieve the position of
lowest cost producer within the industry. In order to assess whether this is possible. PADC must consider
any potential synergies that would exist between its cardboard business and that of the packaging
operation.
From the information available, the option to enter the market for cardboard packs appears to be
unattractive. The directors of PADC should seek alternative performance improvement strategies.
GTG
Solution Rank :05
(b) It would appear that the rival company's market share has declined from 29% to 10% (i.e. (75% 25%)/5]
over the last three years. A 12% fall in market share is very significant due to its effect on profits and
resultant cash flows. Obviously such a declining trend needs to be stopped immediately and this will require
a detailed investigation to be undertaken by the directors of the rival company. Consequently loss of market
share can be seen to be an indicator of possible corporate failure.
Other indicators of corporate failure are as follows:
Poor cash flow
Poor cash flow might render an organisation unable to pay its debts as and when they fall due.
Consequently, providers of finance might invoke the terms of a loan covenant and commence legal action
against an organisation which might eventually lead to its winding-up.
Lack of new production I service introduction
Innovation can be viewed as a move towards growth (or even as a survival strategy) since it does not only
improve the marketability of a company's products but also makes a clear distinction between the company
and its competitors who do not innovate new products or new product features. A lack of new product /
service introduction may arise from a shortage of funds available for research, product development and
marketing.
General economic conditions
Falling demand and increasing interest rates can lead to the failure of organisations. Organisations with
highly geared capital structure will suffer as demand falls and the weight of the interest burden increases.
Organisations can find themselves in a vicious circle as increasing amounts of interest payable are paid
from diminishing gross margins leading to falling profits / increasing losses and negative cash flows. This
leads to the need for further loan finance and even higher interest burden, further diminution in margins and
so on.
Lack of financial controls
The absence of sound financial controls might prove to be costly to many organisations. In extreme
circumstances it can lead to outnght fraud (as was the case in Enron and WorldCom).
Internal rivalry
The extent of internal rivalry that exists within an organisation can prove to be of critical significance to an
organisation as managerial effort is effectively channelled into increasing the amount of internal conflict that
exists to the detriment of the organisation as a whole. Unfortunately the adverse consequences of internal
rivalry remain hidden until it is too late to redress them.
Loss of key personnel
In certain types of organisation, the loss of key personnel can spell the beginning of the end' for an
organisation. This is particularly the case when individuals possess knowledge which can be exploited by
direct competitors, e.g. sales contacts, product specifications and know-how of products.
20. Measures of performance - Tannadens Division
This being a large question, before answering it, read the question carefully and note down the key
requirements before answering the question.
Since the answer contains numerical part, it is necessary to think about the presentation before you
start writing your answer.
This is because:
Planning the presentation saves time by avoiding repetition of the same information and
> Planning eliminates any unnecessary information and makes your answer clear, concise.
i
%: Slralegir Performance Measuremenl GTG
(a) Best outcome situation for the quality improvement programme
Year 1 Year 2 Year 3 Year 4
Additional output capacity (Std. hours) (W1) 1.050 1.365 1,785 2,100
$ $ $ $
Contribution (W2) 1.386.000 1.801,800 2.356.200 2,772.000
Less: Training, consultancy, salary
costs (W3) 97,500 97,500 97,500 97,500
Net margin 1.288.500 1,704,300 2.258.700 2.674.500
Less: Depreciation (W4) 1,000,000 1,000,000 1,000,000 1.000.000
Net profit 288,500 704300 1,258,700 1.674.500
Less: Imputed interest (W5) 320,000 240.000 160,000 80
Residual income (W6) -31,500 464.300 1,098,700 1.594.500
Return on investment (%) (W6) 7.2% 23.5% 62.9% 167.5%
Net present value (NPV) at 8% (W7) $2,412,901
Workings
W1 Using year 3 as an example: additional std. hours =(1,000 +300 +400) x 1.05 =1,785
W2 Contribution (e.g. for year 1) =1,050 hours x ($1,200 x 1.10) =$1,386,000
W3 Training, consultancy & salary cost for each year =$100,000 x 0.975 =$97,500
W4 Depreciation per year
W5 Imputed interest charge (e.g. for year 2)
W6 Return on investment (e.g. for year 4)
=$4,000,000/4 =$1,000,000
=WDV x cost of capital
=(4,000,000 -1,000,000) x 8% =$240,000
=Net profit /WDV
= $1.674.500/1.000.000 = 167.5%
W7 NPV
=(Net margin x Discount factor at 8%) for each year - Initial investment
=$1,288,500 x 0.926 +$1,704,300 x 0.857 +$2,258,700 x 0.794 +$2,674,500 x 0.735 - $4,000,000
=$2,412,901
(b) Bonus calculation for most likely outcome situation
Year 1 Year 2 Year 3 Year 4 Total
$ $ $ $ $
Net profit basis (W1) 0 3,150 10.35 15,750 29,250
Residual income basis (W2) 0 0 9.800 19,000 28.800
ROI basis (W3) 6,000 6,000 6.000 6.000 24.000
NPV basis (W4) 0 0 0 30.843 30.843
Workings: (giving an example for one year in each case)
Bonus =($460,000 - $250,000) x 15% =$3,150
Bonus =($740,000 - $250,000) x (0.05 x $40,000),'100,000 =$9,800
Bonus =$40,000 x 15%
=
<
since R 0
'
i s
positive)
Bonus =$1,233,700 x 2.5% =$30,843
W1: Year 2:
W2: Year 3:
W3: Year 1:
W4: Year 4:
C.TG Solution Hanh:U7
(c)
The programme manager's choice of bonus method will be influenced by factors such as the timing of the
bonus, its size, the relative ease with which it is earned and his risk perception.
The most likely outcome figures calculated in (b) show that the largest total bonus is $30,843 where 25% of
NPV is used as the basis.
The timing of the bonus payments may concern the programme manager. The NPV basis delays any payment
until the end of year 4. The other bonus methods based on ROI, net profit and Rl have initial bonus payments in
years 1, 2 and 3 respectively. The programme manager may have a strong preference for eariy cash inflows
from his bonus and choose the ROI basis which will yield $6,000 in year 1.
His choice may also be influenced by the relative ease with which the bonus is earned and the degree of control
over the factors incorporated into its calculation. The Rl and NPV bases are affected by the cost of capital
percentage which is used. The programme manager may view this as unacceptable because of his lack of
control over the cost of capital percentage used in the calculation.
The bonus payment will inversely vary with the cost of capital even if the efficiency of implementation of the
programme has been improved.
The ROI basis ensures a bonus of $6,000 per year so long as the net profit is greater than S250.000. On the
other hand, no bonus will be payable on the net profit basis unless the net profit per year exceeds $250,000.
The attitude to risk of the programme manager is also relevant. A risk-seeking manager may view the S60.323
bonus from the NPV basis where the best outcome occurs as very attractive. On the other hand, a risk averse
manager may view as unacceptable the possibility of a bonus of only $5,370 from the NPV basis if the worst
outcome occurs. He may then prefer the bonus of 18,000 from the ROI basis which is payable even if the
worst outcome occurs.
The outcome of the implementation of the quality improvement programme will be influenced by the effort of the
programme manager, his attitude to nsk and the rationality of his decision-making. The programme manager's
level of effort and motivation may be affected by the bonus system or by promotion prospects. His attitude to risk
may be related to the extent to which he feels he has control over the implementation of the programme and
how it is monitored. The success of the programme will also depend on the manager's capability to handle the
job in hand and on whether or not he is capable of making relevant decisions about its effective implementation.
It may be argued that it is the individual who chooses actions and implements them. The strength of motivation
to achieve the target (of the programme) will be affected by the expectation that its achievement will result in
some benefit. His actions will be based on intrinsic and extrinsic factors. His motivation to achieve the
implementation of the quality programme will be affected by both intrinsic and extrinsic factors and his
preference for them. Examples of extrinsic factors are the extent to which the manager values the receipt of a
high bonus payment or possible recognition for promotion within the organisation. Examples of intrinsic factors
are the extent to which he is motivated by factors such as a 'feeling of achievement" or the driving force of
'professional pride'?
21. Divisional performance - Galaxy pic and Milky-way group
I
Part 'a' of this question is not scenario-based but general. Vou need to have good knowledge of
these measures, how they are calculated and their application.
Three marks are allotted for discussion of each measure therefore you should plan your answer
accordingly. Do not make your discussion too long or too short. The explanation given below is
sufficient for three marks.
In addition, it is specifically mentioned in the note that you should consider certain points; therefore
make sure that you have covered all of these points in your explanation. The examiner will expect
you to do this and therefore doing so will help you to get good marks.
98: Slrafeglc Performance Measuremenl fi Tf.
It is very difficult to differentiate the performance of a division from the performance of its managers therefore
measuring the performance of a division is always considered a measure of managerial performance. However,
it is argued that the performance of the divisional managers should be measured considering only the revenues
and costs within their control i.e. only the controllable costs and revenues.
In the absence of information on the extent to which the divisional managers have freedom to decide upon
investments, it is difficult to choose a single measure for Galaxy Pic. However, the following analysis of the
performance measures given in the question may help in choosing an appropriate measure.
(i) Contribution margin
This measure will be acceptable to the divisional managers as long as it does not contain any internal sale (i.e.
sale of goods to another division of the same company) over which the manager has no control. In addition, if
internal sales are included in divisional sales, the transfer pnce should be close to the market pnce so that the
performance of any division is not significantly affected because of internal transfers. For example, if transfers
are made at marginal cost, the selling division's performance will be affected since it also has to bear the fixed
costs for the transferred units. On the other hand, the buying division's performance will be enhanced since it
obtains goods at a price much lower than the market price.
In addition, this measure may not be acceptable to the management of the company since it ignores fixed costs
which the divisional manager may control such as short-term fixed costs (fixed labour cost).
(Ii) Controllable profit
This is a well-accepted measure for assessing divisional performance. This is because it considers all the
controllable revenues and costs. It is suggested that if controllable profit is used as a measure of divisional
performance, internal sales should be either cancelled or considered at a pnce close to the market price.
Certain fixed costs, which the divisional manager can avoid in the long term through effective and efficient
working, should be considered. This is because considering these costs will enable detailed measurement of
the performance of the divisional manager. For example, if staff efficiency is improved, more work can be done
within fewer employee hours and the additional employee hours can be utilised elsewhere leading to a reduction
in the overall cost. Alternatively, the manager can get the same work done by fewer employees and save labour
cost in the long run.
However, inclusion of depreciation on non-current assets is a debatable issue which should be decided on a
case-by-case basis depending upon the control that the divisional manager has over investment decisions.
(iii) Divisional profit
Divisional profit is a widely used measure for evaluating the performance of divisions. However, it is greatly
criticised and unacceptable to divisional managers. This is because it is calculated after deducting the non-
controllable costs such as the finance cost of the company / group as a whole.
Such costs are generally allocated to the divisions to arrive at the divisional profits. However, since the
divisional managers cannot control these costs, they may not like divisional profit as a measure of divisional
performance. It can also be argued by the management of the group that where the costs are avoidable only if
the division is closed or are specifically incurred for the division (such as depreciation on operating assets) then
they should be considered while evaluating divisional performance.
Divisional profit can be used in evaluating divisional economic performance since it shows the contribution
made by a division towards the overall profitability of the group.
Finally, the performance measure should be one which is acceptable to the divisional managers and will also
enable the performance of the divisional managers to be assessed in the best possible manner.
>GTG Solution Bank:09
1
This part of the question includes various sub-questions as follows (along with marking scheme):
> calculating ROI for both the divisions
(2 marks)
> commenting on the views likely to be adopted by both of the divisional managers on taking up
the projects
(4 marks)
'r commenting on the impact of such decisions on the overall performance of an organisation
(2 marks)
Giving only the calculations of ROI will be considered a inappropriate answer and you will lose
marks. Therefore read the question carefully and note down all the sub-questions you need to
answer. This will help you to answer all the sub-questions and get good mariks.
Calculating ROI
Project S Project M
Profit 50,000 35,000
ROI = x 100 = x 100 = x 100
Investment 300,000 300,000
=16.67% =11.67%
The ROI of project S is 16.67%.
The current ROI of Sun division is 20%. If Sun division accepts project S, the current ROI of Sun division will
decrease and therefore the manager of Sun division will not accept project S.
However, the ROI of the project is higher than the company's cost of capital. Therefore it is beneficial to accept
the project considenng the company's objective to maximise the profits of the organisation as a whole.
The ROI of project M is 11.67%.
The current ROI of Moon division is 11%. Accepting project M will increase the current ROI of the division.
Therefore the manager of Moon division will be willing to accept the project.
However, the ROI is lower than the cost of capital of the company. Therefore, considering the overall profitability
of the company, it is advisable that Moon division should not accept project M.
From the above discussion, it is clear that since the bonus is based on the yearly performance of the division, it
is likely that the managers will accept the projects which are profitable to their divisions without considering their
impact on the overall profitability of the company.
Under the abovementioned situations, a conflict arises between the goals of the managers and the goal of the
organisation as a whole and finally suboptimal decisions are taken ignoring goal congruence. This is harmful for
the growth of the company and therefore should be avoided.
(c)
rl
This is a very good question to test your knowledge of EVA. This is because only knowing
the formula is not sufficient to calculate EVA and will not help you to score good marks.
Marks are allotted to the workings as follows:
> calculating adjusted profit after tax (3 marks)
> calculating adjusted capital employed (2 marks)
> calculating WACC (2 marks)
> calculating EVA (2 marks)
> comments {1 mark)
(Maximum. 8 marks)
Therefore show your workings and give comments on the performance of Milky-way considering
EVA as a measure. In addition, give explanations for your adjustments to the profit and capital
employed. This will indicate that you have a thorough knowledge of the subject and help you to get
good marks. Without these explanations, your answer will be a poor answer.
EVA is calculated as:
EVA =NOPAT - cK
Where,
NOPAT is net operating profit after tax
c is the weighted average cost of capital
K is capital employed
Capital employed will be the capital at the beginning of the year with certain adjustments. In the given case
certain adjustments are made to the capital employed. These adjustments, along with the calculation of capital
employed, are displayed in the table below:
Calculating adjusted capital employed
20X6 20X7
$ m Sm
Capital employed at the beginning 311 395
Add
Goodwill amortised 60 65
Adjusted capital employed 371 460
In the absence of detailed information on the accounting treatment of capital employed, the book value of the
total assets is taken as a base for calculating the economic value of capital employed at the beginning of the
year.
In addition, goodwill acquired through a business acquisition adds value to a company and therefore represents
an element of the total value of a business. Therefore, in order to show a more realistic value, the goodwill
acquired (although subsequently amortised) should be added back to arrive at the economic value of capital
employed.
Operating profit after tax requires the following adjustments:
Accounting depreciation should be added back and economic depreciation should be deducted to arrive at the
adjusted profit. However, in the given case, since accounting and economic depreciation are the same we do
not need to made any adjustment? The net effect will be the same.
Non-cash expenses should be added back.
>GTG Solution Rank:101
In addition, goodwill is an intangible asset of the business and therefore any amortisation should be added back
to the profit.
Interest on debentures is to be added back subject to tax relief.
Hence, adjusted profit is calculated as follows:
Calculating adjusted profit
20X6 20X7
$m $m
Profit after tax 73.50 91.00
Add
Amortised goodwill 5.00 5.00
Other non-cash expenses 14.00 15.00
Interest (net off tax benefit) (7.5 x 70%) 5.25 5.25
Adjusted profit 97.75 116.25
ifrrr-^ Alternatively, adjusted profit can also be calculated as:
$
EBIT 112.50
Add: Amortised goodwill 5.00
Non-cash expenses 14.00
131.50
Less: Tax 31.50
Less: Tax relief on interest 2.25
Adjusted profit 97.75
The third requirement for calculating EVA is WACC which can be calculated as follows:
WACC
WACC = R(1-Tc)-^
20X6 =10(1 - 0.30) x 60% +15% x 40% =10.2%
20X7 =10(1 - 0.30) x 60% +17% x 40% =11%
Calculating EVA
EVA =NOPAT - cK
EVA 20X6 =S97.75m - (S371m x 10.2%)
EVA 20X6 =5(97.75-37.84)
EVA 20X6 =$59.91 m
EVA 20X7 =116.25 - ($460m x 11%)
EVA 20X7 =$(116.25 - 47.60)
EVA 20X7 =$65.65 m
The above calculation shows that Milky-way has added significant value during each year under consideration
and thereby achieved a satisfactory level of performance.
22. Divisional performance - NAW group
(a)
(i) w^mmwm^m
Before answering this question, keep in mind the following points:
> Read the question careful and note down all the requirements before answering the question.
The following sub-requirements are included in this part of the question:
* preparing a statement of budgeted profit for Division O
^ showing annual budgeted contribution of each branded as well as unbranded product
s calculating Rl and ROI for division O
Be careful not to lose marks by accidentally missing out one of the requirements.
In the case of numerical questions, it is necessary to think about the presentation before you start
writing your answer. This is because:
S planning the presentation saves time by avoiding repetition of the same information
^ good presentation provides better readability
planning eliminates any unnecessary information and makes your answer clear, simple and
concise
> Do not forget to give step-by-step calculations such as sales revenue less cost of sales (including
material / conversion costs, packaging costs) and contribution, as given in the answer below.
This is because marks are allotted to each step and if you miss out any step then you will lose
marks.
NAW Group: Division O
Statement of budgeted profit for the year to 31 May 2005
Product Painfree Digestisalve Awaysafe Total
Branded Unbranded Branded Unbranded Branded
$-000 $'000 $'000 $'000 $'000 $'000
Sales revenue 12.000 18.000 24.000 72,000 120.000 246.000
Cost of sales:
Material 1 conversion costs 4,250 12,750 9,250 37,000 42.000 105,250
Packaging costs 750 750 1,250 3,000 6,000 11,750
Total variable costs 5,000 13,500 10,500 40,000 48,000 117,000
Contribution 7,000 4,500 13,500 32,000 72,000 129,000
Fixed costs:
Fixed overheads 81.558
Advertising and promotion costs 17.400
Not profit 30,042
Residual income (Rl) .
Here, capital employed is $120m.
Rl =Income - Charge on investment I
Where.
Charge on investment =(Investment x Desired rate of return)
Rl =$30,042,000 - ($120,000,000 x 10%)
Rl =$30,042,000 - $12,000,000
Rl =$18,042,000
C.TG Solution Rank:l03
ROI =Returnon Sales x Operating Asset Turnover
E BI T
ROI = x 100
Capital Employed or Asset Employed or Invested
$30,042,000
ROI = x 100
$120,000,000
ROI =25.04%
(II)
I j &m^X.
T hi s
question is worth only 3 marks therefore you should not write a long answer. Additional
information is given below to aid your understanding. However, it is necessary to write the first
paragraph (related to production capacity) since this information is important.
Generally, when an organisation is deciding upon its product mix strategy, profitability, production capacity
and selling capacity (demand for the product) are amongst the important factors which need to be
considered. However, in this question, we are asked to discuss factors other than profitability.
As far as demand for the product is concerned, this is not a problem for NAW Group. This is because the
demand for the product is already more than the production capacity for the year ended 31 May 20X6.
Therefore the important factor to be considered is production capacity.
It is stated that during the year to 31 May 2005. a maximum of 780 million tablets can be produced. Since
tablets are sold in packs of 12, we can say that 65,000,000 packs can be produced whereas there is only
demand for 60,000,000 packs
However, demand for the year ended 31 May 2006 is for 66.000.000 packs i.e. 10% more than that of the
previous year (60,000.000 packs + 10%). This demand is 1,000.000 packs more than the current production
capacity. This should be a major concern for NAW. This is because when a company is not in a position to
satisfy the demand, this does not only affect the company's performance but also its goodwill which indirectly
affects its performance in future. Therefore, considering the short-term as well as the long-term impact of the
shortage of production capacity, NAW should take further steps to identify and resolve any problems and
remove limiting factors.
In addition, internal factors such as allocation of resources, marketing strategies and pricing strategies need to
be considered since these are the factors that are affected as a result of a change in product mix.
Apart from these internal factors, certain external factors should be considered while taking decisions about
product-mix such as:
^ customers: they are important stakeholders who need to be considered before taking any decision. This is
because, without customers, the organisation will have no income and therefore, in order to succeed, the
organisation must keep its customers satisfied. Determining the extent to ^
which any decision will affect the customers is very important. E.g. if - - ^j hi s is how you should
NAW takes the decision to produce a particular product, say \ relate your answer to the
given scenario.
Awaysafe, (whose contribution is the highest) In large quantities by
reducing / eliminating production of, for example, Painfree unbranded
(whose contribution is the lowest), this may affect the organisation
adversely. This is because the customers who buy Painfree unbranded
may become dissatisfied and may create a fear amongst the other customers of NAW Group that the group
may stop producing other products at any time. This will affect the competitive position of the product. In
addition, it will also affect the customer loyalty and customers of other products may also start buying from
other companies.
104: Strategic Performance Measuremenl fiTf.
suppliers: the change in product mix may also affect the suppliers. This is because, with the change in
product mix. the raw material requirement also changes. This may result in changes in the terms and
conditions related to the price, delivery schedule etc. and therefore require negotiation with the suppliers.
Therefore, before taking any decision which may affect the suppliers, the long-term and short-term impact of
the decision should be considered.
competitors: most of the strategies of an organisation are influenced by its competitors. Therefore the
competitors of NAW may also be paying attention to the strategies of NAW. NAW should predict how its
competitors will respond to its decision and the impact of their responses on the performance of NAW in the
short as well as the long term.
(iii)
Both performance measures, i.e. ROI and Rl, have certain advantages and disadvantages. However. NAW
might have chosen Rl as a measure of divisional performance because of the following advantages of Rl over
ROI:
If ROI is accepted as a measure of performance evaluation, it tempts divisional managers to reject projects
whose ROI is less than that of the division, even if they are profitable, which is not good for the performance of
the organisation as a whole. This tendency of divisional managers may be avoided by choosing Rl as a
performance measure instead of ROI so that divisional managers will accept projects with positive Rl which will,
in turn, increase the profitability of the organisation.
