SCM & PE 63 Models Case Study

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63 Models relevant for Case Study Based Questions


1. This file has complete description of all 63 Models which are used in solving case study.
2. Full Explanation has been covered in 73 Pages.
3. If you read 1 hour daily & just read 6 pages daily then you need just 12 days to master all
models which are required to solve case study based questions.

1. Value Chain Analysis 2. Industry Structure 3. Segmentation Analysis


Analysis – Porter
4. Competitive Advantage 5. Vertical Linkage 6. Value Shop Model
Model Analysis
7. Cost of Quality 8. Cost of Quality – 9. Total Quality
components Management
10. PDCA Cycle 11. Business Excellence 12. EFQM Business model
Model
13. Goldratt’s Five-Step 14. Supply Chain – Push & 15. Gain Sharing
Method for Improving Pull Model arrangement
Performance
16. Just in time 17. Backflush Costing 18. Kaizen Costing
19. 5S Approach 20. Total Productive 21. Six Sigma
Management
22. Six Sigma – Methods to 23. Lean Six Sigma 24. Business Process Re-
implement Engineering (BPR)
25. Target Costing 26. Product Life Cycle 27. Various Strategies
Approach under Product Life
Cycle
28. Pareto Analysis 29. Pareto Analysis – 30. Environment Cost –
How Apply Mendoza (1999)
31. Price Customization 32. Cost based Pricing 33. Value Based Pricing
Technique Model
34. Pricing Strategy for 35. Skimming & 36. Predatory Pricing
New Product Penetration Pricing
37. Responsibility 38. Return on Investment 39. Residual Income Model
Accounting Model
40. EVA Model 41. Shareholder value 42. Triple Bottom Line
added Model Model
43. The Performance 44. The Performance 45. The Building Block
Pyramid Model Prism Model Model
46. Linking CSFs and KPIs to 47. Balance Score Card 48. Strategy Mapping
strategy (Kaplan and Norton)

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49. Negotiated Pricing 50. Resolve Divisional 51. Strategic Profitability


Conflict Analysis
52. Direct Product 53. Customer Profitability 54. Activity Based
Profitability Analysis Management
55. Value Added Activities 56. Activity Based 57. Feedback & Feed
Budgeting Forward Control
58. Negative Feedback – 59. Beyond Budgeting 60. Beyond Budgeting –
Impact How Implement
61. Planning Variances 62. Variance Analysis 63. Learning Curve

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Question 1 What are the classification of business activities in relation to value


chain analysis as per Porter?
Answer:- Porter classified business activities into primary activities & secondary activities as follows

Primary activities:- It includes activities which are directly involved in converting raw material into finished
goods, activities helping in delivery of goods and after-sales support.

Support Activities:- It includes activities which help in carrying out primary activities e.g. purchase of raw
material is support activity required for manufacturing of finished goods.

Primary Activities Include

a) Inbound activities:- These include activities in receiving, storing & distributing raw material to
production process e.g. material handling & warehousing activities
b) Operations:- These include activities in transforming raw material in finished goods e.g. packing,
testing
c) Marketing & Sales:- These include activities to make customer aware of product e.g.
advertising, promotion
d) Service:- These include activities related to after sales service e.g. replacement of parts of
product

Support Activities Include

a) Procurement:- These activities includes purchase of raw material required as input for primary
activities
b) Technological Development:- These include technical knowledge, hardware & software used in
transformation of raw material to finished goods
c) Human Resource Management:- These include activities involved in selection, recruitment,
training & promotion of employee/labour
d) Firm Infrastructure:- These include activities involved in general management e.g. finance
department, accounting department.

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Question 2 Write short notes on industry structure analysis of Michael Porter?


Answer An organisation may not earn high profit just because it’s size is large. Hence Porter suggested 5
factors to determine potential profitability of firm in an industry. Under this model, the profitability of an industry
depends mainly upon following 5 factors -

1. Bargaining Power of Buyers: Bargaining power of buyers determines ability of buyer to push the price
down e.g. Customer will pay less price when many alternatives with same quality is available. The bargaining
power of Buyer depends on -

(a) Customer Concentration (higher concentration of customers means higher price negotiation power),

(b) Costs of switching Suppliers (lower switching costs means greater bargaining power), and

(c) Number of Alternative Suppliers (Greater alternatives means Greater bargaining power).

2. Bargaining Power of Suppliers: Bargaining power of suppliers is high when number of suppliers are few
e.g. Raw material supplying company shall charge high price if supplier of such materials are few.

a) Just as powerful Buyers can reduce profits by putting downward pressure on selling prices, suppliers
can reduce profits by increasing raw material costs.
b) The Bargaining Power of Suppliers to the Firm depends upon their contribution towards activities in
Value Chains.
c) Microsoft dominate operating system business of computers and laptops and can determine terms to its
buyers because buyers do not have multiple options to choose from.

3. Threat of Substitute Products or Services: Selling price of a product need to be very competitive when
multiple substitutes are available.

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(a) Profit potential is determined by the maximum price that customers are willing to pay, which in turn depends
on the availability of substitutes.

(b) Products with few substitutes has higher prices than products with many close substitutes since customer
will prefer switching in the latter case.

4. Threat of New Entrants: If an industry is profitable and barriers to entry are low, then new firms could enter
industry & make pressure on existing firms to reduce selling prices.

(a) When an industry is earning a return on invested capital above the cost of capital, that industry will attract
more Firms into it. Unless the entry of new Firms is barred, the rate of profit will fall to the competitive level.

(b) Even a mere threat of entry may be sufficient to ensure that existing Firms keep the selling price at low.

5. Intensity of Competition: In highly competitive market, a firm may resort to cut-throat competition to win
more customers. Normally competition is high if number of firms are high. Intensity to competition is higher –

a) When firms are of equal size


b) When it is difficult to differentiate in the products
c) When exit cost is high since firms would continue to operate in industry inspite of changing the industry.

Question 3 Write short note on segmentation analysis ?


Answer:- A single Industry is collections of different market segments e.g. Motor vehicle industry can be seen
as composite of tyre, glass, battery & metals segment. Segment analysis include analysis of competitive
advantage of different segment. A firm may use this information to decide to exit a particular segment, to enter
a new segment etc. Following steps are used in doing segmentation analysis –

1. Identify segmentation variables and categories: First of all a market is divided into a number of segments
depending upon nature & complexity of industry. A Market may be segmented depending upon geographical
area, life style of customers, price sensitivity of product, loyalty towards brand, leve of competition etc.

2. Construct a Segmentation Matrix: After the segments are identified, a Segmentation Matrix is created e.g.
ITC company may create a matrix based on

 nature of products (Cigarettes, Hotels, Textile etc.)


 geographies (North, East, West & South)
 distribution channel (Wholesale, retail, direct)

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3. Analyse Segment Attractiveness: The segmentation matrix is used to evaluate profitability and
performance of each segment. The interrelationship among segments must be carefully considered while
analysing segmental attractiveness.

4. Identify Key Success Factors for each segment: Make assessment of each segment on the basis of
relative measure of performance. Measurement of performance is Quality, delivery, customer satisfaction,
market share, profitability and return on investment. Each segment must be assessed using the most
appropriate key success factors.
5. Analyse attractiveness of Broad versus Narrow Segment Scope: The competitive advantage of each
segment may be identified in terms of low cost and / or product differentiation. Sharing the costs across
different market segments may provide a competitive advantage. A segment justifying a unique strategy must
be of worthwhile size to support a business strategy.

Question 4 Explain Superior performance & Competitive advantage. What are


possible forms of competencies?
Answer:- Competitive Advantages:-

1. To survive in an industry, a Firm must meet two criteria - (a) Supply what customers want to buy, and (b)
Survive competition. So, a Firm's overall Competitive Advantage is derived from the difference between
Value of product to Customers and Cost of creating that product.
2. This Competitive Advantage takes two possible forms - (a) Differentiation Advantage, and (b) Low-Cost
Advantage. A comparative analysis of these forms is given below –

Differentiation Advantage Low-Cost Advantage

It occurs when customers perceive that a Firm's A Firm enjoys a relative low-cost advantage if its total
product is of higher quality, involves less risk & costs are lower than the market average.
outperforms competing products offered by Competitors.
In such case, Customers are willing to pay a premium
price for this product.

Obtained due to - Obtained due to -

1.Higher Quality of Products / Services, 1. Availability of low-cost Raw Materials,

2.Innovative Products & superior customer service, 2. Availability of Innovative technology,

3.Offering of a wide range of products / services in 3. Availability of Low-cost Distribution Channels,

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accordance with Customer Expectations


4. Economies of Scale,
4.After-Sales Support, On-Time Delivery, reducing
5. Learning Curve Effects (Less Labour hours are
waiting time of Customers, etc.
required when workers gain more & more experience)

Advantage of differentiation advantage can be taken by - Advantage of Low-Cost advantage can be taken by -

1. Increasing selling prices until it just offsets the 1. Pricing the products lower than its Competitors' so
improvement in customer benefits & at same time as to gain Market Share and maintain current
maintaining current market share or profitability, or

2. keeping Pricing at below the 'Full Premium' level in 2. Matching with the price of competing products and
order to build Market Share. increase its profitability.

Superior relative differentiation position offers the Superior relative cost position offers customers
customers better value for an equivalent price. equivalent value for a lower price.

Question 5 Describe the steps involved in vertical linkage analysis ?


Answer:-

Vertical Linkage Analysis is a much broader application of Internal Cost and Differentiation Analysis, that
includes all upstream and downstream value-creating processes throughout the industry. It considers all links
from the source of raw materials to the disposal and/or re-cycling of the product. It involves the following steps
-

1. Identify the Industry's Value Chain and assign Costs, Revenues and Assets to value-creating
processes:

(a) The Firm should identify the Vertical Linkages in the industry Value Chain, e.g. the Petroleum Industry
consists of numerous value creating processes or activities, including exploration, production, refining,
marketing and distribution, which defines its Value Chain.

(b) Costs, Revenues and Assets of each value-creating process may be determined based on Relevant Cost
approach, use of Market Prices, Transfer Prices, Current Replacement Cost of Assets, etc. The Information
Systems to identify and analyse these subtle relationships should be developed.

2. Diagnose the Cost Drivers for each value-creating process: Different Cost Determinants (Cost Drivers)
should be identified for each value-creating process. Direct labour-based measures or Operating Hours or
other suitable measure may be identified, for each value-creating process.

3. Evaluate the Opportunities for sustainable Competitive Advantage:


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(a) Using Benchmarking processes and by understanding how other Companies compete in each process of
the industry Value Chain, a Firm can use the qualitative analysis to seek out competitive niches, even if
financial data are unavailable or unreliable.
(b) To evaluate the opportunities for competitive advantage in the global marketplace, Firms should consider
aspects like a country's values, political climate, environmental concerns, trade relations, tax laws, inflation
rates and currency fluctuations.

Question 6 Explain “Value shop Model OR Service Value Chain” ?


Asnwer The principles of Value Shop were first conceptualized by Thompson in 1967, and properly defined by
Stabell & Fjeldstad (1998), who also created the name. It is also referred to as the Service Value Chain
Model.

A Value Shop is an organization designed to solve Customer problems rather than creating value by producing
output from an input of Raw Materials.

Features of value chain concepts are as follows:-

1. Value Shops mobilize resources (viz. people, knowledge or money) to solve specific problems, i.e.
delivering a solution to a business problem.

2. In Value Shop Principle, no value addition takes place. It only deals with the problem, figure-out the main
area requires its service and finally comes with the solution.

3. The Value Shop process is iterative, involving repeatedly performing a generic set of activities until a
solution is reached.

4. Value Shop Model is applicable for Service Sector Entities, like Telecommunication Companies, Insurance
Companies and Banks.

5. Support Activities in a Value Shop comprise of –

(a) Infrastructure,

(b) Human Resource Management,

(c) Technology Development, and

(d) Infrastructure.

