ACCA - P5 Study text - Emile Woolf INT

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29 Train times

Northern Region Southern Region

Inter-city

services

Suburban

services

Inter-city

services

Suburban

services

Target for completion on time 90% 95% 90% 95%

Actual % on time 82.7%

73.8%

88.3% 91.9%

% not on time, but less than 5

minutes late

7.3%

12.9%

5.6% 4.0%

% between 5 and 10 minutes late

6.0%

10.6%

2.2% 2.9%

% cancelled 3.2%

1.2%

0.1% 0.5%

99.2%

98.5%

96.2% 99.3%

Over 10 minutes late (balance) 0.8%

1.5%

3.8% 0.7%

100.0%

100.0% 100.0%

Assessment of performance

Neither region has achieved its target for journeys completed on time, although

Southern Region appears to be closer to achieving its targets.

Most of the late-completed journeys were completed within ten minutes of the

scheduled time.

Northern Region has a fairly large proportion of cancelled trains – certainly much

higher than Southern Region. However, Southern Region has a comparatively high

proportion of inter-city journeys finishing over ten minutes late.

The managers of the two regions should be asked to provide a report on these

aspects of performance.

30 Non-financial performance measurements

Service quality

(1) The percentage of customers who take their account away in a period (the rate

of ’churn’)

(2) The number of complaints in a period

(3) A measure of ‘satisfaction’ from responses by customers to a questionnaire

about the bank’s services

(4) In some aspects of service, speed of response (for example, the average time to

answer telephone calls from customers: these time measures can be obtained

from the bank’s telephone systems).

Marketing effectiveness

(1) The number of new accounts or growth rate in new accounts in the period

(2) The growth in major business activities in the period (lending, foreign

exchange dealing, and so on)

(3) Market share

Paper P5: Advanced performance management

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Personnel

(1) The rate of absenteeism in the period

(2) The amount of staff training in the period (total training days, for example)

(3) The rate of staff turnover

(4) It might be possible to identify ways of measuring staff efficiency, but this can

be difficult when much of the work is non-standard or non-routine.

31 Mission

Question 1: Meaning of corporate mission. Link to corporate strategy

A corporate mission embodies the overall purposes of an organisation. A corporate

mission should answer fundamental questions such as:

 What are the values of a company?

 What is its culture?

 Why does the company exist?

 Who will be served by company and benefit from it?

 What products or services will be provided?

The majority of mission statements are presented using general concepts rather than

detailed specifications.

In order to prepare an effective strategic plan, senior management should be

conscious of the organisation’s mission.

One view is that the mission statement is very important and a strategic plan cannot

be prepared without reference to it.

An opposing view is that a mission statement is the end result of the strategic-

planning process. Some critics argue that a mission statement has no practical value

at all.

Question 2: The origin of a mission statement and what it covers

The mission statement should be written or approved by the company’s board of

directors. It does not contain quantitative targets. It might cover the following areas:

(a)

The kinds of products and services the company aims to provide

(b)

The customers to be served

(c)

The markets in which the company expects to operate

(d)

An overview of the company’s philosophy or culture

(e)

The company’s attitude towards social obligations (corporate social

responsibility)

(f)

The way in which the company wants to be seen by the public (its reputation).

Answers

Question 3: Benefits of a mission statement

A company might gain several benefits from a mission statement. It should help

decision-makers to focus on fundamental issues in strategic planning, and ensure

that strategic plans do not conflict with the basic purpose of the organisation.

The benefits of a mission statement may be summarised as follows:

 Employees can use it to get an understanding of the company’s purpose and

philosophy.

 The company’s aspirations are expressed in terms of a long-range vision.

 The purpose the company operates will be clearly stated. This should help

management to develop co-ordinated plans that are consistent with this

purpose.

 A statement about the purpose of the company should help planners to allocate

resources more effectively.