Considering the above, it can be said that using Rl is more consistent and effective than ROI when it comes
to maximisation of the overall profitability of the organisation.
By using Rl, it is possible to evaluate projects with different levels of risk by applying different cost of capital
rates to projects with different risks.
Rl focuses on the cost of funds to divisional managers, which is essential information for divisional managers,
(b)
(i) Since the divisional managers of NAW Group have the autonomy to take decisions related to transfer
priang and deciding the source from which to purchase, the impact of their decisions on NAW group will be
as follows:
Quotation 1
It is stated that division O has decided to sell the product at a price which is 30% lower than the market
price i.e.S5.60 (58 less 30%). However, division L can purchase the product from the local market at 55.50.
Therefore it is likely that division L will purchase from the local market rather than from division O so as to
increase the profitability of division L.
As a result of this decision, the additional cost to the NAW Group will be $11,500,000. This is because
since division O has spare capadty available to produce 5.000,000 packs, it can sell the packs to division L
at a marginal cost to the division i.e. S3.20. By doing this, the group can save S2.30 (S5.50 - S3.20) per
pack and $11,500,000 ($2.3 x 5,000,000) in total. In these conditions, if division L decides to purchase from
outside, the group will lose this saving of $11.500.000.
Quotation 2
Since the available production capacity is of 5.000.000 packs only, in order to meet the division L's order
for 9,000,000 packs, division O will have to reduce production of another product which is likely to be
product Painfree unbranded whose contribution per pack is S0.30. As a result, the contribution forgone for
division O will be S1,200,000 (S0.30 x 4,000,000 packs).
The same logic used in the paragraph above is used here.
However, it is likely that division L will purchase from the local market which will cost the company
S20,700,000 i.e. $2.30 ($5.50 - $3.20) x 9,000,000. However, the decision to purchase from the local
market will save the above S1.200.000 contribution that would have been forgone if the product were
purchased from division O. Therefore the net cost to NAW Group will be S19,500,000 ($20,700,000 -
$1,200,000).
(ii) To ensure that the profitability of the NAW group is not affected during the year ended 31 May 2005,
division O should charge the following prices for both of the quotations:
The manager of division L will agree to pay any price below 55.50. The manager of division O can sell at
S3.20 which is the marginal cost to the division. This is because division O has spare capacity available to
produce the required packs. Any price between $5.50 and $3.20 will not affect the profitability of the group
as a whole. However, if it is assumed that division O is offering S3.20 per pack, the quotation price will be
$16,000,000 (S3.20 per pack x 5.000.000 packs).
In the case of quotation 2, for 5,000,000 packs, the discussion and the pricing policy will be the same as
that given above. However, for the next 4,000,000 packs, division O has to forgo the contribution from one
of its products which is likely to be Painfree unbranded as its contribution is the lowest. Considering this,
the quotation price will be $30,000,000 (($3.20 per pack x 9,000,000) plus contribution forgone by division
O i.e. $1,200,000].
(iii) Whenever an alternative is chosen from a choice of two or more options, the opportunity cost should be
considered. The opportunity cost is the benefit forgone from the next best alternative. In this case, the
opportunity cost is the maximum contribution margin forgone by division O if the products and services are
transferred internally to division L. While discussing quotation 1, we can say that the opportunity cost is 0
since there is no opportunity / income forgone (the sale to division L will be out of spare capacity). However,
while considering quotation 2. the opportunity cost will be equal to the market price minus the variable cost
for selling externally.
It is evident from the answer given in (b) (ii) that if the opportunity cost is not considered, the profitability
othe transferor division, i.e. division O, will not be maintained and will in fact be reduced.
Like the selling division, the purchasing division should also consider the opportunity cost to its division,
if any. before taking any decision. For the purchasing division, there will be an opportunity cost when
the market price is lower than the internal transfer price. For example, in this question, if division L
were forced to buy internally (this is not the company's policy), the price which division L would have
agreed would have been the internal transfer price less its opportunity cost which is S5.50 ($5.60 - SO. 10).
This is because the opportunity cost for division L would be the internal transfer pnce less the market price
(S5.60 - S5.50) since the market price is lower than the internal transfer price.
However, in order to consider the impact of opportunity cost, it is necessary to obtain full information about
the opportunity cost, which is quite difficult in reality.
(i) If Division L buys from a local supplier
Here we will consider only the differential revenues and costs (i.e. sale of Painfree unbranded and purchase
from local market by division L) since the other revenues and costs will remain the same.
Quotation 1
Quotation 2
(c)
Here also, planning your presentation is essential.
S
Division O sales
Total contnbution from Unbranded 'Painfree' (15.000.000 packs x $0.30 per pack)
Tax thereon @ 40%
Net contribution after tax
4.500.000
(1,800,000)
2,700,000
Division L purchases
Sale of Awaysafe (9,000,000 packs x S5.50 per pack) 49,500,000
Tax benefit thereon @ 20%
Net purchase cost after tax
(9.900.000)
39,600,000
Net cost to NAW Group (S2.700,000 - $39,600,000) 36,900,000
l()6: Strategic Performance Measuremenl
If Division L buys internally from Division O
fi Tf.
Division O sales
External
Total contribution from Unbranded 'Painfree' (11.000.000 packs x $0.30 per pack)
Total contribution from 'Awaysafe' to Division O (9.000,000 packs x $2.40 per pack)
Tax thereon @ 40%
Sale of Awaysafe (9,000,000 packs x $5.60 per pack)
$
Division O sales
External
Tax thereon @ 40%
3.300,000
21.600,000
Division O sales
External
Tax thereon @ 40%
24.900.000
(9.960,000)
Division O sales
External
Tax thereon @ 40%
14.940,000
Division O sales
External
Tax thereon @ 40%
50,400,000
(10,080,000)
40,320,000
Net cost to NAW Group {$14,940,000 - $40,320,000) 25,380,000
From the above calculations, it is clear that the net cost to NAW Group will be $11,520,000 ($36,900,000 -
$25,380,000) higher if Division L purchases product 'Awaysafe' from a local supplier. In addition, as a result of
the decision to sell Awaysafe to division L, NAW Group can promote the brand in the international market.
Therefore internal transfer will be the better decision for NAW Group.
(ii) When transfer between two divisions in different countries is under consideration, management should
consider the following, before deciding the transfer price.
Issues in setting transfer prices in multinational companies
Taxation
When the operations of an organisation are spread all over the world, the major concern for management is
managing the business in a way that minimises the tax paid by the organisation as a whole. Transfer price is
largely used as a measure for tax avoidance. However, the management of NAW should keep in mind that
avoiding tax using transfer pncing policies to divert profits to subsidiaries / divisions based abroad is legally
not allowed. The transfer price should be the arm's length price i.e. close to the market price / the price that
would have been agreed between two independent parties.
Charges such as custom duty and import duty
Apart from direct tax. i.e. income tax. other taxes such as custom duty and import duty should also be
considered when deciding the transfer price. The higher the transfer price, the higher the import duties and
customs charges. Therefore, the managements of multinational organisations try to keep the transfer price
low so as to reduce this burden. However, anti-avoidance legislation may not allow organisations to do so.
Exchange rate fluctuations
A change in exchange rates leads to a change in the profitability of the transferee as well as the transferor
division. It also affects the performance of the organisation as a whole (with the change in exchange rate, it
is not only the case that the profit will not be transferred from one division to another: other factors such as
import duty will also change which will affect the organisation as a whole). Therefore the management of
NAW should take decisions about the currency in which to deal, i.e. to raise the invoices, and the currency in
which to settle the payments. Generally, when one of the currencies in which the organisation deals is weak
and the other is strong, management attempts to use transfer pnce to transfer the funds from the weaker
currency to the stronger currency.
C.TG Solution Rank:l(i7
Repatriation of funds and dividends
Generally, the organisation reports higher profits in the country where the taxation rates are lower. However,
the organisation needs to repatriate funds from this country. In this case, if it is difficult to repatriate funds
directly due to government restrictions, transfer price is used to transfer these funds. Before taking any
decision, the management of NAW should bear in mind that governments are mindful of such practices and
therefore legal practices should be adopted.
Competitive pressure
If the transferee division is facing competition in the local market, the cost is controlled by adjusting the
transfer price i.e. by setting the transfer price at a minimum.
(d)
I
In this part of the question, you are not expected to explain the product life cycle in general. Instead,
you should apply the model to the given situation.
In addition, since the question is about evaluating the extent to which the model is used, you are
expected to write about the use and limitations of the model (i.e. why the management of NAW
cannot use it) etc. If you explain only the use, you may lose marks.
You are expected to write about each of the following points:
link between pricing strategies / expected returns and where product is in its life cycle
> performance measures required for each stage in product life cycle
> limitations of using product life cycle for NAW Group
> link to product portfolio (appreciation of life cycle issues)
The product life cycle (pic) describes the phases through which a product passes. These phases are
introduction, growth, maturity, decline and withdrawal. By identifying the phase at which the product is, the
management of NAW Group can make a better estimate of the demand for the product. In addition, use of the
product life cycle will help management to estimate the returns from each product. This will help management to
formulate and develop a marketing plan and to allocate the resources accordingly. For example, the advertising
and promotional budget will be higher for the products which are going through the growth phase and will be
lower for the products which are going through the decline and withdrawal phase.
In this case, NAW Group's advertising and promotional budget for the year ending 31 May 2005 is 517,400,000
which is calculated as follows:
$
Painfree branded (5% x S12.000.000)
Digestive branded (10% x S24,000.000)
Awaysafe (12% x 120.000.000)
Total
600.000
2.400.000
14.400.000
Painfree branded (5% x S12.000.000)
Digestive branded (10% x S24,000.000)
Awaysafe (12% x 120.000.000)
Total 17,400,000
This comes to about 7% of the turnover i.e. 17,400,000/246.000.000 x 100
However, it is necessary to identify the phase in which the product is in the product life cyde, in order to allocate
this amount to the products.
In addition, the product life cycle will help in deciding the pricing strategies in the following ways:
Introduction
At the introduction stage, a product is new in the market and therefore demand has to be created i.e. people
should be encouraged to try the product. In such a case, the following pricing strategies can generally be
adopted.
penetration pricing
Under this strategy, the price charged for products and services is set artificially low in order to gain market
share. This strategy is generally used in the following cases:
J when demand for the product is highly price elastic
s to launch a new product in the market
v' to launch an existing product in the new market
> price skimming
If an organisation has a substantial competitive advantage, or a product to be launched is with special features,
a high price can be charged for the product.
At this stage, the pricing policy should be adopted considering the long-term objectives of obtaining good market
share and earning more profit.
> Growth
At this stage, the product achieves recognition in the market and demand for the product begins to rise.
Therefore, if a penetration pricing policy has been adopted earlier, at the time of launching the product, the
prices may be gradually increased so as to earn more profits. However, at this stage, there may be more
competition in the market therefore efforts should be taken to sustain and grow in the market. Since demand for
the product is increasing at this stage, economies of scale can be achieved and thereby an organisation may
attempt to maximise the profits.
> Maturity
At this stage, the demand for the product should be very high and it should be making a handsome profit, but
the competition might also have increased. In order to enjoy higher demand and profits in the long term, an
organisation should have a pricing strategy that is capable of maintaining the product's competitive position.
In addition, at this stage, an organisation should look for new opportunities for the product such as searching for
a new market. If new markets are identified, the organisation may adopt a price discrimination strategy in which
the same product is sold in different markets at different prices.
> Decline
At this stage, when the demand for the product is falling, the pricing strategy should be focused on increasing
the profit without bothering about the market share.
At every stage, different performance measures to be adopted. For example, at the introduction and growth
stages, the performance measures should be such that help in deciding the strategies to gain market share
However, at the maturity and decline stages, measures such as ROI and profit can be used since the objectives
at these stages include the allocation of resources, investment requirements and increasing profitability.
Although product life cycle is an important model that NAW Group can use to decide its pricing strategies,
presently, it is difficult for the management of NAW Group to identify the stages at which the various products
are. This is because only past sales data are available to the management of NAW Group which are not
sufficient to identify the stage at which the product is at present. For example, if the sales volume is declining, it
is not always because the product is in the decline stage. It may be because of another reason, for example an
economic recession. On the other hand, an increase in sales may be due to a boom in the economy.
In addition, even if it is assumed that all other factors such as economic conditions are constant over the period,
when the sales volume is increasing it is difficult to identify the exact stage i.e. whether it is a growth or a
maturity stage. It is also difficult to predict how long a particular stage will last for.
C.TG Solution Bank:loo
23. Product vs. Customer profitability - NAW Group
(a)
i
In the ACCA exam, fifteen minutes are given for reading over the entire question paper.
In this question, you are asked to use information given in an earlier question (question 1). Therefore
you should note down the information relevant to this question when you read the previous question
(i.e. before answering question 1). In this way you will avoid reading the same question twice and
therefore save time.
This is a calculation-based question therefore plan its presentation before you begin your answer.
This will also save vou time.
Statement of budgeted customer profitability for the year to 31 May 2005 - Division O
Large
pharmaceutical
stores
Individual
specialist
pharmacies
Supermarkets Others Total
$'000's $'000's S'OOO'S
$'000*
S
$'000'
s
Contribution (W1) 49,350 27,050 43,350 9,250
129.00
Less:
Delivery costs (W2) 768 2,304 2,048 2,880 8,000
Changed delivery requirements 6
-
2
-
8
Purchase order costs (W3) 2 6 2 20 30
Promotion and exhibition costs
(W3) 110 110
I Retrospective rebates (W4) 9,180 2,280 13,950
-
25.410
I Total - other operating costs 10,066 4,590 16,002 2,900 33,558
Net profit before fixed overheads 39,284 22,460 27,348 6.350 95,442
Workings
W1 Contribution for customer groups
In calculation-based questions, do not forget
to give workings as these are the basis for
your calculations.
Painfree Digestisalve Awaysafe Total
$'000 $'000 $'000 $000 $'000 S'000
Contnbution 7.000 4,500 13.500 32.000 72,000 129,000
Large pharmaceutical 4.200 1,350 5.400 9.600 28,800 49.350
stores
Independent specialist 1.400
-
4.050
-
21,600 27,050
pharmacies
Supermarkets
700 3,150 2.700 22.400 14,400 43,350
Other retail markets 700 - 1.350 - 7,200 9.250
1 1 0 : S tr a te g i c P e r fo r m a n c e M e a s u r e m e n l f i T f .
W2 delivery cost
Large Independent Other
pharmaceutical specialist Supermarkets retail
stores pharmacies outlets
No. of deliveries (A) 400 2,400 800 3,000
Average kilometres per delivery (B) 300 150 400 150
Delivery cost $ (C) 6.4 6.4 6.40 6.40
Total delivery cost $ (A x B x C) 768.000 2.304.000 2.048.000 2.880,000
W3 Note the following formulae
Changed delivery requirements
=No. of times delivery requirements were changed x
Changed delivery requirements cost per change
Purchase order costs
=No. of purchase orders x Order processing cost per order
Promotion and exhibition costs
=Promotion and exhibition events x Promotion and exhibition cost per event
Instead of giving calculations for each
figure, the formulae which are used for
calculations are given.
However, in the exam, you should give
at least a sample of the calculations
from each group in order to show how
denved the figure.
W4 Retrospective rebate
Painfree Digestisalve Awaysafe Total Rebate
$'000 $'000 $'000 $'000 $'000 $'000 $'000
Sales revenue 12,000 18.000 24.000 72.000 120,000 246,000
25,410
Large pharma.
stores 7,200 5,400 9,600 21.600 48,000 91,800 9,180
Independent
pharmacies 2,400
_
7,200
_
36,000 45,600 2,280
Supermarkets 1,200 12,600 4,800 50,400 24,000 93,000
13,950
Other retail
markets
1,200 - 2,400 - 12,000 15,600
^j g p ^ Although this part of the question is theory-based, you are expected to link your explanation to the
given scenario. Even if the scenario is not given and the question is general, it is always good to
give examples wherever possible. This shows that you understand the concept and how it is used
in practice. This will help you to get good marks.
(i) Determining product profitability enables the most profitable and least profitable products to be identified so
that various decisions such as product mix can be taken. Along the same lines, determining customer
profitability helps customers to be identified in accordance with their profitability i.e. the most and least
profitable customers. This determination of customer profitability will enable various decisions to be taken
such as cost to customers. For example, when it is found that an important customer is unprofitable, the
organisation should examine internal processes to see how they can be improved so that the cost of serving
that customer can be reduced.
C.TG Solution Rank:lll
Customer satisfaction, retention etc. are desirable only if such measures increase profitability. This means
that only the customers who increase customer profitability should be concentrated upon. For example, if a
customer group is not profitable but efforts are taken to improve the relationship with these customers, this
is a waste of resources. Customer profitability measures expect that resources should be used only for
those measures which are profitable. This helps an organisation to decide service price i.e. the price to be
charged to a customer.
When products are sold in a highly competitive market, it is necessary to determine not only the product
profitability but the profitability related to the customers, markets and distribution channels. This is because
the long-term performance of the organisation may be affected by the profitability of such customers,
markets and distribution channels. For example, if for a distribution channel, a competitor organisation is
more profitable than NAW Group, then that distribution channel may not be interested in working with NAW
Group.
Product profitability is affected by costs such as manufacturing costs. On the other hand, customer
profitability is affected by selling and distribution costs i.e. post-manufacturing costs. However, in
conventional accounting, post-manufacturing costs are treated as period costs. It is argued that, although
such treatment is acceptable for financial reporting, for management reporting such costs should be
allocated to the customers. This is because the requirements of different customers are different and
accordingly their profitability is affected.
Therefore, use of activity-based techniques may be a better way to allocate such post-manufacturing costs
to the customers. This will enable the cost consumed by different customers to be identified and accordingly
help in controlling the costs to the customers.
From the statement of budgeted customer profitability given above, it is clear that all the customer groups
are profitable. However, a significant amount of the contribution generated by the supermarkets and other
retail outlets is consumed by customer specific costs as shown in the following table:
Giving calculations to support your answer will add value to your
answer. These calculations provide the basis for your explanation.
Large
pharmaceutical
stores
Individual
specialist
pharmacies
Supermarkets Others
Contribution ("000) 49,350 27.050 43,350 9.250
Net profit ('000) 39,284 22,460 27,348 6,350
48,464 24,740 41.298
Contribution/Net profit before fixed overheads
ratio (%)
79.60 83.03 63.09 68.65
Contribution before rebate/Net profit before
fixed overheads ratio (%)
98.20 91.46 95.27 68.65
For supermarkets, the major cost allocated is retrospective rebates. Further study of the costs attnbutable to
individual customers under each group will facilitate finer analysis. For example, if delivery cost to a
particular customer is very high or delivery requirements are changing frequently resulting in an increase in
cost, the delivery schedule may be changed so as to decrease the delivery cost and increase customer
profitability.
For such detailed analysis, detailed information (such as the profitability of a particular customer, customer
group, a market in which such customers operate) is needed, which can only be provided by a good
management information system. However, many organisations ignore this and do not have management
information systems capable of providing such detailed information.
Detailed information is needed, especially in the case of service organisations. This is because these
organisations are customer-focused and the cost of service depends on customer behaviour.
1 1 2 : S tr a te g i c P e r fo r m a n c e M e a s u r e m e n l f i T f .
()
In order to improve customer profitability, the following should be considered:
> pricing policies
> business process improvements
> customer relationship management
Pricing policies
By having effective pricing policies, unprofitable customers can be converted into profitable customers. To
do this, it is necessary to identify the costs attributable to the customers. This enables the organisation to
price its individual orders and transactions which affects customer profitability. Effective pricing policies can
be achieved by using activity-based costing where costs are identified with the activities.
As stated earlier, marketing and selling costs affect customer profitability but in practice, such costs are
treated as period costs in financial as well as management reporting. Using activity-based costing, it is
possible to identify the costs attributable to the customers which will help in deciding the price for individual
orders and transactions. If accurate information on costs and prices is available (which can be gathered
using activity-based costing), this will enable customers to identify their costs and take decisions to reduce
such costs e.g. by changing their ordering, shipping and distribution pattern so as to increase their
profitability. This will also help to strengthen the relationship between supplier and customer.
Business process improvements
Customer profitability requires the costs attributable to customers to be reduced. Although reductions in cost
can be achieved by rescheduling the orders etc., an organisation should ensure that the organisation's
internal operations are cost-effective. Cost-effective operations can reduce customer costs to a large extent.
For example, if an organisation notices that most customers order in small batches and the number of
orders is high, it should try to reduce order processing costs by improving its internal processes.
Therefore, as a measure to improve customer profitability, an organisation should conduct a detailed
analysis of each function with respect to technology, utilisation, performance and planning. This will enable
inefficiencies existing within such functions to be identified. However, only the inefficiencies existing within
the functions will be identified and not the inefficiencies within the inter-functional relationships which are
also an important part of an organisation's costs.
Using advanced technology, costs can be reduced to a great extent. For example, if the product is such that
customers look for variety, an organisation may adopt modular design which will enhance the linkage from
design to manufacturing so that a wider range of products can be offered and tailored to the individual
customer's needs without increasing costs.
Customer relationship management
An organisation can achieve an increase in profitability, revenue and customer satisfaction through
customer relationship management. Most modern performance measurement models, such as the balanced
scorecard, require the customer perspective to be considered while evaluating an organisation's
performance. The customer perspective, as explained in the balanced scorecard, indudes the outcome of
measures such as customer satisfaction, retention rate and market share. However, it is necessary to
measure whether loyal, satisfied customers are profitable or not. This is because most resources are
consumed by these customers.