Activities in Value Shop include -

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1. Acquisition - i.e. Identification of Problem,

2. Problem Solving - i.e. identifying various alternatives as Solutions to the Problem,

3. Decision-making - i.e. Choosing from amongst various alternative Solutions,

4. Execution - i.e. implementation of the appropriate Solution,

5. Control - i.e. evaluating the effectiveness of the Solution in solving the Problem.

Focus Areas of Value Shop includes –


1. Problem and Opportunity Assessment,
2. Resource Mobilisation,
3.Project Management,
4. Solutions Delivery,
5. Outcome Measurement, and
6.Learning.

Question 7 Write short note on Cost of Quality (COQ) ?

Answer:- During the past two decades, the business environment in many sectors has been characterized by
rapid changes. The environment is ever changing and dynamic in nature. The main revolution has been the
transition from a seller’s market to a buyer’s market. Today’s business environment is characterized by Fierce
competition etc. The challenge for businesses today is to satisfy their customers through the exceptional
performance of their processes. We use Cost of Quality, Total Quality Management & Supply Chain
Management to evaluate all business processes.

The concept of cost of quality has been around for many years. Dr. Joseph M. Juran in 1951 in his Quality
Control Handbook included a section on COQ. Mr. Philip B. Crosby in his book Quality Is Free has popularized
the COQ concept.

Quality is concerned with conformance to specification; ability to satisfy customer expectations and value for money.
The cost of control/conformance and the cost of failure of control/non- conformance is the quantitative measure
of COQ.

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Views regarding Cost of Quality

Today view of quality cost among practitioners seems fall into three categories:

Approaches to COQ:

View Explanation

1. Higher Quality • Quality can be achieved only by spending more towards Materials, Labour, and
means Higher Cost. Expenses.

• Additional Benefits obtained from such improved quality, may not always compensate
for the Additional Costs incurred by the Entity. Hence, Quality Costs need not be
incurred.

2. Cost Savings Cost • Improving or maintaining quality, leads to higher cost.


of improving Quality
• However, such higher costs can be offset by Cost Savings in less rework, less scrap,
less defectives, etc. So, it is preferable to incur Costs of Quality.

3. Quality Costs are • Quality Costs are those incurred in excess of those that would have been incurred if the
Relevant Costs for product was produced / service was rendered exactly right the first time.
being in business
• Costs of Quality comprises both Direct Costs (tangible, accounting costs), and also
Indirect Costs (loss of Market Share, Opportunity Costs, etc. that are intangible and non-
a/cing costs).

Question 8 Write short note components of Cost of Quality (COQ) ?


Answer

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Components of COQ are as follows:-

1. COQ Conformance / Compliance:- it is also referred as Cost of Good Quality, Price of


Conformance, Cost of Control, etc. It includes
a. Prevention Costs: These are incurred in preventing the production of products that do
not conform to specification.
b. Appraisal Costs: These are incurred to ensure that materials and products meet quality
conformance standards.

2. COQ Non-conformance / Non-Compliance:- it is also referred as Cost of Poor Quality, Price of


Non- Conformance, Cost of Failure to Control, etc.
a. Internal Failure Costs: These are associated with materials and products that fail to
meet quality standards. They include costs incurred before the product is despatched to the
customer.
b. External Failure Costs: These are incurred when inferior products are delivered to
customers.

Notes:

1. COQ is referred to as the P-A-F (Prevention-Appraisal-Failure) Model, which comprises the following steps -

(a) Obtain information on the number of failures / defects / quality-related problems.

(b) Identify appropriate assumptions to process the quality-reiated data effectively,

(c) Analyse the impact of various resolutions that the available to resolve the quality-related problems,

(d) Allocate the resources to address quality-related problems,

(e) Evaluate the impact of whether the resolutions have sufficiently tackled the occurrence of quality-
related problems.

2. COQ can be computed - (a) in terms of effort (i.e. hours / days), (b) in terms of money (i.e. amounts), (c) in
terms of percentage (% of Total Costs, % of Revenue, etc.)

3. Optimal COQ is the level at which the total of all Costs above are minimized. The relationships of COQ are
as under-

(a) A small increase in Prevention Costs can lead to higher savings in Appraisal Costs,

(b) A small increase in Internal Failure Costs, can lead to reduction / avoidance of many External
Failure Costs.

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(c) A small increase in Cost of Compliance, leads to higher savings in Costs of Non-Compliance.

Examples of COQ
Quality Engineering, Quality Planning and Training, Quality Circles,
Prevention Costs
Design Review, Preventive

Appraisal Costs Inspection & Testing of Purchased Parts and Components, Continuing
Supplier Verification & Rating, Product Acceptance

Internal Failure Costs Waste, Scrap, Re-work, Re-inspection, Re-testing, Repair

External Failure Costs Contribution (or) Revenue lost due to loss of reputation and Goodwill,
Product Liability Warranties & Claims, Service Centre Costs for handling
Customer Complaints, Replacement of Parts in Warranty

Question 9 Write short note on Total Quality Management ?


Answer:- Meaning

1) TQM is the integrated and comprehensive system of planning and controlling all business functions so
that products or services are produced which meet or exceed customer expectations. TQM is a
philosophy of business behaviour, embracing principles such as Employee Involvement, Continuous
Improvement at all levels and focus, as well being a collection of related techniques aimed at improving
quality such as full documentation of activities, dear goal-setting and performance measurement from
the customer perspective."

2) TQM seeks to increase customer satisfaction by finding the factors that limit current performance. The
TQM approach highlights the need for a customer-oriented approach to management reporting,
eliminating some or more of traditional reporting practices.

3) The emphasis of TQM is to design and build quality in the product, rather than allow defectives and
then inspect and rectify them. The focus is on the causes rather than the symptoms of poor quality.

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Principles of TQM
1. Clear exposition of the benefits of a project.
2. Total Employee involvement (TEI).
3.Process measurement.
4. Involvement of all customers and contributors.
6. Understanding the needs of the whole process.
7. Use of graphical & pictorial techniques to achieve understanding.
8. Establishment of performance specifications and targets.
9. Use of errors to prompt continuous improvement.
10. Use of statistics to tell people how well they are doing.

Benefits of TQM:- Implementation of TQM leads to the following benefits to a Firm -

1. Increased awareness of Quality Culture in the Firm, 4. Greater emphasis on Team Work, and

2. Commitment to Continuous Improvement, 5. Better Control over processes, operations and costs.

3. Greater focus on Customer Satisfaction.

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Question 10 Discuss PDCA Cycle in Quality Control ?


Answer:- The Plan- Do-Check-Act (PDCA) Cycle describes the activities a Firm should perform in order to
incorporate continuous improvement in its operation. It is also referred to as the Shewhart Cycle or the
Deming Wheel.

PLAN DO

• Evaluate current process and make plans. • Translate Plans into practices through
operations.
• Identify Problems in current procedures.
• Instruct / educate / enlighten workers on Plans.
• Formulate basic policy to remove problems.
• Document all changes.
• Prepare concrete action plans
• Collect Data for Evaluation.

Continual

Activities

ACTION CHECK

• Review policy and plans based on audit • Study Data collected in earlier "Do" Phase.
results.
• Conduct Awareness Survey and Compliance
• Respond to risks and initiate corrective action. Audit.

• Communicate results to other Members, and • Identify and assess risks.


implement new procedure, if successful.
• Compare impact on "Critical Success Factors".

Note: The circular nature of PDSA Cycle shows that Continuous Improvement is a never-ending process.

Question 11 Describe Business Excellence model in detail ?


Answer:- Concept:-

1. Business Excellence (BE) is a philosophy for developing and strengthening the management systems and
processes of an Entity to improve performance and create value for stakeholders.

2. BE Model seeks to -

(a) develop Quality Management Principles that - (i) increase the overall efficiency of the operation,
(ii) minimize waste in the production of goods and services,

(b) increase Employee Loyalty for maintaining high standards throughout the business,

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(c) achieve excellence in everything that an Entity does (including Leadership, Strategy, Customer
Focus, Information Management, People and Processes),
(d) collaborate various management thoughts as Core Concepts, and thus structure Quality
Management in a manner that can be adapted by any Entity.
Need for BE:-

1. To strengthen the internal function and communication,

2. To cultivate strong ties with Consumers and incorporate into the Organisational Culture,
3. To develop an organizational culture oriented towards Quality, etc.

Related Points

1. Employee Involvement: Excellence cannot be attained if the Employees / Staffs are forced to conform to
certain norms. They have to be motivated to understand -

(a) that by pursuing the goal of their Entity, they are meeting their own objectives, and

(b) that in pursuit of excellence, they learn and develop new skills.

2. Leadership: For achieving Business Excellence, effective leadership is required to manage all the
resources efficiently. Thus, Good Leadership, Effective Communication System, Employee Empowerment,
Employee Motivation, Innovative and Creative Culture are some strategies to make the employees feel
connected to the Entity's Management Philosophy.

Some of the BE Models available are –


1. EFQM Excellence Model (European Model),
2. Baldrige Criteria for Performance Excellence (US Model),
3. Singapore BE Framework,
4. Japan Quality Award Model,
5. Australian Business Excellence Framework, etc.

Question 12 Describe EFQM Business model ?


Answer:- EFQM Excellence Model is a self-assessment model for an Entity that wants to assess its level of
excellence. The EFQM Model presents set of three integrated components -

1. The Fundamental Concepts of Excellence - i.e. the basic principles that describe the essential foundation
for any Entity to achieve sustainable excellence.

2. The Criteria - i.e. Conceptual Framework comprising five "Enablers" and four "Results".

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3. The RADAR - i.e. logic assessment framework - management and evaluation tool for analysing the
performance of an Entity.
Fundamental Concepts of Excellence:-

According to EFQM Model, the Fundamental Concepts of Excellence are -

1) Adding Value for Customers


2) Creating a Sustainable Future
3) Developing Organisational Capability
4) Harnessing Creativity & Innovation
5) Leading with Vision, Inspiration & Integrity
6) Managing with Agility
7) Succeeding through the Talent of People
8) Sustaining Outstanding Results

EFQM Criteria Model:-


According to EFQM Model –

"Enablers" Criteria covers what an Entity does. The 5 "Results" Criteria cover what an Entity achieves.
"Enablers" are – The 4 "Results" are –

1. People Results

1. Leadership 2. Customer Results

2. People 3. Society Results

3. Strategy 4. Business Results

4. Partnerships & Resources, and

5. Processes, Products and Service

Relationship:

• "Results" are caused by "Enablers". There is a cause-and-effect relationships between what the Entity does
and the results it achieves.

• Learning, Creativity and Innovation can help the Enablers, thereby leading to improved Results.

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RADAR stands for "Results-Approaches-Deploy-Assess-Refine" logic.This represents the Circular Flow


amongst the following components -

(a) Results required to be achieved,

(b) Approaches to be planned and developed, for achieving the Results,

(c) Deployment of the approaches, and

(d) Assessment and Refinement - of both the Approaches, and their Deployment.

Question 13 What are the steps involved in managing bottlenecks ?

Answer:- Goldratt‟s Five-Step Method for Improving Performance

The theory of constraints describes the process of identifying and taking steps to remove the bottlenecks that
restrict output. The theory of constraints considers short-run time horizons and assumes other current
operating costing to be fixed costs. The key steps in managing bottleneck resources are as follows:

The key steps in managing Bottleneck Resources are -

1. Identify System Bottlenecks: This involves identification of Constraints, which restrict output from being

expanded / increased. Bottleneck Factor is the Department/Resource with the highest

Ratio.

[Note: This Ratio is called as the Machine Utilisation Ratio (sometimes this is itself considered as TA Ratio).]

2. Describe how to exploit the bottlenecks: Only the Bottleneck can restrict or enhance the flow of products.
So, it is essential to ensure that the bottleneck activity is fully utilised. Decision should be taken on the
optimum-mix of products to be produced by the Bottleneck Activity.

3. Sub-ordinate decisions: Optimum Production Plan of bottleneck activity will determine the Production
Schedule of the non-bottleneck activities. The production of the entire Factory is set at the pace / speed of the
Bottleneck Resource.

