ACCA - P5 Study text - Emile Woolf INT

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48 The Vet Centre

(a)

Profit

The profitability of the Centre should be compared with budget. (Ideally, if shared

costs could be allocated fairly the profitability of each category of treatment should

be measured. Profitability could also be compared with profits in previous years.

However, data for making these measurements is not available.)

Budget Actual

$ $

Revenue

2,520,000

2,820,000

Salaries, full-time vets

(10 × $60,000)

600,000

Bonus

50% × (2,820,000 – 2,520,000)

150,000

Part-time vets 18,000

60,000

Other costs 1,400,000

1,610,000

Total costs

2,018,000

2,420,000

Profit

502,000

400,000

Actual profit is below budgeted profit.

Competitiveness

One measure of competitiveness might be the rate of success at turning customer

enquiries by telephone into actual examinations and treatments. (Note: There could

be other and better measures of competitiveness, such as growth in annual revenue

and share of the local market. However, data is not available here to make these

measurements.)

In the table below, ‘success rate’ is the percentage of customer enquiries by

telephone that result in an actual examination or treatment, for which a fee is

charged.

Budget Actual

New business

Enquiries 5,000

9,000

Examinations/treatments 3,000

4,000

Success rate 60%

44%

Repeat business

Enquiries 18,000

15,000

Examinations/treatments 16,000

14,000

Success rate 89%

93%

The Centre has not been as successful as expected (budgeted) at converting

enquiries from new customers into ‘sales’, but has been more successful than

expected in converting calls from ‘repeat’ customers into sales.

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(b)

Quality

Quality of service can be measured by complaints. A useful measure might be the

number of complaints as a percentage of examinations and treatments.

Budget

Actual

Complaints 380

540

Examinations/treatments 19,000

18,000

Percentage rate of complaints 2%

It would be useful to analyse complaints according to the type of animals treated in

each case, but the data is not available.

The rate of complaints is higher than expected, suggesting that the quality of service

is not up to the expected standard.

Resource utilisation

The key resource at the Centre is probably the time of the full-time vets. A useful

measure of performance would therefore be average revenue per full-time vet.

Ideally, income from the treatment of exotic animals should be excluded from

revenue, but we do not know how much income was earned from treating exotic

animals.

Budget

Actual

Revenue £2,520,000

$2,820,000

Number of full-time vets 10

Average revenue per vet $252,000

$282,000

Average revenue per vet was $30,000 (nearly 12%) above budget, although some of

this increase must be due to the higher-than-budgeted quantity of treatments of

exotic animals.

Flexibility

A key aspect of flexibility is probably the ability of the Vet Centre to respond to

requests to treat exotic animals. A suitable measure of performance might therefore

be the percentage of revenue that comes from the treatment of exotic animals. The

budget might state the minimum required percentage.

Budget

Actual

Total number of treatments 19,000

18,000

Treatments of exotic animals 120

400

0.6%

2.2%

The Centre has possibly demonstrated its flexibility in its ability to treat more exotic

animals than provided for in the budget. However, this still remains a low

proportion of the total annual work done by the Centre.

Answers

Innovation

There is no data for measuring innovation in a satisfactory way, although the

amount spent on training (per vet) might be used as an indication of ‘new learning’

and so an ability to innovate and provide new methods of treatment.

Budget

Actual

Spending on training $75,000

$100,000

Full-time vets 10

Training costs per vet $7,500

$10,000

By spending more than budgeted on training, the Centre might demonstrate its

ability to innovate and offer new treatments for animals.

(c)

Standards

According to Fitzgerald and Moon, the three key factors are:

(1)

Ownership. Do the individuals responsible for achieving the performance

standards ‘own’ them and accept them. (Were the individuals involved in

setting the standards, or were they imposed by senior management?)

(2)

Achievability. Are these standards considered achievable?

(3)

Equity. Are the standards equitable and ‘fair’ for every manager responsible

for achieving performance targets?