Detailed analysis of what makes customers profitable is unnecessary. This is because a large amount of
investment is incurred on marketing a product and attracting new customers. If the management of an
organisation is aware of the factors that make a customer profitable, this huge marketing cost will be best
utilised in attracting only profitable customers. It is quite difficult to identify profitable customers. This is
because initially, the cost to new customers may be high. Sales, marketing, customer service, training,
professional development, performance management, human resource development and compensation etc.
are the functions related to customers. It is necessary to improve the customer relationship using these
functions so that new customers buy many products and services and prove to be profitable to the
organisation. Therefore, caution should be taken while assessing the profitability of new customers. This is
because initially, many of them may be found not to be profitable but may prove profitable over the penod.
GTG
Solution Rank:ll3
24. Transfer pricing - Able and Baker
(a)
A transfer price is the price one department / division charges for a product or service supplied (i.e. transferred)
to another department / division of the same organisation.
Benefits of transfer pricing system
> Facilitates performance evaluation
A need for a transfer price arises when, in any organisation, there is a huge transfer of goods I services
between two independent divisions and it is important to evaluate the performance of the two divisions
separately. This is because internal transfer of goods affects the divisional performance. Therefore the transfer
pnce should be set in such a way that it will not affect the performance of any division involved in the internal
transfer.
> Motivates divisional managers and maintains divisional autonomy
If a transfer pricing system exists, divisional managers can take decisions in the best interests of their divisions.
This will motivate the divisional managers and will also help to maintain divisional autonomy.
> Facilitates divisional performance measurement
When divisional managers have the autonomy to make decisions, they will always try to maximise the profit of
their divisions. Internal sale of goods free of cost affects the performance of the selling division. In the case of
internal sale, it is difficult to measure the performance of the division. This also affects the comparability i.e. it is
difficult to compare the performance of a division which transfers its goods internally with the performance of
another division which doesn't carry out internal transfer.
In such a case, setting the transfer price at a level that does not affect the divisional performance is the solution
to all the above mentioned problems.
^ Tax minimisation
Usually, in the case of multinational companies, transfer price is used to minimise the tax expense of the
company as a whole. This is done by setting the transfer price in such a way that the profit of the division for
which the tax rates are higher is low and the division for which the tax rates are lower makes higher profits.
> Goal congruence
With the help of transfer price, divisional managers can be motivated to take decisions which improve divisional
profit as well as the profit of the organisation as a whole.
Allocating divisional resources optimally
Transfer price provides information about the extent to which internal transfer is made by one division to
another. This will help in deciding the level of output for particular goods I services and the investment
requirement (investment in machinery, manpower etc.) of the selling division.
In this question, the explanation to justify your calculations is equally important as the calculations
themselves. Therefore do not forget to give an explanation for your answer otherwise you will lose
marks.
While answering such questions, remember that opportunity cost should be considered only when
any of the divisions is losing income. In addition, remember that fixed cost is not relevant in taking
transfer pricing decisions, unless it changes with the production capacity. Therefore only differential
costs such as variable costs or any cost incurred if the product is marketed are relevant.
Do not miss out this point as it is very important!
(b)
1 1 4 : S tr a te g i c P e r fo r m a n c e M e a s u r e m e n l fi Tf.
(i) When division Able has spare capacity and limited external demand for product X.
If Able has spare capacity, it can sell the product at any price, as long
as it is above the variable cost of production of product Y, since this
is the additional cost of production of product X. This means that Able
can sell at any price above $35.
On the other hand. Baker will be ready to pay any pnce below $38
which is the price at which the same product can be purchased from
outside.
Remember, since demand for
product X is limited and Baker
is the only customer for
product Y there is no
opportunity cost involved in
deciding the transfer price.
This shows that the transfer pnce should be any price between $35 and $38. However, before taking any
decision the following points should be considered:
> The price should provide some incentive to division Able.
> The price should encourage division Baker to purchase internally.
> Goal congruence should be obtained.
In the exam, do not give the
alternative solution.
Alternatively. $3 ($38 - $35) can be split equally between the two divisions i.e. average of $35 & S38 can be
taken as the transfer price. Therefore the transfer price should be $36.50.
(ii) When Able is operating at full capacity and demand for product X is unlimited, an additional unit of product
Y can be produced only by eliminating a unit of product X. Therefore opportunity cost is involved in deciding
the transfer price for product Y.
The opportunity cost to division Able is calculated as follows:
$
Selling pnce per unit of product X 42
Less: Variable cost of product X 32
Contribution 10
The contribution forgone of product X is the opportunity cost to division Able.
The variable cost of production of product Y plus the opportunity cost comes to S45 ($35 +$10).
Therefore. Able will not agree to sell product Y to division Baker at any price which is below $45.
However, division Baker will not agree to pay any price above $38, which is the price at which it can
purchase product Y from the external market.
In the above situation, in order to obtain goal congruence, division Able should continue to make product X
and sell at a contribution of $10 and division Baker should purchase product Y from the external market. As
a result, division Baker has to pay $3 more than the price it would have paid had it bought the product from
division Able at a variable cost i.e. ($38 - $35). This decision will be beneficial for the company a whole
since effectively the company earns $7 ($10 - S3). In this way. the profit of division Able as well as of the
company as a whole can be maximised.
Alternatively, if as a company policy, it is obligatory to purchase internally, the difference of $7 ($45 - $38)
should be divided in two and borne by both the divisions. The resulting transfer price will be decided by
adding S3.50 to $38 or subtracting $3.50 from $45 i.e. $41.50...
(c)
Remember, only including the data that are required from an information system is not sufficient.
You should explain how these data are used in taking transfer pricing decisions, or else you will lose
marks.
In order to save time, do not mention more than seven types of data that are required from an
information system.
GTG
Solution Rank:ll5
An information system should be able to provide the following information that can be used to decide the
transfer price:
Data Use
Whether a perfectly competitive market is in
existence
As a basis for deciding transfer price
To decide need to consider opportunity cost
If market is not perfectly competitive, whether
any other customer is available
To calculate opportunity cost, if consideration is required
Availability of production capacity To decide need to consider opportunity cost
Market demand for products To decide need to consider opportunity cost
Any other limiting factor
To take make or buy decision
To decide need to consider opportunity cost
To decide how to overcome the limiting factor
External market price
To calculate contribution from a product
To calculate opportunity cost, if necessary
Variable cost
To calculate opportunity cost, if necessary
Cost incurred only if the product is marketed To calculate opportunity cost, if necessary
Shadow price
To determine whether the additional resources can be obtained
and if so, at what price.
25. Transfer pricing - Alpha and Beta division
(a) m y ^ ^ ^ m
This is a very good question to test your understanding of how to set a transfer pnce. This is a
scenario based question therefore do not give a general answer. In addition, give an appropriate
example in support of the explanation given, to make it clear that you understand the concept
thoroughly.
(i) A transfer price aims to achieve goal congruence, maximise the profitability of the group and maintain the
autonomy of the divisional managers.
In order to achieve this, the receiving division agrees to pay an amount less than the external market price.
The supplying division, when operating at full capacity, agrees to sell at the marginal cost plus opportunity
cost. This means the price is dedded as the marginal cost to the supplying division plus the opportunity cost
to the organisation.
When the supplying division is operating at full capaaty, the opportunity cost to the division (or to the
organisation) is the contribution earned by selling in the external market, which is the external market price
less the variable cost.
For example, if the external market pnce is S15 and the variable cost is $12. the opportunity cost is S3 (S15
- S12). Therefore the transfer price should be S15 (S12 marginal cost plus S3 opportunity cost).
Therefore, when Alpha division is operating at full production capacity and requires to transfer products
internally, goal congruence suggests that the transfer price should be the market price.
(ii) The supplying division may transfer goods internally at a price which is lower than the market pnce when it
is not operating at full capacity and when marketing the product would require additional cost to be incurred
in comparison to transferring the product internally.
In the given case, it is stated that Alpha is operating at full capacity. In such a case, there is only one set of
circumstances in which Alpha can sell the product at less than the market price and yet maintain the
profitability of the organisation.
This is when it is incurring extra costs to market the product such as packaging costs and transportation
costs. For example, consider that, out of a total cost of S12, the cost of packaging the product is S1 and the
cost of transporting the product is S1.ln this case, the actual marginal cost to Alpha division would be S10
($12 - S1 - S1). Therefore the internal transfer price would be S13 (S10 marginal cost plus S3 contribution
forgone, as calculated above).
1 1 6 : S tr a te g i c P e r fo r m a n c e Measuremenl fi Tf.
This part of the question requires you to comment on the following:
> the impact of all three bases
> the acceptability of all three bases to the receiving division
the acceptability of all three bases to the supplying division
Therefore read the question carefully and note down the requirements so that you do not leave any of
them out.
Actual cost plus 25% profit mark-up
When actual cost plus 25% profit mark-up is the basis, this allows the supplying division to transfer its
inefficiencies to the receiving division. This will improve the performance of the supplying division and therefore
will be acceptable to it. On the other hand, it will affect the performance of the receiving division adversely and
therefore will be unacceptable to the receiving division.
For the group, this basis will not have any impact on its profitability since the cost is transferred from one
division to another division within the organisation. However, this may discourage the receiving division and
indirectly affect the performance of the group in future.
Standard cost plus 25% profit mark-up
As a result of this pricing strategy, the supplying division will be prohibited from transferring its inefficiencies to
the receiving division. Therefore this basis will be acceptable to the receiving division and good for the group.
However, if there is a significant difference between the standard cost and the actual cost and the supplying
division is unable to control its cost (which is not because of inefficiency of the supplying division), then the
supplying division may not agree to this.
Revised standard cost plus 25% profit mark-up
Under this method, the inefficiencies of the supplying division will be categorised as operational vanances and
any increase in the cost for any reason beyond the control of the supplying division (e.g. an increase in the raw
material prices or labour cost) will be categorised as a planning variance. Planning variances will be considered
in order to revise the standards. Therefore, under this basis, the interests of both the divisions as well as of the
group will be protected, as the supplying division will be able to pass on only the increase in the cost due to
reasons beyond its control.
Therefore this basis will be acceptable to both the divisions.
This is a challenging question. In this question, you are required to calculate the transfer price for
3.000 units (which is the spare capacity) and also for the remaining units.
You need to read the question carefully and make sure that you understand its requirements. In
addition, you should give explanations for your calculations since these explanations are the basis for
your answer.
In order to answer this question correctly, you need to have a thorough knowledge of where to use
opportunity cost. Opportunity cost is to be considered only when the division is operating at full
capacity and it has an external market. In addition, do not forget to consider packaging cost which is
avoidable.
In this case, Alpha is not operating at full capacity and therefore, by selling goods internally, it is not losing any
contribution (i.e. there is no opportunity cost). Therefore it should sell at a marginal cost. However, the marginal
cost should be calculated after deducting the packaging cost (which is avoidable if the product is transferred
internally).
GTG
Solution Rank:ll7
Therefore the transfer price for 3,000 units would be calculated as follows:
Selling cost =Total cost +25%
= $20
Therefore,
Total cost =$20 x 100/125
= $16
Let the cost be S100
Profit given is 25% on cost
Therefore, selling price =$100 +S25 =$125
Therefore if the selling price is given as $20,
the cost will be calculated as follows:
S20x 100/125
Variable cost =75% of total cost
= $12
Adjusted variable cost =Variable cost - Packaging cost
= $12-1.5
=S10.5
The remaining units, i.e. any units produced over and above the 3,000 units, should be transferred at the
adjusted selling price of $18.5 which is the selling price less the packaging cost ($20 - $1.5).
26. Not-for-profit organisation - AV & BW
(a)
I In this part of the question, it is necessary to write about the following points:
> what value for money is
> the 3 Es of value for money
> how it can be measured (by management, benchmarking)
> any other relevant comment
Only explaining the concept of value for money is not sufficient to get good marks.
Generally, value for money signifies economy, efficiency and effectiveness relating to the internal operations
of an organisation and its use of money.
Economy implies the principle of prudence i.e. the minimum costs that should be incurred for acquinng / using
resources, while maintaining quality. For AV, economy is related to purchasing the materials required. All
purchases dunng the period such as those for maintenance and repair work e.g. fitted kitchen, heating equipment,
windows and doors of 3-bedroomed properties, should be at minimum cost without compromising on quality.
Therefore, while assessing the economy, the management of AV should keep in mind that cost cutting
should not be at the cost of quality because this is not economy but "false economy'.
Efficiency is concerned with the relationship between resources (input) and the output of goods, services or other
results. Ideally, it can be achieved by any of the following:
> using minimum input for the same output
> obtaining maximum output with the same input
^ increasing output by a greater proportion than the increase in input
> decreasing input by a greater proportion than the decrease in output
In the case of BW, efficiency may be in the form of employee efficiency i.e. more work is performed by the same
number of employees for the same salary or more repair and maintenance work is carried out i.e. the maximum
number of units are replaced for the same maintenance and repair cost. This can be achieved through obtaining
the tender for repair work and selecting the one whose cost is less. Doing this, economy as well as efficiency
may be achieved.
Effectiveness is concerned with the relationship between planned results and actual results. It measures the extent
to which the outputs of goods or services successfully achieve operational goals. A non-profit seeking organisation,
such as AV. may have a number of objectives, such as the following:.
> to meet accommodation needs
> to provide quality service and accommodation
> to meet customer expectations
> to provide an effective care and repair service
> to support the community within which it operates
The management of AV should be aware that the three performance measures require individual
consideration since one measure alone may not give an indication of the other e.g. efficiency or economy
in decisions may not give an indication of the efficiency. In the case of AV, the amount spent i.e. 5234,000,
indicates that the decision was economical because if AV had purchased the same replacement kitchen units as
BW. then AV would only have been able to refit only 45 properties ($234.900/$5.220). However this does not
indicate that AV's equipment was of a similar or better quality.
The management should be aware that these measures may sometimes conflict with each other. For example, if
we consider the above example where AV purchased more than BW (i.e. 90 kitchen fitted properties for
S234.000 whereas BW could purchase only 45), AV may have compromised on effectiveness i.e. the properties
purchased by BW may give a higher level of effectiveness i.e. longer life, enhanced aesthetic 'appeal' to
residents, safety etc.
The performance of AV can bo better measured by adopting benchmarking against similar charities
whose primary objective is the provision of accommodation to the communities in which they operate
Benchmarking is a good method of measuring performance because it enables a comparison of the processes,
costs etc. with those of a close competitor. In addition, in the case of not-for-profit organisations where profit is
not a prime objective, it may be possible to obtain such information which is usually quite difficult in the case of
profit-seeking organisations (for them it may be a commercial threat to share sensitive information). However, it
is often difficult to find a suitable benchmark with organisations sharing the same objectives and operating in the
same environment under similar circumstances. For example, the management of AV can enquire about a
norm' in respect of the repair charges or fitted kitchen or windows / doors replacement charges from similar non
profit-seeking organisations.
Do not write a very detailed answer. Instead write only two points for each measure, since only 0.5
marks are allotted to each point. This part of the question is worth only 2 marks.
The building block model proposed by Fitzgerald and Moon, gives six dimensions of performance measurement
including service quality and flexibility.
> service quality
Service quality can be measured by the number of complaints from customers, customer feedback, customer
retention rate / loyalty etc. In the case of AV. the following performance measures can be used to assess the
service quality:
v' behaviour, attitude, proactivity of staff employed by AV
extent of luxury / amenities provided
This could be measured by asking tenants to fill in questionnaires or by asking them to give more general
feedback, complaints etc.
> flexibility
Generally, flexibility can be measured through delivery time, promptness in responding to customer requests,
ability of employees to perform different kinds of work etc. In the case of AV the following performance
measures can be used to assess the flexibility:
GTG
Solution Rank:ll<J
J mean waiting time for a house to become available to a tenant
v mean waiting time to give another house of a different size to a tenant after receipt of a request from a
tenant
J waiting time for undertaking repairs of an emergency nature, once notified by a tenant
(ii) The management of AV could use the following performance measures:
You may consider other points such as percentage of rent
collected, day-to-day repair cost per week per house.
The average staff & management cost, per week per house
This can be calculated by dividing the staff and management cost by the number of properties.
AV BW
The average staff & management cost, per week per house.
[450.000/(900 x 52)] and [620.000/(400 x 52)] $9.61 $29.81
The average staff and management cost per week per house of BW is $20.20 (67.76%) more than that of AV. In
addition, although the number of staff employed is the same for organisations, the total staff and management
cost to BW is S 170,000 (27.42%) more than that of AV. This is because of the different pay structures and
remuneration policies in both the organisations.
\ The analysis is very important; don't
The average day-to-day repair cost per week, per house just reproduce what is in the table
AV BW
The average day-to-day repair cost per week, per house
[478.320/(900 x 52)] and [127.600/(400 x 52)] $10-22 $6-13
The average day-to-day repair cost per week per house for BW is $4.09 less than that of AV. This is an increase
of 40%. This may be due to the fewer repairs required and the fact that there is no extra cost required for
emergency and urgent repairs. The cost of repairs whether emergency, urgent or non-urgent to BW is the same,
$100 |127.600/(230 +752 +204)] whereas the cost of emergency repairs to AV is $140 ($134,400/960). urgent
$120 ($225,600/1.880) and for non-urgent repairs it is $116.
BW's low cost of repairs (which is identical for all types of repairs - emergency, urgent and non-urgent) may
have been achieved through entering into a contractual agreement for repairs. AV should also think of
entering into such contracts in order to save money.
Percentage of rent lost
AV BW
Percentage of rent lost
[(36.348/(2.386.852 +36.348)] and (2.500.000/2.500.000) 1.5% -
BW did not have any unoccupied properties at any time during the year; it has 100% occupancy. This shows
that BWs properties are in high demand. On the other hand, AV has lost rent worth $36,348 through unoccupied
properties; this is about 1.5% of the gross rent receivable.
The management of AV should identify the reason why the company's houses remained unoccupied when the
occupancy rate is 100% for a competitor such as BW.
27. Not-for-profit organisation - GA and EA
For questions in which calculations are involved, while going through the question, note down the
relevant information such as working days for GA and EA. This means that, after you finish reading
the question, the information is already available and you can quickly work out where to use which
information. This will save you time.
In addition, if any question is made up of two sub-questions make sure that you answer both. For
example, in part a' of this question, you are asked to evaluate the operating as well as the financial
performance of both the companies. In such a case you should not miss out any part i.e. you should
consider both the companies and the operating as well as financial performances.
Do not forget to write calculations. Even if marks are not allotted, giving calculations in appropriate
places will help you in writing your analysis and will help the examiner to identify the basis of your
answer
Operating performance
Operating performance can be measured by determining the occupancy rate i.e. the companies' ability to serve
customers.
Passenger fares and cargo income are the only sources of business therefore, while assessing the operating
performances of GA and EA. the occupancies of the aircrafts and helicopters are critical.
The occupancy I utilisation rate can be compared with the budgeted rate and that of the previous year to give a
better analysis.
The actual and budgeted levels of total occupancy (including concessional fare-paying passengers) achieved /
to be achieved were as follows:
Year
GA EA
Year
Occupancy(%) \
Year 2006
2007
Budget
2007
Actual
2006
2007
Budget
2007
Actual
Domestic 55 58 48 60 65 67
International 65 58 60 57 65 70
Helicopter services 85 85 82 - - -
Cargo 50 50 50 60 70 75
It is important
to give the
calculations as
they are worth
marks. This
calculation, for
example, is
worth 2 marks.
This shows that, in the case of GA, for all other services except Cargo services, the occupancy rate has fallen
from the level achieved during the previous year and is also below the budgeted rate. Moreover, the occupancy
rate, in the case of domestic services, includes the senior citizens who receive a discount of 50%. The
occupancy rate of the fully paying passengers is therefore even lower than what is shown in the table.
On the other hand, EA has exceeded expectations. Its occupancy has increased from that of the previous year
and is also above the budgeted rate.
From the above, it can be concluded that EA is slowly taking over the market of GA. This will be harmful for the
survival of GA.
> fiTG
Financial performance
Sales volume, net profit, net profit ratio. ROI etc. r
an organisation.
The following information is related to GA and EA:
Solution Rank:l21
can be used to assess the financial performance of
GA EA
2006
Actual
2007
Actual
2007
Budget
2006
Actual
2007
Actual
2007
Budget
Turnover (S'000)
Net profit ($ 000)
Net profit ratio (%)
Assets (WDV)($'000)
15,470,120
3.926.640
25.38
2,240,000
14,618,720
2.992.816
20.47
2,016,000
15,922,960
4,298,960
27.00
2,016,000
12,063.744
3,211,680
26.62
7,000,000
15,584,992
5,139,552
32.98
6,300,000
14,579,680
4.686.080
32.14
6,300,000
GA
When financial performance is considered. 20X7 proved to be a bad year for GA since it could not meet its
targets and also performed badly as compared to the previous year i.e. 20X6.
The revenue of GA has fallen by 5.50% [S(15.470.120 - 14,618.720) / 15,470,120 x 100], from the previous year
and is $1,304,240, i.e. 8.19% ($(15,922,960 - 14.618,720) /15,922,960 x 100], below the budgeted figure.
Profit for the year 20X7 has decreased by 23.78% [$(3,926,640 - 2,992,816) / 3,926,640 x 100], from 20X6 and
is 30.38% [$(4,298,960 - 2,992,816) / 4,298,960 x 100], below the budgeted profit.
As stated in the question, one of the reasons for the increase in the costs of GA is its higher insurance cover for
its passengers and on-board staff. Although this concern for society is good, it also affects the financial
performance of GA.
Fixed costs have increased to a large extent. Repair and maintenance costs, in particular, have increased
disproportionately. This has a great impact on the cost. ~ ~
Although the revenue has decreased, all the costs have
A
P
art f rom the
general
increased. This shows a very poor control over the costs. 1 discussion, such comments are
necessary since they will help
The WDV of the fixed assets of GA is much lower than that of EA.
