ACCA - P5 Study text - Emile Woolf INT

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Chapter 18: Developments in management accounting and performance management

7.5 Processes and capabilities

In practice, managers often fail to achieve the strategic objectives of their company.

One reason is that the performance targets that have been selected are

inappropriate.

Another important reason for ‘strategic failure’ is that the processes of the entity are

not consistent with its strategies. The processes that the entity uses do not allow the

strategies to be implemented.

Neely and Adams refer to the view of Michael Hammer, advocate of Business

Process Re-engineering. Hammer argues that processes should be analysed from the

point of view of the customer. A customer usually wants a product or service:

 with quick delivery (‘quick’)

 to the required quality standard (‘right’)

 at a good price (‘cheap’), and

 in a way that is easy to organise and arrange (‘easy’).

Providing products or services that are ‘quick, right, cheap and easy’ should be a

strategic objective, but in many cases a company’s products or services are ‘slow,

wrong, expensive and unfriendly’, because its processes are inappropriate for

delivering what the customer wants.

Neely and Adams argue that it is necessary to identify suitable performance

measures for processes, as well as for strategies.

In addition, an entity must have the resources and capabilities to operate the

processes. Capabilities are the combination of the entity’s people, policies and

procedures, technology and physical infrastructure that create value for the

stakeholder ‘Even the most brilliantly designed process needs people with certain

skills, some policies and procedures about the way things are done, some physical

infrastructure for it to happen and … some technology to enable or enhance it’

(Neely and Adams).

Taken together, the processes and capabilities of an entity are able to create a

competitive advantage. Neely and Adams make a distinction between:

 ‘winners’: these are processes and capabilities that make the entity distinctive

and give it a competitive advantage, and

 ‘qualifiers’: these are processes and capabilities that need to be improved or

maintained at standard levels that are expected within the industry.

7.6 Stakeholder contribution

The fifth side of the performance prism is stakeholder contribution. It is important

to consider not only satisfaction for key stakeholders, but also what the entity

expects to obtain from its stakeholders.

P5: Advanced performance management

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Customers are stakeholders of a business entity, and the entity should expect its

customers to be profitable. Customer profitability should be an important aspect of

performance measurement. However, research has shown that entities often ignore

this aspect of performance.

 Some types of customer might not be profitable. This should raise the question:

do we want to keep these customers? Or, how can we make these customers

profitable? Research in retail banking, for example, has suggested that 20% of

customers generate 130% of the profits of a bank, and the remaining 80% of

customers contribute a loss.

 Creating an improvement in customer satisfaction might cost more than the

benefits are worth.

A business entity wants its customers to be loyal and profitable, but its customers

want high quality products for a low price. An entity’s ideas about stakeholder

contribution are therefore different from stakeholder satisfaction.

A difference also exists between:

 what a business expects from its suppliers (prompt and reliable delivery, low

prices, high quality), and

 what is required to provide supplier satisfaction (prompt payment, a forward

schedule of orders).

The performance prism includes stakeholder contribution as an element of

performance measurement. ‘Gaining a clear understanding of the “dynamic

tension” that exists between what stakeholders want and need from the

organisation and what the organisation wants and needs from its stakeholders, can

be an extremely valuable learning exercise for the vast majority of corporations and,

especially, their … business units’ (Neely and Adams).

7.7 Performance prism: a summary

To provide a complete system of performance measurement, entities should

consider five inter-related aspects of performance:

 Who are the key stakeholders and what do they want?

 What strategies must be implemented in order to satisfy the key stakeholders?

 What are the critical processes needed to execute these strategies successfully?

 What capabilities are needed to operate and improve these critical processes?

 What contributions are required from stakeholders in order to maintain and

develop these capabilities?

Paper P5

Advanced performance management

Q&A

Practice questions

Contents

Page

ABC and other accounting methods

1 LardCompany 450

2 LCCompany 451

3 Throughput  452

4 Throughput ratio 452

5 Backflush 453

Accounting for decision making

6 Villaco 453

7 Shortages 453

8 ProductB22 455

Decision making with risk and uncertainty

9 Payofftable 456

10 GrabCompany 456

Quantitative techniques in budgeting

11 Learning 458

12 Greenears 458

13 Regression 459

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Discounted cash flow (DCF) and long-term

decisions

14 Replacementproduct 459

15 Probabilities 460

16 Sensitivity 461

17 TheJinCompany 462

Introduction to strategic management accounting

18 Growthobjective 462

19 Gapanalysis 463

Budgets and alternative budgeting models

20 Zerobasedbudgeting 464

Economic, fiscal and environmental factors.