4. Bottleneck Removal or Improvement: To arrive at best results, TOC emphasizes the importance of
removing Bottlenecks or Limiting Factor. This involves either of two actions -

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(a) Remove the bottleneck: e.g. replacing a Bottleneck Machine with a faster one. If the Bottleneck
Activity has been replaced by a new bottleneck activity, it is necessary to return to Step 1 and repeat
the process.

(b) Increase Bottleneck Efficiency and Capacity: This might involve providing additional training for a
slow worker or changing the product design to reduce the processing time required by a Bottleneck
Activity.

5. Repeat for Other Constraints: To arrive at best results, TOC emphasizes the importance of removing
Bottlenecks or Limiting Factor. This involves either of two actions -

Question 14 What are the types of supply chain – Push & Pull ?
Answer:- During the traditional chain suppliers were at one end. Suppliers give their products to
manufacturer or distributers who further send it to retailers. Although customers are the source of the profits,
they are at the end of the chain in the ‘push’ model.

Under Push model stocks are produced on the basis of anticipated demand. Demand forecasting can be
done via a variety of sophisticated techniques may be from operations research area or data mining.

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Push Model Pull Model

Process Flow: Process Flow:

(a) Supplier gives materials to the (a) Customer orders the Goods with Retailer.
Manufacturer/Producer.

(b) Manufacturer produces Products as per (b) Retailer calls for Stock from the Wholesaler
Demand

Forecast, and supplies to Wholesaler Distributor. Distributor, as per Orders received.

(c) Wholesaler forwards goods to Retailer based on (c) Wholesaler calls for Products from the
past Manufacturer

stock movements and demand forecast. as per Retailers' Orders received.

(d) Retailer stocks goods as per Supplies received. (d) Manufacturer produces Products as per Orders

(e) Customer buys the goods, if available with received from Wholesaler Distributor.
Retailer.

Note: Demand Forecasting is done by many (e) Supplier gives materials to the Manufacturer as
advanced techniques including Operations per orders received from the Manufacturer.
Research, Data Mining, etc.

This is a production-availability based approach. This is a customer-oriented and market-driven


Customer is generally required to buy whatever is approach. Customers have a significant voice in the
available in the market. functioning of the Supply Chain

Question 15 Explain gain sharing arrangement ?


Answer:-
Meaning:- It is an arrangement where a Supplier agrees to perform its side of the contract with no
guarantee of receiving a payment. Instead, any payment received is based upon the benefits that emerge
to the Customer as a result of the successful completion of the Supplier's side of the bargain.
Risk:- The Supplier can be described as taking an Equity Stake in the Customer rather than entering into a
contract with the Customer. The Supplier has the risk of receiving no payment at all.

Returns:- If the benefits to the Customer are very high, the Supplier can be rewarded with a large return.
Thus, Gain-Sharing Arrangements constitute a win-win situation for Suppliers and their Customers.
Effectiveness:- For Gain-Sharing to be effective, there must be no rewards for the Suppliers to achieve a
higher return through adversarial behaviour or by hiding behind the contract.
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Question 16 Write short note JIT and Scope of JIT Philosophy ?


Answer:-

A. Concept: "Just-in-Time" is a time management philosophy that seeks to utilize the most important
resource, i.e. time, in an efficient and effective manner. JIT philosophy/ concept operates as under -

1. Identify significant activities in the Firm, and classify into VA (Value-Added) and NVA (Non-Value-Added)
activities.

2. Simplify VA Activities so as to improve productivity/ efficiency/ output.

3. Eliminate NVA Activities, so that time earlier spent on NVA Activities can now be used for VA Activities.

4. Achieve significant cost reduction by eliminating time-related, and NVA Activity-related costs.

Scope of JIT Philosophy: To initiate processes that -

1. reduces the amount of Raw Material Inventory, and improves the quality of received parts,

2. reduces the amount of Work in Process, also reducing the number of products that can be produced
before defects are identified and fixed, thereby reducing Scrap Costs,

3. manages the variety of Finished Products, aligning Production, Sales and Despatch Schedules, in order
to reduce Finished Goods Inventories,

4. alter the supporting accounting systems, e.g. -

(a) Payment of Materials / Parts Suppliers on a consolidated basis per month, per quarter, etc. instead of
multiple payments for every small lot purchases,
(b) Elimination of Paperwork by making payment to Suppliers based on internally generated documents,
i.e. Entity's Production as per its Production Records × Standard Material Consumption (adjusting for
normal wastages).

Pre-Requisites of JIT
1. Lower Variety of Goods / Products 4. Defect-free Materials 7. TQM Culture
2. Demand Stability 5. Preventive Maintenance 8. Process Orientation
3. Vendor Reliability 6. Trained Workforce 9. Communication & Co-
ordination

Question 17 What is backflush costing in JIT?

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Answer:-

1. Sequential Tracking: Traditional normal and standard costing systems use the Sequential Tracking
method for accounting costs. This involves recording journal entries in the same order as transactions
occur, i.e. purchase, issue of materials, production, OH absorption, etc.

2. Backflush Costing: An alternative approach to Sequential Tracking is Backflush Costing. It is a


costing system that omits recording some or all of the journal entries relating to the cycle from purchase
of Direct Materials to the sale of Finished Goods. The Journal Entries for the subsequent stages use
normal or standard costs to work backward to flush out the costs in the cycle for which the Journal
Entries were omitted earlier.

3. Suitability in JIT: In JIT, Backflush Costing is better than Sequential Tracking method, due to large
transaction volumes. However, the following issues must be corrected before effective implementation of
Backflush Costing -

(a) Accurate Production Reports: The total production figure entered into the system must be
absolutely correct, or else the wrong component types and quantities will be subtracted from stock.
Errors in Production Reporting can be reduced by proper staff training and reducing staff turnover.

(b) Proper Scrap Reports: All abnormal scrap must be diligently tracked and recorded. Otherwise,
these materials will fall outside the Backflushing System and will not be charged to inventory. Since
Scrap can occur anywhere in a production process, lack of attention by any of the Production Staff
can result in an inaccurate inventory.

(c) Lot Tracing: Lot Tracing is impossible under Backflushing System. It is required when a
Manufacturer needs to keep records of which production lots were used to create a product in case
all the items in a lot must be recalled. Only a Picking System can adequately record this
information. Some computer systems allow Picking and Backflushing System to co-exist.

(d) Inventory Accuracy: The inventory balance may be too high at all times because the
Backflushing Transaction that relieves inventory usually does so only once a day, during which time
other inventory is sent to the production process. This makes it difficult to maintain an accurate set
of inventory records in the warehouse.

The success of a Backflushing System is directly related to the Company's willingness to invest in a well-
paid, well- experienced, well-educated production staff that undergoes little turnover.

Question 18 Write short note on Kaizen Costing?


Answer:-

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1. Meaning: Kaizen Costing refers to the ongoing continuous improvement program that focusses on
the reduction of waste in the production process, thereby further lowering costs below the initial targets
specified during the design phase. It is a Japanese term for a number of cost reduction steps that can be
used, subsequent to issuing a new product design to the factory floor.

2. Need: The need for continuous cost reduction, i.e. Kaizen Costing, is brought out as below -

(a) At the time of implementation of Cost Reduction Methods, there may be further chances of
waste reduction, cost and time reduction and product improvement, which were not visualized or
identified in earlier review.

(b) There are always opportunities to control costs, after the Design Phase on a new product is
completed, though these opportunities are fewer than during the Design Phase.

(c) The Firm can obtain further unplanned cost reductions at the implementation stage, on account
of workers' feedback and newer shop floor techniques.

3. Kaizen Costing Process: Activities in Kaizen Costing include elimination of waste in production,
assembly, and distribution processes, as well as the elimination of unnecessary work steps in any of these
areas. Thus, Kaizen Costing is intended to repeat many of the Value Engineering steps, continuously and
constantly refining the process, thereby eliminating out extra costs at each stage.

4. Savings from Kaizen Costing: Cost reductions resulting from Kaizen Costing are much smaller than
those achieved with Value Engineering. But, these are significant, since competitive pressures are likely to
force down the price of a product over time, and any possible cost savings allow a Company to still attain
its targeted profit margins.

5. Kaizen Costing Principles:

(a) It seeks to achieve gradual improvements in the existing situation, at an acceptable cost.

(b) It involves setting standards and then improving them, to achieve long-term sustainable
improvements.

(c) It recognises that Improvements are endless, i.e. there is no limit to the level of improvements
that are possible.

(d) It encourages collective decision-making, and application of knowledge.

(e) It covers all areas of business, and is not restricted to Shop-Floor only.

(f) It focuses on eliminating wastes, improving systems and improving productivity.

6. Multiple Versions of Products, i.e. Continuous Kaizen Costing: Multiple improved versions of
products can be introduced to meet the challenge of gradually reducing costs and prices. The market price
of products continues to drop over time, which forces a Company to use both Target Costing and Kaizen
Costing to reduce costs and retain its profit margin.
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However, prices eventually drop to the point where margins are reduced, which forces the Firm to develop
a new product with lower initial costs, and for which Kaizen Costing can again be used to further reduce
costs. This pattern may be repeated many times as the Firm forces its costs down through successive
generations of products.
The exact timing of a switch to a new product is easy to determine well in advance since the returns from
Kaizen Costing follow a trend line of gradually shrinking savings. Since prices also follow a predictable
downward track, plotting these two trend lines into the future reveals when a new product version must be
ready for production.

Question 19 Describe 5S?


Answer:-

1. Concept: 5S is the name of a workplace organization method that uses a list of five Japanese words:
Seiri, Seiton, Seiso, Seiketsu, and Shitsuke. It explains how a work space should be organized for
efficiency and effectiveness by identifying and storing the items used, maintaining the area and items, and
sustaining the new order.

2. Phases In 5S: The 5S Phases translated are - (a) Sort, (b) Set in Order, (c) Shine, (d) Standardise, (e)
Sustain.
Phase Description
(a) SORT (Seiri) • Make work easier by eliminating obstacles.
• Reduce chances of being disturbed with unnecessary items.
• Evaluate necessary items with regard to Cost or other factors.
• Remove all parts or tools that are not in use.
• Segregate unwanted material from the workplace.
• Define Red-Tag area to place unnecessary items that cannot immediately be
disposed of.
Dispose of these items when possible.
• Need fully skilled Supervisor for checking on a regular basis.
• Ensure waste removal.
• Make clear all working floor except using material.
• Ensure daily fillings.

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(b) SET IN ORDER • Arrange all necessary items so that they can be easily selected for use.
(Seiton) • Prevent loss and waste of time by arranging work station in such a way that all
tooling / equipment is in close proximity.
• Make it easy to find and pick up necessary items.
• Ensure First-In-First-Out basis.
• Make workflow smooth and easy.
• All of the above work should be done on a regular basis.
• Place components according to their uses, with the frequently used components
being nearest to the work place.
(c) SHINE (Seiso) • Clean the workplace on daily basis completely or set cleaning frequency time to time.
• Use cleaning as inspection.
• Prevent Machinery and Equipment deterioration.
• Keep workplace safe, easy to work, clean and pleasing to work in.
• When in place, anyone not familiar to the environment must be able to detect any
problems within 50 feet in 5 seconds.
(d) STANDARDIZE • Standardize the best practices in the work area.
(Seiketsu) • Maintain high standards in workplace organization at all times.
• Ensure that everything is in its right place.
• Every process has a Standard. People should know the process of that specific job.
• Standardize Color Coding of usable items.
(e) SUSTAIN • This means - "Not harmful to anyone", and also translated as "do without being told".
(Shitsuke) • Perform regular audits.
• Focus on Training and Discipline.
• Training is goal-oriented process. Its resulting feedback is necessary monthly.
• Ensure Self-Discipline, to maintain proper order.
• Ensure all defined standards are being implemented and heard.
• Follow the process, but also be open to improvement.

3. Application: 5S Methodology has its origins in Manufacturing Sector, but it can also be applied to
Knowledge Economy work, with Information, Software, or Media in the place of physical product. It is also
applied to Sectors like Healthcare, Government, etc.