Therefore, it seems that GA is operating old aircrafts on flights, V ^
Th
analysis is very
leading to higher maintenance and operation costs. This may also
increase the risk of accidents leading to higher insurance premiums for
the aircrafts (and further contributing to higher costs).
important; don't just
reproduce what is in the
table
EA
In contrast to GA, EA performed very well in the year 20X7. Its revenue i profit for the year 20X7 have increased
beyond the budgeted levels. The performance of EA. when compared with the previous year, shows fast
growth. This may be because EA announces attractive schemes from time to time and operates for 345 days a
year which is more than GA (which operates for only 325 days), amongst other reasons.
The net profit of EA has increased by 60% [$(5,139,552 - 3,211.680) / 3,211.680 x 100) in companson to the
previous year and is 9.68% [5(5,139,552 - 4.686,080) / 4,686,080 x 100] above the budgeted figure
Although variable costs as well as fixed costs are higher than the figures for both the previous year and the
budget, we can relate this to the increased revenue.
(b)
rt
This part of the question is made up of three questions worth equal marks. Your answer should be in
accordance with the number of marks available. Don't make any answer too long or too short.
In (i) each point is worth two marks and the maximum number of marks is five therefore writing 3
points is enough as long as you can explain them properly.
In (ii) five items of additional information are asked for and there are 5 marks available therefore do
not give more than 5 items. However, do not forget to explain how such additional information is
helpful, otherwise you will lose marks.
(iii) is worth 5 marks. Relate your answer to the given scenario.
(i) It is not feasible to compare the performance of GA with EA. This is because of the following reasons:
> funding pattern
GA is substantially funded by the government and therefore may have certain obligations to fulfil in order to
ensure continued financial assistance. For example, GA may have to provide all the necessary services
even if some of them are not profitable.
On the other hand, EA has raised funds by way of long-term
loans for which it has to pay a heavy amount as interest
which is not the case for GA.
> objectives
In the exam, make sure that you
apply your knowledge to the given
scenario; this will help you to earn
From the information given, it seems that GA is a not-for-profit company whereas EA is profit seeking company.
This means that there will be basic differences in their primary objective. GA assumes its social responsibility
and therefore continues to provide services / routes even if they are not profitable; provide concessions to
senior citizens who affect its revenue; and takes higher insurance cover for its passengers and on-board staff
which increases its cost substantially.
On the other hand, the decisions of EA are motivated only by profit.
> assets
The WDV of EA's assets is higher than that of GA's assets which suggests that EA uses good aeroplanes which
may be more comfortable, newer etc. than those of GA. Since the WDV of EA's aeroplanes is higher, the
depreciation cost is high which will affect EA's financial performance.
> unavailability of additional information
The given information is not sufficient to evaluate and compare the two companies. This is because, as
mentioned in the above point, although the use of new aeroplanes may adversely affect the financial
performance of EA it may also have improved EA's service quality and thereby attracted new customers.
Additional information on the number of staff employed, the routes etc. of the two companies would be useful in
order to compare them effectively.
In addition, GA is, to some extent, under the control of government. On the other hand, being free to take
decisions. EA can change its policies frequently and thereby take advantage of the current circumstances in the
market. For example, EA can offer discounts to customers who book tickets 2-3 months prior to the scheduled
takeoff date in order to attract more customers and those who book just 2-3 days in advance can be charged
heavily.
GTG
Solution Rank :23
(ii) The additional information required for detailed analysis of the performance of GA and EA and how that
helps in assessing performance includes the following:
In-flight services, quality of food / beverages provided Service quality
Flight schedule delay, cancellation of flights Competitiveness
Man-equipment ratio, staff employed, revenue / cost per staff Resource utilisation, productivity
Quality of service provided to the customers, behaviour! attitude of
staff
Service quality
Models used for passenger service as well as for cargo services Service quality
Safety / accident records Service quality
New routes added, number of aeroplanes
Competitiveness, business growth,
flexibility
Enquiries converted into sales Competitiveness
Customer retention rate Customer satisfaction, competitiveness
The above mentioned information on measures such as competitiveness, quality of service, flexibility and
resource utilisation may help in measuring the performance of GA & EA.
(iii) The following three decisions taken by GA indicate that GA is a not-for profit organisation:
> having higher insurance cover for the passengers and on-board staff
> providing concessions to senior citizens
r- not eliminating any service / route only because it is not profit making
Impact of these decisions on the financial performance of GA
^ Higher insurance cover: as a result of this, the cost may increase to a large extent and affect the short-
term financial performance.
s Concession to senior citizens: the decision to provide a 50% discount to senior citizens has an adverse
impact on the short-term performance of GA. This is because, out of the total occupancy, 10% are senior
citizens and therefore, in the domestic market. GA is losing 50% of its fares on 10% of its clients, which is a
significant amount.
v However, such decisions may result in increasing the financial performance of GA in the long term. For
example, taking higher insurance will not only help the company to discharge its soaal responsibility but will
also increase its customer and employee satisfaction and accordingly increase its customer retention rate
and reduce employee turnover.
(c) Importance of qualitative information
From the information given on GA and EA, only their short-term performance can be measured. Net profit ratio,
revenue generated, profit earned during a year etc. are all short-term measures. These measures do not
highlight the strategies which have a long-term impact. GA's decisions to provide more insurance cover and to
continue services in remote areas might prove fruitful in the long term. Only qualitative information can reveal
the impact of such decisions in long term. Information that GA's decision to take higher insurance cover for its
passengers and on-board staff shows that as a result of this decision, the overall cost has increased. However,
more information (especially qualitative) is needed for detailed analysis.
Qualitative information gives information over and above quantitative information and therefore facilitates finer,
more detailed analysis. For example, in the given case, the information that GA's costs for the year 20X7 were
higher than those of EA would have misied the analyser by giving the impression that the increase in vanable
cost is on account of the inefficiency of GA. However, the additional information that GA has taken out higher
insurance cover for its passengers and on-board staff gives a clear reason for the increase in the costs.
In addition, the information that even if a route / service is not profit making. GA will continue to provide it. gives
more evidence that the objectives of GA are different from those of EA.
The qualitative information provided in the question communicated that GA is a not-for-profit company and
provided more detailed information about the objectives of GA. In the absence of this information, proper
performance measurement may not be possible.
Other qualitative information such as information on-time departures / arrivals, employee behaviour, the
customer as well as employee satisfaction and the number of individuals employed etc., if provided, will facilitate
better companson between GA and EA.
In addition, information on customer satisfaction, customer complaints and retention rate will help in predicting
the future performance of GA and EA. From the given information, it can be concluded that EA is performing
very well and is growing very fast. However, this may be a result of its strong marketing strategies which may be
effective only in the short term. Often decisions are taken which lead to good performance in the short term but
at the cost of long-term performance. In such cases, qualitative information enables users to gain some idea
about the future performance.
A
Score Mor e
Qualitative information provides additional information over the financial information and
therefore facilitates better analysis. Qualitative information focuses on long-term
organisational strategies whereas quantitative information, especially financial information, focuses
on short-term performance and provides a short-term vision. If qualitative information is not used for
performance evaluation, managers may be tempted to take dysfunctional decisions.
Note: the answer given above is not a wrong answer but it will not earn you good marks. This is
because, according to the question, you should highlight the importance of qualitative information in
assessing the performance of GA and EA. In addition, you have not provided a proper explanation
of your points. For example, when you state that qualitative information gives information over and
above quantitative information, you should explain how i.e. as explained in the original answer
above, with the example of increase in operational cost.
28. Behavioural aspects of performance management
rt
For this question, read the question carefully and note down the key information before
start answering.
If the key informations are noted down well in advance you can keep track of your
answer and make sure that you have answered all the requirements.
This will save you time and prevent you from loosing marks.
(i) The term short-termism refers to the tendency to focus on immediate gain without considering the long-
term consequences of the decision.
For example, in a machine shop {i.e. a cost centre), in order to reduce the costs of the period, the manager
may decide not to spend money on preventive maintenance. This decision may improve the efficiency of
the cost centre, but at the cost of running the risk of break-down of the machinery leading to a halt in
production and potentially huge loss of profit.
Similarly, in the budgetary process, there may be unjustified focus on allocating scarce funds to help
improve short-term performance measures, such as idle time percentages on existing machinery or the
sales volume of a product which is in the declining phase of its life cycle. These scarce funds could,
however, be better utilised in increased market research into new areas of customer demand or in research
and development work into improved methods of production, perhaps focusing more on production layout
dedicated to individual projects or products. These measures will ensure the long-term viability of the
organisation.
Short-termism and financial manipulation of results are caused by over-emphasis on short-term
performance evaluation and too much focus on immediate profitability. Managers whose incentives are
linked to profitability will be interested in boosting immediate revenue or in postponing the costs as far as
possible in order to improve profitability.
GTG
Solution Rank :25
(ii) This implies behaviour and activity in order to achieve specific performance indicators which may not be
effective. For example, machine output efficiency may be measured as the ratio of output achieved (in
standard hours of work) to total operating hours.
Efforts to improve this measure from, for example. 95% to 99% may focus on increasing machine speed in
order to increase throughput rates. This may not be an effective course of action. The increase in machine
speed may create problems in maintaining the quality of output. This could lead to greater losses in
process and/or problems with the finished product when It reaches the customer, resulting in returned
goods and possibly the loss of future orders.
(iii) Oversimplification of performance measures may lead to their misinterpretation. It may involve failure to
identify the intncacy of the environment in which the organisation operates. A drop in the volume of sales for
a product may be seen as an indication that greater focus on market promotion activity is required. This
interpretation ignores the likelihood that a number of other factors, both internal and external, may be
contributing to the reduction in sales volume (for example, internal problems with the quality of output, with
meeting delivery dates to customers or with maintaining good relationships with customers). External
problems may include increased competition from alternative products, the introduction of new product
features by competitors or increased sales efforts by competitors. In addition, factors such as a decrease in
customers' purchasing power or changing customer tastes may be pertinent.
(iv) The deliberate distortion of a measure in order to increase strategic advantage may be resorted to for
different reasons. It may involve purposeful under-performing in order to avoid higher targets being set for a
future period. For example, the restriction of departmental consultancy earnings in a university department
in order that the target for next year will not be increased and/or to hold back consultancy possibilities which
are 'in the pipeline' in order to create slack.
(b) Examples of actions which may be implemented in order to overcome problems in the operation of a
performance measurement system are as follows:
Involvement of staff at all levels in the development and implementation of the performance measurement
system is important to overcome behavioural problems. Staff involvement in the development and
implementation of the system helps in improving staff willingness to accept and work towards any
performance measures which are developed to monitor their part in the operation of the organisation and
the achievement of its objectives.
^ A flexible approach to the use of performance measures makes the measurement system more acceptable.
It is best to acknowledge that they should not be relied upon exclusively for control. Sometimes
performance may be improved through the informal interaction of individuals and groups.
> The 'dimensions of performance' need to be given careful consideration. Action here may indude efforts to
quantify all objectives.
Quantifying all objectives should help to overcome a sub-optimal plan which omits some aspects of what is
required. Moreover it is important to focus on customer satisfaction. This will help ensure an external focus,
which is vital to the level of achievement and future effectiveness of the organisation.
Audit of the system is essential in order to make the system effective. This may include an external review
of the system by an expert. An 'arm's length' review will help to eliminate any inefficiency in the system due
to the views of those operating the system. In addition, there should be a careful audit of the data used. Any
scheme is only as good as the data analysis and how the data are interpreted. A focus on key features is
necessary in the system. These may include nurturing a long-term perspective among staff; restricting the
number of performance measures to allow focus on key areas and developing performance benchmarks
which are independent of past activity in order to focus on the way ahead and the achievement of plans for
the future.
Relevant alternative examples and comment would I
accepted
29. Performance measurement - Sportstown and Totaleisure
(a)
I
For case study based questions, read the question carefully and note down the relevant
information. This means that, after you finish reading the question, the information is already
available and you can quickly work out where to use which information. This will save you time.
In addition, you can note down the sub-requirements of the question. For example, in this part of
the question, you are asked to discuss the operating as well as financial performance of both the
companies. In the exam, there is a possibility that you may lose marks by accidentally missing out
one of the sub-requirements, e.g. the operational performance of Totaleisure. However, if the sub-
requirements are noted down well in advance you can keep track of your answer and make sure
that you have answered all the requirements. This will save you time and prevent you from losing
marks.
(i) Operational performance
Operational performance can be measured by determining the facilities utilisation ratio. The utilisation ratio can
then be compared with the budgeted ratio and that of the previous year for a better analysis of operational
performance. The calculations of the utilisation ratio are as follows, considering daytime occupancy, evening
occupancy and occupancy for the whole day.
It is important to give the calculations as they are worth marks.
Sportstown Totaleisure
Daytime
(50 +70 +15 +50)
=46.25
(20 +40 +25 +40)
=31.25
Evening
(80 +70 +50 +50)
=62.5
(85 +80 +85 +60)
=77.5
For the whole day
(50 +70 +15 +50 +80 +70 +50 +50)
8
=54.4
(20 +40 25 +40 +85 +80 +85 +60)
8
=54.4
The above calculations show that, during the daytime, the utilisation ratio of Sportstown is 15% higher than that
of Totaleisure but in the evening, the utilisation ratio of Totaleisure is 15% higher than that of Sportstown. This
means that the utilisation ratios of both Sportstown and Totaleisure for a day are equal i.e. 54.4% (assuming
that the same weighting is given to daytime and evening).
However, in the case of Totaleisure. the usage varies to a great extent i.e. usage is 31% during the day and a
very high 78% in the evening. On the other hand, the usage of facilities of Sportstown is balanced. Balanced
usage is beneficial as it will allow maintenance of the facilities to be undertaken and will also ease traffic
congestion. For Totaleisure. in the evening, when many people may want to use the same facility, this will cause
chaos and potentially increase customer complaints.
Sportstown offers free access to all facilities to local schools which may be the reason behind its high utilisation
ratio during the daytime.
GTG
Solution Rank :27
(ii) Financial performance
It is important to give the calculations as
they are worth marks.
Sportstown ($'000) Totaleisure ($'000)
20X0 20X1
Budget
20X1 20X0 20X1
Budget
20X1
Revenues (W1) 700.00 606.20 792.40 850.00 1,000.00 950.00
Less: Costs
Salaries 450.00 500.00 550.00 350.00 400.00 350.00
Maintenance 150.00 200.00 200.00 75.00 100.00 90.00
Depreciation 25.00 25.00 25.00 50.00 50.00 50.00
Other costs 125.00 75.00 125.00 100.00 150.00 150.00
Loan interest - - - 200.00 200.00 200.00
Profit / (loss) (50.00) (193.80) (107.60) 75.00 100.00 110.00
Financial ratios
Assets (WDV) 400.00 375.00 375.00 800.00 750.00 750.00
Profit/Assets (%) (12.50) (51.70) (28.70) 9.40 13.30 14.70
Profit/Sales (%) (7.10) (32.00) (13.60) 8.80 10.00 11.58
Workings
W1 Revenue
Remember, even if separate marks are not allotted to any answer,
giving calculations in appropriate places will help you in writing your
analysis and will help the examiner to identify the basis of your
answer. Therefore do not forget to give workings.
Revenue for Totaleisure 1,700x500 = $850,000
2,000 x 500 = $1,000,000
1,900 x 500 = $950,000
Sample calculation of revenue of Sportstown (20X1 actual)
Opening
hours(A)
Paying
people
(B)
Price $
(C)
Number of
days
(D)
Total $
(A x B x C x
D)
Squash 12 6 4 350 100,800
Swimming 10 29 2 350 203,000
Gym 12 20 3 350 252,000
Badminton 6 6 4 350 50,400
606,200
Totaleisure has performed well in the Year 20X1. It is a profit making company and profit has increased by
$25,000 ($100,000 - $75,000) i.e. 33.33% from the previous year. However, this figure is $10,000 ($110,000 -
$100,000) i.e. 9% below the budgeted figure.
The revenue of Totaleisure has increased by $150,000 ($1,000,000 - $850,000), i.e. 17.65%, from the previous
year and is $50,000, i.e. 5.26%, above the budgeted revenue. Although
the actual revenue is more than the budgeted revenue, the actual profit is j The analysis is very
less than the budgeted profit. This fall in profit is due to an increase in important; don't just
salaries and maintenance costs beyond the budgeted level. Salaries ) reproduce what is in the
are $50,000 ($400,000 - $350,000), i.e. 14.08%, higher than the budget table
and maintenance cost is S10.000 ($100,000 - $90,000), i.e. 11.11%, "
higher than the budget.
The higher value of non-current assets for Totaleisure shows that the company is using new equipment.
This may be the reason that the revenue for Totaleisure is more than that of Sportstown. However, this
results in an increase in depreciation cost and therefore deterioration in financial performance.
On the other hand, in 20X1. Sportstown has performed badly. In 20X1. Sportstown's loss has increased by
about three times its loss in the year 2000 i.e. by 5143,800 ($193,800 - $50,000). In addition, it cannot achieve
the budget i.e. the actual loss is $86,200 ($193,800 - $107,600) higher than the budgeted loss. This increase in
loss may be due to a decrease in revenue and increase in costs such as salanes and maintenance costs.
Revenue has fallen by 23.5% from the level achieved during the previous year and is also below the budgeted
by 23.5%. Salary cost has increased by 11.11 % from the year 20X0 but is 9% below the budgeted salaries.
Although maintenance cost has increased by 33.33% from the previous year, the increase is expected and
therefore budgeted for.
In addition, it is found that the revenue generated from the badminton facility is not sufficient to recover the cost
savings from discontinuing the facility i.e. $50,400 <$60,000. This means that if the badminton facility was
discontinued, it would result in a cost saving of $60,000 and the revenue generated from the facility is
$50,400. Therefore it is better to discontinue the facility.
(b) Validity of appraising the relative performance
Meaningful comparison is possible only when two similar companies are compared i.e. companies operating
under the same environment, with similar risks and objectives. Finer and detailed performance measurement is
possible only when the objectives of both the companies are clear and well defined and performance measures
are also defined. Here, sufficient information is not available regarding the objectives of Sportstown and
Totaleisure.
However, since Sportstown gives free access to its facilities to schools and to senior citizens, this shows that it
assumes its social responsibility and tries to meet a social need. On the other hand, Totaleisure is a private,
profit-seeking company.
Both the companies operate in different financial environments with different objectives and have the following
issues:
Totaleisure
r The higher asset value results in larger depreciation charges.
> It makes significant interest repayments on debt.
Sportstown
> Maintenance charges are higher possibly because the premises are older.
> Losing income due to the free access provision.
> In a private sector business, facilities which are not profitable i.e. uneconomic would have been
discontinued. However, Sportstown is continuing with Badminton facility which is giving negative
contribution.
This difference in the financial environments within which the companies are operating, the difference in
objectives and the different issues affecting them makes it difficult to compare them solely on the basis of
financial performance. Additional information is therefore required i.e. non-financial / qualitative information such
as the safety measures taken by the companies, the behaviour etc. of the staff, customer complaints, customer
satisfaction and the quality of the pieces of equipment.
Finally, in order to compare Sportstown and Totaleisure. additional information and adjustments to the financial
statements (to deal with the issues mentioned above) are required.
The adjustments to be made to the data used to appraise performance in order to compare the performance of
Sportstown and Totaleisure are as follows:
Attributable income: income from those who are not paying presently but will pay if charged.
Interest adjustment: to bnng both the companies to the same level when financial environment is considered.
Discontinuing uneconomic facilities: saving in costs if uneconomic activities are discontinued.
Sportstown Totaleisure
Budget Budget
20X0 20X1 20X1 20X0 20X1 20X1
Original profit (Loss) (50) (193.80) (107.60) 75 100 110
Attributable income (W1) 180 155.90 203.80 - - -
Interest adjustments - - - 200 200 200
Discontinuing uneconomic facilities (W2) 18 9.60 -
Operating profit after adjustments 148 (28.30) 96.20 275 300 310
Workings
W1 Attributable income
Revenue paying customers are only 70% of the total customers therefore the revenue attnbutable to people
who have free access, if charged can be calculated as 30/70. However, only 60% of these will continue if they
will be charged therefore the attributable income will be calculated as 3/7 x 60/100 i.e. 9/35.
A B (AxB)
20X0 700 9/35 180
20X1 Actual 606.2 9/35 155.9
20X1 Budget 792.4 9/35 203.8
W2 Negative contribution
Badminton*
20X1 (6 x 4 x 350 x 6)
20X0 (5 x 4 x 350 x 6)
Budget (10x4x350x6)
Income Cost
Negative
Contribution
20X1 (6 x 4 x 350 x 6)
20X0 (5 x 4 x 350 x 6)
Budget (10x4x350x6)
50,400
42,000
84,000
(60.000)
(60,000)
(60,000)
(9.600)
(18,000)
24.000
* Except for badminton, the revenue generated by all the facilities / activities exceeds their avoidable costs. See
calculations below.
Revenue Costs Contribution
Squash 100.800 21,000 79.800
Swimming 203,000 120,000 83,000
Gym 252.000 51.000 201,000
Badminton 50,400 60,000 (9,600)
606,200 252,000 354,200
(d)
rt
Remember to give only the information which will help you to provide an appropriate and
comprehensive comparison of the financial performance of both the companies. Please do not
mention any non-financial information here. There is a separate question on non-financial
information.
Additional information for appropriate financial performance:
r The reason for the increase in salary and maintenance costs for both the companies.
> Information about the number of employees in each company and their salary structure.
> Revenue and cost per employee per square metre of premises.
Allocation of the revenue of Totaleisure to its facilities since a lump sum fee is charged.
> Further comparative data from other similar companies including publicly owned companies.
> Since Sportstown is a publicly owned company and assumes its social responsibility, further information is
required on whether the price charged by it is the market price or is controlled by the government. This is
because, although the utility ratio per day of both the companies is the same, the revenues are different.
i
^j j p ^ Mention only non-financial performance indicators (both quantitative and qualitative) and not
financial performance indicators. In the answer given below, the NFPIs are categorised as
quantitative and qualitative. However, you may categorise the indicators according to the
dimensions of service quality such as competitiveness, flexibility, service quality, resource utilisation
and innovation.