Pricing strategy

21 Marginal 464

22 MC=MR 465

23 SnapCompany 466

24 Bridgecompany 467

Performance measurement systems

25 Responsibility 467

26 CrosstreetsHotel 468

Measuring performance

27 Threeservices 469

28 Privatemedicalpractice 469

29 Traintimes 470

30 Non‐financialperformance

measurements

471

31 Mission 471

32 Customerprofitability 471

33 RTC 473

34 Valueformoney 474

Practice questions

Decentralisation and divisional performance

35 Decentralisation 474

36 WestDivision 474

37 Annuitymethod 475

38 Residual 476

39 Uncertain 476

Transfer pricing

40 Twodivisions 477

41 Trainingcompany 478

42 Shadowprice 479

43 Bricks 479

44 Internationaltransfers 480

45 LongandShort 481

Alternative views of performance measurement

46 Balanced 483

47 Pyramid 483

48 TheVetCentre 483

Developments in management accounting and

performance management

49 Totalquality 485

50 PooleCompany 485

51 Targetcost 486

52 Costandquality 487

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1 Lard Company

Lard Company is a warehousing and distribution company. It receives and stores

products from customers, and then re-packs them for distribution as required. There

are three customers for whom the service is provided – Customer A, Customer B

and Customer C. The products stored and re-packaged for all three customers are

similar in nature and size, but some are more fragile than others and break more

easily. These have to be packaged more carefully.

Basic budget information has been gathered for the year to 31st December 20X6 and

is shown in the following table:

Products handled

units

Customer A 30,000

Customer B 45,000

Customer C 25,000

Costs

$000

Packaging materials (See note) 1,950

Labour:

Basic pay 350

Overtime pay 30

Occupancy costs 500

Administration and management costs

Note

Packaging materials are used in re-packing each unit of product for Customer A,

Customer B and Customer C in the ratio 1:2:3 respectively. This ratio is linked to the

relative fragility of the goods for each customer. It applies to the cost of packaging

materials but not to the costs of labour and overheads.

Additional information has been obtained so that unit costs can be prepared for

each of the three customers using an activity based costing approach. The additional

information for the year to 31st December 20X6 has been estimated as follows:

(1) Labour and overhead costs have been identified as attributable to each of

three work centres: receipt and inspection, storage, and packing as follows:

(2)

Cost allocation proportions

Receipt and

inspection

Storage

Packing

% % %

Labour:

Basic pay 20

10 70

Occupancy cost 20

60 20

Administration cost 40

10 50

Labour: overtime pay $15,000

$6,250 $8,750

(3) A study has shown that the fragility of different goods affects the receipt and

inspection time needed for the products for each customer. Storage required is

related to the average size of the basic incoming product units from each

customer. The re-packing of goods for distribution is related to the complexity

Practice questions

of packaging required by each customer. The relevant requirements per unit

of product for each customer have been evaluated as follows:

Customer A Customer B Customer C

Receipt and inspection (minutes) 6 9 15

Storage (square metres) 0.3

0.3 0.3

Packing (minutes) 36

45 60

Required

(a) Calculate the average cost per unit of packaged products for each customer

using each of the following methods:

(i) Ignoring the ABC study, calculate a cost per unit using traditional

absorption costing.

(ii) Taking an activity based costing approach, using the information

provided.

(b) Suggest ways in which activity based costing might improve product costing

and cost control for Lard Company.

2 LC Company

LC Company has total budgeted production overheads for next year of $816,000

and has traditionally absorbed overheads on a machine hour basis. It makes two

products, Product V and Product W.

Product V Product W

Direct material cost per unit $20 $60

Direct labour cost per unit $50

$40

Machine time per unit 3 hours

4 hours

Annual production 6,000 units

4,000 units

Required

(a) Calculate the product cost for each of the two products on the assumption the

firm continues to absorb overhead costs on a machine hour basis.

(b) The firm is considering changing to an activity based costing (ABC) system

and has identified the following information:

Product V Product W

Number of set-ups 18 32

Number of purchase orders

112

Overhead cost analysis

Machine-related overhead costs

204,000

Set up related overhead costs

280,000

Purchasing-related overhead costs

332,000

Total production overheads

816,000

You are required to calculate the unit cost for each of the two products on the

assumption that the firm changes to an ABC system, using whatever

assumptions you consider appropriate.

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improving profitability.

