Answers

Part 3 Examination Paper 3.3 Performance Management

June 2006 Answers

(a) Sales units Sales revenue Costs: Direct Materials Packaging Direct Labour Royalties Variable overheads Fixed overheads Total costs Profit Less: Cost of investment Projected return: Average annual projected return Average annual rate of return Required average annual rate of return: (Working 1) (Working 1)

12 months 1,200,000 18,000,000 7,686,000 916,000 4,140,155 900,000 1,449,054 900,000 15,991,209 2,008,791 1,900,000 108,791 108,791 573% 35%

18 months 1,590,000 23,850,000 10,020,150 1,216,500 5,179,115 1,100,000 1,812,690 1,350,000 20,678,455 3,171,545 1,900,000 1,271,545 847,697 (2/3) 4462% 35%

(Working (Working (Working (Working (Working

2) 3) 4) 5) 6)

The required average annual rate of return (35%) will be achieved over an eighteen month period (projected = 4462%) but will not be achieved in the event that the product is withdrawn from the market after a period of twelve months (projected = 573%). Workings: (1) Sales units are 100,000 units per month for months 112 inclusive. Thereafter sales units fall by 10,000 each month. Thus sales units in months 1318 are as follows: Month No. Sales (units) 12 months 18 months 13 90,000 14 80,000 15 70,000 16 60,000 17 50,000 18 40,000 Total months (1318) 390,000 1,200,000 1,590,000 Selling price per cake = 2025 x (100/135) 15 15 Sales revenue= 18,000,000 23,850,000 (2) Direct materials: Months 13 46 712 Cost for 12 months 1318 Cost for 18 months Batches 300 x 7,000 300 x 6,650 600 x 5,985 s 2,100,000 1,995,000 3,591,000 7,686,000 2,334,150 10,020,150

390 x 5,985

13

(3) Packaging costs: Months 112 Unit costs = 075 x 1,200,000 = Design and artwork costs: 24,000 less refund of 8,000 = 900,000 16,000 916,000 1,192,500 24,000 1,216,500

Months 118 Unit costs = 075 x 1,590,000 = Design and artwork costs =

(4) Direct Labour: For months (15 inclusive)

y = axb y = 60,000 x 5000415 y = 4,55071 Therefore the total cost = 4,55071 x 500 =2,275,355 All batches after the first 500 batches will have the labour cost of the 500th batch. For 499 batches y = axb y = 60,000 x 4990415 y = 4,55449 Therefore the total cost =4,55449 x 499 = 2,272,691 The cost of the 500th batch is 2,275,355 2,272,691 = 2,664 The total cost for 12 months is 2,275,355 + (700 x 2,664) = 4,140,155 The total cost for 18 months is 4,140,155 + (390 x 2,664) = 5,179,115

(5) Royalties Months 112: 5% x 18,000,000 = 900,000 Months 118: 5% x 23,850,000 = 1,192,500 (subject to a maximum of 1,100,000). (6) Variable overheads amount to 350 per hour i.e. 35% of direct labour. (b) (i) The directors of GWCC might consider any of the following specific actions in order to improve the return on the investment: Attempt to raise the selling price of the Mighty Ben cake to Superstores plc. Much will depend on the nature of the relationship in terms of mutuality of trust and co-operation between the parties. If Superstores plc are insistent on a launch price of 2025 and a mark-up of 35% on its purchase price from GWCC then this is likely to be unsuccessful. Attempt to reduce the material losses in the first 600 batches of production via improved process control. Attempt to negotiate a retrospective rebate based on volumes of packaging purchased. Improve the rate of learning of the hand-skilled cake decorators via a more intensive training programme and/or altering the flow of production. Undertake a thorough review of all variable overheads which have been absorbed on the basis of direct labour hours. It might well be the case that labour is not the only cost driver in which case variable overheads might be overstated. Undertake a thorough review of all fixed overheads to ensure that they are specific to the production of the Mighty Ben cake. Adopt a value engineering approach in order to identify non value added features/aspects of the product or processes used to produce it. This would have to be done in conjunction with Superstores plc, but might end in a win-win scenario. Ensure that all overhead expenditure will be incurred in the most economic manner. Two factors which might reduce the return earned by the investment are as follows: (i) Poor product quality The very nature of the product requires that it is of the highest quality i.e. the cakes are made for human consumption. Bad publicity via a product recall could potentially have a catastrophic effect on the total sales to Superstores plc over the eighteen month period. The popularity of the Mighty Ben character There is always the risk that the popularity of the character upon which the product is based will diminish with a resultant impact on sales volumes achieved. In this regard it would be advisable to attempt to negotiate with Superstores plc in order to minimise potential future losses.