Non-financial performance indicators can further be categorised into quantifiable and non-quantifiable
(qualitative):
Quantifiable
r number of customer complaints
> number of complaints resolved to the satisfaction of the customer
> man-equipment ratio
> safety and accident records
> customer retention rate
> market share
> number of equipment in good and in bad condition
> waiting time for facilities
> average time required for repairing equipment from when noticed as faulty
> development of new activities
Qualitative
> other services provided at the centres e.g. drink facilities provided in gym
impact on society such as sports development in the area, improvement in lifestyles of senior citizens
> ease of use of facilities
> use of the centre for regional, national and international events
> the extent of innovation and development of new activities
^ the contribution to the health of the community e.g. the participation rate by the over 50s
SOLUTION BANK
o PERFORMANCE EVALUATION
S AND CORPORATE FAILURE
UJ
30. Balanced scorecard and Building blocks
(a)
A
In this part of the question, you are asked to discuss the advantages of using the balanced
scorecard over traditional performance measures. Since the question is worth fifteen marks, you
are expected to explain the advantages of the balanced scorecard and disadvantages of traditional
measures in detail. Do not write just points.
In addition, do not forget to write quantitative measures for each aspect of the balanced scorecard
since this is specifically asked for and is worth marks.
As the name suggests, the balanced scorecard achieves a balance between short-term and long-term
objectives as well as financial and non-financial performance measures. It is a four layer measure which
considers four different perspectives i.e. financial, customer, internal business process and learning process.
The balanced scorecard has an advantage over traditional measures. This is because traditional measures
focus on financial performance only whereas the balanced scorecard, along with financial performance,
considers vanous critical areas of the business such as customers who are critical to the business i.e. without
whom, the business would not be in operation.
In addition, traditional measures focus only on the short-term performance of the business and ignore its long-
term impacts, which may prove risky in the long term. For example, in order to show higher profit in the current
year, a manager may decide to curtail marketing expenses (which may not affect the profitability in the short
term). However, marketing expenses are necessary to maintain business and will therefore affect the long-term
profitability.
On the other hand, the balanced scorecard focuses on the long term. It presents a balanced view of the
performance of the organisation to management. Even before the emergence of the balanced scorecard, some
organisations were using financial as well as non-financial performance measures. However, the balanced
scorecard establishes cause and effect relationships between the four perspectives and attempts to identify the
following for each strategy:
^ the shareholders' expectations from the business
> how customers perceive the business
> the extent to which improvement is needed in the internal processes and how to achieve it
> how to improve and create value i.e. be innovative
In order to answer these questions, the balanced scorecard requires the organisation to define the following for
each of the perspectives mentioned above.
Strategic objectives: to decide what it is to achieve from a particular perspective.
Measures: to measure progress towards the strategic objective.
Targets: to decide target values for the measures.
Initiatives: to have programmes to meet the objectives.
For example. In a railway company, under financial perspective, the strategic objective could be to increase
profitability, the measure could be the market value of shares, target could be a 25% increase and the initiative
could be optimising routes.
Since, in the balanced scorecard. the strategic objectives are translated into a coherent set of performance
measures, all the information on the strategies and the performance measures is provided in a single report.
This helps management to assess the impact of a particular action on the organisation from four different
perspectives.
132: Performance evaluation and Corporate Failure fiTfi
Examples of measures that could be used for all the four perspectives of the balanced scorecard are as follows:
Measures
Financial perspective Profit, sales growth, ROI, payback period, cash flow analysis
Customer perspective
Customer retention rate, customers' complaints, % on-time
delivery, % sale of new product
Internal business perspective
Cycle time, unit cost and yield, engineering efficiency, actual
launch date vs. plan (for a new product)
Innovation and learning
perspective
Time to develop new product. Time taken to take a product to
the market vs. competitors, process time to maturity, availability
of required cost and revenue information.
(b)
A
In this part of the question, discuss only the rewards and not the dimensions and standards.
Do not forget to discuss clanty, motivation and controllability since this is specif cally asked for.
According to the building block model proposed by Fitzgerald and Moon, controllable performance in service
industries can be measured in six different ways called dimensions. These dimensions are financial
performance, competitiveness, quality of service, flexibility, resource utilisation and innovation.
This model also discusses certain factors regarding the standards and rewards that should be considered in
performance measurement e.g. while evaluating standards of performance, the ownership, achievability and
equity of the standards must be considered..
Rewards in the performance measurement system are necessary since they motivate individuals to achieve the
standards and accordingly improve the dimensions of the service quality. Therefore, the organisation should
define how the achievement of standards will be rewarded i.e. the reward system.
The reward system should include the following:
Clarity
Clarity of rewards requires that the targets should be clear and not ambiguous. If the targets are ambiguous, the
individuals may have some insecurity about the rewards and therefore they may not feel motivated.
For example, stating that an individual who brings substantial business to the organisation will be given a
surprise gift may not be sufficient to motivate individuals. This is because, here, what is substantial is not
defined and also the reward, i.e. the surprise gift, is not clearly defined. On the other hand, if it is said that every
salesman who exceeds his target by 10% will be given a reward of 1% of his sales, this reward will be
motivating.
Motivation
The reward system should be motivating. It should not have any negative impact on the employees. There
should not be any severe punishment if targets are missed by a small amount. Reward may be financial such as
commission / bonus or non-financial such as promotion.
Controllability
It is important that the reward system is controllable in order to motivate individuals to improve their
performance. Individuals should only be made responsible for the revenue and the costs they can control.
31. Performance measurement system
i
This question deals with the performance dimensions, performance standards and evaluation of
rewards system.
Your answer to the question should be bnef. justifying the marks allotted. Moreover, ensure that
your answer is to the point.
C.TG Solution Rank : 133
(I) The dimensions of performance (such as competitiveness, flexibility, quality of service, resource utilisation
and innovation) are decided based on the result to be achieved. At the same time, they are the
determinants of the factors that are likely to influence the results achieved. The results will comprise the
financial results as well as the market related results. The financial results may be measured in terms of
profit, liquidity, capital structure and a range of financial ratios. The market related results may be viewed in
terms of competitiveness as measured by sales growth, relative market share and measures of customer
base.
The ultimate performance level an organisation will target to achieve will be influenced by determinants
such as quality, flexibility, resource utilisation and innovation. Some strategic management accounting
techniques such as TOM and J IT programmes may help to improve the level of such determinants in
various ways. TQM can take care of quality related issues in an organisation and flexibility and resource
utilisation can be optimised mainly through an effective J IT system.
Innovation may be measured by factors such as the number of new product features added to the existing
products, the number of new products launched in the market, the time to market for a new product and
innovation in the work process.
(ii) Standards of performance must consider the ownership, achievability and equity of the standards set.
These factors will affect the extent to which the determinants and hence the results of performance will have
targets which are met and hopefully exceeded.
The matter of ownership may be investigated by asking questions such as:
> Who sets the standards?
r- Are they imposed by senior management or are they set considering the ground realities at the work
place?
> Are they set after carrying out a benchmarking exercise?
Are they set after negotiations with suppliers and customers?
Achievability of standards is likely to be linked to the ownership questions stated above.
Setting standards should motivate staff to higher performance. There is likely to be a point at which non-
acceptance of the standards will apply if they are seen as unrealistic. There is a need for a company /
employee balance. The most appropriate strategy is likely to be one in which the aim is continuous
improvement within perceived achievable limits.
Equity of standards is an important element. Are there factors which mean that the targets set are unfair or
unjust? For example, standards which are set by benchmarking with the best practices of other group
companies or with best practice in the industry may be unachievable because of inherent bottlenecks in the
system. Again, it is important to set standards such that standards become equitable for all the functional
areas or divisions or strategic business units as far as practicable.
(iii) The key objectives of the organisation are to develop a reward system that supports the firm's strategic
objectives, as set out by the firm's management and owners. The objectives of the reward system should
therefore be consistent with the three objectives of management control:
> to motivate managers to exert a high level of effort to achieve the organisation's goals
> to provide the right incentive for managers, acting autonomously, to make decisions consistent with the
firm's goals
> to determine fairly the rewards earned by managers for their effort and skill, and for the effectiveness of
their decision-making
The first objective is to motivate managers to put in a high level of effort to achieve the organisation's goals.
A performance-based compensation plan is best for this purpose. For example, a bonus plan that would
reward the manager for achieving particular goals would be appropriate. The goals could be financial or
non-financial, current or long-term.
The second objective is to provide the right incentive for managers to make decisions consistent with the
organisation's objectives. The organisation's objectives are identified in the strategic competitive analysis
from which is derived the firm's critical success factors. Critical success factors include customer
satisfaction, quality, service, product development and innovation in production and distribution. Firms
attend to critical success factors by making them part of the managers' compensation.
Clarity of rewards requires that there are dear, unambiguous targets. This should lead to a positive reaction
by those charged with achieving the targets.
Motivation may be achieved through the provision of financial or non-financial rewards. The rewards must
be seen to encourage improvement and not be unduly negative where a target is narrowly missed. Financial
rewards may, for example, take the form of a bonus system linked to performance achieved. Non-financial
rewards may include promotion and career moves.
Controllability of the reward system is important if it is to motivate the participants towards performance
improvement. It may be that the team principle may be used in order to share accountability for a target and
for the acceptance of goals.
32. Key performance indicators - The Eatwell Restaurant
I / C ^r^y ^ The question discusses performance measures (both financial and non-financial) and focuses
on identifying key performance dimensions.
r- Your answer should contain logical analysis of the case referred to in the question. You should
answer point-by-point in order to earn more marks.
(a) The performance of The Eatwell Restaurant can be categorised into key areas such as financial
performance, competitiveness, resource utilisation, quality of service and innovation / flexibility based on the
financial as well as non-financial performance parameters available for the years from 1998 to 2001.
Analysis of the financial performance reveals the following:
Financial:
> Consistent growth in turnover over the years. The growth in the last year over the previous year is about
35% and the overall growth in the four years under consideration is approximately 31% on average.
> The turnover from special events has also grown at a rate of 120% in the last year and growth remained
consistent over the years from 1998 to 2001.
The average annual growth in profit for the four years under consideration is approximately 98% and growth
in profit in the year 2001 is approximately 31%. The growth figure for 2001 is lower because it is compared
with a larger base year (year 2000) profit.
It appears that the company could maintain a high growth rate because of improved resource utilisation
resulting in a gradual decrease in the ratio of fixed costs to revenue.
Competitiveness
The competitiveness of the restaurant can be measured in terms of its market share and expansion into new
business areas.
Market share can be calculated by dividing the restaurant turnover by the turnover of all restaurants in the
locality. The market shares for the four years under consideration are 9.27%, 10.09%, 13.98% and 17.52%
respectively.
There has also been consistent growth in the proposals submitted for new events (from 10 in 1998 to 38 in
2001). Moreover, it is significant that contracts are won at a greater rate than that at which proposals are
submitted. The ratios of contracts won to proposals submitted i.e. the success rates in terms of winning
contracts from 1998 to 2001 are 20%, 29.41%, 51.72% and 65.79% respectively which shows that the company
has had more success in winning contracts in recent years The restaurant is therefore competing increasingly
successfully in this developing business area. Moreover, it can be construed that the restaurant is becoming
increasingly price competitive.
Quality of service
The number of regular customers (attending weekly) has increased consistently over the years indicating that
the customers are satisfied with the overall quality of service. This may be partly due to service quality or other
factors such as pnce competitiveness. Over the course of time, the restaurant has received an increasing
number of complimentary letters from satisfied customers. Of course, customers write complimentary letters
only if they are extremely satisfied with the performance of the company. On the other hand, the growth in the
number of complaints and reported cases of food poisoning and the service delivery data would suggest a poor
performance. In light of the available information, it is difficult to provide a definitive comment on the quality of
service over the period, especially as the number of customers has nearly doubled over the penod. Even
additional calculations, such as those involving key service quality data per 100 customers, cannot be taken to
be conclusive indicators of overall performance.
Innovation I flexibility
The restaurant has performed well in respect of innovation and flexibility. In particular, the number of dishes on
offer has increased, theme evenings have been introduced and catering activities for special events have been
developed.
The restaurant has continued to prepare new dishes, although the extent of its experimentation varies
considerably from year to year. Moreover, the fluctuating and somewhat unsatisfactory service delays suggest
that the restaurant is not able to manage its resources adequately to meet peak demand levels.
Resource utilisation
The level of business activity has increased continually over the period. This is evident from the increasing
number of meals served along with the decline in non-productive time and the hours of operation with no
customers. These figures indicate that there has been improvement in resource utilisation.
It is not clear how the seating capacity was increased in 2000 - was it done by extending the floor area
available or by providing more seating within the limited space available?
Although this increase in capacity enabled the restaurant to serve more customers at peak times, it also
resulted in a fluctuation in the annual number of meals served per seat (150. 204, 155 and 167 from 1998 to
2001 respectively). A brief attempt was made in 2000 to extend the opening hours and increase the hourly
utilisation of the premises. It is not clear why the restaurant went back to the earlier opening hours (36 hours) in
2001.
(b) The following additional information will help in assessing the performance of The Eatwell
Restaurant in comparison with another restaurant:
Financial
> The total amount invested in the business to generate the profits, in order to calculate the ROCE for the
restaurant over the years.
V Cost details according to the cost categories, e.g. material, labour and overheads, in order to calculate and
assess comparative financial ratios.
> Additional capital investment required in 2000 to enhance capacity, in order to assess the marginal returns.
> Expected return on capital employed in the restaurant business, in order to assess the overall performance
of the business. The expected return of an alternative business and the level of business risk inherent in the
alternative business must be available in order to carry out comparative analysis.
Competitiveness
^ Trends in restaurant attendance and revenues in a broader geographical area (e.g. a nation) instead of
comparing the performance of the restaurant with that of local restaurants. This will facilitate a broader
comparison of performance.
> Data on customer surveys of restaurants in targeted customer groups, to obtain more detailed customer
feedback.
Quality of service
> Various qualitative factors e.g. politeness of staff, atmosphere and decor (i.e. overall ambience),
responsiveness to customer requests and expert ratings.
> Innovation / flexibility
> Information on staff training and the potential for activities requiring multiple-skills to provide greater
operational flexibility
> Feedback on the restaurant's ability to cope with non-standard requests, e.g. special dietary needs, and to
respond to customer needs.
> Data on employee numbers, to facilitate the calculation of business activity per employee.
^ Data on floor area per customer, in order to understand whether optimum utilisation of resources is taking
place.
33. Performance measurement - BLA Ltd
i E E S n W "
^( J p! ^ Part a of the question is designed to test your knowledge about the model and its application in
real life. To answer this question, you should have thorough knowledge of the model and its
application. Remember that a general descnption of the model is not required and will not give you
marks in the exam. You should relate the model to the given scenario and assess the performance
using the model.
Explanation of each performance measure used in the model carries a maximum of 3 marks and
the maximum marks available from this part are 15. Therefore, plan your answer accordingly.
Keep in mind the time constraint i.e. do not make any explanation too long.
(a) Fitzgerald and Moon, in their building block model, proposed six dimensions of performance which are
controlled by service industries. These are:
(i) financial performance
(ii) competitiveness
(iii) quality of service
(iv) flexibility
(v) resource utilisation
(vi) innovation
The first two dimensions are related to past performance and the remaining four determine the competitive
success in present and in future.
Financial performance
Summary income statement for the year ended 31
October 2003
Even if this is not specifically asked for, you
may need to make some calculations so as
to use results for analysis.
Budget
$'000
Actual
$'000
Gross receipts (fees) ( W1) 6,075 6.300
Less:
Salary to consultants 2,025 2,025
Bonus ((6,300 - 6,075) x 40%) 90
Other operating costs 2,550 2,805
Subcontract payments (W2) 18
Not profit 1,500 1,362
W1 fees receipts
Budget Actual
New business
Repeat business
Total chargeable client consultations
24,300
16.200
22,400
19.600
New business
Repeat business
Total chargeable client consultations 40.500 42.000
Fees =Total chargeable client consultations x Rate per consultation
Budget =40.500x5150
=56,075,000
Actual =42,000 x 5150
=$6,300,000
W2 subcontract payment
Number of non-chargeable client consultations undertaken by subcontractors =120
Subcontract payment =120 x S150
Subcontract payment = S 18,000
Analysis
Although the gross receipts are more than the budgeted receipts (56,300,000 as against 56,075,000), the net
profit is less than the budgeted profit (S1.362.000 as against S1.500.000). A 10% increase in the operating cost
is observed. Since the gross receipts are more than those budgeted, a bonus is paid to the consultants at 40%
of the additional amount. In addition, $18,000 is paid to the subcontractors (which was not budgeted for).
It was necessary to employ subcontractors because of the following reasons:
the remedial consultations increased from 45 to 405
> the business development consultations were also more than budgeted for
> increase in overall business
This cost to consultants may create income in the future by increasing business.
The business development activity may be the reason for the increase in business i.e. number of consultations
from 40,500 to 42,000.
However, an increase in operating expenses by 10% is unusual and therefore comparison with the previous two
year will facilitate better analysis.
(i) Competitiveness
Competitiveness can be assessed in terms of relative market share, repeat business, sales growth, % of
enquiries converted into actual business etc.
The gross receipts are more than the budgeted receipts and the repeat business is also more than that
budgeted (i.e. 19.600 consultations as against 16,200). This shows an increase in business beyond the
budgeted increase and thereby testifies to the competitiveness of BLA Ltd.
In terms of % of enquiries converted into actual business:
Repeat business New business
Budgeted
Actual
50% (i.e. 16.200/32.400)
70% (i.e. 19,600/28.000)
36% (i.e. 24.300/67.500)
27% (i.e. 22,400/84.000)
Since BLA Ltd can successfully convert the enquiries into actual business in the case of repeat business i.e.
70%, this indicates that customers are satisfied with BLA and are therefore loyal to it. This is also indicates that
BLA is a competitive company.
However, in the case of new business, BLA is not successful and could obtain only 27% of the enquiries. What's
more, the new business received is less than that budgeted therefore the management of BLA should review its
market strategies once again in an attempt to formulate effective strategies.
According to the detailed analysis, the number of consultation for exterior design has decreased in comparison
to the budgeted figure and interior and landscape and garden design has increased from the budgeted figure.
Dunng the year, BLA has provided 1,200 business development consultations free of cost and also 405
remedial consultations. Hopefully this will result in an increase in the competitiveness of BLA.
(II) Service quality
Factors such as the number of complaints, customer feedback and customer retention / loyalty are used to
determine the quality of service. BLA s success in maintaining its existing clients shows that the clients are
satisfied with the service of BLA. However, this may be related to the previous year's service. This is because
the increase in the number of complaints (almost double the budgeted figure) and the increase in remedial
consultation (almost nine times the budgeted figure, which is quite high) indicate that there is some problem with
the sen/ice.
BLA does not carry out building work; it only gives advice and recommends contractors when requested by
clients. The number of complaints related to recommendations made by BLA Ltd should be investigated. It is
extremely useful to carry out a detailed analysis of the client complaints.
The remedial consultation also affected the financial performance. This is because if the time spent on 405
remedial consultations is utilised for chargeable consultations, it would have resulted in income of $60,750.
Each of the 120 consultations undertaken by subcontractors was of a non-chargeable nature. The work which is
for business development should be undertaken by the consultants employed on a full-time basis by BLA Ltd
and not by the retired consultants working as subcontractors.
(iii) Flexibility
Delivery time, promptness in responding to customer requests, ability of employees to perform different kinds of
work etc. are the measures of flexibility. In this case, flexibility can be assessed in terms of the different kinds of
work performed by the consultants.
The following table gives a comparison of the actual and budgeted consultations by category of consultant.
Consultations by category of consultancy service
Budget % Actual %
Increase/
(decrease)
Extenor design 40.0 32.9% (7.1%)
v/
Intenor design 40.0 41.0% 1.0%
Garden design 20.0 26.1% 6.1%
Workings
W1 consultations (sample)
Exterior design (budget)
16,200/40,500 x 100
=40%
Exterior design (actual)
13.830/42.000 x 100
=32.9%
From this chart it is evident that there has been a decrease in the demand for exterior design and an increase in
the demand for interior design and garden design. BLA Ltd has accordingly decreased its mix of 45 consultants
i.e. it has employed 3 more consultants for garden design and reduced three from exterior design. However, the
data for previous years will help in determining the trend and accordingly deciding the mix of consultants.
(iv) Resource utilisation
Utilisation of resources can be measured in terms of utilisation rate, productivity, service rendered per labour
hour etc. In this case, the average number of consultations per consultant can be used to measure whether the
consultants are being used optimally.
Average consultations per consultant
Budget Actual
Increase 1
(decrease)
Extenor design '900 '922 "2-4%
Intenor design 900 957 6-3%
Garden design 900 912 1-3%
Workings
W1 Average consultations (sample calculation)
Exterior design (budget)
16,200/18 =900
Exterior design (actual)
13.830/15 =922
(922 - 900K900 x 100 =2.4%
From the above, it is evident that consultants had done more work than the budgeted for. This is a good
indication, however, BLA should analyse whether this pressure on consultants has any impact on the quality.
This is because, during the year, the number of complaints increased. A detailed analysis of complaints, i.e.
whether a large number of complaints are related to a particular job or a particular consultant, is required.
(v) Innovation
Innovation should be measured by the number of new products / features in the existing product offered,
amount of R&D spending etc. Innovation can also be viewed in terms of its impact on the other dimensions of
the service such as financial performance and flexibility.
C.TG Solution Rank :i :w
The idea of providing certain consultations (including remedial consultations) without charging any fee is an
innovative one and might have resulted in an increase in business. In addition, the acquisition of 'state of the art'
business software is. by its very nature, innovative. An increase in garden and landscape design may be an
outcome of using this software. BLA has plans to use the software for exterior and interior design which may
result in an increase in business for those consultations.
However, it is necessary to identify whether there is any relation between the use of software and the increase
in the number of complaints.