Rewards for achieving targets

According to Fitzgerald and Moon, the three key factors are:

(1)

Clarity. Is the connection between operational performance standards and the

achievement of corporate goals clear and fully understood by all employees

and managers?

(2)

Motivation. Are the rewards for achieving targets (both financial rewards and

non-financial rewards) sufficient to motivate the managers responsible for

achieving the targets?

(3)

Controllability. Are there any problems with the allocation of the costs of

shared services, and charging managers with costs over which they have no

proper control?

49 Total quality

(a) The key aspects of Total Quality Management are:

(1) continuous improvement in operations and systems, to improve quality

(2) a policy of trying to achieve zero defects in production (getting things

right the first time)

(3) the use of statistical quality control to prevent defective items reaching

customers

(4) employee involvement in efforts to improve quality, for example by

using quality circles

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(5) measures to improve production systems, such as minimising inventory

levels, minimising the movement of materials, minimising setup times:

all these take time and money but do not add any value.

(b)

Quality-related costs can be grouped into four categories:

(1) Prevention costs: these are costs incurred in preventing quality

problems. Important elements of prevention costs are costs of ensuring

good product design and costs of training employees.

(2) Appraisal costs: these are the costs of testing for quality, such as

inspection costs and quality control costs.

(3) Internal failure costs: these are the costs of faults and errors in

processing, such as costs of waste, scrap and re-working rejected items.

(4) External failure costs: these are the costs of quality problems after the

product (or service) has been delivered to the customer such as the cost

of handling customer complaints, and the loss of future business/sales.

In the traditional approach, the aim should be to minimise the total of quality-

related costs. At this cost-minimising level of quality, some errors will occur.

The TQM approach is that all errors should be avoided and sub-standard

work is unacceptable. External failure costs are under-estimated, and it is

worth spending money on prevention and appraisal costs to avoid internal

and external failure costs, which will be higher.

(c)

Key aspects of JIT management are:

(1) Hold no inventory. This requires just-in-time purchasing (to avoid raw

materials inventory) and just-in-time production (to avoid finished

goods inventory). Holding inventory is wasteful, and does not add

value.

(2) Just-in-time purchasing calls for close collaboration with key suppliers.

(3) Just-in-time production involves trying to produce items exactly in time

to meet customer needs for delivery: this calls for fast production times

and avoiding breakdowns and any hold-ups or bottleneck in

production.

(4) Production systems need to be flexible, to react to changes in demand

from customers.

(5) Avoid over-production (which results in finished goods inventory).

(6) Eliminate inefficiency and poor quality in production – eliminate waste,

minimise the movement of materials (which adds no value), minimise

waiting times, improve the layout of the factory floor (to minimise

movement of materials), reduce setup times (which do not add value)

and improve visibility in the work place (by using cards or other

signalling systems).

(d) Activity based management uses activity based costing to analyse the cost of

activities within an organisation. It focuses on the cost of activities and the

causes of these costs occuring (cost drivers). The aim of ABM should be to

improve the value obtained from the activities, eliminate activities that do not

add value or reduce the costs of activities.

Answers

50 Poole Company

(a) Projected data

(i) Total production units

Before TQM After TQM

Sales 5,000 5,000

Returns: (5%/2.5% of sales)

263 128

5,263 5,128

Final inspection (12.5%/7.5% of production)

750 416

Total production units

6,000 5,541

(ii)

Purchases of material X

Before TQM After TQM

Material usage (6,000 or 5,541 × 8 m

/unit) 48,000 44,328

Processing losses: (4%/2.5% of input)

2,000 1,137

50,000 45,465

Storage losses: (5%/3% of receipts)

2,632 1,406

52,632 46,871

(iii) Gross machine hours

Before TQM After TQM

Machine usage

(6,000 × 0.6 hrs/unit)

3,600 (5,541 × 0.5hrs/unit) 2,771

Work on 3rd quality units

(80% × 250 x 0.2)

(80% × 125 × 0.2)

3,640

2,791

Idle time

(20% of gross machine hours)

910

(12.5% of gross machine hours) 399

4,550

3,190

(b) Income statements

Before TQM $ $ $

Sales:

