ACCA - P5 Advanced Performance Management - Passport ATC 2009
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SUMMARY OF KEY THEORY
Accountancy Tuition Centre (International Holdings) Ltd 2009 0105
No link between revenue (often based on donations)
and costs (depends on demand for the service.)
Organisation may not therefore have funds to satisfy all
demand.
Budgeting therefore focuses on costs.
Traditional budgeting in non profit organisations
Budgets prepared on a “line item basis” whereby a
budget amount for each major line of expenditure is
prepared (Employment costs, depreciation etc.)
Such budgets do not related expenditure to the
organisation’s activities
Budgets do not ensure funds are being used efficiently
and effectively.
Planning, programming budgeting systems
Effectively a zero based budgeting approach to
budgeting in non profit organisations. Follows the
following steps:
1. Identify the overall objectives of the organisation
2. Identify programs that could meet these
3. Establish the costs and benefits of each program
4. Decide how much funds to allocate to each
program.
Advantage of ppbs- costs are allocated to programs that
best meet the objectives of the organisation.
Potential problem- budgets may ignore organisational
structure, since activities involve several departments.
Beyond Budgeting
Weaknesses with traditional budgetary control systems
1. Budgeting takes up too much managers’ time.
2. Budgets prepared 15 months before the end of the
accounting period to which they relate become out of
date.
3. Managers “gaming” activities means the budget process
loses its validity. Gaming includes:
Adding slack to budgets to make them easier to
perform
Never beating the budget significantly
Always spending what’s in the budget.
SUMMARY OF KEY THEORY
Accountancy Tuition Centre (International Holdings) Ltd 2009 0106
4. In some organisations, funds are only available for
projects in the budget. This may constrain managers
who identify potential new projects after the budget
process.
5. Too much focus on profits is not consistent with the
overall goals of the organisation- to maximise the
wealth of shareholders.
The “Beyond Budgeting” Model
1. Targets will be based on the organisations key
performance indicators rather than being purely profit
or cost based.
2. The use of rolling budgets to ensure that budgets are
kept up to date.
3. The more flexible use of budgets as an evaluation tool-
so that managers are not punished for factors outside of
their control.
4. Devolve responsibility for planning away from the
centre to the front line.
5. Allocation of resources for managers should be based
on whether projects meet pre determined criteria (such
as NPV) rather than on whether they are in the budget.
Behavioural Aspects of Budgeting
Responsibility accounting
Responsibility is delegated to managers via the budget.
They are then evaluated on how they perform in
comparison with the budget.
Level of difficulty
If budget is not achievable, it will de-motivate. If it is
too easy, it will not challenge.
Top down v Bottom up
Bottom up means managers prepare their own budgets. These
are then approved by a budget committee. Top down means
that budgets are prepared centrally, and imposed on
managers.
Bottom up has the following advantages:
Managers are more motivated to take ownership of the
budget
Managers have better knowledge of situation “at the
coal face”
SUMMARY OF KEY THEORY
Accountancy Tuition Centre (International Holdings) Ltd 2009 0107
Top down has the following advantages
Non financial managers may not have the financial
knowledge to prepare budgets
Preparing the budgets centrally may minimise problems
such as adding slack to budgets.
Controllability principle
Managers should only be judged on things they control.
They should not be blamed for adverse factors outside
of their control- such as increases in the price of
commodities on world markets.
CHANGES IN BUSINESS STRUCTURE AND
MANAGEMENT ACCOUNTING
Continuing effectiveness of traditional management
accounting techniques
Changes in the business environment
Globalisation has led to more competition in domestic
markets
Computerised manufacturing systems provide the
opportunity for competitive advantage
Shorter product lifecycles
Growth of service industry
Growth in multinationals as a result of business combinations
More decentralised decision making.
Limitations of traditional management accounting techniques
Too focussed on financial factors. Ignores important
non financial information such as quality.
Too internally focussed- in dynamic world,
management needs to be aware of external factors too.
Management accountants focus too much on the
production phase. Most costs are determined at the
design stage of a product.
Limitations of variance analysis
In just in time environments, long term contracts with
suppliers mean there will be no price variance
Many companies do not produce standard products, but
customise for each customer- so there is no standard
cost
Super efficient manufacturing systems mean that there
will be few usage variances.