A
For example, for calculating the % of complaints from clients, the number of complaints should be
divided by the number of client consultations but candidates often use the number of client
enquiries instead of client consultations.
Note: you should read the question carefully and note down the relevant information while you
read so that you will have the information to hand while answering. Otherwise, while answering,
you may forget to use a relevant piece of information given in the question.
In addition, do not use non-comparable information. Before comparing any information, first check
its comparability.
Score Mor e
Common observations
measunng performance without using the model
discussing the model in general
not using information fully / property
using non-comparable information for performance measurement
This is a model based question. If you have a thorough knowledge of the model you will be able to
answer the question very well.
A maximum 2 marks are allotted for each point with a maximum 5 marks overall.
The building block model suggests that while deciding the standards, the following three points should be
considered for the effective working of the standards.
(i) Ownership
Ownership refers to the individual who is responsible for meeting the targets. The model suggests that the
individuals who are ultimately responsible for meeting the standards should be involved in the process of
standard setting / budgeting. This means that instead of the top authorities deciding the standards by and
communicating them to the individuals concerned, the individuals themselves should set the standards. This
motivates the individuals and gives them a sense of responsibility.
(ii) Achievable
The standards set should not be too high. They should be realistic / achievable by the individuals otherwise they
demotivate the individuals. However, there may be a gap between the expectation level of the mangers and the
individuals. In such a case, a balance must be achieved.
(iii) Equity
The standards should be fair to all the managers. They should provide fair comparison of all processes and all
areas of operations, across all business units. For example, when different business units are measured, the
environment in which the units are working, the risk associated with those business units etc. should be taken
into consideration and the financial data should not be the sole criterion.
34. Performance measurement - Compuaid Ltd
(a)
Since this is a calculation-based question, you need to plan your presentation beforehand. In
addition, do not forget to show your workings. Workings are the basis for your answer and show
the examiner that you understand the concept and know how to calculate the figures.
Remember, in this question, there is more than one source of income. Read the question carefully
and note down the relevant information.
Profit and loss accounts for the 12 month period
Compuaid Ltd Competitor company
Budget Actual A B
$ $ $ $
Revenue
Annual fee income (Wl) 584,000 765.000 495,OOC 1,000,000
All other advisory income (W2) 1,168,000 1.442,000 756,18C 1.266,000
Home visits income(W2) 440.000 464.000 87.50C 810,000
Total 2,192,000 2.671,000 1.338.68C 3,076,000
Cost of sales
Service wages (W3) 832,000 998,400 720,OOC 1,099,000
Sundry operating costs 950.000 1,000.000 650.00C 1,250.000
Total 1,782,000 1.998.400 1.370.00C 2.349,000
Net profit / (loss) 410,000 672,600 (31,320 727.000
Workings
W1 annual customer fees
Budget Actual A B
S $ $ $
Number of annual agreement customers (A) 5,840 7,650 6,600 10,000
Annual fees (B) 100 100 75 100
Annual income (A x B) 584.000 765,000 495,000 1,000.000
W2 other advisory and home visit income
Compuaid Ltd
Budget
$
Actual
$
Advisor time billed to customers (A)
58,400 72,100
Home visits billed to customers (B) 22,000 23.200
Per hour charqes for advisory and visit services (C) 20 20
Other advisory income (A x C)
Home visit income (B x C)
1,168,000
440,000
1,442,000
464.000
W4 service wages
Compuaid Ltd
Budget
$
Actual
$
Total hours worked (A) 104,000 124,800
Wage rate per hour for advisory service staff $(B) 8 8
Annual income (A x B) 832,000 998,400
(H)
t
In this part of the question, you are asked to analyse Compuaid's financial performance on the
basis of the profit and loss account prepared above. Remember, your answer should discuss the
points mentioned in the question such as customer billing rates and level of uptake.
In addition to these points, you are expected to discuss other points such as net profit, revenue
and costs. In short, a detailed discussion is expected since the question is worth 12 marks.
Net profit
Compuaid's net profit has increased by $262,600 ($672,600 - $410,000) or 64% which shows that the company
has performed very well. Competitor A is making loss but competitor B's profit is higher than the profit earned by
Compuaid.
Revenue and cost
Compuaid's actual net profit is higher than that budgeted because of an increase in revenue of $479,000
($2,671,000 - $2,192,000) or 21.85% ($479,000/52,192,000 x 100). In addition, Compuaid's total costs have
only increased by 12.14% ($216,400/$1,782,000 x 100). A closer analysis shows sundry operating expenses
have increased by 5.26% ($ (1,000.000 - 950.000)/$950.000). a negligible increase. Operating costs were
budgeted at 43.3% ($950,000/2,192,000) of sales revenue but are actually 37.4% ($(1,000,000 12,671,000) x
100) of revenue. This means that Compuaid has improved its performance by increasing revenue and
controlling costs.
Further analysis of revenues shows that the percentage uptake of advice by annual fee customers has an
impact on profit levels. The following table shows the relative figures for Compuaid Ltd and competitors A and B:
Compuaid
(budget)
Compuaid
(actual)
Competitor A
(actual)
Competitor B
(actual)
Total hours per agreement (A)
(customers x 5 hours)
Actual hours taken-up (B)
(per appendix 1.1)
Percentage uptake (B/A x 100)
29,200
(5,840 x 5)
14.600
50%
38.250
(7,650 x 5)
15.300
40%
33,000
(6,600 x 5)
29,700
90%
50,000
(10,000 x 5)
35,000
70%
When compared with its competitors, Compuaid's uptake is much less, 40% as opposed to 90% and 70% for its
competitors. This also has helped increase Compuaid's profits. Compuaid served fewer customers with annual
agreements but charged $100. which is more than competitor As charges of $75 and equal to those of
competitor B.
In addition, since the percentage uptake for Compuaid is less, its wage cost is also less. However, this may not
be a permanent situation. This is because since the uptake percentage is less than the competitors, it could
mean that customers are unhappy with the service provided, which may have an impact on long-term
performance.
Net profit ratio
Budget
$
Actual
$
A
$
B
$
Net profit / (loss) (A)
Total revenue (B)
410,000
2,192,000
672,600
2,671.000
(31,320)
1,338.680
727.000
3,076,000
Net profit 1 (loss) ratio % (A/B x
100)
18.70 25.18 (2.34) 23.63
From the table above it is apparent that, although competitor B's net profit is more than Compuaid, if the net
profit ratio (Net profit/Sales x 100) is considered, Compuaid is performing better than competitor B. This is
because, as shown in the following table, competitor B's operating costs are higher than those of Compuaid.
Compuaid Actual
$
o C71 AAA
Competitor B
$
1 fl7C rtflA
i oiai revenue (dj
Service wages (C)
Sundry operating costs (D)
Z.O/ I.UIAJ
998,400
1.000.000
j.u/b.uuu
1,099,000
1.250,000
Service wages/Sales x 100
Operating costs'Salesx 100
37.38
37.44
35.73
40.64
Other points
> Compuaid charges$20 per hour for advisors (both telephone and written). Competitor B charges the same
$20 per hour $1.266,000/63.300) but competitor A charges $2 less i.e. $18 per hour ($756,180/42.010).
> Compuaid charges $20 per hour for home visits. Competitors A and B charge more than Compuaid.
Competitor A charges $25 ($87,500/3,500) and competitor B charges $22.50 ($810,000/36,000).
> Compuaid paid its workers $8 per hour, which was budgeted. However, competitor A paid $9 per hour
(720,000/80,000 hours) and competitor B paid $7 per hour ($1,099,000/157,000).
> Compuaid's operating cost is 37.44% of its revenue. However, their competitors' operating costs are 48.6%
($(650,000/1.338.680) x 100) of revenue for competitor A and 40.6% for competitor B.
A detailed analysis can only be made if the previous year's figures were available. This is because the previous
year's figures may be used for determining revenue and costs trends
(b)
(i) Competitiveness
While answering this part of the question, remember the following:
to use the relevant quantitative data given in the question
> to give necessary calculations to support your answer
^ to analyse the performance measurements and discuss logically
> to compare with the competitors.
In order to get good marks, your answer should contain all the above points for each performance
measure.
Competitiveness can be measured in terms of relative market share, customer retention rate, growth in sales
and converting enquiries into actual business. Compuaid's revenue has increased in all areas of business when
compared with the budgeted revenue. A 30.99% [(7,650 - 5,840)/5.840 x 100] increase in the number of annual
agreement customers, 5.45% [(23,200 - 22,000)/22,000 x 100)] increase in home visits and 23.46% [(72,100 -
58,400)/58.400 x 100] increase in advisory services. The overall increase in business is 20% [(104,000 -
124.800V104.000 x 100) in terms of total hours.
This increase in business shows that sales, as well as market, share has increased.
Compuaid Ltd
Competitor
company
Budget Actual A B
$ $ $ $
Number of home visit enquiries received (A) 15.000 16,000 2,000 24.000
Number of home visits obtained/completed (B) 10,000 8.000 1,400 15,000
Annual income (B/A x 100) 66.67% 50% 70% 62.50%
When it comes to the conversion of enquiries into actual business, Compuaid has budgeted a conversion of
66.67% of enquiries into sales but actually managed to convert only 50% of enquines. Competitor A converted
70% of enquines into business and competitor B converted 62.50%, both figures are more than Compuaid.
However, competitor A may not be considered as suitable for comparison since its home visit service is far less
than that of Compuaid. Competitor B is more appropnate for the companson.
t
Quality
Quality can be measured by number of complaints, customer feedback, customer retention / loyalty etc. In order
to better measure quality, both quantitative as well as qualitative information is required.
Here, quality can be measured by examining customer complaints and number of visits required for remedial
work.
Compuaid
(budget)
Compuaid
(actual)
Competitor
A
(actual)
Competitor
B
(actual)
Number of home visits
obtained'completed (A)
Num. of home visits requiring remedial
work (B)
% of remedial work required (B/A x
100)
10.000
300
3%
8.000
1,200
15%
1.400
400
28.57%
15.000
3.400
22.67%
In Compuaid's case, since the percentage of remedial work required increased from the 3% budgeted to an
actual of 15%, we can deduce that the quality of service has deteriorated. However, Compuaid seems to be
offering a better service when compared with its competitors, since competitor A did around 29% remedial work
and competitor B did 23% remedial work which is more than Compuaid.
Compuaid
(budget)
Compuaid
(actual)
Competitor A
(actual)
Competitor B
(actual)
Number of home visits
obtained/completed (A)
Number of customer complaints-
home visits (B)
Complaints - home visits (B/A x
100)
10,000
100
1%
8,000
160
2%
1,400
70
5%
15,000
225
1.50%
If quality is measured by customer complaints, the number of complaints for Compuaid has increased from a
budgeted 1% to an actual 2%. Competitor B has a lower percentage of complaints than Compuaid but the
number for competitor A is higher at 5%. However, as mentioned above, competitor A is not as effective for
comparing as competitor B since its home visits cost much less than those of Compuaid.
Compuaid
(budget)
Compuaid
(actual)
Competitor A
(actual)
Competitor B
(actual)
Num. of hours worked for annual
agreements (A) 14,600 15,300 29.700 35,000
Number of hours advisory
services given (B) 58,400 72,100 42.010 63,300
Total hours worked (C) 73,000 87,400 71.710 98,300
Number of customer complaints-
advisors (D) 73 131 35 196
A complaint per X hours of
advice
1.000 hrs 667 hrs 2.049 hrs 502 hrs
Compuaid has budgeted that for its advisory sen/ices, it will receive one complaint per 1.000 hours. However,
the actual shows one complaint per 667 hours. This could indicate deterioration in the quality of Compuaid's
service. Additionally, competitor A only receives one complaint per 2,049 hours. However, Compuaid is better
than competitor B which receives one complaint per 502 hours.
As previously mentioned, Compuaid has taken fewer advisory calls for annual agreements, only 40% whereas
competitors A and B have taken a far higher number. 90% and 70% respectively (as calculated in revenue and
costs)
Further information about the type of complaint will facilitate a detailed analysis for Compuaid. This will help the
company take corrective action.
Competitiveness can be measured in terms of utilisation rate, productivity and service rendered per labour-hour.
In this case, resource utilisation can be measured in terms of input: output ratio. Input: output hour ratio can be
calculated as total hours of actual work done divide by total hours paid, which is given below:
Compuaid Compuaid
Competitor
A
Competitor
B
(budget) (actual) (actual) (actual)
Annual agreement advisor call uptake 14.600 15.300 29,700 35,000
Advisor time billed to customers 58.400 72,100 42,010 63,300
Home visits billed to customers 22,000 23,200 3,500 36,000
Total hours actually worked (A) 95,000 110,600 75,210 134,300
Total hours paid (B) 104,000 124,800 80,000 157,000
Output: input hours (%) (A-'B x 100) 91.30% 88.62% 94.01% 85.54%
The calculations above show that output: input hours ratio has fallen from the budgeted number. Competitor A
has best utilised its resources whereas competitor B's utilisation is slightly lower than that of Compuaid.
However, if home visits can be analysed further, it will give a more detailed picture. This is because travel time,
idle time, time spent in remedial work etc., timings related to home visits are not charged to the customer but
are paid for by the company.
Compuaid Compuaid Compuaid Compuaid
(budget) (budget) (actual) (actual)
Travel 2,500 9.26% 4,800 14.72%
Remedial work 500 1.85% 2,000 6.13%
Other idle time 2,000 7.41% 2,600 7.98%
Chargeable hours 22,000 81.48% 23,200 71.17%
Total 27,000 100.00% 32,600 100.00%
Competitor
A
Competitor
A
Competitor
B
Competitor B
(actual) (actual) (actual) (actual)
Travel 390 5.35% 4,500 8.70%
Remedial work 600 8.23% 5,200 10.06%
Other idle time 2.800 38.41% 6.000 11.61%
Chargeable hours 3.500 48.01% 36.000 69.63%
Total 7,290 100.00% 51,700 100.00%
The table above shows that utilisation of resources (actual chargeable hours) has fallen by 10.3% (81.48% -
71.17%). About 30% of total time is not actually utilised for work but is used for travelling or remedial work,
which is not chargeable. The increase in travel time may be caused by jobs being taken far from the office as a
way of increasing sales. Remedial work increased from the budgeted level which could mean that quality has
deteriorated as well as the utilisation ratio.
However, the overall position of Compuaid is better than that of its competitors. This is because competitor A is
able to charge less than 50% of the total time and its idle time is 38.41%. This shows that competitor A s utility
in home visits is poor. Competitor B's position is better than competitor A but its useful time ratio is lower than
Compuaid.
For services other than home visits, the output: input ratio can also be calculated as follows:
Compuaid
(budget)
Compuaid
(actual)
Competitor
A
(actual)
Competitor
B
(actual)
Annual agreement advisor call uptake (A) 14.600 15.300 29,700 35.000
Advisor time billed to customers (B) 58.400 72,100 42,010 63.300
Idle time advisor (C) 4.000 4.800 1.000 7.000
Hours actually worked (other than home visit)
(D =A +B) 73.000 87,400 71,710 98,300
Hours paid (other than home visit)
(E =A +B +C) 77.000 92,200 72,710 105,300
Output: input hours (%) (E/D x 100) 94.81% 94.79% 98.62% 93.35%
For services other than home visits, Compuaid has almost achieved its budgeted target. However, it has done
less well than competitor A but better than competitor B. This could be because for customers with annual
agreements, competitor A has maximum uptake. 90% and so its staff is better utilised; but Compuaid might
have budgeted for 5 hours per customer on the agreement and employed staff accordingly, many of whom
remained unutilised.
35. Performance measurement - Mack-King
(a)
I
^Mmf^K You can use the following financial performance measures to evaluate Madk-King's performance:
> revenue
^ sales margin ratio (profit before interest / revenue)
> ROCE/ROI
> assets turnover ratio
> financial structure
> residual income
N.B. you do not need to give an explanation for all the above mentioned performance measures.
Discuss any four of them.
$000)
2000 ACTUALS 2001 ACTUALS
UK COJ A TOTAL UK COJ A TOTAL
Actual revenue ($ 000) 780.00 70.00 850.00 845.00 106.00 951.00
1. Actual revenue growth %
(W1)
_ _ _
8.3% 51.4% 11.9%
Profit before interest 190.00 (3.00) 173.00 209.00 (21.0) 147.00
2.
Sales margin ratio (W1) 24.40 (4-20) 22.00 24.70 (19.80) 19.80
3. ROCE % (W2) - - 25.30 - - 17.30
Fixed asset turnover (W3) 1.50 1.75 1.52 1.63 1.18 1.56
4. Financial structure
(Debt/Equity) (W4) 0.23 0.46
Workings
W1 sample calculations
Actual revenue growth % UK 2001 (actual)
$845,000-$780,000
x 100 =8.3%
$780,000
Sales margin ratio (total 2000 actual)
Profit +Interest
x 100
Revenue
173 +14
= x 100
850
= 22%
W2 ROCE (2000 actual)
R Q C E _ Profit Before Interest and Tax (PBIT) / Operating Profit ^ ^
Capital Employed
W3 asset turnover ratio
Sales revenue
Asset turnover ratio = x 100
Fixed assets
780
Asset turnover ratio (UK 2000) =
Comments:
> Revenue
Asset turnover ratio for
others can be calculated
in the same way.
The revenue of both divisions has increased, the growth rate of the UK division is about 8% and the Coja
division rate is about 51%. However. Coja's revenue is just 10% (106/951 x 100 =10.08%) of the total group
and so the growth rate of Mack-King is 12%.
This shows that the group is performing well in terms of
revenue.
> Profits
This detailed analysis is for your
information. In the exam do not wnte too
much for any particular point.
The sales margin ratio of the UK division is almost constant, 24.4% in 2000 slightly increasing to 24.7% in 2001.
Despite this, Mack-King s profitability has decreased. The sales margin ratio of Mack-King has decreased from
22% in 2000 to 19.8% in 2001. This decrease in Mack-King's sales margin ratio has been caused by the
performance of the Coja division. Although Coja's revenue has increased at a high rate, its costs have also
increased at a rate higher than the increase in revenue and so its sales margin ratio (which is negative,
indicating loss) has increased from 4.2% in 2000 to 19.80% in 2001.
The increased loss in the Coja division is caused by higher marketing costs. Although the Coja division is a
small division when compared to the UK division, Coja's marketing costs are equal to those of the UK division.
The Coja division may require higher marketing expenses as the organisation and its products are new in Coja
and so it is necessary to make more effort to sell the products in the new market.
If we compare Coja's operating costs in 2001 to those of the previous year, Coja has improved its cost control.
For example, although the increase in revenue is more than by 50%, material and labour costs have increased
by just 20% [$(12-10V10 x 100) and other operating costs have remained the same.
However, when the Coja division's operating costs are compared with those of the UK division, in 2000 Coja's
labour cost of 13.69% [$ (10 / 73) x 100] is less than the UK division's 33.89% (200 / 590 x 100); but Coja's
materials cost of 27.39% [S (20 / 73 ) x 100] is higher than that of the UK division (25.42% i.e. $150 / $590) x
100). However, in 2001, Coja's materials cost decreased from 27.39% to 18.89% [$ (24 /127) x 100] and labour
cost from 13.69% to 9.45% ($(12 / 127) x 100],
The depreciation and amortisation expenses for the Coja division have increased. This, together with increasing
interest, has affected Mack-King's profitability. This can be seen from a comparison between the profit before
interest, tax. depreciation and amortisation and the profit after interest, depreciation and amortisation. The
decrease in profit after these expenses have been deducted is S26.000 ($173,000 - $147,000) whereas the
decrease in profit when these expenses are not deducted is just $9,000 ($304,000 - $295,000).
$147,000 +$116,000 +$41,000 =S304.000
$173,000 +$108,000 +$14,000 =S295.000
> ROCE
This demonstrates how efficiently the company is using its capital to generate profits. It is the multiplication of
sales margin ratio and asset turnover ratio.
In the given case. ROCE of Mack-King is decreased from 25.3% to 17.3%. Mack-King's asset turnover ratio
increased from 1.52 to 1.56. However, sales margin ratio has decreased from 22% to 19.8%. An increase in the
asset turnover ratio indicates that assets are used more efficiently to generate sales when compared with the
previous year.
> Asset turnover ratio
This ratio demonstrates how efficiently the assets are utilised. The table above shows that the UK division used
its assets more efficiently in 2001 than 2000. However, the Coja division did not use its assets as efficiently as
the previous year.
> Financial structure
The increase in ratio from 0.23 to 0.46 shows that Mack-King has increased its borrowings. Debts have
increased by about 150% ($(340 - 140) 1 140 x 100). This may have adverse impact on Mack-King's liquidity.
Note: in the absence of a proper explanation, you will not get good marks. This is because an
answer without an explanation will not fulfil the question requirement (assessing the financial
performance). By giving only calculations, you are giving only information and not measuring the
performance. Therefore, do not forget to give an explanation.
Note down the given information while reading the question so that you can use the information in
appropnate places and need not waste time in searching for the relevant information.
Score Mor e
Common observations
> Most candidates only calculate the ratios and do not analyse them.
^ Most candidates do not use the given information sufficiently.
In the exam, write about four points. Additional points discussed here are for your information only.
When you are asked to give additional information to facilitate financial performance, remember to
include competitors' information, industry trends, budgets, historical data and economic condition
etc. Vou should choose to give information that is not already given in the question. For example, if
competitors' data is available, you should write about something other than competitors.
In addition to the financial information given above, the following will provide a more detailed evaluation of
Mack-King's financial performance:
^ Competitors' information for 2001 as well as 2000: to compare Mack-King's financial performance with
that of its competitors.
> Budgeted information of 2001 and 2002 (if possible): to evaluate whether Mack-King and its divisions
have performed according to expectations.
r- Historical data: to determine revenue and cost trends and evaluating current performance according to
such a trend.
^ Business cycle I economic boom: to determine whether the growth is due to overall economic or
business growth or is actual growth.
