Cima p2 2012 Notes

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CIMA Paper P2
Management Performance
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CIMA P2 Performance Management
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7 1. 2. 3. 4. Pricing and Product Decisions Cost planning and analysis 22 31 37 Budgeting and Management Control Control/Performance Measurement of Responsibility Centres
Contents
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2011 The ExP Group. Individuals may reproduce this material if it is for their own private study use only. Reproduction by any means for any other purpose is prohibited. These course materials are for educational purposes only and so are necessarily simplified and summarised. Always obtain expert advice on any specific issue. Refer to our full terms and conditions of use. No liability for damage arising from use of these notes will be accepted by the ExP Group.
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We are very pleased that you have downloaded a copy of our ExPress notes for this paper. We expect that you are keen to get on with the job in hand, so we will keep the introduction brief. First, we would like to draw your attention to the terms and conditions of usage. Its a condition of printing these notes that you agree to the terms and conditions of usage. These are available to view at www.theexpgroup.com. Essentially, we want to help people get through their exams. If you are a student for the CIMA exams and you are using these notes for yourself only, you will have no problems complying with our fair use policy. You will however need to get our written permission in advance if you want to use these notes as part of a training programme that you are delivering. WARNING! These notes are not designed to cover everything in the syllabus! They are designed to help you assimilate and understand the most important areas for the exam as quickly as possible. If you study from these notes only, you will not have covered everything that is in the CIMA syllabus and study guide for this paper. Components of an effective study system On ExP classroom courses, we provide people with the following learning materials: The ExPress notes for that paper The ExP recommended course notes / essential text or the ExPedite classroom course notes where we have published our own course notes for that paper The ExP recommended exam kit for that paper. In addition, we will recommend a study text / complete text from one of the CIMA official publishers, but we do not necessarily give this as part of a classroom course, as we think that it can sometimes slow people down and reduce the time that they are able to spend practising past questions.
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How to get the most from these ExPress notes
For people on a classroom course, this is how we recommend that you use the suite of learning materials that we provide. This depends where you are in terms of your exam preparation for each paper.
Your stage in study for each paper These ExPress notes ExP recommended course notes, or ExPedite notes Dont use yet ExP recommended exam kit Dont use yet CIMA online past exams Prior to study, e.g. deciding which optional papers to take Skim through the ExPress notes to get a feel for whats in the syllabus, the size of the paper and how much it appeals to you. Work through each chapter of the ExPress notes in detail before you then work through your course notes. Dont try to feel that you have to understand everything just get an idea for what you are about to study. Dont make any annotations on the ExPress notes at this stage. Have a quick look at the two most recent real CIMA exam papers to get a feel for examiners style. Dont use at this stage.
At the start of the learning phase
Work through in detail. Review each chapter after class at least once. Make sure that you understand each area reasonably well, but also make sure that you can recall key definitions, concepts, approaches to exam questions, mnemonics, etc.
Nobody passes an exam by what they have studied we pass exams by being efficient in being able to prove what we know. In other words, you need to have effectively input the knowledge and be effective in the output of what you know. Exam practice is key to this. Try to do at least one past exam question on the learning phase for each major chapter.
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Practice phase Work through the ExPress notes again, this time annotating to explain bits that you think are easy and be brave enough to cross out the bits that you are confident youll remember without reviewing them. Avoid reading through your notes again. Try to focus on doing past exam questions first and then go back to your course notes/ ExPress notes if theres something in an answer that you dont understand. This is your most important tool at this stage. You should aim to have worked through and understood at least two or three questions on each major area of the syllabus. You pass real exams by passing mock exams. Dont be tempted to fall into passive revision at this stage (e.g. reading notes or listening to CDs). Passive revision tends to be a waste of time. Dont touch it! Download the two most recent real exam questions and answers. Read through the technical articles written by the examiner. Read through the two most recent examiners reports in detail. Read through some other older ones. Try to see if there are any recurring criticism he/ she makes. You must avoid these!
Your stage in study for each paper
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The night before the real exam
Read through the ExPress notes in full. Highlight the bits that you think are important but you think you are most likely to forget.
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ExPress Notes
CHAPTER 1
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Pricing SAMPLE PAGES and Product Decisions
START The Big Picture

This chapter examines the key concepts of costs and revenue relevant to product and pricing decisions.
KEY KNOWLEDGE Relevant Decision-making
One of managements responsibilities involves making decisions affecting the firm in the short- and long-run based on relevant costs. Such decisions typically take the form of: Accept-Reject Costing projects Make-Buy Shut down
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What is Relevance?