32 Customer profitability

Workings

Product Units Contribution

per unit

Total

contribution

Total sales

revenue

$ $ $

A 100,000 1.20

120,000

360,000

B 150,000 0.50

75,000

375,000

C 120,000 1.20

144,000

480,000

D 180,000 0.90

162,000

432,000

E 80,000 2.00

160,000

480,000

661,000

2,127,000

Contribution per customer category

Total contribution Category of customer

C1 C2 C3 C4

$ $ $ $ $

Product A 120,000

12,000

24,000

24,000 60,000

Product B 75,000

30,000

22,500 22,500

Product C 144,000

14,400

28,800

14,400 86,400

Product D 162,000

48,600

16,200

32,400 64,800

Product E 160,000

32,000

32,000 96,000

Total 661,000

137,000

69,000

125,300 329,700

Rebates

Total sales C3 C4

$ $ $

Product A 360,000 20%

72,000

50%

180,000

Product B 375,000 30%

112,500

30%

112,500

Product C 480,000 10%

48,000

60%

288,000

Product D 432,000 20%

86,400

40%

172,800

Product E 480,000 20%

96,000

60%

288,000

Total

414,900

1,041,300

Rebate %

10%

Rebate in $

$20,745

$104,130

Paper P5: Advanced performance management

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ABC apportionment rates

Number of

deliveries

Km per

delivery

Total

kilometres

C1 40 100 4,000

C2 80

200

16,000

C3 50

300

15,000

C4 100

150

15,000

50,000

Apportionment rates

 Delivery costs: $250,000/50,000 = $5 per kilometre

 Order processing: $105,000/(30 + 70 + 50 + 60) = $500 per order

 Promotion events: $30,000/12 = $2,500 per event.

Statement of customer profitability

C1 C2 C3 C4 Total

$ $ $ $ $

Contribution 137,000

69,000

125,300

329,700 661,000

Rebates 0

(20,745)

(104,130) (124,875)

137,000

69,000

104,555

225,570 536,125

Activity costs

Delivery (20,000)

(80,000)

(75,000)

(75,000) (250,000)

Order processing (15,000)

(35,000)

(25,000)

(30,000) (105,000)

Promotion events 0

(5,000)

(25,000) (30,000)

Customer profitability 102,000

(46,000)

(445)

95,570 151,125

Other fixed costs

(80,000)

Company profit

71,125

33 RTC

(a)

Workings:

Year 4

Year 5

Hereland

Thereland

Total

Hereland

Thereland

Total

Gross profit

($000)

1,450 (60)

1,390

1,520

170

1,690

Gross

profit/sales

33.7% (6.3)%

26.5%

33.8%

14.2%

29.6%

Net profit/

sales

20.5% (18.4)%

11.2%

20.0%

(1.7)%

13.8%

Sales growth

4.7%

26.3%

8.6%

Sales/non-

current assets

1.65 3.96

1.84

1.73

2.50

1.85

ROCE (%)

18.9%

19.5%

Gearing (%)

60.9%

36.1%

EBITDA

($000)

1,080

1,305

Notes:

1 ROCE = profit before interest/capital + reserves + loan stock.

2 EBITDA = earnings before interest, depreciation and amortisation.

Answers

Analysis

Total growth in sales revenue was 8.6% in Year 5. Sales growth was 4.7% in

Hereland, but 26.3% - much stronger - in Thereland.

There was an increase in both the gross profit margin and the net profit margin for

RTC. The gross profit margin was up from 26.5% to 29.6%, and the net profit margin

was up from 11.2% to 13.8%. There was little change in Hereland, and the

improvement is due to the improvement in Thereland, where a gross loss was

turned into a gross profit, and the net loss was reduced.

Taking the financial performance of RTC as a whole, return on capital employed

improved from 18.9% to 19.5%, and there was an increase in EBITDA from $1.08

million to $1.30 million. EBITDA is a useful approximation of cash flows from

operating activities, and the growth in EBITDA would suggest that operational cash

flows should be positive, in spite of the large increase in investment in non-current

assets.

The ratio of sales to non-current assets remained roughly the same in Year 5 as in

Year 4 for RTC as a whole. However, whereas sales per $1 invested in non-current

assets went up in Hereland, it fell in Thereland.

Financial gearing fell in Year 5, partly because of the increase in equity invested, and

partly due to the reduction on long-term debt. $200,000 of loan stock was redeemed

during Year 5.

(b)

The following additional information would be useful:

Financial results for Years 1 to 3. This would make it possible to analyse

the trends in performance in Homeland, and make a comparison of the

early years of operations in Homeland with the initial years of operating

in Thereland.

It would also be useful to have the financial targets or budgets for Years

4 and 5, so that actual performance can be compared with planned

performance.

Information about cash flows would also be useful, particularly for RTC

as a whole. This would provide data for the analysis of cash

management.

It would also be helpful to have some information about the market as a

whole for scientific conferences in Homeland and Thereland, and in

particular the estimated size of the total market and the relative size of

major competitors. This would make it possible to carry out some

analysis of market share and some competitor analysis.

equally acceptable.

Paper P5: Advanced performance management

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1 It is difficult to compare the results in Hereland and Thereland because

operations in Hereland have been established for five years, and in

Thereland they have been established for only three years.

2 The relative size of the total market in each country should also be

considered, and the market share that RTC has in each country.