> Industrial trend I information: whether the fast-food industry is growing or what the prospects of the
industry are in the long term.
r- Expectations of shareholders I investors: to determine the impact of the expansion into Coja on Mack-
King's share prices.
^ Market share: whether the increase in profitability means that market share is also increasing.
Long-term marketing strategies: to find out whether the increased marketing costs incurred by Coja are
part of any strategy this will be of long-term benefit.
(C)
rl
Here, you are expected to write about the problems as well as suggestions for allowances,
^ so remember to write about both otherwise you will lose marks.
However, a long answer is not expected: two marks are given for identifying the problems and half
a mark is given for each point made in suggesting the allowances. Therefore plan your question
accordingly.
Problems in comparing financial performance of management of two divisions are as follows:
Although divisional performance is a better indicator of managerial performance, this is true only when the two
divisions operate in the same external environment. The Coja division is making a loss but management alone
cannot be blamed. In addition, since the UK division is performing better than the Coja division, it cannot be
inferred that the UK manager is more competent than the Coja manager. This is because both divisions are
operating in different environments and therefore cannot be directly compared.
The following are problems in comparing the financial performance of management in the two divisions:
> The Coja division is operated in an uncertain political environment.
< In Coja's case, the products and outlets are new to the market.
Higher marketing costs in 2001 have deteriorated Coja's financial performance, but this may be beneficial
in the long term. On the other hand, the UK management may place more emphasis on short-term
performance.
In order to deal with the problems in comparing the management performance of either division, allowances for
the following can be made:
^ If one division is working in a more uncertain environment (difficult conditions) than the other, this should be
considered.
> If a country's economic condition has an impact on the division's performance, this should be taken into
account. For example, a division in a country whose economy is booming will perform better than a division
in a country whose economy is in recession.
> Restrictive political environment, government polides, local rules and regulations may have an adverse
impact on divisional performance. Therefore, local legislation and its impact on divisional performance
should be considered. For example, in Coja's case, there is political uncertainty in that country, which could
impact the division's performance. Allowance should be made for this when companng performance with
the UK division.
> The economic environment for different divisions may also be different. There could be different taxation
rates, interest rates and inflation which will have an impact on divisional performance, therefore allowance
must be made for different economic environments.
> Availability of resources gives a competitive advantage. However, when one division has a competitive
advantage over the other, allowances should be made.
> One division could be operating in a country with more local competition whereas the other may have fewer
competitors. This affects the financial position of the division facing local competition. Therefore allowances
are needed.
> The socio-cultural environment such as demographic patterns (population size, growth rate, educational
level, age groups) also has an impact on divisional performance.
(d)
Service quality
r customer satisfaction report
> customer retention rate
> customer waiting time
> number of customer complaints
Marketing effectiveness
> revenue growth
> market share
> ability to convert enquines into business
You should give only two measures for each
area asked for in the question.
However, in this answer, more measures are
given for your information.
>GTG Solution Bank : 149
Personnel
> cost per employee
> revenue per employee
> employees attitude i.e. absenteeism
> employee retention rate
> training days per employee
Food preparation
> customer complaints
> adherence to recommended food preparation methods
> material usage per product
> wastage per product
36. Performance measurement - The Dental health partnership
A
In this part of the question, you are asked to give the following:
> summary profit and loss account for the year ending 31 May 2005
^ break even capacity utilisation
Seven marks are allotted to profit and loss account and five marks are allotted to percentage of
maximum capacity utilisation therefore do not forget to answer both parts.
Do not forget to show workings as your answers are based on the workings. In addition, four marks
are allotted to the calculation of fees received which is more than 50% of the total marks allotted to
the answer. If you do not show workings you will lose marks.
Dental Health Partnership
Summary profit and loss account for the year ended 31 May 2005
%
Fees received (W1) 1,226.880
Other income 20,800
1,247,680
Less: Variable costs
Material and consumables 446.400
Less: Fixed costs
Salaries (W2) 538.880
Establishment costs 85,000
Other operating costs 75,775
Total costs 1,146,055
Net profit for the period 101,625
Workings
W1 Fees received
An explanation like this
for your calculations is
also necessary.
Number of patients treated during the year or total number of consultations
= working days per week x working weeks x number of patients actually treated per dentist x number of
dentists.
Number of patients treated during the year =5 x 48 x 20 x 6
=28.800
Patient mix
We need to adjust the patient mix and calculate fees accordingly. This is because adult fees are received twice,
from the patients as well as from the government. Therefore, adjusted patient mix is as follows:
Adults 50% x 2 100%
Children 40%
Senior Citizens 10%
Total 150%
Weighted average fee
However, since the payment from government is based on the type of treatment, the following is weighted
average fee per patient:
Type of patient treatment
$
None 0.70 x $12
Minor 0.20 x $50
Major 0.10 x $100
Total
8.40
10.00
10.00
None 0.70 x $12
Minor 0.20 x $50
Major 0.10 x $100
Total 28.40
Therefore, fees received during the year ending 31 May 2005 is calculated as:
=28.800 x 150% x $28.40
= $1,226,880
W2 salaries
Category of
Employee
Salary per annum,
per employee
$
Number of
employees
$
Total salary
$
Bonus
@4%
$
Total
$
Dentist 60,000 6 360,000 360,000
Dental assistant 20.000 7 140,000 5.600 145,600
Administrator 16,000 2 32,000 1280 33,280
Total 538,880
Break even capacity
In order to calculate break even capacity, we will first calculate break even point. Break even point can be
calculated as follows:
Total fixed costs
Break even point =
Contribution per unit
Total fixed costs are calculated as follows:
Fixed income should
be deducted while
calculating total fixed
costs for BEP purpose
$
Salanes 538,880
Establishment costs 85,000
Other operating costs 75,775
Total fixed costs 699,655
Less: Fixed income (20,800).
Total fixed costs less fixed income 678,855
Weighted average contribution per patient
$
Fees received 1.226.880
Less: Variable costs (446.400)
Contribution 780.480
Total number of consultations (W1) 28.800
Weighted average contribution per patient visit
780,480
-
=27.10
28.800
$678,855
Therefore BEP = = 25,050 consultations
$27.10
Therefore, percentage of maximum capacity required in order to break-even is:
25,050
= x 100
34,560 (W1)
=72.5%
Workings
W1 Consultations per year
=working days per week x working weeks x number of patients can be treated by each dentist x number of
dentists.
=5 x 48 x 24 x 6
=34,560 consultations per year
Alternatively, it can be calculated as follows
Actual patients treated per day
= x 100
Actual capacity of each dentist per day
20
= x 100
24
=83.33%
Therefore, capacity of actual consultations can be calculated as follows:
Actual consultations
= x 100
Capacity utilised
28,800
= x 100
83.33%
=34,560 consultations per year
(b)
In this part of the question you are asked to give the following:
> four distinguishing features of service
relate such factors to the service provided by the Dental Health Partnership
Do not mention more than four factors and do not forget to relate these factors to the Dental Health
Partnership. More factors are given here for your information.
Most of the services are intangible
Services are intangible in nature. Unlike products, no one can see. touch or physically measure them. So are
the dental services. Surgery, medical treatment etc. are also intangible in nature. In addition, the skill,
competence and knowledge of the dentist; efficiency and behaviour of the dental assistant are the factors
involved in the services provided by the dentist and which are intangible in nature.
Simultaneous production and consumption
All the services are consumed simultaneous to their creation and therefore there is no inventory of the services.
For example, when a dentist treats a patient, the patient consumes the services simultaneously to its creation by
the dentist.
There can be considerable variability in service delivery
In the case of sen/ices, it is very difficult to provide consistent service of the same quality. Service quality often
changes from customer to customer and from dentist to dentist. Although dentists have same qualification,
customers have same needs; the services provided by two different dentists will differ.
Service usually consists of "substantive" and "peripheral" components
In the service industry, there are substantive and peripheral components. For example, the treatment by the
dentist will be the substantive component whereas the behaviour of the dental assistants or administrators will
be the peripheral component.
Quality control - a major challenge
It is more difficult to achieve quality control and consistency in the service industry than it is in
manufactunng. This is because of the measurement problems that exist. For example, in this case, it is very
difficult to measure the quality of a surgery or any other treatment given by the dentists to their patients.
In addition, since service is created and consumed simultaneously, it is difficult to determine and control its
quality in advance.
(c)
i In this part of the question, you are asked to give the following: s "
~ M o r e than three
measures are given
here for your
three quantitative, non-financial performance measures
> relate such measures to the Dental Health Partnership
information.
Therefore,
> if you give more than three measures, you will be wasting your time.
> if you give financial measures or qualitative measures, you will lose marks for the wrong answer.
> if you do not give measures relating to the Dental Health Partnership, your answer will
be considered as incomplete and you will lose marks.
GTG
Solution Rank : 153
Although it is difficult to control the quality of service, it can be analyses with the following quantitative non-
financial measures:
> On-time treatment / waiting time: how many patients are treated on time', the waiting time between the
scheduled appointment and the time at which patients are actually treated can be accurately measured.
Patients will be satisfied with better punctuality and less waiting time. This increases their loyalty towards
Dental Health Partnership.
^ Retention rate I customer loyalty: if a patient comes for a subsequent visit after their first treatment, it
indicates that the patient is satisfied with the service and will remain loyal to Dental Health Partnership.
^ Number of times appointments were re-arranged, causing inconvenience to patients. This leads to patient
dissatisfaction and will decrease customer loyalty.
^ Whether patients get appointments at times which are convenient to them? If this is the case, this indicates
good availability of the service which is one of the dimensions of service.
> Number of complaints received from patients and also number of complaints resolved by Dental Health
Partnership to the satisfaction of patients.
37. Performance measurement-Alisha PIc
I In this part of the question you are required to calculate the statement of comprehensive income for
the years ended 31 December 2006 and 31 December 2007 (budgeted). Therefore decide how
you will present your answer in advance to make sure that you do not waste time by repeating the
information.
In addition, do not forget to show your workings since marks are allotted to them and they are the
basis for your answer. Workings will indicate that you have a thorough knowledge of the subject
and help you to get good marks.
(a) Statement of comprehensive income for Alisha PIc
Naturopathy Meditation Total
Actual
2006
Budget
2007
Actual
2006
Budget
2007
Actual
2006
Budget
2007
$('000) $('000) $('000) S('OOO) $('000) $(000)
Admission fees (W1) 54,250.00 59,675.00 59,819.20 62,810.16 114,069.20 122,485.16
Transportation fees (W2) 50.00 52.00 560.00 582.40 610.00 634.40
Other incomes 1,500.00 1,500.00 1,500.00 1,500.00 3,000.00 3,000.00
Total revenue 55,800.00 61,227.00 61,879.20 64,892.56 117,679.20 126,119.56
Less: Operating costs
(W3)
40,000.00 42,800.00 50,000.00 53,500.00 90,000.00 96,300.00
Net profit / loss 15,800.00 18,427.00 11,879.20 11,392.56 27,679.20 29,819.56
W1 Admission fees
Naturopathy
For actual 2006
Adults (10 batches x 1,000 patients x 40% x $4,000) =$16,000,000
Children (10 batches x 1.000 patients x 5% x $5,000) =$2,500,000
Senior citizens (10 batches x 1.000 patients x 55% x $6,500) =$35,750,000
Total =$16,000,000 +S2.500.000 +$35,750,000
=$54,250,000
Do not forget to consider the patient mix.
For budget 2007
Adults $16,000,000 +10% rise =$17,600,000
Children $2,500,000 +10% rise =$2,750,000
Senior citizens $35,750,000 +10% rise =$39,325,000
Total =$17.600.000 +$2,750,000 +S39.325.000
=$59,675,000
Meditation
For actual 2006
Total visitors in a year =70 classes x 2,000 persons x 80% occupancy
=112,000 persons
Adults (112,000 persons x 60% x $500) =$33,600,000
Children (112,000 persons x 10% x $500) =$5,600,000
Senior citizens (112,000 persons x 30% x $650) =S21.840,000
Total =$33,600,000 +$5,600,000 +S21.840,000
=$61,040,000
However, only 80% of visitors pay the full amount i.e. 20% of visitors pay
only 90% of the amount.
Therefore the admission fees from meditation can be calculated as
follows:
= S61,040,000 x 80% +($61,040.000 x 20% x 90%)
= $48,832,000 +$10,987,200
= $59,819,200
For budget 2007
Total visitors in a year =70 classes x 2,000 persons x 80% occupancy
- 112,000 persons
Adults $33,600,000 +5% nse =$35,280,000
Children $5,600,000 5% rise =$5,880,000
Senior citizens S21,840,000 +5% rise =S22,932,000
Total =$35,280,000 +$5,880,000 $22,932,000
=$64,092,000
Admission fees can be calculated as follows:
=S64.092.000 x 80% +($64,092,000 x 20% x 90%)
=S51,273,600 +$11,536,560
=$62,810,160
OR
Alternatively and easily calculated as:
$59,819,200 +5% rise =$62,810,160
W2 Transportation fees
For actual 2006
Naturopathy: (10.000 patients x $2.5 x 2 way travelling) =S50.000
Meditation: (112,000 x $2.5 x 2 way travelling) =$560,000
This 80:20 mix of first time
and repeat visits should be
considered only after
calculating the total fees and
considenng the 80%
^occupancy.
For budget 2007
Naturopathy: $50,000 +4% rise =$52,000
Meditation: $560,000 +4% rise =$582,400
No discount on transportation fees for
repeat business
GTG
Solution Rank : 155
W3 Operating costs
For actual 2006
For naturopathy centre: $40,000,000
For meditation courses: $50,000,000
For budget 2007
For naturopathy centre: $40,000,000 +7% rise =S42.800.000
For meditation courses: $50,000,000 +7% rise =$53,500,000
(b) If 10% discount is not provided
Revenue from repeat business is $11,536,560
See W1 meditation,
budget 2007 calculations
If the discount is not provided, 5% of repeat business will be lost.
Therefore the revenue will be:
=($11,536.560/90%) - 5% loss of business
=$12,818,400 - (5% x $11,536,560)
=$12,241,572
The 5% loss in business will be due to loss of
those visitors who receive the 10% discount
therefore do not consider the full amount, i.e.
$12,818,400, but consider S11,536,560 which
is after the 10% discount.
If the discount is not provided for the repeat business, revenue will
increase by $705,012 ($12,241,572 - $11,536,560) and therefore considering profitability is the main objective
of the business, it is advisable to discontinue the practice of providing a 10% discount.
(c) The percentage of maximum capacity at which the meditation course will break even during the year
ended 31 December 2007
Revenue from meditation centre
Admission fees (W1)
Travel fees
62.810,160
582,400
63.392.560
Total visitors (including repeat business) =112,000
Revenue per visitor =$63,392,560/112,000
=$566 005
Fixed costs 53,500,000
Less:
Fixed income 1,500,000
Fixed costs less fixed income 52.000.000
Do not forget to deduct the fixed
income since fixed cost will be
covered to th is extent,
irrespective of the number of
visitors.
Number of visitors which will cover total fixed cost = Total fixed
cost/Average contribution per visit
=$52,000,000/S566.005 =91,872 visitors
Total capacity for visitors to the meditation courses =2,000 x 70 =140,000
Therefore
The percentage of maximum capacity required in order to break even =Number of visitors required to cover
fixed costs/Total capacity of visitors to the meditation course.
=91,872/140,000
=65.62%
(d) The importance of qualitative information for assessing the performance of Alisha
In this part of the question. 2 marks are allotted to the general discussion and 5 marks are for
discussing the non-financial measures.
According to Professor R.S. Kaplan, if too much emphasis is placed on financial measures, an organisation's
long-term viability becomes threatened. This is because financial measures, such as profitability, ROI and
revenue growth, focus on short-term performance. If excessive emphasis is placed on financial measures and
the reward system is linked to financial performance, there is the possibility that the managers may take
dysfunctional decisions. For example. Alisha Pic may choose to admit more than 1,000 patients without
increasing its capacity. This will increase Alisha's profitability in the short term but will affect its service quality
and reputation and thereby its profitability in the long term.
This example demonstrates that financial measures of performance ignore qualitative measures, which are very
important for a service organisation such as Alisha. Qualitative information provides additional information over
financial information. For example, if the profit for the year is increased by 10% than the previous year
apparently it seems that the organisation is performing well and shows trend of increasing revenue. However, if
a customer satisfaction report shows that the customers are not satisfied with the service provided by the
organisation, it may indicate that the revenue of the organisation may not continue to increase.
Therefore, in order to assess the performance of Alisha. it is necessary to obtain the following qualitative
information:
Service quality: service quality can be determined by its dimensions. According to a team of research experts
comprising Parasuraman, Berry and Zeithaml. service dimensions are:
reliability (ability to perform promised service)
> appearance of physical facility (personnel, equipment, communication materials)
> responsiveness (willingness to help customers promptly)
> assurance (knowledge, courtesy of employees)
> empathy (of employees)
For example, a meditation hall should be properly ventilated.
Employee behaviour: staff should be polite and cooperative. Doctors, lecturers, dieticians etc. should be
experts in their respective fields.
Cleanliness I tidiness: the accommodation provided by Alisha Pic to its visitors / patients should be clean and
tidy. Hygienic food should be provided in consultation with the dieticians. The customers of Alisha Pic are of all
ages from senior citizens to children and therefore food and shelter should be provided accordingly.
Security: the transportation facility for people coming to Alisha Pic is provided by the company itself. Therefore
it should ensure the safety of its visitors / patients during transportation. Some patients (such as senior citizens)
may require special treatment because of their health. Alisha should be able to respond to any requirements
with the help of its doctors and dieticians.
Availability This refers to the sufficiency of resources e.g. whether the number of doctors, dieticians and
other supporting (administrative) staff is sufficient.
(e) Strategies to enhance profitability
> Increase the batches of naturopathy treatment i.e. the number of batches in a year can be increased
from 10 to 11 or 12.
r It is stated that Alisha's naturopathy treatment is very famous and the naturopathy courses are fully
occupied. Therefore increasing the capacity of each batch will be beneficial for Alisha and will
increase its profitability.
^ Undertake a detailed analysis of operating costs to identify non-value-added costs so that they can be
eliminated to increase profitability.
> As discussed earlier. Alisha can discontinue the practice of providing a 10% discount for repeat business.
> Alisha may consider conducting other courses e.g. yoga or a one-day meditation programme. An
organisation should always come up with innovative ideas so as to survive in the market and improve its
profitability.
GTG Solution Rank : 157
A
Score Mor e
In order to improve its performance, Alisha should control its costs. In addition, it should
be innovative and come up with different courses to supplement the meditation and naturopathy
treatment. It should analyse its strengths and weaknesses and try to convert its strengths into a
competitive advantage and weaknesses into strengths.
Note: the answer given above is a correct answer but in order to score good marks, you need to
be more specific. You should relate your answer to the given scenano. For example, instead of
saying just that Alisha should be more innovative, you should give an example of an innovative
idea which could improve its performance (as given in the original answer, which suggests
conducting yoga classes or increasing the batches for naturopathy treatment).
38. Corporate failure - Fashion Plus
(a) Calculating Z score
4
In part 'a' of the question, you are specifically asked to calculate the Z score therefore show the
step by step calculation of the Z score. You should also show the working notes since marks are
also given for workings.
Remember, however, that only calculating the Z score will not give you full marks. You need to
comment on the probability of failure of Fashion Plus.
The current (31 March 20X7) Z score for Fashion Plus can be calculated as follows:
Z =1.2Xi +1.4X2 +3.3Xj
+
0.6X +1.0X5
Ratio $m
X, Working capital/Total assets (W1) & (W2) (5.40)/675 (0.008)
x2
Retained earnings-Total assets 145.80/675 0.216
x3
X,
Earnings before interest & tax/Total assets 56.70/675 0.084 x3
X, Market value of equity/Book value of total debt (W3) & (W4) 70.20/461.70 0.152
x5
Sales/Total assets 586.80/675 0.869
Workings
W1 Working capital
W2 Total assets
=Current assets - Current liabilities
=S209.25 - $214.65
=($5.40) m
=Non-current assets +Current assets
=$465.75 +$209.25
=S675.00m
W3 Market value of equity book =No. of shares x Market pnce
=135m (67.50/50 cents) shares x 52 cents
=$70.20m
W4 Total debt =Long-term debt +Current liabilities
=$247.05+ $214.65
=$461.70m
Z =1.2X1 +1.4X2 +3.3X3 +0.6X4+1.0X5
Z =1.2(-0.008) +1.4(0.216) +3.3(0.084) +0.6(0.152) +1.0(0.869)
=-0.0096 +0.3024 +0.2772 +0.091 +0.869
=1.53
Assessment of Z score
Z-score Prediction
Less than 1.81 High probability of corporate failure
1.81 to 3 Needs further investigation
Above 3' Financially sound company
Remember, the lower the score,
the higher the possibility of
bankruptcy.
Since the Z-score derived above is below 1.81, Fashion Plus has a high probability of failure. The managing
director of Fashion Plus should not be surprised by this score as the statement of financial position and
statement of comprehensive income clearly reflect the failing position of Fashion Plus. For example, the EBIT
(S66.50m in 20X6 & $56.70m in 20X7) and retained earnings ($11.10m in 20X6 & $1.79m in 20X7) are
declining whereas the loan balances are increasing (S213.30m in 20X6 & $247.05m in 20X7).
(b) Qualitative information
The following qualitative information indicates that Fashion Plus may fail:
> The chief executive is an autocrat: it is stated that he has a dominant and arrogant style of working.
> Passive board: the members of the board have not shown any interest in the suggestion made by
Waterman and have also not put forward any suggestions of their own.
> Sales and profits have shown a decreasing trend over the last two years.
> There has been a significant fall in the market share of Fashion Plus.
> No innovative product: the company has not offered any new product In the market for the last three years
and currently has no plans to do so in future.
In addition, due to the many changes in retailing style etc. it has become difficult to survive in the market
without innovative ideas or at least following competitors.