Each of the above will be illustrated by practical exercises. But first it is necessary to establish the meaning of a relevant cost. Cash & Incremental A relevant cost is a cash cost which is uniquely incurred (or avoided) as a consequence of taking a decision; cash, because it is the main determinant of value (unlike accounting profit); and unique in the sense that is not common to the alternative choices that are under consideration.
EXAMPLE
A company seeking to determine whether to continue to transport its products by truck or to switch to the railroad, discovers that insurance costs are identical in both choices; it that case, insurance costs are not relevant to the decision. If, however, there is a difference in the two insurance costs, then one can speak as the difference between the two choices as being incremental; this difference (referred to in some places as the differential) is relevant to the decision under consideration.
Future Relevant costs refer to the future, i.e. they can be influenced prospectively by choice. It follows that: Sunk costs are not relevant: They have already taken place and cannot be reversed. Committed costs, if they cannot be avoided, are likewise not relevant, even if the timing of their occurrence is in the future. Their unavoidability has already been established in the past (making them effectively the equivalent of sunk costs).
In keeping with the above logic, relevant costs therefore involve cash, are incremental and relate to the future. Relevant costs need to be identified with care, as they may include opportunity costs.
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A company considers building a storage facility on the site of a parking lot. If the parking lot had been generating parking fees which will now be lost, then this foregone revenue is an opportunity cost. Accept-Reject decisions
EXAMPLE
EXERCISE
A company currently produces fire hydrants with the following per unit data: Selling Price Direct materials Direct labour 1 h Fixed overheads 50 15 25 100
This company has been asked to supply a one-time contract supplying garden ornaments with the following conditions: Contract revenue is 750 10 hours of labor are required Materials specific to this contract are valued at 200
Required 1. Should the company accept or reject the order? 2. What would be the impact on your decision if labor was at full capacity? Learning Points The relevant cost for labor depends on the capacity utilization of labor: If there is spare labor capacity, then the relevant cost is zero; If labor is at full capacity, then the relevant cost is either:
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o o
its variable market cost, if additional labor can be hired, or the value sacrificed as a result of diverting labor from another activity already performed within the firm

Costing projects It is a standard management accounting practice to determine the relevant costs of a new project in order to come up with a price quotation. Setting a price without having an accurate understanding of costs can put a company at a competitive disadvantage, particularly if there is intense competition.
EXERCISE
A proposed contract calls for the use of 200 liters of Agent Q and 50 kg. of Compound P. Additional data: Agent Q Compound P In stock 150 liters 100 kg Historical price USD 7 USD 12 Current price USD 5 USD 15 Scrap value USD 1 USD 2
Agent Q is no longer in use. Compound P is in regular use at the company. Required 1. What are the relevant costs of the two materials for the proposed contract? 2. The company discovers that as the result of a change in environmental laws, the residual value of Agent Q has actually become negative, i.e. there is a net cost of USD 1.50/liter disposal cost. How does this affect the relevant cost?
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Learning Points

The relevant cost for materials depends on the following: If the material is not owned, then it must be bought at the current replacement (market) price; If the material is already in stock, then the relevant cost is either: o o its current replacement cost, if it is to be replaced in the regular course of business, or its current scrap (resale) value, if it is no longer in use, or its value (if greater than scrap) if it can be applied as a substitute for another product. If the material is scarce (i.e. cannot be purchased externally) and must be diverted from another activity already performed at the company, then its opportunity cost must be ascertained in order to arrive at an accurate relevant cost.
Make-Buy An automotive components producer can buy car heaters from an outside supplier for USD 165 per unit. In considering whether to make these internally, the company calculates that an equivalent unit can be made in 2 labour hours using USD 100 worth of materials. Labor is currently at full capacity producing carburetors which generate contribution of USD 90. A carburetor takes 3 hours to produce. Labor costs USD 6 per hour. The carburetor also absorbs fixed overhead costs at the rate of USD 20 per labour hour. Should the company make or buy the heaters?
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Shut Down decisions

EXERCISE
Assume car factory with three locations: Erie 25 10 Revenues (m) Profits (m) Huron 30 Superior 40 Costs (m)* (15) (26) 4 (44) (4) * 25% of the costs are fixed costs allocated by H.O. Required Management is considering shutting down the Superior plant. Please advise management. Even if we take allocated costs out of the equation, it is necessary to examine the structure of the costs to determine whether a plant generating a positive contribution should stay open.
The dilemma of short-term decisions and fixed costs Beware of allocated costs; but dont forget: In the long-run, all costs are variable. In the cases above, we focused on Contribution (Revenue minus Variable Costs). In the short-run, contribution is relevant in decision-making. However, one must not forget that fixed costs have to be covered they dont simply vanish! In the long-run, a companys business model must include how fixed costs are to be covered, otherwise the business model lacks long-run viability.
Non-financial factors for investment appraisal Although the financial case for making an investment is a vital part of the decision-making process, non-financial factors can also be important.
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How does one assess non-financial criteria?
EXERCISE
Cost-Volume-Profit Analysis (CVP)
The breakeven formula Total Costs = Fixed Costs + Unit Variable Cost x Number of Units Total Revenue = Sales Price x Number of Units If TC = Total Costs, FC = Fixed Costs, V = Unit Variable Cost, X = Number of Units, TR = Total Revenue, SP = Selling Price, C = SP V = Unit Contribution and CM%= C/SP = Contribution Margin, Then the break-even point (the output level at which TR=TC) is: In units sold: X = FC/C In dollar sales: TR = FC/CM%
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ExPress Notes