1st quality (5,000 × 100)

500,000

2nd quality (750 × 70)

52,500

3rd quality (200 × 50)

10,000

Scrap (50 × 5)

250

562,750

Costs:

Fixed

Prevention 20,000

Sundry

60,000

Inspection 25,000

105,000

Variable

Inspection/storage (52,632

0.1)

5,263

Material (52,632 × 4)

210,528

Machine hours (4,550 × 40)

182,000

Delivery costs (250 × 8)

2,000

Product liability claims (3%

500,000)

15,000

414,791

Total costs

519,791

Profit

42,959

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After TQM $ $ $

Sales:

1st quality (5,000 × 100)

500,000

2nd quality (416 × 70)

29,120

3rd quality (100 × 50)

5,000

Scrap (25 × 5)

125

534,245

Costs:

Fixed

Prevention 60,000

Sundry

54,000

Inspection 15,000

129,000

Variable

Inspection/storage (46,871

0.1)

4,687

Material (46,871 × 4)

187,484

Machine hours (3,190 × 40)

127,600

Delivery costs (125 × 8)

1,000

Product liability claims (1%

500,000)

5,000

325,771

Total costs

454,771

Profit

79,474

51 Target cost

(a)

Year 0 1 2 3 4

$000 $000 $000 $000 $000

Working capital

(400)

400

Cost/residual value (1,400)

600

Sales revenue

1,400

2,100

1,750 700

Advertising costs (800)

(600)

(400)

(200)

Fixed production (cash) costs

(200)

(200) (200)

Net cash flows, excluding variable

costs

(2,600)

600

1,500

1,350 1,500

Discount factor at 12% 1.000

0.893

0.797

0.712 0.636

Present value (2,600)

535.8

1,195.5

961.2 954.0

NPV of cash flows, excluding variable production costs = $1,046,500

(b)

Let the maximum variable cost per unit (the target variable cost) be V.

Year Variable costs Discount factor at 12% PV of variable costs

$ $

1 40,000V 0.893

35,720V

2 60,000V 0.797

47,820V

3 50,000V 0.712

35,600V

4 20,000V 0.636

12,720V

131,860V

The variable cost per unit that will give the project a DCF return of 12% =

$1,046,500/131,860 = $7.94. The DCF return will be less than 12% if the variable cost

exceeds $7.94.

Answers

The current estimate of the variable cost per unit is $10. The cost gap is therefore

$2.06 ($100– $7.94).

52 Cost and quality

(1) Total Quality Management

TQM seeks to reduce quality costs, where quality costs are categorised as:

 Prevention costs

 Appraisal costs (inspection costs, etcetera)

 Internal failure costs (costs of scrap, waste, re-working and so on)

 External failure costs (cost of lost customer goodwill, lost sales, returned

goods from customers, warranty costs)

The aim should be to improve quality and reduce total quality costs.

TQM also seeks continuous improvement: improvement can be achieved by

reducing costs or improving quality.

(2) Activity based costing

A system of ABC might identify activities related to achieving quality, such as

quality planning and control, and a cost driver for those activities. ABC could

then be used to identify the costs related to the quality activity.

(3) Balanced scorecard

In a balanced scorecard, cost targets could be an element for the financial

perspective. Quality targets could be an element in the balanced scorecard for

the internal perspective or the customer perspective.

(4) Just in Time management

JIT seeks reductions in costs through improvements in production

performance. The aim is to eliminate breakdowns and bottlenecks, so that

items can be manufactured as quickly as possible.

(5) Value analysis

Value analysis looks at activities and costs in the value chain, and attempts to

identify ways of adding more value. Value is added by providing extra

quality (where the value of the extra quality is less than any additional cost) or

by providing the same quality at less cost.