(c) Performance improvement strategies
4
Remember that your answer should be related to the scenario given in the question i.e. it should
not be a general answer. In addition, remember that even if your answer to part a' is that Fashion
Plus is not in danger of failure; you should suggest performance improvement strategies. This is
because performance improvement strategies are not required only when the company is facing
problems (and striving for survival in the market); even if it is performing well, such strategies are
necessary to improve its competitiveness. In such cases, these strategies will enable the company
to become a market leader.
According to the Z score model and some of the qualitative information. Fashion Plus has a high probability of
failure. The expected corporate failure of Fashion Plus may be avoided if the following corrective actions are
taken immediately:
> become low cost producer
Being a low cost producer often gives a competitive advantage. Fashion Plus is facing tough competition from
competitors. By minimising the total cost. Fashion Plus can sell its products at prices lower than those of
competitors, keeping the margin intact. At the same time, being a low cost producer may help Fashion Plus to
avoid the problem of a cash crunch / lack of sufficient working capital to some extent.
^ be flexible and fast
Fashion Plus should become more flexible by accepting opportunities and challenges as well as taking
decisions quickly and implementing them immediately. The managers of Fashion Plus should take immediate
steps to improve the performance of the company. They should think over the suggestion given by Waterman.
If they do not consider this suggestion to be viable, they should come up with other ideas to save the company
from bankruptcy.
GTG
Solution Rank : 159
> be innovative
Fashion Plus should take innovative steps (such as selling its products online) in order to bring the ultimate
user closer to the company. This will also strengthen the interaction between the company and its customers
so that Fashion Plus can decide on strategies to improve customer satisfaction.
^ have sustainable competitive advantage
Fashion Plus should take steps towards achieving a sustainable competitive advantage by continuously
developing existing resources and/or creating new resources and capabilities in response to rapidly changing
market conditions. Fashion Plus must take these steps in order to survive and grow in the modern, competitive
era.
In addition to this,
v Fashion Plus needs to improve its marketing function in order to increase sales. It may do this by creating
brand awareness, producing high quality and innovative products and meeting the expectations of its
customers.
s Fashion Plus should focus on the three Ms of successful business i.e. money, management and marketing.
The management of Fashion Plus should investigate whether it is lacking in any of the Ms and, if so, take
corrective actions immediately. It is clear that there is a problem in the management of Fashion Plus
therefore Robin, the CEO, should change his style of working and should listen to the suggestions given by
the board members. In addition, the board of Fashion Plus needs to be restructured to include participating
directors.
161: Performance evaluation and Corporate Failure
SOLUTION BANK
a. CURRENT DEVELOVEMENTS
I AND EMERGING ISSUES IN
g PERFORMANCE MANAGEMENT
UJ
CO
F
39. Contemporary management accounting techniques
EESQF
As has been done in part (a) of the answer, a point-by-point answer analysing each case of the
cost-quality relationships is preferred in order to get high marks in the exam.
Part (b) of the question needs to be answered in sub-parts analysing the relationship between
costs and quality in light of contemporary management accounting techniques such as Total
Quality Management. J ust In Time. Value Analysis. Activity Based Costing and Balanced Scored.
I
(a) The probable business consequences of pursuing the alternative paths available and arriving at points B to
F are explained below:
> Movement towards B from A indicates a combination of higher costs and higher quality. Whether the
strategy is worthwhile will depend on the overall market situation and how competitors respond to it.
> Movement towards C from A indicates achieving higher quality at constant costs. It appears to be a
successful option but the success of this strategy will depend on the overall market situation and how
competitors respond to it.
> Movement towards D from A indicates improvement in quality at a lower cost. It is certainly the most
desirable path to follow. This will generate long-term business success if it can be sustained. However, its
feasibility in the long term is questionable.
Movement towards E from A indicates a reduction in costs while maintaining quality. This may be successful
in the short term but. in the long term, quality improvements amongst competitors may pose a threat to
market retention.
> Movement towards F from A indicates lower costs and quality. This strategy will not be successful for all
classes of customers. However, for the poorer segment of consumers (particularly in third world countries)
this strategy may be successful in penetrating the market in the short term. In the long term, however, this
strategy may not be accepted by the market.
Path D is the most desirable option for the business in order to bring business success.
(b)
Total quality management (TQM)
Total quality management (TQM) is a management technique centred on quality and based on the participation
of all the members of an organisation. Its aim is the long-term success of the organisation, achieved through
customer satisfaction and provision of benefits to all members of the organisation and the society as a whole.
Like most quality management concepts. TQM views 'quality' entirely from the point of view of "the customer'.
The TQM approach involves finding out what the customer wants, designing a product or service that will meet
the customer's needs, designing processes that will complete the job correctly the first time and keeping track of
the result in order to make more improvements.
TQM recognises that all businesses require processes that enable customer requirements to be met. TQM
focuses on the ways in which these processes can be managed - with two key objectives:
> 100% customer satisfaction
> zero defects
102: Current Development and Emerging Issues In Performance Management GTG
The underlying principle of TQM is that the costs of preventing deficient quality are less than the costs of
correcting poor quality. This denies the idea that improved quality can only be secured with greater expenditure,
but adopts the approach that improved quality will reduce costs.
Quality related costs are concerned with both achieving quality and failure to achieve quality. Quality related
costs can be classified as the following:
a- Prevention costs: originate from communicating the concept, providing training and establishing systems
to deliver quality services.
> Appraisal costs: mostly generated from inspection and testing.
^ Internal failure costs: generated from materials used in rejects, down time resulting from internal service
quality failures and resources devoted to dealing with complaints.
^ External failure costs: relate to loss of goodwill and future business, compensation paid to customers and
rectification costs.
The TQM view is that by getting it right first time and every time, the prevention and appraisal costs can be
justified by the savings in failure costs. TQM considers lower costs and improved quality to be congruent goals.
A
Score Mor e
The answer to part (b) of the question should specifically explain how important the
aspects of costs and quality are in contemporary management accounting / management
techniques.
A bad answer would omit to mention quality related costs and their classification with reference to
TQM.
J ust in time (J IT)
J IT involves the elimination of waste and excess resources. It also recommends performing activities only as
customers need them at the next stage in the process. A J IT system always encourages production in response
to the demand for a product and strongly discourages production for creating inventory. It is in stark contrast
with traditional production systems.
According to the J IT system, to ensure rapid production, individual materials will spend much less time in work-
in-progress and accordingly, the total volume of work-in-progress will reduce.
The advantages of arranging the factory into cells (these are small specialised manufacturing plants that are
dedicated to production of small number of products) also include obtaining more accurate product costs. Some
support services such as production scheduling, engineering, maintenance and human resource management
are also decentralised which reduces the amount of indirect costs. Since the cells are production units
dedicated to producing a product, these costs (incurred in the cells) become direct costs (because of their easy
traceability) of the products produced in the cell.
J IT is a manufacturing and supply chain process that is intended to reduce inventory levels and improve
customer service by ensuring that customers receive their orders at the right time and in the nght quantity. The
system should facilitate a smooth workflow throughout the business and reduce waste. Goods are produced to
meet customer needs directly, not for stock.
Cost reductions in J IT anse from:
> a reduction in waste
> lower raw material and finished goods inventory levels, therefore reduced holding costs
> reduced material handling (thereby reducing handling losses)
the fact that J IT frequently results in a reduction in the number of suppliers and accordingly reduces
administration and communication costs
^ the guaranteed quality of supplies, which reduces inspection and rectification costs
GTG
Solution Rank :163
Quality improvements arise from:
> depending on fewer suppliers or even a single supplier, which strengthens the buyer-supplier relationship
and is likely to improve the quality.
> the absence of customer stockholding, which compels the suppliers (if they want continued business) to
guarantee the quality of the matenal that they deliver just in time.
> production in the cells, which ensures specialised and rapid production and leads to an improvement in
quality.
> a direct focus on meeting an identified customer's needs, rather than production merely to add to an
anonymous stock pile.
Performing activities only as customers need them at the next stage in the process. Accordingly, J IT ensures
quality of production in order to satisfy its ultimate customers.
Value analysis
Value analysis is a systematic inter-disciplinary assessment of factors affecting the cost of a product or service.
Its objective is to reduce cost while satisfying customer needs. It can result in improvements in product designs,
changes in material specifications or modifications in process methods.
The aim of value analysis is to achieve the assigned target cost by:
^ identifying improved product designs that reduce the product's cost without sacnficing functionality; and/or
eliminating unnecessary functions that increase the product's costs and for which customers are not
prepared to pay extra
Value analysis examines business activities and questions why they are being undertaken and what contribution
they make. Value-added activities include designing products, producing output and developing customer
relationships. Non-value-added activities include returning goods, inventory holding and checking on the quality
of supplies received. Wherever possible, value analysis recommends the elimination of non-value-added
activities.
Value analysis commences with a focus on the customer - what do they want, what do they regard as
significant in the buying decision: function, appearance, longevity or disposal value? This is concerned with
identifying what customers regard as quality and then providing it. The principle is that organisations should not
waste effort on activities that are regarded as unimportant from the customer's point of view.
Activity-based costing (ABC)
Activity-based costing may be described in simple terms as a method of assigning overhead costs to products
or services on a more realistic basis than simply production volume (or machine hour / labour hour). The ABC
method also attempts to show the relationship between overhead costs and the activities that cause them.
There are considerable similanties between the traditional absorption costing system and the ABC system.
Under both systems, direct costs are charged directly to the product and indirect costs are assigned to the
product using a two stage allocation process. Significant dissimilarities, however, arise in the second stage of
the overhead allocation process.
In brief, it can be said that activity-based costing refines the traditional absorption costing system by focusing on
the individual activities that have a cause and effect relationship with the overhead costs. The ABC system
calculates the costs of individual activities and assigns the activity costs to products or services (i.e. the cost
objects) on the basis of the activities needed to produce each product or service.
ABC not only helps in calculating costs more accurately than the traditional system but also links costs to
activities. Accordingly, it becomes easier to cut costs by eliminating non-value-added activities.
The balanced scorecard
The main concept of the balanced scorecard is that no one measure can properly evaluate the organisation's
progress to strategic success. Rather, multiple measures typically grouped in the four key areas provide the
desired comprehensive evaluation of the organisation's performance. Moreover, by attending directly to the
firm's critical success factors, the balanced scorecard effectively links the performance measurement /
evaluation to the organisation's strategy.
164: Current Development and Emerging Issues In Performance Management GTG
The balanced scorecard is made up of the following components:
> formulation of strategy in line with the institutional vision and mission
translation of institutional strategy into measurable performance goals for each unit based on a cause and
effect relationship
^ definition of assessment policies and procedures including criteria of success
> design of data collection and analysis tools
> monitoring and measurement of actual performance
alignment of strategies, intended outcomes and assessment procedures in the light of assessment results
reporting recommendations for improvements to the strategic committee for review and use in strategic
planning
A useful approach for a complete strategic performance evaluation is to include both financial and non-financial
factors for an organisation, using the balanced scorecard. The balanced scorecard measures an organisation's
performance in four key areas:
> internal business process
> learning and growth
> An organisation needs to monitor what factors customers regard as contributing to improved quality, not
what the business thinks it should provide. Therefore the scorecards are suitable for inclusion as quantifiable
indicators on the axis on the Costs and Quality diagram. The balanced scorecard attempts to improve the range
of and relationship between alternative performance measures, i.e. in the given case, costs and quality.
40. Traditional vis-a-vis modern management accounting
I j Gmj r^ This question deals with issues such as the charactenstic features of traditional management
accounting function vis-^-vis current 'techniques or philosophies' of management accounting such
as J IT, TQM.
Your answer should contain logical analysis of the issues raised in the question. You should
answer point-by-point in order to earn high marks.
(a) The aspects of the operation of the management accounting function which are likely to apply in the
traditional system are as follows:
In the traditional system, raw materials are purchased to build up inventory. Such purchases are traditionally
monitored based on material resource planning. Material resource planning takes into consideration standard
product specification and an allowance for lead times in delivery by suppliers and estimated usage rates in
production. Purchases, in the traditional system, are generally made in large quantities in order to take
advantage of discounts offered for bulk orders. The traditional system requires the pricing of issues (in
order to calculate costs of material consumption in production) from stores and the valuation of inventory
balances.
> The production cycle in a traditional system involves a number of operations or processes in sequence.
The management accounting function is required to value work-in-process at various stages of the
production cycle. Cost control exercises take place at the cost centres in response to deviations of actual
expenditure from the budgeted expenditure. Cost efficiency is achieved by increasing the budgeted volume
of production as far as possible and thereby absorbing lower costs per unit. Normal levels of losses in the
production process are incorporated into the costs of output achieved and abnormal losses, if any, are
charged directly to the income statement in order not to change the production cost to a large extent.
Production takes place according to the production plan conceived beforehand and production volume
that cannot be sold during the period is held in inventory. The finished goods inventory is valued for each
product type.
> Selling prices for a range of products are likely to be known and profits are monitored, for example, by
product range and/or geographical area. Profit margins will be measured against budgeted I standard levels.
GTG
Solution Rank :165
(b) An alternative sequence, more applicable to the modern business environment, is likely to incorporate:
> shorter product life cycles and the need to identify and obtain new markets.
^ a 'pull through" production environment to meet customer demand with minimum stock requirements.
(For example, in a J IT system, production is made according to market demand and building up
inventory at every stage of production is discouraged).
flexible manufacturing facilities dedicated to the completion of a cycle of operations for a component or
product during its life cycle. (In a J IT environment, dedicated production systems called cells' produce each of
the components resulting in rapid production, easy identification of costs and minimum wastage).
f a 'right first time' philosophy (as is encouraged in a TQM environment) focusing on total quality and
continuous improvement.
^ identification of a few suppliers who will supply the required quality of raw materials just in time (without
causing any pause in production and at the same time without requiring raw materials to be kept in the
inventory).
(c) The operation of a management accounting system will be affected in a number of ways from changes
such as those indicated above. Areas of change in management accounting may include the following:
> The need for a raw material inventory valuation and issue pncing system will be significantly reduced.
^ An activity-based cost analysis system, focusing on the analysis of value-added and non-value-added
activities, is likely to replace a cost-based system. Moreover, focus will be shifted to the fact that activities
drive costs and accordingly costs can be controlled if activities are controlled.
> The need for the valuation of VVIP will be minimised through the use of dedicated production facilities (as in
the case of a J IT manufacturing system). Focus will be on the trend of average cost per unit produced by
the dedicated facility rather than on the determination of normal and abnormal losses and their valuation.
There may be increased emphasis on the use of techniques such as backflush accounting, which attempts
to simplify accounting requirements at the shop floor and at the same time is suitable for a new kind of
production system such as J IT.
There will be increased use of non-financial performance indicators (in particular, qualitative performance
indicators).
> There will be greater focus on benchmarking as part of the survival and growth strategy.
r- Techniques such as target costing will be more relevant in negotiating new business proposals (and as a
tool for cost reduction) and deciding on their financial viability.
r Customer profitability analysis will be more important in order to ensure that more care is taken to serve
highly profitable customers and a long-term customer relationship can be built as a growth strategy.
Note: Alternative relevant points would be accepted.
166: Current Development and Emerging Issues In Performance Management
PRESENT VALUE TABLE
APPENDIX
1
Present value of 1 i.e. (1 + it"
Where r = discount rate
n - number ol periods until payment
Discountrate (r)
<n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
1 0-990 os s o 0-971 0-962 0-952 0-943 0-935 0-926 0 917 0- 909 1
2 0-980 0961 0-943 0-925 0-907 0-890 0 873 0-857 0-842 0- 826 2
3 0-971 0942 0 915 0-889 0-864 0-840 0-816 0-794 0-772 0- 751 3
4 0961 924 0-888 0-855 0-823 0-792 0-763 0-735 0-708 0- 683 4
5 0-951 0006 0-863 0-822 0-784 0-747 0-713 0 681 0650 0- 621 5
6 0-942 0888 0837 0-790 0- 746 0-705 0-666 0-630 0-596 0- 564 6
7 0-933 0-871 0-813 0-760 0711 0-665 0-623 0-583 0-547 0- 513 7
8 0-923 0853 0-789 0-731 0-677 0-627 0582 0-540 0-502 0-467 8
9 0-914 0837 0-766 0-703 0- 645 0-592 0-544 0-500 0-460 0- 424 9
10 0-905 0820 0-744 0-676 0-614 0-558 0-508 0-463 0-422 0- 386 10
11 0-896 0804 0-722 0-650 0-585 0-527 0-475 0-429 0- 388 0- 350 11
12 0-887 0 788 0-701 0-625 0557 0-497 0-444 0-397 0- 356 0- 319 12
13 0-879 0773 0681 0-601 0530 0-469 0-415 0-368 0- 326 0- 290 13
14 0-870 0758 0661 0-577 0-505 0-442 0-388 0-340 0- 299 0- 263 14
15 0-861 0-743 0642 0-555 0-481 0 417 0-362 0-315 0- 275 0- 239 15
(n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%
1 0-901 0893 0-885 0-877 0- 870 0-862 0855 0-847 0-840 0- 833 1
2 0-812 0797 0-783 0-769 0- 756 0-743 0-731 0-718 0-706 0-694 2
3 0-731 0712 0-693 0-675 0- 658 0-641 0624 0-609 0-593 0- 579 3
4 0-659 0636 0-613 0-592 0-572 0-552 0-534 0-516 0-499 0- 482 4
5 0-593 0567 0-543 0-519 0-497 0-476 0-456 0-437 0-419 0- 402 5
6 0-535 0507 0-480 0-456 0-432 0-410 0-390 0-370 0-352 0- 335 6
7 0-482 0452 0-425 0-400 0- 376 0-354 0333 0-314 0-296 0- 279 7
8 0-434 0404 0-376 0-351 0-327 0-305 0-285 0-266 0-249 0- 233 8
9 0391 0361 0-333 0-308 0-284 0-263 0 243 0-225 0-209 0- 194 9
10 0-352 0 322 0-295 0-270 0-247 0-227 0 208 0-191 0- 176 0- 162 10
11 0-317 0287 0-261 0-237 0-215 0-195 0-178 0-162 0- 148 0- 135 11
12 0-286 0-257 0-231 0-208 0-187 0-168 0-152 0-137 0- 124 0- 112 12
13 0-258 0-229 0-204 0-182 0163 0 145 0-130 0-116 0-104 0- 093 13
14 0-232 0205 0-181 0-160 0-141 0-125 0 111 0-099 0- 088 0- 078 14
15 0-209 0-183 0-160 0-140 0123 0-108 0 095 0-084 0-074 0- 065 15
ANNUITY TABLE
APPENDIX
2
i _d J. /)<
Present value of an annuity ot 1 i.e. 1
Where r = discount rate
n ^ number of periods
Discount rate (f)
Periods
<n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
1 0-990
2 1-970
3 2-941
4 3-902
5 4-853
6 5-795
7 6-728
8 7-652
9 8-566
10 9471
11 10-37
12 11-26
13 1213
14 13-00
15 13-87
(n) 11%
0 580 0- 971
1 942 1 913
2 884 2-829
3 808 3-717
4-713 4 580
5-601 5-417
6-472 6-230
7-325 7 020
8-162 7 786
8963 8530
9787 9253
10-58 9-954
11-35 10 63
12-11 11-30
12-85 11-94
12% 13%
0-962 0-952
1 886 1-859
2-775 2-723
3-630 3-546
4-452 4-329
5-242 5-076
6-002 5-786
6-733 6-463
7-435 7-108
8-111 7-722
8-760 8-306
9-385 8-863
9-986 9-394
10-56 9-899
11-12 10-38
14% 15%
0-943 0935
1-833 1808
2-673 2 624
3-465 3387
4-212 4-100
4-917 4-767
5-582 5 389
6-210 5971
6-802 6 515
7-360 7 024
7-887 7499
8-384 7 943
8-853 8 358
9-295 8 745
9-712 9108
16% 17%
0 926 0-917
1-783 1-759
2-577 2-531
3-312 3-240
3-993 3-890
4-623 4-486
5-206 5-033
5-747 5-535
6-247 5-995
6-710 6-418
7-139 6-805
7-536 7-161
7-904 7-487
8-244 7-786
8-559 8-061
18% 19%
0-909 1
1-736 2
2-487 3
3170 4
3-791 5
4-355 6
4-868 7
5-335 8
5-759 9
6- 145 10
6- 495 11
6-814 12
7-103 13
7-367 14
7-606 15
20%
1 0-901
2 1-713
3 2-444
4 3-102
5 3-696
6 4-231
7 4-712
8 5146
9 5-537
10 5-889
11 6-207
12 6-492
13 6-750
14 6-982
15 7-191
0893 0885
1 690 1-668
2-402 2-361
3 037 2-974
3 605 3-517
4-111 3-998
4 564 4-423
4 968 4-799
5-328 5 132
5 650 5-426
5938 5-687
6-194 5-918
6 424 6 122
6 628 6-302
6 811 6 462
0 877 0-870
1-647 1-626
2-322 2-283
2-914 2-855
3-433 3-352
3-889 3-784
4-288 4-160
4-639 4-487
4-946 4-772
5-216 5-019
5-453 5-234
5-660 5-421
5842 5-583
6-002 5-724
6-142 5-847
0862 0855
1-605 1585
2-246 2-210
2-798 2-743
3-274 3-199
3-685 3589
4-039 3922
4-344 4-207
4-607 4 451
4-833 4659
5-029 4836
5197 4 988
5-342 5118
5-468 5-229
5-575 5-324
0 847 0 840
1-566 1-547
2-174 2-140
2-690 2-639
3-127 3-058
3-498 3-410
3-812 3-706
4-078 3-954
4-303 4-163
4-494 4-339
4-656 4- ^86
4-793 4-611
4-910 4-715
5-008 4-802
5092 4-876
0 833 1
1-528 2
2-106 3
2-589 4
2-991 5
3-326 6
3-605 7
3-837 8
4-031 9
4-192 10
4-327 11
4-439 12
4- 533 13
4- 611 14
4- 675 15
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