(ii)

(ii)

14

(c)

Target costing should be viewed as an integral part of a strategic profit management system. The initial consideration in target costing is the determination of an estimate of the selling price for a new product which will enable a firm to capture its required share of the market. In this particular example, Superstores plc, which on the face of it looks a powerful commercial organisation, wishes to apply a 35% mark-up on the purchase price of each cake from GWCC. Since Superstores plc has already decided on a launch price of 2025 then it follows that the maximum selling price that can be charged by GWCC is (100/135) x 2025 which is 1500. This is clearly a situation which lends itself to the application of target costing/pricing techniques as in essence GWCC can see the extent to which they fall short of the required level of return with regard to a contract with Superstores plc which ends after twelve months. Thus it is necessary to reduce the total costs by 556,029 to this figure in order to achieve the desired level of profit, having regard to the rate of return required on new capital investment. The deduction of required profit from the proposed selling price will produce a target price that must be met in order to ensure that the desired rate of return is obtained. Thus the main theme that underpins target costing can be seen to be what should a product cost in order to achieve the desired level of return. Target costing will necessitate comparison of current estimated cost levels against the target level which must be achieved if the desired levels of profitability, and hence return on investment, are to be achieved. Thus where a gap exists between the current estimated cost levels and the target cost, it is essential that this gap be closed. The Directors of GWCC plc should be aware of the fact that it is far easier to design out cost during the pre-production phase than to control out cost during the production phase. Thus cost reduction at this stage of a products life cycle is of critical significance to business success. A number of techniques may be employed in order to help in the achievement and maintenance of the desired level of target cost. Attention should be focussed upon the identification of value added and non-value added activities with the aim of the elimination of the latter. The product should be developed in an atmosphere of continuous improvement. In this regard, total quality techniques such as the use of Quality circles may be used in attempting to find ways of achieving reductions in product cost. Value engineering techniques can be used to evaluate necessary product features such as the quality of materials used. It is essential that a collaborative approach is taken by the management of GWCC and that all interested parties such as suppliers and customers are closely involved in order to engineer product enhancements at reduced cost. The degree of success that will be achieved by GWCC via the application of target costing principles will be very much dependent on the extent of flexibility in variable costs. Also the accuracy of information gathered by GWCC will assume critical importance because the use of inaccurate information will produce calculated cost gaps which are meaningless and render the application of target costing principles of little value.

(a)

Many writers including Lynch and Cross suggest a number of measures that go beyond traditional financial measures such as profitability, cash flow and return on capital employed. The measures that they propose relate to business operating systems, and they address the driving forces that guide the strategic objectives of the organisation. Lynch and Cross suggest that customer satisfaction, flexibility and productivity are the driving forces upon which company objectives are based. They suggest that the status of these driving forces can be monitored by various indicators which can be derived from lower level (departmental) measures of waste, delivery, quality and cycle time. The Performance Pyramid derives from the idea that an organisation operates at different levels each of which has a different focus. However, it is vital that these different levels support each other. Thus the pyramid links the business strategy with day to day operations. The Performance Pyramid Measure up the essential guide to measuring business performance, Lynch and Cross (1991).