Question 20 Explain Total productive management ?


Answer:-

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1. Meaning: Total Productive Maintenance (TPM) is a system of maintaining and improving the integrity of
production and quality systems. TPM is achieved through the Machines, Equipment, Processes, and
Employees that add to the value in a Business Entity.

2. Origin: TPM helps in keeping all equipment in top working condition so as to avoid breakdowns and
delays in manufacturing processes. TPM was first introduced by M/s Nippon Denso Co. Ltd of Japan, a
supplier of M/s Toyota Motor Company. Seiichi Nakajima is regarded as the father of TPM because of his
numerous contributions to TPM.

3. 8 Pillars: With 5S Concept as its Foundation, TPM operates through the following 8 Pillars, to achieve
its Goals -

Pillar Activity and Objectives How Achieved?

Pillar-1: This involves operation of Equipment without Cleaning, Lubricating, Visual


breakdown and eliminating the defects at Inspection, Tightening of Loosened
Autonomous
source through active Employee Participation. Bolts, etc.
Maintenance

Pillar-2: Focussed This involves making minor improvements on Kaizen Register, Kaizen Summary
Improvement continuous basis, reducing losses in the Sheet, Why-Why Analysis, Summary of
workplace that affect efficiencies, etc. (Kaizen Losses, etc.
Principle)

Pillar-3: Planned This involves having a proper maintenance Preventive Maintenance, Breakdown
Maintenance system for - (a) improvement in reliability and Maintenance, Corrective Maintenance,
maintainability of equipment, (b) zero and Maintenance Prevention.
breakdowns, (c) optimum maintenance cost.

Pillar-4: Early This focuses on shortening the time required Engineering and Re-engineering
Management for product and equipment development. Processes.

Pillar-5: Quality This aims at achieving customer satisfaction Root Cause Analysis, Customer Data
Maintenance through delivery of highest quality product. Analysis, etc.

Pillar-6: Education It aims to improve knowledge/ skills and Training Calendar, Policies for
8L Training enhance morale of employees. Education and Training, On-site
Training, etc.

Pillar-7: Office TPM This is the application of TPM techniques in Office Automation, Analysis of
administration to improve productivity & Processes, Process Flow Study, etc.
efficiency in those functions, and eliminate
losses.

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Pillar-8: Safety, Here, the objective is to have zero accidents Safety Slogans, Quizzes, Posters, etc.
Health, and and zero health damages. to create awareness related to safety.
Environment

4. Performance Measurement using OEE: In TPM, Performance Measurement is done using "Overall
Equipment Effectiveness" (PEE) measure, where PEE % = Performance × Availability × Quality, as
explained below -

Aspect Performance Availability Quality

Formula

Losses • Idling & Minor Stoppages • Equipment Failure/ • Reduced Yield,


measured in this Breakdown
• Reduced Speed • Quality Defects & Rework
aspect
• Set-up/ Adjustments

Ideal Measure > 95% > 90% > 99%

Note: The above Ideal Measures are as per the view of certain Scholars. However, other Scholars are of
the view that an overall OEE > 50% may be considered acceptable.

5. Implementing TPM: Successful introduction of TPM in an Entity can be analysed in 4 stages -

(a) Preparation Stage: Create a suitable environment, conducting TPM awareness, training programmes,
etc.

(b) Introduction Stage: Initialization of TPM, information to Suppliers, Customers, and other Stakeholders.

(c) Implementation Stage: Implementation of the Eight Pillars of TPM.

(d) Institutionalization Stage: Achieving the rewards for the efforts put in TPM.

6. TQM vs TPM:

Common • require commitment from Top Management for successful implementation,


Points: Both
• make the Entity more competitive by reducing costs and improving customer
TQM and TPM -
satisfaction,

• require the involvement of the Workers at all Phases,

• need fundamental training and education of all Participants and Stakeholders,

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• take longer time period to obtain sustained tangible benefits.

Differences TQM focusses on the quality of the product, while TPM focusses on the equipment
used to produce the products.

Relationship By preventing equipment break-down, improving the quality of the equipment and by
standardizing the equipment, the quality of the products increases. So, TPM can be seen
as a way to help achieving the goal of TQM.

Question 21 Write a short note on Six Sigma?


Answer:- Numerical Concept of Six Sigma

1. Sigma is a statistical term that measures how far a process deviates from perfection. The higher the
Sigma Number, the closer the process is to perfection.

2. Six Sigma is 3.4 Defects Per Million Opportunities, i.e. getting things right 99.99966% of the time, as
given below -

Six Sigma Capability / Productivity Chart

Level One Sigma Two Sigma Three Sigma Four Sigma Five Sigma Six Sigma

Denoted as 1σ 2σ 3σ 4σ 5σ 6σ

Defects per Million 6,91,462 3,08,538 66,807 6,210 233 3.4


Opportunities (DPMO)

% Defectives 69% 31% 6.7% 0.62% 0.023% 0.0034%

% Yield 31% 69% 93.3% 99.38% 99.977% 99.99966%

Quality / Profitability Loss Non- Average Above Below Near

Competitive Average Maximum Perfection

Note: It may not be possible to achieve "perfect Six Sigma" but significant benefits can be achieved from a
rise from one Sigma Level to another.

Six Sigma - Concept

1. Continuous Improvement can be brought into the Firm's culture by introducing continuously changing
planned targets.

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2. One of the targets can be Six-Sigma Accuracy, i.e. the process is 99.99966%accurate. In other words,
the process will/can produce only 3.4 defects per million. This is the structural meaning of Six-Sigma.

3. Six Sigma Concept is based on the fact that it is possible to develop ways of reducing defects by
measuring the level of defects in a process and discovering the causes.

4. Lean Six Sigma: It is the combination of Lean and Six Sigma which help to achieve greater results that
had not been achieved if Lean or Six Sigma would have been used individually. It increases the speed and
effectiveness of any process within the Entity. By using Lean Six Sigma, Entities will be able to - (a)
Maximize Profits, (b) Build Better Teams, (c) Minimize Costs, and (d) Satisfy Customers.

Question 22 What are the procedures / methodologies for implementing Six


Sigma. Also provide points of distinction between DMAIC and DMADV?
Answer:-

Six Sigma Implementation Methodologies for -

Improvements in existing products, processes or


Designing new products, processes or services
services

↓ ↓

D, M, A, I, C D, M,A,D,V

Define, Measure, Analyse, Improve, Control Define, Measure, Analyse, Design, Verify

These are explained below -

1. DMAIC (for existing products, processes and services)

Define • Define the process improvement goals that are consistent with the Firm's overall strategy 8i
customer demands.

Measure • Measure the existing processes to determine current performance, and to facilitate future
comparison.

• Collect process data by mapping and measuring relevant processes.

Analyse • Verify Cause-and-Effect relationship between the factors in the processes.

• Identify the inter-relationship between the factors which affect performance.

• Make a comprehensive analysis to identify hidden or latent factors, and Root Causes for defects.

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Improve • Make a detailed plan to improve the process, by addressing and eliminating the Root Causes.

Control • Perform initial trials or Pilot Runs, to establish process capability and transition to production.

• Measure the process continuously to ensure that Variances are identified and corrected before
they result in defects.

2. DMADV (for new products, processes and services)


Define • Define the goals of the design activity, consistent with the Firm's overall strategy and Customer
Demands.
Measure • Identify the factors that are Critical To Quality (CTQs). Also assess the risks involved.
• Measure factors such as Product Capabilities and Production Process Capability.
Analyse • Develop and design alternatives & process options, to meet the Customer Demands.
• Create high-level design and evaluate to select the best design.
Design • Develop details of design and optimise it using various techniques.
Verify • Verify designs through Simulations or Pilot Runs.
• Hand over the verified and implemented processes to the Process-Owners.

DMAIC vs DMADV:
DMAIC DMADV
Review the existing processes and fixes problem(s) Emphasis on the design of the product and
processes.
More reactive process. Pro-active process.
Increases the capability. Increases the capacity.
Easier to quantify the Benefits in Rupee Terms, even in Difficult to quantify the Benefits in Rupee Terms,
short run. they arise only in the long run.
Examples of DMAIC problem-solving methods: Examples of procedures that the DMADV
• Reduce the Cycle Time to process a Patent, Development Method is designed to address:
• Reduce the number of errors in Sales List, • Add a new service,
• Improve Search Time for critical information, etc. • Create a real-time system,
• Create a multiple-source lead tracking system.
DMAIC is used when - DMADV is used when -
• A. product or process exists. • A product or process is not in existence
• The Project is part of ongoing continuous improvement • Existing process has been optimised using either
process. DMAIC or some other process.
• Strategic importance of the Project is comparatively • Projects have high strategic importance.
less. • Multiple Processes need to be altered.
• Only a single process needs to be altered. • Competitor's actions are changing.
• Competitor's actions are stable. • Customer's Behaviour is changing.

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• Customer's Behaviour is unchanging. • Technology is growing.


• Technology is stable.

Question 23 Explain Lean Six Sigma ?


Answer:- It is the combination of Lean and Six Sigma, to achieve greater results that had not been
achieved if Lean or Six Sigma would have been used individually. It increases the speed and effectiveness
of any process within the Entity. By using Lean Six Sigma, Entities will be able to - (a) Maximize Profits, (b)
Build Better Teams, (c) Minimize Costs, and (d) Satisfy Customers.

Question 24 Describe Business Process Re-engineering (BPR)?


Answer:-

1. Business Process: A Business Process consists of a collection of activities that are linked together in a
co-ordinated and sequential manner to achieve specified goals and objectives. For example, in a broad
sense, Material Handling Management may be taken to include - (a) Scheduling Production, (b) Storing
Materials, (c) Processing Purchase Orders, (d) Inspecting Materials, and (e) Paying Suppliers.

2. Business Process Re-Engineering (BPR):

(a) BPR refers to the analysis and re-design of workflows and processes. It is a total deconstruction and re-
thinking of a business process in its entirety, unconstrained by its existing structure and pattern.

(b) BPR is the fundamental re-thinking and radical re-design of business processes to achieve dramatic
improvements in critical contemporary measures of performance, such as cost, quality, service, and speed.

(c) Porter's Value Chain is commonly used in BPR as a technique to identify and analyse processes that
are of strategic significance to the Entity.

3. Concept / Key Components: The Key Components of BPR are -

(a) Fundamental Re-thinking of Business Processes requires Management to challenge the very basic
assumptions under which it operates and to ask as "Why do we do what we do?" and "Why do we this
way?"

(b) Radical Re-design relies on a fresh-start, clean-slate approach to examining an organization's


business processes. For considering totally new ways of re-designing processes, every concept,

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assumption, purpose and principle should be abandoned temporarily. There is a need to proceed afresh,
without influence of old ideas.

(c) Dramatic Improvement in performance is the pre-requisite for overcoming competition. Continuous
Improvement is not sufficient when the Company is far below industry standards. In such cases, the
Company needs to make quantum leaps in performance. Making marginal, incremental, superficial
improvements to what is already being done is not the objective of BPR.

(d) A customer-focussed Firm should be re-aligned in terms of a Process Orientation. Processes (not
functions) need to be managed effectively. The Firm should look at "what work is being done" & also "how
work is being done". BPR focusses on end-to-end Business Processes rather than on the individual
activities that comprise the processes. BPR takes a holistic view of a Business Process as comprising a
string of activities that cuts across traditional departmental or functional lines.

4. Purpose: The aim of BPR is to improve key Business Processes in a Firm by focussing on - (a)
Simplification, (b) Cost

Reduction, (c) Improved Quality, (d) Enhanced Customer Satisfaction, (e) Operational Excellence, (f)
Competitive

Advantage, i.e. "how to compete".

5. Stages of BPR: BPR Implementation involves the following stages -

(a) Process Identification: Each task performed being re-engineered is broken down into a series of
processes.

(b) Process Rationalisation: Processes which are non-value adding, should be discarded.

(c) Process Re-Design: Remaining processes (Value Adding) are re-designed.

(d) Process Re-Assembly: Re-engineered Processes are implemented in the most efficient manner.