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Organisational form and implications for performance
management
Functional form
In a functional form, departments are formed according to
their function- e.g. sales, production, finance etc.
Top level management will require detailed
management reports.
The form does not reflect the processes by which value
is created
It is hard to identify where profits are made, as revenues
and costs are not matched on a department by
department basis.
Budgets and consolidated figures are likely to be
available only to top management.
Divisional form
The organisation is divided into product divisions, or
geographic regions. Managers of the division are given
autonomy.
Top management will require only high level reports
from the division.
A performance measurement system should be used to
assess the performance of divisional managers that
ensures goal congruence. (Discussed in more detail on
the section on divisional performance evaluation.)
Divisional managers are “sheltered” from the market-
that is, they do not face the same pressures as if they
were running independent businesses.
Business Process Reengineering
Definition
The fundamental rethinking and redesigning of business
processes to achieve dramatic improvement in critical
measures of performance such as coast, quality, service and
speed.
Influence of BPR on business performance
Organisational structures tend to be flatter, encouraging
more team work than traditional command structures.
The teams are more customer focussed and able to react
to the needs of customers more quickly.
Costs have been saved by eliminating non value added
activities.
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Impact of BPR on systems development
Management accounting systems are likely to focus
more on business processes, rather than the old
functional approach.
Systems will attempt to identify where value is added.
Activity Based Management
Definition
Activity based management views the business as a set of
linked activities that ultimately add value to the customer. It
focuses on managing the business on the basis of these
activities.
Discussion
Activity based management is more than just applying
activity based costing principles to management. It also
implies:
Activity analysis- identifying the costs associated with
the activities that are performed. Some activities may be
eliminated on the basis that the cost exceeds the
benefits.
Cost driver analysis- identifying the driver of costs, and
attempting to reduce the incidence of it (for example
reducing the number of machine set ups by having
larger production runs)
Continuous improvement- the elimination of non value
added activities.
Operational control- by better understanding the
activities that are being performed, management can
identify where cost savings are available.
Performance evaluation- in activity based management,
the focus of performance evaluation will be on the
effectiveness and efficiency of the activities.
Required changes in management accounting systems as
a result of empowering staff to manage sectors of the
business
The governance framework should be based on clear
principles and boundaries
Performance measurement system should be based on
the goals of the organisation as a whole
Performance evaluation should be based on relative
performance (compared to peers) rather than absolute
performance
SUMMARY OF KEY THEORY
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EFFECT OF IT ON MODERN MANAGEMENT
ACCOUNTING SYSTEMS
Service industries compared to manufacturing
Performance measurement in the service sector may be more
difficult than in the traditional manufacturing industries, due
to:
Intangibility- with a service, it is not always obvious
what aspect of the service is valued by the customer.
Simultaneity- consumption of a service takes place
when the service is performed- therefore quality
measurement must take place at this stage
Perishability- services cannot be stored and must be
provided when the client needs them
Heterogeneity- unlike goods manufactured in mass
production, each service varies in quality, making it
difficult to measure the whole.
Service industries are likely to require much more
qualitative data than manufacturing industries.
Instant Access to Data
Modern IT systems provide the opportunity for instant access
to management accounting data throughout the organisation.
The following are examples of how:
Databases
Intranets
Reports
Enterprise resource planning systems (ERP)
Potential impact on business performance
Businesses can react more quickly to customer
enquiries, thus providing a better service to customers.
Management obtain control information more quickly,
without having to wait for the publication of the
monthly management accounts.
Remote input of management accounting data by non
financial staff
Modern information systems enable data to be input into the
system by non financial staff. Examples are:
Use of electronic point of sales (EPOS) systems in
supermarkets- as the cashier scans the goods purchased,
using the bar code scanner, the revenue, cash and
inventory records in the accounting system are
automatically updated.
SUMMARY OF KEY THEORY
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Electronic commerce- whereby customers place orders
over the internet- some systems may require minimal
processing by the staff of the organisation.
Instant Access to previously unavailable data
Used for benchmarking purposes
The internet is a useful source of information about
competitors- information such as prices, financial
statements, press cuttings may all be obtained easily.
Some organisations compile databases of benchmarking
statistics that can be shared,
Used for control purposes
Detailed information can be stored about customers in
databases. Data mining may then be used to identify
trends.
Inventory control methods such as Radio Frequency
Identification Tags (RFID) can enable companies to
monitor inventory levels in real time, and react to sales
trends.