The Vision

Corporate vision

Market satisfaction 9 dimensions of pyramid Customer satisfaction Quality Delivery

Financial measures Flexibility Productivity Waste

SBUs Business operating system Departments

Process time

Operations External effectiveness Internal effectiveness

15

(b)

(i) EAJ Financial performance and Competitiveness Summary Profit and Loss Account for the year ended 31 May 2006 Budget 000s Fee income: New Existing 2,940 6,930 9,870 5,000 3,600 8,600 1,270 Actual 000s 3,150 8,085 11,235 5,000 294 4,500 9,794 1,441

Costs: Consultants salaries Bonus Other operating costs Total costs Net profit

It is clear that EAJ performed well during the year ended 31 May 2006. Fee income was 138% above budget, in spite of the fact that other operating costs were 25% higher than budget. The management of EAJ should investigate what caused this significant overspend and therefore it would be extremely useful to have a more detailed breakdown of other operating costs. Consultants earned an aggregate bonus of ((11,235,000 9,870,000) (450 x 2 x 700)) x 40% = 294,000 in respect of activity above budgeted levels. Actual net profit was 1,441,000 against a budgeted net profit of 1,270,000. In spite of the overspend on other operating costs EAJ is achieving rapid growth in levels of net profit. In 2005 (its second year of trading) net profit was 50% higher than in its first year. In 2006 net profit has increased by 601% over 2005 net profit. EAJ could measure its competitiveness in terms of sales growth and the relative success in obtaining business from enquiries made by customers. In assessing sales growth it needs to be borne in mind that this is the start-up phase of EAJ. However, EAJ increased sales revenue from 4,000,000 in its first year to 11,235,000 in its third year of operation, which is very impressive. EAJs success in obtaining business from enquiries made by customers for the year ended 31 May 2006 is shown in the following table. Conversion rate from enquiries: New clients Repeat clients Budget 350% 500% Actual 300% 600%

60% of enquiries from existing clients resulted in additional chargeable consultancy days for EAJ. This may well indicate that EAJ is starting to build customer loyalty despite the fact that the organisation has only been in existence for three years. With regard to enquiries from potential first time clients, EAJ achieved a conversion ratio of 300%, against a budgeted conversion ratio of 35% that was budgeted. However, in absolute terms new business was approximately 71% above budget whilst existing business was 167% above budget. As regards the nature of the chargeable activities undertaken by the consultants it can be seen that Distribution software implementation was 206% below budget, whereas Accounting and Manufacturing implementations were 262% and 333% respectively above budget. EAJ provided 300 consultations on a no-fee basis with a view to gaining new business. Also, during the year EAJ consultants provided non-chargeable remedial consultations. Both of these non-chargeable activities might be viewed as initiatives aimed at increasing future levels of competitiveness. However, each remedial consultation could be viewed as inefficiency.

16

(ii)

External effectiveness In order to achieve external effectiveness EAJ has to satisfy its customers. Customer satisfaction may be defined as meeting customer expectations. The quality of service provision and delivery are operational criteria that can be used to monitor levels of customer satisfaction. To some extent the increase in the number of complaints and non-chargeable consultations associated with the remedying of those complaints is indicative of a quality problem that must be addressed. This problem needs to be investigated. In particular the number of chargeable days for implementation of distribution applications is significantly below budget and it might well be the case that poor service delivery is giving rise to the need for remedial consultations. Assuming consultants could otherwise have undertaken chargeable work at a rate of 700 per day, revenue amounting to 630,000 was lost as a consequence of having to undertake remedial consultations. It would appear that EAJ does not budget for complaints. A summary of client complaints received by EAJ is shown in the following table: Year ended 31 May Number of complaints Number of clients Complaint: client ratio (%) 2004 160 320 50% 2005 225 500 45% 2006 280 700 40%