Paper P5: Advanced performance management

Paper P5

Advanced performance management

Index

ABCinformation 21

ABC:advantages 23

ABC:limitations 23

ABC:traditionalabsorptioncosting 19

Activitybasedbudgeting(ABB) 185,189

Activitybasedcosting(ABC) 15

Activitybasedmanagement(ABM) 224

Addingvalue 136

Agencytheory 284

Altman:Zscoremodel 402

Analysingcosts 74

Analysisofcosts 264

Annuities 96

Annuity‐baseddeprec

iation 351

Ansoff’sgrowthvectoranalysis 331

 gapanalysis 333

Argenti:‘Ascore’model 404

Argyris:fourbehaviouralissuesin

 budgeting 195

Aspirationalbudgets 193

Assessingriskindecision‐making 66

Assetreplacementdecisions 108

Backflushaccounting 31

Backflushaccounting

 triggerpoint 35

 twotriggerpoints 32

Balancedscorecardapproach 384

Balancingcharge 102

Bargainingpowerofcustomers 324

Bargainingpowerofsuppliers 323

Balancing 102

BCGmatrix 325

Benchmarking 162

Benchmarkingprocess 162

Beyondbudgeting 202

Beyondbudgetingmodel 204

 performancemanagement 205

BeyondB

udgetingRoundTable(BBRT) 202

BostonConsultingGroup(BCG)model 325

BPRexercise 230

Budgetslack(budgetbias) 194

Budgetarycontrol 173

 behaviouralaspects 198

 managementstyles 200

Budgetedincomestatement 177

Budget‐constrainedstyle 200

Budgeting

 bargainingprocess 195

 behaviouralaspects 192

 planningandco‐ordination 17

2

 uncertainly 83

BurnsandScapens 410

Paper P5: Advanced performance management

Burrittetal(2001) 432

BusinessProcessRe‐engineering(BPR) 228

Capacityutilisation 300,301

Capitalinvestment 322

Cashcows 326

Changeagents 410

Changesinstrategicplans 117

Channelsofdistribution 315

ChrisArgyris(1953) 195

Classificationofcosts:controllability 265

Closedsystems 273

Competitivebenchmarking 164

Competitiverivalry 321

Competitivestrength:fiveforces 320

Contingencytheory 215

 managementaccounting 21

0

Contingentvariables 211

Continuousimprovement(Kaizen) 421

Controlsystemtheory 273,277

Controllability 268

 long‐termandshort‐term 271

Controllableprofitandtraceableprofit 337

Coreactivities 22

Corporateaspirations 194

Corporatefailureprediction 400

Corporatevision 288

Costcentres 267

Costcontrol 22

Costdrivers 15,22

Costle

adership 240

 strategy 254

Costreduction 22

Cost‐basedpricingmethods 243

Cost‐basedtransferprices 367

Cost‐cutting 193

Criticalsuccessfactors(CSFs) 290

Customerbenchmarking 168

Customerprofitability 315

Customerprofitabilityanalysis 316

Customersatisfaction 135

CVPanalysisanddecision‐making 52

DavidOtley 201

DCFanalysis:evaluation 111

DCFandinflation 104

DCFandtaxation 100

DCF:basicrevisionpoints 94

Decentralisationofauthority 336

Decisionpackages 187

Decision‐making 58

 quantitativeandqualitativefactors 43

Depreciation 349

Dimensionsofperformance 393

Directlabourbudget 176

Directmaterialsusagebudget 176

Discontin

uancedecisions

 (shutdowndecisions) 45

Discounttables 95

Diversificationstrategy 121,332

Diversionaryactivities 22

Divisionalautonomy 366

Divisionalmanagers 365

Divisionalperformance 349

Divisionalperformanceevaluation 336

DMADV 440

Dogs 326

Driversofcost 22

Dualpricing 380

Earningspersharegrowth 294

EBITDA 294

Economicandmarkettrends 236

EconomicValueAdded(EVA) 354

Economiesofscale 322

Economist’sdemandcurve 251

Economy 308

Effectiveness 308

Efficiency 308

Eliminatingwaste 413

EMAtechniques 434

Empowermentofemployees(BPR) 230

Endogenousvariables 266

ACCA - P5 Study text - Emile Woolf INT - 2010

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