3 Throughput

A company manufactures two products, product X and product Y, on the same

machines. Sales demand for the products exceeds the machine capacity of the

company’s production department. The potential sales demand in each period is for

8,000 units of Product X and 12,000 units of Product Y. Sales prices cannot be

increased due to competition from other firms in the market. The maximum

machine capacity in the production department is 32,000 hours in each period.

The following cost and profitability estimates have been prepared:

Product X Product Y

$ $

Sales price 22

Direct materials

Direct labour and variable overhead

Contribution per unit

Machine hours per unit 1.5 hours

2 hours

Fixed costs in each period are $90,000.

Required

(a) Using marginal costing principles, calculate the profit-maximising output in

each period, and calculate the amount of profit.

(b) Explain how throughput accounting differs from marginal costing in its

approach to maximising profit.

Product X and for Product Y. You should assume that the direct labour cost

and variable overhead cost in your answer to part (a) is fixed in the short-

term.

(d) Using throughput accounting principles, calculate the profit-maximising

output in each period, and calculate the amount of profit.

4 Throughput ratio

Dust Company exports cases to Spain. Each pallet of cases costs $2,000 in material

costs and are sold for $3,000. Production and sales are limited by a shortage of

highly trained quality control inspectors. Only 200 inspection hours are available

per week. Every pallet is inspected and an inspection takes 30 minutes.

Other factory costs are $300,000 per week.

Required

Calculate the throughput accounting ratio.

Practice questions

5 Backflush

Transactions for the year for AYZ are as follows:

Purchases of raw materials $5,000,000

Conversion costs $3,000,000

Finished goods manufactured 100,000 units

Sales 98,000 units at $100 per unit

There was no inventory at the beginning of the year. The cost per unit is $80,

consisting of $50 per unit for materials and $30 per unit for conversion costs.

Required

Show the book-keeping entries in the cost accounting system using backflush

accounting, with two trigger points.

6 Villaco

Villaco produces two products with the following costs and revenue per unit.

Product A Product B

$ $

Sales price 20

Variable cost 8

Fixed cost 4

units

Sales demand

2,000

3,000

There are only 7,000 machine hours available, and Product A requires four machine

hours per unit and Product B requires one machine hour per unit

Required

(a) Calculate the profit-maximising production and sales mix.

(b) Assume that all the data is the same, except that we are able to sub-contract

the products for an additional variable cost of $1 per unit for A and $0.50 per

unit for B.

What is the profit-maximising decision?

7 Shortages

An engineering company has been experiencing problems with restricted

availability of resources. The company manufactures a variety of casings. It makes

four types of casing. Each casing requires the same bought-in component and some

high-grade steel. The standard costs for the four types of casing are as follows:

Paper P5: Advanced performance management

Casing A B C D

$ $ $ $

Steel 250

500

190 390

Bought-in component 50

50 50

Direct labour 60

50 100

Variable production costs 40

40 50

Fixed production costs 180

240

150 270

Selling and administration costs 145

225

120 215

Profit 35

30 55

Selling price 760

1,180

630 1,130

All the selling and administration costs are fixed and the same single component is

used for each of the four products. Direct labour is paid $8 per standard hour and

each member of the workforce is capable of producing any of the casings.

The company’s main customer has ordered 30 units of Casing A, 20 units of B, 30

units of C and 20 units of D for production and delivery in the next month. Senior

management have agreed that this order should be treated as a priority order and

that these casings must be manufactured and delivered to the customer next month.

This is necessary to maintain the goodwill of the customer. It is estimated that this

order represents 10% of the total demand next month for each type of casing.

The company operates a just in time system, and has no inventories of steel,

components or finished goods.

Required

If the aim is to maximise profit for the month, establish the production and selling

plan for the company next month in each of the following situations:

(a) Situation 1. Supplies of steel are limited to $250,000.

(b) Situation 2. Only 400 bought-in components are available from suppliers.

month to 2,125.

(d) Situation 4. A labour dispute restricts available productive labour hours in the

month to 2,125; but the manufacture of any quantities of the four casings

could be sub-contracted to an outside supplier. The cost of buying the casings

externally would be $475, $705, $380 and $640 for Casing A, Casing B, Casing

C and Casing D respectively. In addition, it should be assumed that a major

customer insists that its order is completed by the company itself and the

manufacture should not be sub-contracted.

Each of the restrictions on production should be treated independently, as four

different situations.

ACCA - P5 Study text - Emile Woolf INT - 2010

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