Whilst it can be seen that the complaint:client ratio is improving, it should be recognised that this may be due to the fact that the size of the client base is increasing very rapidly. Such a trend might be expected during the first few years of operation, especially in a business such as EAJ. The harsh fact is that the number of complaints is increasing in absolute terms. In order to be able to better assess customer satisfaction, complaints need to be analysed since the nature of complaints may well be of far more relevance than the number of complaints! The number of customer support desk queries resolved is improving; i.e. 2004 (85%); 2005 (95%) and 2006 (99%). This will further enhance the level of customer satisfaction. The fact that the number of accounts in dispute is falling whilst the number of clients is increasing significantly on a year-on-year basis may also be an indication of improved customer satisfaction. The increase in the number of new customers and the increased revenues generated per customer are probably indicators of increasing levels of customer satisfaction. (iii) Internal efficiency Internal efficiency may be assessed by reference to flexibility and productivity. Flexibility relates to the business operating system as a whole whilst productivity relates to the management of resources such as, in the case of EAJ, consultants time. Flexibility might be substantiated by looking at the mix of work undertaken by the consultants during the year. The following table gives a comparison of actual and budgeted consultations by category of consultant. Consultations by category of consultant: Budget % Accounting 400 Distribution 300 Manufacturing 300 Actual % 442 208 350 Increase/(decrease) 42% (92%) 50%

It is a deliberate policy of EAJ to retain 100 Consultants thereby maintaining flexibility to meet increasing demand. The delivery speed will be increased as a consequence of the retention of consultants. It would appear that a change has occurred in the mix of consultants which may well be a response to changing market requirements. Again, it would be useful to see recent years statistics in order to consider trends. Productivity can be measured by the ratio of output achieved from those resources input. In this scenario the average number of chargeable days per consultant may be used as a guide. Average number of chargeable days per consultant Budget Actual Increase/(decrease) Accounting 168 212 262% Distribution 168 160 (48%) Manufacturing 168 192 143% The implementation of distribution application software was more than 20% below budget. Chargeable distribution consultancy days based on the original budget of 168 days per consultant would produce a total of 4,200 chargeable days which is 200 more than the actual levels. Again this might be indicative of a quality problem. Cycle time would appear to be improving as evidenced by the increasing number of on-time implementations as well as the reduction in the implementation time of each application. In this respect EAJ needs to be certain that the reduction in implementation time has not caused a diminution in the quality of service delivery. Consequently an aggregate bonus amounting to 294,000 was paid in respect of the year ended 31 May 2006. EAJ needs to ensure that the incentive provided by the bonus is not causing a loss of internal efficiency. With regard to the bonus paid to consultants then it is questionable whether the bonus should be shared equally by consultants since chargeable activity levels clearly vary between categories of consultant.

17

(a)

The management of The Specialist Clothing Company Ltd (SCC) could use the Boston Consulting growth share matrix in order to assess its divisions companies in terms of their rate of market growth and relative market share. The model is based on the premise that the market position of a strategic business unit (SBU) i.e. division, can be assessed by reference to its growth rate and that its relative market share best indicates the strength of an organisation. The model uses four categories, these are: Stars A star product has a relatively high market share in a high growth market. The fashion division is experiencing strong growth in a rapidly growing market. It is forecast to have a market share of 10% by the end of 2007 and therefore it seems reasonable to categorise the Fashion division as a star. Problem children (sometimes called question marks) The distinguishing feature of a problem child is that they have a relatively low market share in a high-growth market. The Childrens division would appear to fall into this category. The market leader enjoys 33% of the market whilst SCC Ltd appears to be struggling to achieve any growth in turnover and hence profits and therefore cash flow remain relatively static. Similarly, the Industrial division would appear to be a problem child since it operates in a relatively high-growth market but appears unable to achieve a reasonable market share. It would appear that the introduction of sales of industrial clothing via mailorder has not been successful. Cash cows A cash cow is characterised by a relatively high market share in a low growth market and should generate significant cash flows. The Leisure division appears to be a cash cow since it has a very high market share (70%) in what can be regarded as a low-growth market. Dogs A dog is characterised by a relatively low market share in a low growth market and might well be loss making and therefore have negative cash flow. The Footwear division would appear to fall into this category since its market share is relatively low and forecast to fall during each of the next two years in what is a low-growth market. The forecast situation of SCC Ltd is far from ideal. It has a dog (the Footwear division) and two problem children (Industrial and Childrens divisions) that require the immediate attention of management. The dog classification of the Footwear division is precarious to say the least. Competitors within low growth markets will invariably offer high levels of resistance to any attempts to reduce their share of a low-growth or declining market. As far as the problem children are concerned, management need to devise appropriate strategies to convert them into stars since at the present time they appear to be in high growth markets but are unable to capture a reasonable market share. The cash generated by the Leisure division should be applied to ensure the continued upward trend of the only current star (the Fashion division) and then applied to assist in the development of the problem children.