6. Principles of BPR: The principles of successful BPR include the following -

Principle Description

(a) Focus on • An Entity should have one person perform all the steps in a process, design the
job around an objective or outcome rather than a single task.
"Outcomes" and not on
tasks • This eliminates many handoffs, numerous errors, delays, misunderstandings, and
also the traditional segregation of duties that relate to job performance.

• The Customer is not concerned about how the Entity organizes itself to carry out
his job. He is more concerned on the timely "outcome" and quality delivery.

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(b) Single Point Data / • Data should be collected at a single point and stored in online data-bases for all
Information Capture who need them, using Information Technology Tools.

• Some tools are Telecommunications, Networking, Client/Server Architecture, EDI,


Image Processing, Relational Database System, Bar Coding, Intelligent Workflow
Software.

(c) Link the persons • BPR seeks to have those who need the results of a process perform the process.
performing the
• Departments in organizations are organized around specialized functions
process, to the results
performed for Customers for the output of other units. BPR can provide
expected
"Customers" with more timely service and reduce the OH needed to coordinate the
activities of these units by having customers provide their own service.

(d) Integrate • BPR should integrate the processing of information into the Work Process that
produces the information.
Information with Work
Process • Thus, when a Suppliers' Invoice is submitted, the Material Receiving Department
(not the Accounts Department) should compare it with the goods received and take
appropriate action (e.g. rejection of Invoice or authorizing for Payment).

(e) Centralise Activities • Decentralized Resources may provide better service to Customers, but lead to
to achieve economies redundant operations and lost economies of scale.

• BPR should treat geographically dispersed resources as though they were


centralized, in order to achieve economies of scale, and effectiveness of
operations.

(f) Line Parallel • If parallel activities have been created, BPR seeks to use Communications
Networks, Shared Databases, and Teleconferencing to coordinate activities that
Activities instead of
must eventually come together.
integrating their results

(g) Decision Point is • Entities distinguish those who do the work from those who monitor and make
where the work is decisions about the work, based on the assumption that those who do the work do
performed, but build not have the time, inclination, knowledge, or responsibility for monitoring and
controls controlling what they do.

• However, Information Technology Tools can be used to capture and store data,
and Expert Systems to supply knowledge, to enable people to make their own
decisions.

• Thus, BPR seeks to changes the role of a Manager from Controller and
Supervisor, to a Supporter and Facilitator. This also eliminates the Middle

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Managers who had been summarizing and reporting information to Top


Management.

Process Innovation vs BPR

Process Innovation (PI) BPR

PI seeks to implement new processes into an Entity. BPR focusses on amending existing processes.

PI is more radical than BPR, since it seeks to change BPR is streamlining processes that are already in
the overall structure of an Entity. place.

Question 25 What is meaning of target costing and enumerate the steps /


Features involved in target costing ?
Answer:- Meaning of Target Costing:- In today’s perfect competition, selling price of product is
determined by customers. A firm cannot sell at its desired selling price. Hence to earn desired profit, the
only option available with a firm is to reduce cost per unit. Hence to reduce per unit cost & bring down to
desired level, A firm set a standard cost to produce a product. This decided cost is called target cost.

Target Costing is defined as "a structured approach in determining the cost at which a proposed product
with specified functionality and quality must be produced, to generate a desired level of profitability at its
anticipated Selling Price". It is part of an overall Profit Management Process.

Steps involved in Target Costing


Step Description
1 Identify market requirements e.g. which features, utility & design is required by customer.

2 Set Target Selling Price based on market competition & customer capability to pay.
3 Set Target Production and Sales Volumes based on expected market share & capacity of factory.
4 Set Target Profit Margin

5 Set Target Cost (or Allowable Cost) per unit.


Target Cost = Target Selling Price Minus Target Profit Margin.
6 Determine Current Cost of producing the product.
7 Set Cost Reduction Target in order to reduce the Current Cost to the Target Cost.
8 Analyse Cost reduction opportunities using Value Engineering (VE), Value Analysis (VA) &
Activity Based Costing (ABC) techniques.

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9 Achieve Cost Reduction and Target Profit by Effective Implementation of cost reduction decisions.
10 Focus on further possibilities of cost reduction, i.e. Continuous Improvement program.

Question 26 Describe phases in product life cycle?


Answer:- The 4 identifiable phases in the Product Life Cycle are - (a) Introduction, (b) Growth, (c) Maturity,
and (d) Decline. A comparative analysis of these Phases is given below –

Particulars Introduction / Growth Maturity / Saturation/ Decline


Development Stabilization / Replacement

Phase I II III IV

Sales Volume / Initial stages, hence low. Rise in sales Rise in sales Sales level off and
Quantities quantities at quantities at then start
increasing rates. decreasing rates. decreasing.

Prices of Either high prices Retention of high level Prices fall closer to Gap between Price
Products (Skimming Pricing) or prices except in cost, due to effect of and Cost is further
low prices (Penetration certain cases. (See competition. reduced.
Pricing). Note)

Sales Values Low (even inspite of Rise in Sales Values Rise in Sales Values Sales Value starts
skimming pricing), due to at increasing rates. at decreasing rates. decreasing.
low sales quantities.

Ratio of Highest, due to effort Amount of SOH Ratio reaches a Reduced, due to low
Promotion needed to inform increases, while Ratio normal % of sales. promotional efforts
Expenses to potential as the product is no
Sales longer in demand.
customers, launch of S&D OH to Sales Such normal %
products, distribute to Value is reduced due becomes the
customers, etc. to increase in sales. industry standard.

Nature of Innovators, Acceptors of Early Adopters Middle Majority Resistors of Change,


Customers new changes Prefer Old Styles.

Nature of Negligible and Entry of a large Fierce Competition. Starts disappearing


Competition insignificant. number of due to withdrawal of
competitors. products.

Major Cost R&D Costs, Design Manufacturing Costs, Manufacturing Plants re-used / sold

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Items involved Costs, Promotional Distribution Costs, Costs, Distribution / scrapped / related
(M 07) Costs, Capacity Costs Product Support Costs, Product costs
Costs Support Costs

Profits Nil, due to heavy initial Increase in Profits at Normal Rate of Declining Profits due
costs. Sometimes, even increasing rates. Profits since Costs to price competition,
cash losses are and Prices are new products, etc.
possible. normalised.

Note 1: In the Growth Stage, the Firm will maintain prices at high levels, in order to realise maximum
profits. Price Reduction will not be undertaken unless - (a) the low prices will lead to market penetration, (b)
the Firm has sufficient production capacity to absorb the increased sales volume, and (c) Competitors enter
the market.

Note 2: Sometimes, the above broad stages may be sub-classified into sub-stages as under -

1. Market Research 4. Prototype Manufacture 8. Selling

2. Design Specification 5. Development 9. Distribution

3. Design 6. Tooling 10. Product Support

7. Manufacture 11. Decommissioning or


Replacement

Question 27 What strategies are adopted by an organisation during product


life cycle stages?
Answer:- A summary of strategies during various stages of Product Life Cycle is as under –

Aspect Introduction Growth Maturity Decline

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Pricing Penetration Pricing to • Cost plus Pricing, • Pricing to match or Price Cutting to sell-
attract more customers, or beat competitors off existing stocks.
Strategies • Value based Pricing,
Skimming Pricing for Niche
• Reduced prices to
• Demand-Elasticity
Customers.
attract price- sensitive
based pricing
customers

Product Basic Product only - No Product Extensions • Brand Phasing out of weak
product refinements or and Add-ons, Service, Diversification, products at lower
Strategies
addons. Warranty features, etc. prices.
• More Models &
Versions,

• Improved Product
Features.

Customer • Acquisition of Customers, • Customer Retention, Preserve Loyalty of Preserve Loyalty of


existing customers, existing customers
Strategies • Motivating Product Trials, • Repeat Purchases,
and encourage for next product
• Building Brand
switch-over from version.
Loyalty
Competitors.

Adver • Create Product • Create interest in the Focus on Brand Maintain hard core
Awareness and Visibility, product in the mass Differences, Superior loyalty of customers
tising
market, Quality & Benefits, for next product
• Inform Product Features,
Strategies
etc. version.
• Create Brand identity
• Inform
Dealers/Customers.

Distribution • Selective Distribution to • Expanding Supply • Extensive Selective


Focus Group Customers Chain Relationships, Distribution, Distribution, Close
Strategies
who are Early Adopters down unprofitable
• Make product more • Higher Incentives to
distribution outlets /
available & visible. Dealers, to handle
channels.
competition.

Promotion • Heavy Sales Promotion Leveraging the Incentives for - Reduce all
products' "perceived" Promotional
Strategies • Free Trials to Customers • Brand Switching,
differentiation Expenses, and
• Sale or Return Offers • Higher buying from
advantages for spend only for
loyal customers, etc.
securing market reducing inventory
position levels.

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Question 28 Write short note on Pareto Analysis ?


Answer:- Pareto Analysis

1. Meaning:

(a) Pareto Analysis is a rule that recommends focus on the most important aspects of decision making, in
order to simplify the process of decision-making.

(b) It is based on the 80:20 phenomenon, first observed by Vilfredo Pareto, an Italian economist. He
noticed that 80% of the wealth of Milan was owned by 20% of its citizens. This pattern of 80:20, or
approximations like 70:30 can be observed in many different business situations.

(c) Management can use this 80:20 relationship in a number of business situations to direct its attention to
key control mechanism or planning aspects. It helps to clearly establish top priorities and to identify both
profitable and unprofitable targets.

2. Usefulness: Pareto Analysis is useful to -

(a) Prioritize problems, goals, and objectives. (f) Select & define key performance improvement
programs.

(b) Identify root causes. (g) Maximize Research and Product Development
time.

(c) Select and define key quality improvement (h) Verify operating procedures & manufacturing
programs. processes.

(d) Select key customer relations and service (i) Sales/distribution of products or services.
programs.

(e) Select key employee relations improvement (j) Allocate physical, financial and human resources.
programs.

Question 29 Write short note on applications of Pareto Analysis ?


Answer:- Pareto Analysis is generally applicable to the following business situations -

Aspect Description

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Product (a) If a Firm sells a number of products, it may not be possible to analyse cost-volume-
price-profit relationships for all products. Pareto Analysis might indicate that approximately
Pricing
80% of the Total Sales Revenue is earned from about 20% of the Firm's products.

(b) This helps Top Management to delegate the pricing decision for approximately 80% of
its products to lower managerial levels, and concentrate on pricing decisions for the
important 20% products.

(c) Sophisticated pricing methods can be adopted for the important products while for other
products, Cost Based Pricing methods may be used.

Customer (a) Instead of products, Customers can be analysed for their relative profitability to the
Firm. Using Pareto analysis, it is often found that approximately 20% of customers
Profitability
generate 80% of the profit.
Analysis
(b) Such analysis is useful for evaluation of the portfolio of customer profile, and decision
making such as whether to continue serving a Customer Group, extent of promotion
expenses to be incurred, etc.

ABC Analysis - (a) In Raw Material Stock Control, about 80% of the materials value, is due to high priced
Stock Control materials, which constitute only 20% of the quantity. Hence, these materials are classified
into A, B and C categories based on their importance. Control is directed primarily over 'A'
category items by setting EOQ, Stock Levels, Surprise Stock Verification Procedures, etc.

(b) By concentrating on small proportion of stock items that jointly accounts for 80% of the
total value, a Firm will be able to control most of the monetary investment in stocks.

Activity Based (a) Activity Based Costing involves the identification of Cost Drivers for various items of OH
Costing Expenses.

(b) Generally, 20% of the Firm's Cost Drivers are responsible for 80% of the Total Cost.

(c) By analysing, monitoring and controlling those Cost Drivers that attribute to high costs,
a better control and understanding of Overheads will be obtained.

Quality (a) Pareto Analysis can be extended to discover from an analysis of Defects Report or
Customer Complaints, as to which "vital few" causes are responsible for most of the
Control
reported problems.