Safety Margin = Budgeted Sales Break-even point (units/dollars) C is an important indicator, as it shows the contribution of each unit sold towards covering fixed costs. Therefore, in the short run, the firm may prefer to produce/sell below break-even in order to recover some of its fixed costs.
Break-even Analysis Marginal costing is useful in calculating the break-even level of sales. The break-even point is the level where the company achieves zero profit (neither gain nor loss). It just manages to cover its fixed costs. Contribution per sale C/S ratio
This is understood as the amount of contribution generated by every dollar sold.
KEY KNOWLEDGE Limiting factors

When a single limiting factor is present in a production plan, then it is necessary to identify it and to plan production around it.
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ExPress Notes
Take the following example:

Product Selling price Labour cost per unit ($) Material cost per unit ($) Contribution X 30 10 5 15 Y 40 16 8 16 Z 50 20 10 20 It appears that in the face of unlimited demand for all three products, Product Z would be given priority as it maximizes the contribution per unit. Now, assume that labour hours are limited to 500 and that labour costs $2 per hour (demand remains unlimited for all three products). In the above case, Product Labour cost per unit ($) No. of hours per unit Contribution per hour X 10 5 3 Y 8 8 2 Z 20 10 2
Now it becomes clear that Product X is favoured for the full number of hours available (500). 100 units of X can be produced. If demand for X were limited to, say, 80 units (requiring 400 labour hours), then the remaining available hours (100) could be used to produce either Y or Z (in this case there is indifference between the two). The steps to be followed in working out the optimal production plan are: (1) (2) (3) (4) Calculate the contribution per unit of product; Calculate the contribution per unit of limited resource; Rank the products according to Step 2; Produce according to the priority established in Step 3, up to the demand limit of each product or until the limited resource is exhausted
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ExPress Notes

Multi-limiting factors and the use of linear programming and shadow pricing.
When resources are scarce, or other limiting factors are present in a given situation, then management is concerned with achieving the most efficient allocation of available resources. Whereas planning with one limiting factor involves the use of key factor analysis (in which typically one seeks to maximize the contribution per unit of the limited, or bottleneck, resource), the presence of several limiting factors requires the use of linear programming. In such cases, linear programming is typically used to either maximise contribution or to minimize costs. The usual steps to be followed are: 1) 2) 3) 4) Define the variables Define the objective function Express the constraints as equations Solve the equations simultaneously as well as feasible values corresponding to the corner points; 5) Determine the combination of specific values that satisfies the objective function. The answer can also be graphed and Step 5 determined visually. A graph also shows the feasible region of value combinations that are consistent with the constraints.
KEY KNOWLEDGE
Shadow (dual) price A shadow price is the additional value to be obtained (usually an increase in contribution) by having available one more unit of a scarce resource.
Slack This represents the amount of a resource that has not been exhausted (i.e. its availability does not act as a constraint or limiting factor in a given set of circumstances).
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Concept: A linear programming algorithm capable of solving optimization problems involving several output variables. The steps involve: Formulating the initial tableau; Interpreting the final tableau; Applying tableau information
KEY KNOWLEDGE Linear Programming Simplex Method
EXAMPLE
Assume a company produces two products (A and B) which pass through three departments (X, Y and Z). Process constraints (S1, S2 and S3) are represented by the number of hours of processing time available in each department. A final tableau could look as follows: Variable A B S3(z) Contribution A 1 0 0 0 B 0 1 0 0 S1(x) 0.3 -0.2 -3.5 0.5 S2(y) -0.3 0.1 2.5 0.4 S3(z) 0 0 1 0 Solution 200 300 2,000 5,500 expression units (output) units (output) hours avail. monetary ($)
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External pricing considerations Good businesses do not compete on price alone, but seek to differentiate their products and services. Intelligent pricing nevertheless is a key component of strategy. This is especially true in recessionary economic climates. Price-Quality Relationship A priori one would expect a positive correlation between price and quality.
KEY KNOWLEDGE Pricing strategies
High
Skimming
Premium
Price
Low Economy Penetration
Low
Quality
High
The four principal pricing strategies are shown in the above quadrants. The more interesting ones involve High-Low and Low-High combinations. There are a variety of pricing strategies with which one should be familiar: Cost plus: A markup is added to a given cost base (which can be variable or full production cost).
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START About ExPress Notes

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At the start of the learning phase

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Your stage in study for each paper

These ExPress notes

ExP recommended course notes, or ExPedite notes

ExP recommended exam kit

CIMA online past exams

The night before the real exam

At the door of the exam room before you go in.

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START About The ExP Group

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Pricing SAMPLE PAGES and Product Decisions

START The Big Picture

KEY KNOWLEDGE Relevant Decision-making

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Shut Down decisions

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SAMPLE PAGES Free full set from www.facebook.com/theexpgroup KEY KNOWLEDGE

Cost-Volume-Profit Analysis (CVP)

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This is understood as the amount of contribution generated by every dollar sold.

KEY KNOWLEDGE Limiting factors

Take the following example:

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KEY KNOWLEDGE Linear Programming Simplex Method

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KEY KNOWLEDGE Pricing strategies

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