3 The number and size of competitors in each country will affect the

relative performance of RTC in homeland and Thereland. Performance

should be better in the country where competition is weaker, provided

that the overall size of the market in each country is about the same.

4 Data about the average number of delegates at conferences in Hereland

and Thereland would also be useful. Profit margins should be higher in

the country where average numbers are higher.

5 The availability and cost of conference speakers in each country should

be compared. This may affect the gross profit margins in each country.

34 Value for money

(a) A value for money exercise looks at economy, efficiency and effectiveness in

the use of resources.

(1)

Economy. A VFM study should look at major items of spending, and

assess whether the school is obtaining good value for the money it is

spending. For example, is it getting teachers of a suitable quality for the

amount it is paying in salaries? Is the school paying sensible prices for

books and other equipment, or is it possibly paying prices that are too

high? All major items of spending can be investigated in this way, to

establish that resources are of a suitable quality and that the prices paid

for them are not too high.

(2)

Efficiency. A VFM study will also look at the efficiency of using

resources. Key resources might be teachers’ time and some teaching

equipment, such as laboratory equipment and a computer centre.

Efficiency can be assessed by measuring the use of these resources, such

as average teaching time per teacher per week, average number of hours

of computer time used per computer per day, and so on.

(3)

Effectiveness. The VFM study must have a clear idea of the strategic

aims of the school. These may be expressed in terms of the average

grades expected in key examinations, or the percentage of school leavers

going on to a university education. There may be other key objectives –

such as providing an ‘all round’ education, or providing an education

with an emphasis on particular skills, such as the teaching of science or

art. The might also be a financial objective, such as operating the school

without making a loss. The VFM study should then measure actual

performance in these key areas, to establish whether the school is

successful. If the school is failing to achieve its objectives, the study

should try to establish the causes of the problem.

(b) The VFM study team might benefit from a benchmarking exercise –

comparing the performance of the school with the performance of similar

schools in the region or country.

Answers

35 Decentralisation

(a) (i) Responsibility accounting is the structuring of performance reports for

individual managers in a way that identifies the factors that are

controllable by them and for which they are responsible. Depending on

the factors under the control of the manager, responsibility accounting

reports may be prepared for cost centres, revenue centres, profit centres

or investment centres.

(ii) An

investment centre is an operating division within an organisation

whose manager has responsibility for both the profits of the division

and the investments that it makes.

(iii)

Return on investment (ROI) = The divisional profit divided by the

capital employed within that division.

(iv)

Residual income = Divisional income – a notional interest charge for the

investment in capital investment in the division

Residual income = Divisional income – Divisional investment × cost of

capital

Note:

Both ROI and residual income can be used as:

 ex ante targets (planning targets) – in order to motivate divisional

managers and to guide their decision-making

 ex post appraisal measures (actual performance measures) – to evaluate

the divisional manager’s performance.

(b) Divisions M and W

(i) The performance of the two divisions will be evaluated using both ROI

and residual income. There is no specific performance target for either

division. To compare divisional performance, it is assumed that the

division with the higher ROI or residual income has performed ‘better’.

Division M Division W

ROI

20/200 410/5,000

10%

8.2%

$000

Profit 20

410

Less: Interest on investment at 8%

(16)

(400)

Residual income

Division M has a higher ROI than Division W. However, the reason for

this difference in performance may be that Division M has older non-

current assets, and is reluctant to invest in new capital equipment. New

investments would increase the division’s profit but reduce its ROI in

the short-term (because capital investment will also be higher).

Division M has a higher residual income than Division W. Therefore, in

a situation where both divisional managers are motivated to accept

projects that meet the firm’s investment criteria (i.e. cost of capital).

Division W may therefore have been more successful in finding

investments that earn a return above the cost of capital. However, the

Paper P5: Advanced performance management

difference in residual income is only $6,000, but Division W has invested

$4.8 more than Division M.

Both divisions have a positive residual income, which means that they

have succeeded in investing in projects with accounting returns higher

than the company’s cost of capital.

(ii) (i) A change in the company’s cost of capital will only affect the

residual income figure; it has no effect on the ROI. The revised

residual income figures for cost of capital at 6% and 10%

respectively are as follows:

Division M Division W

(1) Cost of capital 6% $000 $000

Profit 20

410

Less Interest on investment at 6%

(12)

(300)

Residual income

110

(2) Cost of capital 10%

Profit 20

410

Less Interest on investment at 10%

(20)

(500)

Residual income

(90)

If the cost of capital for the company is only 6%, the residual

income of both Division M and Division W is higher. The larger

size of the investment in Division W results in a proportionally

higher RI figure.