Exception reports can be produced by management
information systems, alerting management to issues
which need to be controlled- such as customers whose
balance exceeds a certain amount, or any unusual
transactions.
ECONOMIC, FISCAL AND ENVIRONMENTAL
FACTORS
Impact of external factors on an organisation and its
strategy
External factors can be grouped into the categories
represented by PESTEL:
Political- for example bureaucratic regulations in
socialist countries
Economic
Social – changing social attitudes- for example toward
healthy lifestyles
Technological- provides new opportunities
Environmental
Legal
The porter’s five forces model (see later) can also be used to
analyse the competitive environment within which an
organisation operates.
SUMMARY OF KEY THEORY
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Pricing policies
Pricing policies should consider the 4 C’c of pricing:
Costs – A company must cover its costs in the long run
Competitors – It should consider the market price of
competing firms
Customers – A firm should take into amount how much
its customers are prepared to pay
Corporate objectives – The firm’s specified goal e.g.
profit maximisation should be integrated with its
pricing policy
Economist’s approach
Demand curve:
P = A – BQ
P = price
Q = quantity demanded
A = price at which demand would be nil
B = slope of the demand curve (price changes over the
change in quality demanded)
Marginal revenue -MR = A – 2BQ
MR = the change in revenue from selling one more unit
2BQ = note that the marginal revenue falls at twice the rate
of the demand curve
To maximise sales set MR = 0, solve Q and place Q in
the demand curve equation to gain price.
To maximise profits set MR = MC, solve for Q and
place Q in the demand curve equation to gain price.
Accountant’s approaches
Full cost
Full total absorption cost is calculated and then an allowance
for profit is added. Although costs are covered it takes no
amount of customers or competition
Marginal cost pricing
Marginal variable cost is calculated and then an allowance
for contribution is added. Not all costs are covered and as
such should only be used in short term relevant cost decision
making.
Return on investment pricing
Full total absorption cost is calculated and then the allowance
for profit is based on the required return on the investment
base. Its limitations are as for full cost pricing.
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Strategic Approaches to pricing
Market penetration policy
In accordance with the product development life cycle
(PDLC) this involves a policy of low prices when the product
is in its growth phase to obtain market share.
Market skimming
Can be used with the PDLC and involves charging high
prices during the introductory phase usually when the
company has brought a new product to the market.
Going rate pricing
During the maturity phase of the PLDC a company may
adopt this policy of charging the market rate.
Impact of governmental regulation on performance
measurement
Fiscal policy
Use government spending or taxation policy.
If government is running a budget deficit, an increase in
taxes and/or reduction of government spending may be
necessary. This may reduce demand for the company’s
products.
Populist governments may increase government
spending or cut taxes. This may increase aggregate
demand in the economy, and therefore increase demand
for the company’s products.
An increase in government spending if financed by
borrowing, may lead to an increase in inflation, which
may affect monetary policy.
Monetary Policy
Involves governments aiming to influence the supply or
demand for money in order to achieve policy
objectives.
If there is high inflation in the economy, the
government may increase interest rates in order to
reduce the supply of money, and therefore reduce
inflation.
High interest rates lead to an increase in the cost of
financing for organisations.
High interest rates may also reduce demand for
companies’ products, as individuals will save more/
borrow less.
SUMMARY OF KEY THEORY
Accountancy Tuition Centre (International Holdings) Ltd 2009 0114
Government regulations
Price limits for utility companies or former state
monopolies
Quality control
Government regulations may reduce the profits of the
companies. During performance measurement, this
should be taken into account.
Other environmental and ethical issues
Mendelow’s matrix suggests an approach to dealing
with various stakeholder groups:
Keep
informed
Key
players
Ignore
Keep
satisfied
Level of interest
High
Low
High
Low
Stakeholder Power
Ethical Issues
Organisations play a role in the society in which they exist.
They may have ethical policies which guide:
How the organisation behaves- e.g. health and safety
Expected behaviour of employees and directors
The organisations beliefs on political issues where it
may be in a position to influence governments.
Ethical behaviour may “cost” the business, in terms of lost
business opportunities, or costs of implementation. However,
it may have the following advantages:
Improved image may lead to increased sales
Avoidance of fines (e.g. for pollution)
Organisation and its stakeholders may simply believe in
“doing the right thing