(b)

The four quadrants of the Boston-growth share matrix summarise expected profits and resultant cash flows and recommends an outline strategy to follow which rather simplistically may be summarised as invest in stars, scrutinise the problem children, milk the cows and divest the dogs. Value Chain Analysis It is vital that the management of SCC Ltd undertake a value chain analysis of each of its divisions in order to identify and eliminate all non-value added activities, thereby improving profitability and cash flow without necessarily increasing turnover or market share. Divestment of the Footwear division Serious consideration should be given to the divestment of the Footwear division. This will enable resources to be redirected to divisions categorised as problem children i.e. the Industrial and Childrens divisions. Support the Stars As far as the Fashion division is concerned, it is obviously in a growth market and currently performing well. It is vital, given the forecast performance of the other subsidiaries that the management of SCC Ltd do not concentrate on the poor performers to the detriment of its only star.

(c)

There are numerous criticisms that have been made regarding the BCG growth share matrix. Two such criticisms are as follows: It is a model and the weakness of any model is inherent in its assumptions. For example many strategists are of the opinion that the axes of the model are much too simplistic. The model implies that competitive strength is indicated by relative market share. However other factors such as strength of brands, perceived product/service quality and costs structures also contribute to competitive strength. Likewise the model implies that the attractiveness of the marketplace is indicated by the growth rate of the market. This is not necessarily the case as organisations that lack the necessary capital resources may find low-growth markets an attractive proposition especially as they tend to have a lower risk profile than high-growth markets. There are problems with defining the market. The model requires management to define the marketplace within which a business is trading in order that its rate of growth and relative market share can be calculated. This can prove problematic in comparing competitors since if they supply different products and services then the absence of a consistent basis for comparison impairs the usefulness of the model.

18

Other valid criticisms include the following: The application of the BCG matrix may prove costly and time-consuming since it necessitates the collection of a large amount of data. The use of the model may also lead to unfortunate consequences, such as: Moving into areas where there is little experience Over-milking of cash cows Abandonment of potentially healthy businesses labelled as problem children Neglect of interrelationships among businesses, and Too many problem children within the business portfolio largely as a consequence of incorrect focus of management attention.

(a)

(i)

The taxation liability calculations are as follows: Steadychill Year 1 Operating cash flows (excluding 440,000 maintenance) Maintenance (50,000) Capital allowances (110,000) Profits liable to corporation tax 280,000 Taxation at 30% 84,000 Technofreeze Year Operating cash flows (excluding maintenance) Maintenance Capital allowances Profits liable to corporation tax Taxation at 30%

2 500,000 (50,000) (82,500) 367,500 110,250

3 460,000 (50,000) (61,875) 348,125 104,438

4 420,000 (50,000) (185,625) 184,375 55,313

1 500,000

2 540,000

3 600,000

4 600,000

5 450,000

6 350,000

(50,000) (172,500) 277,500 83,250

(60,000) (129,375) 350,625 105,188

(70,000) (97,031) 432,969 129,891

(80,000) (72,773) 447,227 134,168

(90,000) (54,580) 305,420 91,626

(100,000) (163,740) 86,260 25,878

The net present value calculations are as follows: Steadychill Year Initial investment Working capital Net operating cash flows Taxation Net cash flow Discount factor (10%) Present values 0 (440,000) (120,000) 390,000 (560,000) 1000 (560,000) 390,000 0909 354,510 450,000 (84,000) 366,000 0826 302,316 410,000 (110,250) 299,750 0751 255,112 1 2 3 4 120,000 370,000 (104,438) 385,562 0683 263,339 5

(55,313) (55,313) 0621 (34,349)