On the other hand, if the cost of capital is raised to 10%, Division

M is the better performer with a residual income of 0 compared

with a negative residual income (a residual loss) of $90,000 for

Division W.

36 West Division

Sales

price

Variable

cost

Contribution

per unit

Sales

Total

contribution

$ per unit $ per unit $ per unit units $

Product A:

Titan brand 2.50

1.50

1.00

160,000 160,000

Unbranded 1.50

1.30

0.20

450,000 90,000

Product B:

Titan brand 3.20

2.00

1.20

120,000 144,000

Unbranded 2.00

1.80

0.20

600,000 120,000

Product C:

Titan brand 5.00

3.00

2.00

50,000 100,000

614,000

Marketing costs

180,000

Other fixed costs

375,000

555,000

59,000

Notional interest: 10% × $400,000

(40,000)

Residual income

19,000

(a) ROI = 59,000/400,000 = 14.75%.

(b) Residual income (see above) = $19,000.

Answers

37 Annuity method

(a) Annual depreciation = $600,000/3 years = $200,000.

Year 1 Year 2 Year 3

$ $ $

Average capital employed

500,000

300,000

100,000

Cash profit 300,000

300,000

Depreciation 200,000

200,000

Profit 100,000

100,000

Notional interest at 12% 60,000

36,000

12,000

Residual income 40,000

64,000

88,000

(b) Annual depreciation = $/Year 1 – 3 annuity factor at 12%

= $600,000/2.402 = $249,792.

Year 1 Year 2 Year 3

$ $ $

Cash profit 300,000

300,000

Depreciation 249,792

249,792

Residual income 50,208

50,208

It could be argued that when an investment provides constant annual cash

flows over its full life, it is appropriate that the change in annual performance

should be a constant amount in each year.

 The annuity method of depreciation applies a constant annual charge for

depreciation and notional interest, and when the annual cash flows from

an investment are constant in each year, the effect on the residual income

is also a constant amount in each year.

 In contrast, the effect on residual income differs each year over the life of

an investment, when notional interest is calculated on the carrying amount

(net book value) of the investment.

38 Residual

(a) NPV

Year Cash flow Discount factor at 12% PV

$ $

0 Cost of investment

(42,000)

1.000

(42,000)

–

3 Annual cash flow

19,000

2.402

45,638

NPV

+ 3,638

(b) ROI

Annual depreciation (straight-line) = $42,000/3 = $14,000.

Annual accounting profit = $5,000

Year Profit Average investment ROI

$ $

1 5,000 35,000

14.3%

2 5,000 21,000

23.8%

3 5,000 7,000

71.4%

Average

5,000 21,000

23.8%

Paper P5: Advanced performance management

Note: Average investment, measured as the net book value of the asset, is the

mid-point between $42,000 and $28,000 in Year 1, the mid-point between

$28,000 and $14,000 in Year 2, and the mid-point between $14,000 and $0 in

Year 3.

several years. Investing in this project will therefore have the effect of bringing

ROI down, although the investment is probably quite small in relation to the

total size of the investment centre and its assets. The managers of the

investment centre would therefore have no particular reason to undertake the

investment, even though it has a positive NPV when the cash flows are

discounted at 12%.

(d) Residual income

For each year, Years 1 – 3, the residual income would be as follows:

Year 1 Year 2 Year 3

Average investment $35,000 $21,000 $7,000

$ $

Profit after depreciation 5,000

5,000 5,000

Notional interest (12% of investment)

4,200

2,520 840

Residual income 800

2,480 4,160

The residual income is positive in each of the three years, although it increases

each year as the value of the investment declines.

If the performance of the investment centre is measured by residual income,

its managers would be willing to undertake the investment because it will

improve the divisional performance by increasing the residual income.

(e) Residual income and annuity depreciation

If the annuity method is used to calculate annual depreciation, the annual

depreciation charge will be:

Cost of investment/12% annuity factor, Years 1 – 3 = $42,000/2.402 = $17,485.

The residual income reported each year for this investment would then be:

Each year

Profit before depreciation

19,000

Annuity depreciation 17,485

Residual income 1,515

(f) Connection with NPV

Since the annual profit before deprecation is the same in each year of the

project, there is a direct mathematical connection between the residual income

using annuity depreciation and the project NPV:

Residual income × Annuity factor (here, for Years 1 – 3 at 12%) = NPV

$1,515 × 2.402 = $3,639. (There is a rounding error of $1.)

ACCA - P5 Study text - Emile Woolf INT - 2010

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