(b) Pareto Analysis indicates how frequently each type of failure (defect) occurs. The
purpose of the analysis is to direct managerial attention to the area where the best returns
can be achieved by solving most of quality problems, perhaps just with a single action.

(c) Generally, 80% of reported quality problems are traceable to 20% of the underlying

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causes. By concentrating the efforts on rectifying the vital 20%, the Firm can have the
greatest immediate impact on product quality.

Question 30 Explain the relationship of environmental costs with COQ ?


Answer:-

1. Hansen and Mendoza (1999) point out that Environmental Costs are incurred because of poor quality
controls.

2. Accordingly, an Entity can manage these costs better by preparing a periodical Environmental Cost
Report, based on the principles of COQ Report.

3. The categories of Environment Costs from a COQ Report Perspective is as under -

Type Environmental Environmental Environmental Internal Environmental


Prevention Costs Appraisal Costs Failure Costs External Failure
Costs

Meaning Costs associated Cost of activities Costs incurred from Costs incurred on
with preventing performed to examine activities that have been activities performed
adverse whether products, produced but not after discharging waste
environmental process and activities, discharged into the into the environment.
impacts comply with environment.
environmental standards,
policies and laws.

Examples • Investment in • Monitoring, testing, • Recycling Scrap • Cleaning up


Pollution Control inspection and reporting contaminated Soil.
• Disposing off toxic
Equipment
• Improved systems & material • Restoring Land to its
• Defining checks to prevent fines/ natural state.
• Back-end costs, e.g.
Environmental penalties
Decommissioning Costs Note: These costs
Policies
• Regulatory Compliances on project completion have adverse impact
• Environment- on the Entity's
• Contamination Tests
friendly R & D reputation and Natural
• Audit of Environmental
Resources.
• Site & Feasibility
Activities
Studies

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Question 31 Describe Price customization?


Answer:- Price Customisation (or) Customary Pricing

1. Customary Pricing is a method of determining the Price for a good or service based on the perceived
expectations of customers.

2. Customary Pricing is generally used for products with a relatively long market history of being sold for a
particular amount, and is driven by intuitive notions of value on the part of Buyers.

3. Price Customization can be done in many ways, including -

(a) Product Line: Products and their prices can be customized based on Customer requirements. In case
of Smartphone, different product versions have different prices, based on customers' preferences/
requirements as to Memory / Speed / Camera features, etc.

(b) Past Behaviour: A customer with good payment record may be given more discounts than new / other
customers.

(c) Demographics: Different Pricing may be applied based on age, social status, other demographic
factors, e.g. Railway Fare Concession for Senior Citizens, and Concessional Price Tickets for Students /
Military Personnel, etc.

(d) Time Differential: This involves fixing different prices for different time period.

Question 32 Describe in detail cost based pricing method?


Answer:-

Pricing Methods

Cost Based Pricing Competitive Pricing Value Based Pricing

Cost Plus Pricing:- Cost based Pricing can take any of the following variants - (a) Cost Plus Pricing, (b)
ROCE Pricing, (c) Variable Cost Pricing

1. Cost plus Pricing: Selling Prices of a product are determined based on its estimated Cost plus a Profit
Margin. Here, 'Cost' means Full Cost at Current Output and Cost Levels.

2. Cost Determination: For cost determination purposes, the following principles are adopted -
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Aspect Description

Classification Costs may be classified into -

(a) Manufacturing, Administration and Selling & Distribution Costs, or

(b) Variable and Fixed Costs.

Fixed (a) Variable Costs can be easily determined on a per unit basis.

Costs (b) Fixed Cost per unit should normally be based on the level of production and capacity
utilisation likely to be achieved, i.e. Normal Capacity or Capacity based on Sales
Expectancy.

Depre (a) Depreciation should be included as part of cost so as to leave sufficient profits for Asset
Replacement.
Citation
(b) Depreciation based on Historical Cost of Fixed Assets would be adequate for achieving
this objective, in case of relatively stable price levels. Otherwise, Current Cost Method may
be adopted.

Interest Generally, Interest is not included for the purpose of "Cost" Computation. Interest is
recognised while adding the Profit Margin, i.e. in this case, Profit means EBIT Marqin.

Different (a) Small Entities: An individual Manufacturer may take his Cost of Production into account
and arrive at a price at which the products are to be sold in the concerned region.
Factories
(b) Medium & Large Entities: A Manufacturer having several Factories all over the country
may determine the Weighted Average Cost of the Factories so as to arrive at a uniform
Ex-Factory Price for the Country as a whole.

Uniform The Selling Price may be fixed after taking into account the cost of representative unit from
the Industry, which may fall within the range of lowest cost unit and the highest cost unit.
Costing

3. Advantages: The merits of Cost Plus Pricing include -

(a) Guaranteed Contribution: When Full Costs Plus basis is used for pricing, the Firm earns a guaranteed
Contribution equivalent to Fixed Costs plus Profit Margin. Even, if Profit Margin is taken as Nil, Fixed Costs
included in prices will guarantee minimum Contribution.

(b) Assured Profit: Cost plus is a fair method of price fixation. The Management is convinced that the
Selling Price so determined, will cover the Cost.

(c) Reduced risks and uncertainties: If Sale Price is greater than cost, the risk is covered. This is true
when normal expected capacity basis of cost estimation is used. It is useful particularly in long-term
contract work, when the cost of work to be done is not definitely fixed at the time of making the estimate.

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(d) Most suitable in long run: Cost plus pricing is ideal in the long run, since there are no permanent
Opportunity Costs. The effect of seasonal fluctuations is ironed out and prices are established based on
normal long-run costs.

(e) Market Factors: Cost plus pricing recognizes market forces indirectly. The mark-up added to the cost
to make a price reflects the well-established customs of trade, which guide the Price Fixer towards a
competitive price.

(f) Full Recovery of all costs: For long-run pricing decisions, Full Costs of the product inform Managers of
the minimum costs to be recovered so as to continue in business rather than shut down.

(g) Price Stability: Price fixation based on Full Costs of the product promotes price stability, because it
limits the ability of Salespersons to cut prices. Price stability facilitates planning.

(h) Simplicity: A Full-Cost formula for pricing does not require a detailed analysis of cost-behaviour
patterns to separate Costs into Fixed and Variable components for each product. It is simple to operate.

4. Disadvantages: The demerits of Cost Plus Pricing include -

(a) Ignores demand: Cost Plus Pricing ignores demand and fails to take into account the buyers' needs
and willingness to pay, which govern the sales volume obtainable at each series of prices.

(b) Ignores competition: It fails to reflect competition adequately.

(c) Arbitrary Cost allocation: It assumes that the costs have been estimated with exact accuracy. But, this
assumption is not true in multi-product firms where the Common Costs are allocated arbitrarily.

(d) Ignores Opportunity Costs: For many decisions, Incremental Costs play a vital role in pricing, rather
than Full Costs. Also Opportunity Costs, which are most relevant for decision-making, are fully ignored.

(e) Price-Volume relationships: Since Fixed OH are apportioned based on volume of production, the cost
will be more if sales volume is less and vice-versa. The increase or decrease in sales volume is dependent
on price. Thus it is a vicious circle - Cost plus Mark up is based on Sales Volume, and Sales Volume is
based on Price.

ROCE Pricing

1. Investment Centres: Rate of Return Pricing is used when each division is treated as an Investment
Centre. Determination of Return on Capital Employed is one of the most crucial aspects in price fixation
and performance evaluation of Investment Centres.

2. Determination of ROCE: The Firm should determine an average mark-up on cost, which is necessary
to produce a desired rate of ROCE. The issues to be considered are -

(a) Basis and Assumptions on which the Capital Employed is computed,

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(b) Components to be covered in the ROCE, and

(c) Fairness of the ROCE.

Note: Fairness of ROCE varies from industry to industry and from time to time and is primarily dependent
on - (a) the risks involved, and (b) the desirability of earning adequate profits to plough back into business.

3. Advantages: Allowing each Firm (and hence the industry as a whole) to earn an adequate ROCE would
- (a) attract additional capital, (b) increase the number of factories and production of the commodity, which
would ultimately lead to competition and reduction in costs and prices.

Variable Cost Pricing

1. Pricing below Variable Cost: To earn contribution, Selling Price is fixed above Variable Cost. However,
in the short run, Selling Price may be equal to Variable Cost or sometimes even below Variable Cost. Some
illustrative situations are -

(a) When goods are of perishable nature. (d) To eliminate Competitors from the market.

(b) When the Firm has already purchased huge (e) To obviate shut-down costs.
quantities of Raw Materials, and the prices of
(f) To push up sales of another highly profitable
these Materials is falling considerably in the
product.
market.
(g) To capture / retain future market.

(c) To launch or introduce a new product in the


market at competitive prices (using Penetration
(h) To capture / retain foreign market.
Pricing Strategy).
(i) To ensure sale of old and defective stocks,
seconds, etc.

2. Pricing above Variable Cost but below Total Cost: In periods of recession, a Firm may sell its articles
at a price less than the Total Cost but above the Marginal Cost for a limited period. The advantages of this
policy arise due to avoidance of Shut-Down. The benefits are -

(a) The Firm can continue to produce and use the services of Skilled Employees who are well trained and
will be difficult to re-employ later if discharged now.

(b) Plant and Machinery can be prevented from deterioration through idleness.

(c) The Firm would be ready to take advantage of improved business conditions later.

(d) The Firm can continue in the market and reduce loss of market share to Competitors.

Such pricing policy is necessarily restricted to the short-run. When business conditions improve in the long
run, such pricing below Total Cost but above Marginal Cost is not advisable.
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3. Differential Selling Prices: Use of Differential Selling Price, which is above Marginal Cost but below
Total Cost, is primarily intended to absorb surplus capacity. It can be achieved in any of the following
ways -

(a) Different Markets (e.g. Export Pricing): The Firm producing a branded article may use the surplus
capacity to produce the same article to be sold above Variable Cost in a different market, e.g. Export
Sales. The articles sold in the home market will recover all Fixed Expenses. Price reduction in the local
market (DTA) will reflect on sales value and profits, and is not resorted to. Any reduction in the Selling
Prices in the Export Market will not affect the price prevailing in the home market.

(b) Different products: The Firm may produce and sell one product, which covers the entire Fixed
Overheads and use the surplus capacity to produce another product, which may be sold at a price above
its Marginal Cost. The overall profitability will thus increase. The manufacture of the second product should
be confined to surplus capacity, and it should not have the possibility of becoming a major product at the
low price at which it is sold. If it becomes so, there will be a reduction in profit.

Question 33 Write short note on value based pricing model?


Answer:- there is an increasing trend to price the product on the basis of customer’s perception of its
value. This method helps the firm in reducing the threat of price wars. Marketing research is important for
this method. It is based on

1. Objective value or true economic value (TEV)


2. Perceived value
3. The relationship between the terms Cost, Price, Perceived Value and True Economic Value is as
under-

Price (-) Cost Perceived Value (-) Price TEV (-) Perceived Value

= Profit = Benefit to Consumer = Perception Gap

Total Cost Sale Price Perceived Value True Economic Value

4.

Term Meaning /Description

Total Cost Total of all Costs in producing the product / rendering the service, i.e. Cost of Sales

Sale Price Consideration charged from the Customer, for the Product / Service.

Perceived 1. It is the Value that the consumer understands the product delivered to it.

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Value
2. It is the price of a product that a consumer is willing to spend to have that product.

True Economic 1. TEV is a measure of benefits that a product is intended to deliver to the consumers
Value (TEV) relative to the other products, without giving any regard whether the Consumer can
recognise these benefits or not.

2. It is also called Objective Value.

3. TEV = Cost of the next best alternative (i.e. cost of a comparable product offered by
another Firm) + Value of Performance Differential (i.e. value of additional features provided
by the Seller Firm).

Question 34 Describe pricing strategy for new product?


Answer:- New Product Pricing

A New Product is analysed into three categories for the purpose of pricing -

Category Description

1. Revolutionary (e) is new to the market and has the potential to create its own value.
Product - i.e. a
(f) has a revolutionary impact on the market and consumer behaviour.
product that
(g) replaces the existing method or technology with a different and unique method.