The net present value = 550,928. 170,000 The payback period is 1 year + = 1464 years 366,000 Technofreeze Year 0 (690,000) (120,000) 1 2 3 4 5 6 7

Initial investment Working capital Net operating cash flows 450,000 480,000 530,00 520,000 360,000 Taxation (83,250) (105,188) (129,891) (134,168) Net cash flow (810,000) 450,000 396,750 424,812 390,109 225,832 Discount factor (12%) 1000 0893 0797 0712 0636 0567 Present values (810,000) 410,850 316,210 302,467 248,110 128,047 The net present value = 716,123. 360,000 The payback period is 1 year + = 1907 years 396,750

120,000 250,000 (91,626) (25,878) 278,374 (25,878) 0507 0452 141,136 (11,697)

19

(ii)

The Technofreeze refrigeration system has the larger NPV however consideration needs to be given to the fact that we are comparing two refrigeration systems which have unequal lives. In order to do this we can convert the cash flows into an equivalent annual cash flow with NPVs of 550,928 for the Steadychill and 716,123 for the Technofreeze refrigeration systems. The equivalent annual cash flow can be calculated using the following formula: Net present value Annuity factor for n years at r% Where r = the cost of capital. Net present value Annuity factor (from tables) Equivalent annual cash flow = Steadychill 550,928 3170 173,794 Technofreeze 716,123 4111 174,197

On the basis of equivalent annual cash flows then the directors of Stay Cool Ltd should be advised to purchase the Technofreeze refrigeration system, although the difference is so small that other factors would undoubtedly influence their decision. (b) (i) Payback period is widely used by organisations in the capital investment appraisal process due to the following reasons: It is easy to calculate and understand There is a lack of understanding of more sophisticated techniques which take into consideration the time value of money Payback may be expedient for organisations who need to recover their capital outlay quickly due to the fact that they are experiencing liquidity problems Payback is appropriate for smaller investments which do not warrant the use of more sophisticated techniques Payback reduces uncertainty by focusing on nearer and therefore more certain cash flows. Sensitivity analysis could be used to assess how responsive the NPV calculated in part (a) in respect of each decision option change is to changes in the variables used to calculate it. The application of sensitivity analysis requires that the net present values are calculated under alternative assumptions in order to determine how sensitive they are to changing conditions. In this particular example then a relatively small change in the forecast cash flows might lead to a change in the investment decision. The application of sensitivity analysis can indicate those variables to which the NPV is most sensitive and the extent to which these variables may change before an investment results in a negative NPV. Thus the application of sensitivity analysis may provide management with an indication of why a particular project might fail. The directors of Stay Cool Ltd should give consideration to the potential variations in the independent variables which feature in the decision-making process such as: estimated revenues estimated operating costs estimated working lives estimated repair costs the estimated discount rate i.e. cost of capital of each alternative investment.

(ii)

Sensitivity analysis has some serious limitations. The use of the method requires changes in each variable under consideration are isolated. However management may be focused on what happens if changes occur in two or more critical variables. Another problem relating to the use of sensitivity analysis to forecast outcomes lies in the fact that it provides no indication of the likelihood of the occurrence of changes in critical variables.

20

(a)

Memorandum To: The board of directors From: Senior management accountant Date: 9 June 2006 Subject: Factors to be considered in the design of a reward scheme. Further to your recent request concerning the above please find detailed below factors for your consideration: (i) The potential benefits to be gained from the implementation of a reward scheme. Rewards and incentives can make a positive contribution to strategy implementation by shaping the behaviour of individuals and groups. A well designed reward scheme will be consistent with organisational objectives and structure. There is evidence which suggests that the existence of a reward scheme provides an incentive to achieve a good level of performance. Moreover, the existence of effective schemes also helps not only to attract but to retain employees who make positive contributions to the running of an organisation. Key values can be emphasised by incorporating key performance indicators in the performance-rewards mechanisms which underpin the scheme. This helps to create an understood environment in which it is clear to all employees what performance aspects precipitate organisational success. An effective reward scheme will create an environment in which all employees are focused upon continuous improvement. Schemes which incorporate equity share ownership for managers and employees alike can encourage behaviour which is in the longer-term interests of the organisation by focusing on actions aimed at increasing the market value of the organisation.

(ii)

The factors that should be considered in the design of a reward scheme for BGL. Whether performance targets should be set with regard to results or effort. It is more difficult to set targets for administrative and support staff since in many instances the results of their efforts are not easily quantifiable. For example, sales administrators will improve levels of customer satisfaction but quantifying this is extremely difficult. Whether rewards should be monetary or non-monetary. Money means different things to different people. In many instances people will prefer increased job security which results from improved organisational performance and adopt a longer term-perspective. Thus the attractiveness of employee share option schemes will appeal to such individuals. Well designed schemes will correlate the prosperity of the organisation with that of the individuals it employs. Whether the reward promise should be implicit or explicit. Explicit reward promises are easy to understand but in many respects management will have their hands tied. Implicit reward promises such as the promise of promotion for good performance is also problematic since not all organisations are large enough to offer a structured career progression. Thus in situations where not everyone can be promoted there needs to be a range of alternative reward systems in place to acknowledge good performance and encourage commitment from the workforce. The size and time span of the reward. This can be difficult to determine especially in businesses such as BGL which are subject to seasonal variations. i.e. summerhouses will invariably be purchased prior to the summer season! Hence activity levels may vary and there remains the potential problem of assessing performance when an organisation operates with surplus capacity. Whether the reward should be individual or group based. This is potentially problematic for BGL since the assembly operatives comprise some individuals who are responsible for their own output and others who work in groups. Similarly with regard to the sales force then the setting of individual performance targets is problematic since sales territories will vary in terms of geographical spread and customer concentration. Whether the reward scheme should involve equity participation? Such schemes invariably appeal to directors and senior managers but should arguably be open to all individuals if perceptions of inequity are to be avoided. Tax considerations need to be taken into account when designing a reward scheme.

(iii) If we implement a reward scheme then it is bound to be beneficial for BGL. The statement of the manufacturing director is not necessarily correct. Indeed there is much evidence to support the proposition that the existence of performance-related reward schemes can encourage dysfunctional behaviour. This often manifests itself in the form of budgetary slack which is incorporated into budgets in anticipation of subsequent cuts by higher levels of management or to make subsequent performance look better.

21

(b)

Good performance should result in improved profitability and therefore other stakeholder groups may be rewarded for good performance as follows: Shareholders may receive increased returns on equity in the form of increased dividends and /or capital growth. Customers may benefit from improved quality of products and services, and possibly lower prices. Suppliers may benefit from increased volumes of purchases. Government will benefit from increased amounts of taxation.

22

Part 3 Examination Paper 3.3 Performance Management

June 2006 Marking Scheme

(a)

Sales: first 12 months Sales next 6 months Direct materials Packaging Direct labour: first 12 months Direct labour: next 6 months Royalties Variable overheads Fixed overheads Returns Conclusion (i) (ii) Recommended actions Factors

2x1 2x1

2 2 2 2

x x x x

05 05 05 05

(b)

2x2

(c)

Target costing explanation Target costing application Target costing limitations

Marks 05 15 2 2 6 3 1 1 1 1 1 8 4 2 5 3

Marks

20 8 4

Maximum 8 40

(a) (b)

Explanation of link between strategy and operations Explanation of the Pyramid Financial performance & competitiveness External effectiveness Internal efficiency

2 3 6 6 6

Maximum 15 20

(a) (b) (c)

Assessment of subsidiaries Appropriate strategies Criticisms

5x2 3x2 2x2

10 6 4 20

(a)

(i) (ii)

NPV calculations Payback Equivalent annual cash flow calculations Recommendation Reasons Use Limitations

2x1 4 x 05

(b)

(i) (ii)

10 2 2 1 2 1 2

15 2

3 20

(a)

(i) Benefits (ii) Factors to be considered (iii) Discussion of production directors statement Explanation 4x1

(b)

6 7 3 4

16 4 20

23