(h) enjoys the benefit of product differentials.

(i) has the potential of being a Market Leader.

(j) may enjoy the Premium Price as a reward for its innovation and taking first
initiative, and hence may be a "Price Maker".

2. Evolutionary (e) introduces an upgraded version (with few additional characteristics) of an existing
Product - i.e. a product.
product that
(f) may be priced taking Cost-Benefit, Competitor and Demand for the product into
account.

3. Me-too (a) emerges as a result of the success of a revolutionary product.

Product - i.e. a (b) may be seen as a "imitation" of an revolutionary and/or evolutionary products' of
product that other Firms.

(c) is generally considered as a "Market Follower" (as opposed to a Market Leader)

(d) is a "Price Taker", as the Price is determined by the mainly by the competitive

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forces.

For determining optimal prices for new products, the following procedure may be adopted -

1. Market Survey: Experimental sales are conducted in different markets using different prices to see
which price is suitable. For example, choose three different markets and by using the same amount of
sales promotional activities, ascertain what is the right price.

2. Price Volume Relationship: The relationship between Price and Volume should be ascertained, using
the concept of elasticity of demand. The extent of volume increase due to price reduction and vice-versa,
can be reasonably quantified through such analysis.

3. Incremental Contribution Approach: Using Incremental Contribution, i.e. Additional Total Contribution
from additional sales quantity, the Firm can increase its prices as long as there is further Incremental
Contribution. Such analysis may prove that the highest prices yielding the largest unit contributory margin
need not necessarily maximise the profits. A lower price sometimes result in maximum profits.

Question 35 Write short note on skimming & penetrating pricing for new
products ?
Answer:- Skimming Pricing for New Products

Skimming Pricing is a policy of charging high prices during the early period of a product's existence and in
the later years the prices are gradually reduced. The reasons for following such a policy are -

1. Inelastic Demand: The demand is likely to be inelastic in the earlier stages till the product is established
in the market. The Firm can take advantage of high prices.

2. Sales Boost: The change of high price in the initial periods serves to skim the cream of the market that
is relatively insensitive to price. The gradual reduction in price in the later year wiil tend to increase the
sales.

3. Assured Profit: This method is preferred in the beginning because in the initial periods when the
demand for the product is not known, the price covers the initial cost of production. Contribution is
guaranteed.

4. Cost-Revenue Matching: High initial capital outlays needed for manufacture, results in high cost of
production. Also, the Manufacturer has to incur huge promotional activities resulting in increased costs.
High initial prices will be able to finance the cost of production. Gradually, the economies of scale and
savings in costs are passed on to customers.

Penetration Pricing for New Products

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1. Penetration Pricing is a policy of using a low price as the principal instrument for penetrating mass
markets early. This method is used for pricing a new product and to popularise it initially.

2. Profits may not be earned in the initial stages. However, Prices may be increased as and when the
product is established and its demand picks up.

3. The low price policy is introduced for the purpose of long-term survival and profitability. Hence, careful
analysis of the scope for market expansion and considerable amount of research and forecasting are
necessary before determining the price under this Strategy.

4. The circumstances in which Penetrating Pricing can be adopted are -

(a) Elastic demand: The demand of the product is high when price is low. Hence, lower prices mean large
volumes and so more profits.

(b) Mass Production: When there are substantial savings in large-scale production, increase in demand is
sustained by the adoption of low pricing policy.

(c) Frighten off competition: The prices fixed at a low-level act as an entry barrier to the prospective
Competitors. The use of this policy by existing Firms will discourage the new Firms to enter the market.
This pricing policy is aiso known as "Stay-Out-Pricing".

Question 36 Describe non-cost factors in pricing policy? OR Write short note


Predatory Pricing?
Answer:- Some pricing practices in which non-cost reasons are important when setting prices are -

1. Price Discrimination: This is the practice of charging to some customers a higher price than that
charged to other customers, e.g. in the case of Airline Tickets, for Business Class and Economy Class.

2. Peak Load Pricing: This pricing system is based on capacity constraints, where a higher price for the
same service or product is demanded when it approaches physical capacity limits, e.g. Telephones,
Telecommunications, Hotel or Car Rentals, etc.

3. Predatory Pricing: Such pricing happens when a Firm with significant market power sets prices at a
sufficiently low level with the purpose of damaging or forcing a Competitor to withdraw from the market. It
may involve dumping, i.e. selling a product in a Foreign Market at below cost, or below the domestic
market price (subject to, e.g. adjustments for taxation differences, transportation costs, specification
differences), if applicable.

Question 37 Explain responsibility accounting and state types of


responsibility centres?
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Answer:- Responsibility Accounting

1. Responsibility Accounting is a control system of Management Accounting and Reporting.

2. It involves the creation / recognition of various responsibility centers in an organisation, classified into -
(a) Cost Centre, (b) Revenue Centre, (c) Profit Centre, and (d) Investment Centre.

3. The standards of performance are clearly defined in respect of each Executive / Head of Responsibility
Centre. He is clearly informed of what he is required to do and what performance is expected of him.

4. At periodic intervals, Performance Reports are furnished by the heads of Responsibility Centres.

5. The actual performance is compared with standards to identify deviations and initiate appropriate action.

Types of Responsibility Centres:

Particulars Cost Centres Revenue Centres Profit Centres Investment Centres

Meaning A centre for which a A centre devoted to A centre whose A centre responsible
standard amount of raising revenue (no performance is measured for earning profits and
cost is pre- responsibility for in terms of income earned also for asset
determined and used production). and cost incurred (profit utilization.
for control. earning).

Primary Cost Reduction and Generation of Sale Profit earning. Earning Return on
Cost Control. Revenue. Investments.
responsibility

Performance Standard Cost Less Budgeted Revenue Budgeted Profits Less Budgeted ROI Less
Actual Cost. Less Actual Actual Profits. Actual ROI.
Evaluation
Revenue.

Other points Control of cost is Also responsible for It includes those divisions —
subject to - some expenses which sell their output to
related to marketing other divisions within the
1. Time,
of products. Firm - i.e. inter-divisional
2. Location,
transfer pricing.
3. Product.

Question 38 Write a short note on Return on Investment (ROI)?


Answer:- Return on Investment (ROI) Model:

Concept 1. Divisional ROI = Divisional Profit expressed as a percentage of the Assets employed in the
Division.

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2. Assets Employed can either be - (a) Total Divisional Assets, (b) Assets controllable by the
Divisional Manager, or (c) Net Divisional Assets.

Merits 1. Ideal for comparison across Corporate Divisions for Companies of similar size and in similar
sectors.

2. Focus is on the ROI, and not on the absolute size (amount) of a Division's Profits.

3. Easy to understand, compute, and evaluate performance.

Demerits 1. May not support Goal Congruence, since there can be decisions which may decrease the
Divisional ROI, but may make the Company as a whole better off.

2. Does not recognize the effects of one Division's decisions on the other Corporate Divisions.

Question 39 Write a short note on Residual Income (RI) Model?


Answer:- Residual Income (Rl) Model:

Concept 1. Residual Income is defined as Controllable Contribution less a Cost of Capital Charge on the
Investment controllable by the Divisional Manager.

So, Residual Income of a Division = Divisional Profit (less) [Divisional Investment × Cost of
Capital].

2. Cost of Capital may be taken as applicable for the overall Company, or as applicable for a
particular Division.

Merits 1. There is a greater probability that Divisional Managers will be encouraged, when acting in
their own best interests, also to act in the best interests of the overall Company.

2. Easy to understand, compute, and evaluate performance.

and measures of a Firm's BSC are derived from the Firm's vision and strategy.

Question 40 Write short note on economic value added (EVA) model?


Answer:- Economic Value Added (EVA) Model:

1. EVA = Net Operating Profit after Tax (NOPAT) less [WACC × Capital Employed].

Concept 2. NOPAT is computed as -

(a) Operating Profit (EBIT) (-) Tax Expense (+) (Interest × Tax Rate) [OR]

(b) Profit After Tax (EAT) + [Interest × (100% - Tax Rate)].

1. EVA seeks to overcome the shortcomings of EBIT or Profit as a Performance Measure.

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Merits 2. EVA recognizes the Cost of Equity Capital. Entities generate wealth only when they generate
a Return in excess of the Return required by Providers of Capital - both Equity and Debt.

3. Profit as per Financial Statements is calculated as per Accounting Standards and does not
truly reflect the wealth that has been created. Hence, EVA is a better performance evaluation
measure.

Demerits 1. Use of WACC (Opportunity Cost of Capital) requires careful consideration of many factors,
and may not always be subjective.

2. The base figure for computation viz. Operating Profit, may be manipulated in Financial
Statements.

Question 41 Write short note on Shareholder value added (SVA) model?


Answer:- Shareholder Value Added (SVA) Model: (Alfred Rappaport)

1. Shareholder Value = Value of a Company's present and future Cash Flows, discounted at an
appropriate Cost of Capital. SVA per Share = Total Shareholder Value ÷ Number of Shares
Outstanding.

Concept 2. SVA can be used at - (a) the overall Entity level (for decisions like re-investment in present
businesses vs dividends, Mergers & Acquisitions, etc. and (b) Business Unit Level (for
evaluating Divisional Performance).

3. The following "Value Drivers" are considered to impact Shareholder Value - (a) Fixed Capital
Investment, (b) Investment in Working Capital, (c) Rate of Sales Growth, (d) Operating Profit
Margin, (e) Income Tax Rate, (f) Cost of Capital, and (g) Life of the Project.

Merits 1. It recognizes Future Cash Flows also. It is not merely a historical measure of profits actually
earned.

2. It has all the advantages of EVA as to recognition of Capital provided by Equity and Debt.

Demerits 1. Value is not just a financial concept. Shareholders can attach non-financial values also, e.g.
Corporate Social Responsibility.

2. Most Shareholders are not informed enough to understand the basis of computation of SVA.
For them, it is merely a number provided by the Company in its Annual Reports.

Question 42 Write short note on Triple Bottom Line (TBL) model?


Answer:- Triple Bottom Line (TBL) Model: (John Elkington)

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Bottom Line represents "Profit" or "Loss". TBL (or 3BL or 3P) Concept focusses on the following
dimensions -

Concept 1. People, i.e. the Social Equity Bottom Line - relates to Corporate Governance, Motivation,
Incentives, Health and Safety, Human Capital Development, Human Rights, Ethical Behaviour -
i.e. Fair and Beneficial Business Practices toward Labour and the Community and region in
which an Entity conducts its business.

2. Planet, the Environmental Bottom Line - relates to sustainable environmental practices, and
measures the impact on resources, such as air, water, ground and waste emissions.

3. Profit, the Economic bottom line - deals with the Economic Value added by the Entity, i.e.
"real" economic benefit enjoyed by the host society, and measures the Company's success in
that context.

Merits 1. TBL expands the traditional Financial Reporting Systems, and includes social and
environmental performance, in addition to financial performance.

2. TBL can be used to help encourage each Division and Manager to act in a socially
responsible manner.

3. TBL recognizes all Stakeholders' interests in the 3P Dimension - People, Planet and Profit.

Demerits 1. TBL is unenforceable due to the difficulty of achieving global agreement on simultaneous
policy on all 3Ps.

2. The 3Ps cannot easily be added up. It is difficult to measure the Planet and People
dimensions in the same terms as Profits - that is, in terms of money.

Question 43 Write short note on “The Performance Pyramid” model ?


Answer:- “The Performance Pyramid” Model: (Cross and Lynch)

Performance Pyramid links the business strategy with day-to-day operations, as under -

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1. Level 1 or Top Level: The Entity's Corporate Vision of long term success and Competitive Advantages
are described in this level.

2. Level 2 or Business Level: This focusses on achievements of an Entity's CSF in terms of market and
financial measures. The marketing and financial success of a proposal is the initial focus for the
achievement of Corporate Vision.

3. Level 3 or Operating System Level: The

above businesses are linked to achieving Customers' Satisfaction, Increase in Flexibility and High
Productivity. The above driving forces can be monitored using the Operating Forces of the Entity.

4. Level 4 or Department Level: These deal with the measureable factors through which the work is
performed.

5. "Objectives" are shown from top to bottom, whereas "Measures" are from bottom to the top.

6. The Left-hand side of the pyramid contains External Effectiveness which are primarily "non-financial" in
nature, while the Right-hand side contains Internal Efficiency which are pre-dominantly "financial" in nature.

Question 44 Write short note on “The performance Prism” model?


Answer:- “The Performance Prism” Model (Andy Neely and Chris Adams):

The Performance Prism aims to manage the performance of an Entity from five inter-related
"facets" -

Concept 1. Stakeholder Satisfaction - who are the Stakeholders and what do they want?

2. Stakeholder Contribution - what does an Entity want and need from its Stakeholders?

3. Strategies - what Strategies an Entity should adopt, to satisfy the wants and needs of the

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Entity, as well as its Stakeholders?

4. Processes - what Processes does the Entity need to put in place to enable it to execute its
Strategies?

5. Capabilities - what Capabilities does the Entity need to put in place to allow it to operate its
Processes?

Features 1. It takes Stakeholder Requirements as the start point for the development of Performance
Measures rather than the strategy of the Entity.

2. It recognises the need to work with Stakeholders to ensure that their needs are met.

Merits 1. Whiie Balanced Score Card and Performance Pyramid focus only on Shareholders and
Customers, the Prism approach focusses on all Stakeholders, including Regulators, Business
Communities, etc.

2. Prism Approach is much better when compared to Value-based management (EVA, SVA,
etc.), which prioritizes the needs of Shareholders only.

3. Use of Prism Approach to develop measures for each relevant Stakeholder, facilitates the
communication and implementation of strategy.

4. Prism Approach enables an Entity to more directly address the risks and opportunities in its
business environment.

Question 45 Write short note on “The Building Block” model?


Answer:- „The Building Block” Model: (Fitzgerald and Moon)

Concept This Mode! focusses on three aspects -

1. Standards- i.e. KPIs or Measures used for performance evaluation,

2. Rewards - i.e. Incentives provided if Standards are met, KPIs are achieved, etc.

3. Dimensions - i.e. Goals of the Business, measured from different viewpoints.

Standards are the KPIs or Performance Measures used for evaluation. It should have the
following features - 1. Ownership (acceptable to everyone): Ownership here refers to the
responsibility for the results. Employees should be got involved in the identification of
measures rather than being imposed on them.

Standards 2. Achievability (realistic): Standards perceived as impossible, do not motivate people into
performance. To ensure that Employees are motivated to meet Standards, the Standards
should be clear and linked to controllable factors.

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3. Equity (equally challenging for all parts of business): Relaxation given to one part of the
Business leads to perception of unfair treatment and affects productivity.

Rewards Reward Schemes should have the following features -

1. Motivation: Employees should be motivated to achieve the Business Goals. Example:


Employee Incentive based on increase in number of units over previous year, for Sales
Growth Goal.

2. Clarity: Rewards Scheme should be clearly communicated to employees in advance, as to


what kind to performance will be rewarded, and how their performance will be measured.

3. Controllability: Employees should only be rewarded or penalized of the result over which
they some control or influence.

Dimensions 1. Dimensions are the Goals for the business, i.e. CSFs. Suitable Measures must be
developed to measure each Performance Dimension.

2. Dimensions are further classified into Determinants and Results, as explained below.

Question 46 Write a short note on linking CSFs and KPIs to strategy?


Answer:- Linking CSFs and KPIs to Strategy

Critical Success Factors (CSF) Key Performance Indicators (KPI)

Meaning CSFs represent objectives that Businesses are trying KPIs are the sets of measures and
to achieve, as an Entity, as a Department, or as a associated targets, that will result in
Business Unit. successful completion of a CSF.

Focus CSFs denote the "what" factors - i.e. what are the KPIs represent the "how" factors - i.e.
things the Company needs to do in order to achieve how the Company will achieve what it
its goals. wants to.

Linkage CSFs are elements tied to the overall strategy of the KPIs are elements linked to the CSF. A
Business. They are derived from the strategic goals. single CSF can have more than one KPI,
if required.

Purpose CSFs seek to go deeper into the high-level strategic KPIs seek to operationalize the CSFs into
goals, and lay them out as a list of categorized achievable elements called Targets or
objectives that will collectively drive the Company's Thresholds. KPI Targets should be
strategy forward. specific, measurable, achievable, relevant
and time-constrained.

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Factors CSFs are determined using factors like - (a) Industry KPI Targets are ascertained using factors
Structure, (b) Competitive Strategy, (c) Environmental like Industry Analysis, and Internal
Factors, and (d) Temporary Influences. Analysis.

Review CSFs should be reviewed and evaluated with respect KPIs should be governed by a feedback
to the Company's high-level strategic goals. and monitoring process, to achieve CSFs
& Goals.

Question 47 Write concept of Balanced score card (BSC)?


Answer:- Concept of BSC

1. BSC is a set of financial and non-financial measures relating to a Company's Critical Success Factors
(CSF).

2. It is an approach advocated by Kaplan & Norton, which provides information to Management to assist in
strategic policy formulation and achievement.

3. The main objective of Balanced Score Card is to provide a comprehensive framework for translating a
Firm's strategic objectives into a coherent set of performance measures.

4. A well-designed BSC combines financial measures of past performance with measures of the Firm's
drivers of future performance. The specific objectives

Perspectives in BSC

Perspectives in a Balanced Score Card

What we want to achieve? How we plan to accomplish it?

↓ ↓ ↓ ↓

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Financial Perspective Customer Internal Business Learning & Growth

Perspective Perspective Perspective

↓ ↓ ↓ ↓

To succeed To achieve our To satisfy our Shareholders To achieve our Vision, how
financially, how Vision, how should and Customers, What wili we sustain our ability to
should we appear to we appear to our Business Processes must change and improve?
our Shareholders? Customers? we excel at?

Perspective Description

Financial • Corporate strategy and strategic initiatives are examined from the financial perspective to
see feasibility of these initiatives of being met.
Perspective
• Financial performance measures indicate whether the company's strategy implementation
and execution are contributing to its revenue and earnings.

Customer • Companies should identify customers and market segments in which they compete and
also the means by which they provide value to these customers and markets.
Perspective
• Lead indicators or Differentiation features which make a particular business unit or product
different from that of others should be identified.

• Examples of Lead indicators include - (i) On-time delivery, (ii) On-site service, (iii) After
sales support, (iv) Defects per order, (v) Cost of the product, (vi) Free shipments, etc.

Internal • Companies should identify processes and activities which are necessary to achieve the
objectives as identified at financial perspectives and customer perspective stage.
Business
• These objectives may be achieved by reassessing the value chain and making necessary
Perspective
changes to the existing operating activities.

Learning & • Companies should determine the activities and infrastructure that the company must build
to create long term growth, which are necessary to achieve the objectives set in the previous
Growth
three perspectives.
Perspective
• Organisational learning and growth comes from three principle sources - (i) People i.e.
employee capabilities, (ii) Systems i.e. information system capabilities, and (iii)
Organisational procedures i.e. motivation, empowerment and alignment.

Question 48 Write short note on strategy mapping (Kalpan & Norton)?

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Answer:- Strategy Mapping (Kaplan and Norton)

1. Strategy Mapping -

(a) allows Entities to describe and communicate their strategies,

(b) serves as a basis for the development of financial and non-financial BSC measures that can be used to
monitor strategy execution and performance,

(c) links & aligns organisational and individual targets and initiatives with a defined mission and desired
strategic outcomes,

2. Strategy Maps can be created for Profit-oriented as well as Not-For-Profit Entities.

Question 49 Write short note on bargained or negotiated pricing?


Answer:- Negotiated or Bargained Transfer Pricing

1. Meaning:

(a) Negotiated Transfer Pricing refers to the determination of Transfer Prices based on active participation,
involvement, co-ordination and agreement of the Managers of the Transferring and Recipient Divisions.

(b) In this method, each decentralised unit is considered as an independent unit. Such units decide the
Transfer Price by negotiations or bargaining.

(c) Divisional Managers have full freedom to purchase their requirement from Outside Suppliers, if the
prices quoted by the Transferring Division are not acceptable to them.

2. Advantages: (a) Proper Decisions: Negotiated Prices lead to business-like attitude amongst divisions
of the Company. The Buying Division may purchase from outside sources, if the outside prices are lower
than the Internal Division's price.

(b) Autonomy and Motivation Vaiue: Buying and Selling Divisions are completely free to deal outside the
Company. This promotes sub-unit autonomy and motivates Managers.

(c) Optimality: Through properly directed negotiations, Managers can determine the appropriate Transfer
Prices that satisfy the requirements of the Divisions and is in the best interest of the Company as a whole.

3. Limitations: M 03

(a) Sub-Optimal: The agreed Transfer Price may depend on the negotiating skills and bargaining powers
of the Managers involved. The final result may not always be optimal.

(b) Conflicts: Rather than agreement on Transfer Prices, negotiations can lead to conflict between
divisions and may require top-management mediation.

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(c) No scope for Performance Evaluation: Transfer Prices dependent on Manager's negotiation skills will
defeat the very purpose of performance evaluation.

(d) Time and Cost: Negotiations are time-consuming for the Managers involved, particularly when the
number of transactions and inter-dependencies are large.

4. Pre-conditions for Negotiated Transfer Pricing: For an effective system of transfer pricing -

(a) Prices of all transfers in and out of a Profit Centre should be determined by negotiation between the
buyer and the seller divisions.

(b) Negotiations should have access to full data on alternative sources and markets, and to public and
private information about market prices.

(c) Buyers and Sellers should be completely free to deal outside the Company.

Question 50 Explain divisional conflict and ways to resolve it?


Answer:- Conflicts between Divisions and Company

1. Objectives and Conflicts: The criteria for fixing Transfer Prices are - (a) Goal Congruence, (b)
Management Effort, (c) Segment Performance Evaluation, (d) Sub-unit autonomy, and (e) Motivation
Value. However, no single transfer price can serve all of these criteria. They often conflict and managers
are forced to make trade-offs.

Some situations of conflicts between objectives are -

(a) Goal Congruence vs Performance Evaluation: The Transfer Price that leads to the short-run optimal
economic decision is Relevant Cost. If the Transferring Division has excess capacity, this cost will be equal
to Variable Cost only (since Opportunity Costs are Nil). The Transferring Division will not recover any of its
Fixed Costs when transfers are made at Variable Costs, and will therefore report a Loss.

(b) Goal Congruence vs. Divisional Autonomy: In case of failure of a division to achieve the objective of
'Goal Congruence', the Management of the Company may dictate their 'Transfer Price'. If a Transfer Price
is imposed on the Manager of the Supplying Division, the concept of divisional autonomy and
decentralisation is undermined.

(c) Performance Evaluation vs Profitability: A Transfer Price that may be satisfactory for evaluating
divisional performance may lead divisions to make sub-optimal decisions when viewed from overall
Company perspective.

2. Conflicts between Divisions and Company as a whole: If Divisional Managers are given "absolute
free hand" in decision making on Transfer Prices, there is a possibility that divisional goals may be pursued,
ignoring overall Company interests. This may force the top Management to interfere in decision-making.

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However, interference of top Management and "dictating a Transfer Price" on the divisions is usually the
main basis of conflict between a Division and the Company as a whole.

3. Conflicts Resolution: To resolve transfer pricing conflicts, the following transfer pricing methods can be
suggested -

(a) Dual-Rate Transfer Pricing System, and / or (b) Two-Part Transfer Pricing System.

Dual Rate Transfer Pricing System

1. Dual-Rate Transfer Pricing uses two separate Transfer Prices to price each inter-divisional transaction,
as under –

Dual Rate Transfer Pricing Method

Debit Cost in Recipient Division Cost = Relevant Credit Income in Transferring Division Income =
Costs, i.e. Variable Cost + Opportunity Cost, if any Market Price, or Full Cost plus mark-up (whether or
not Intermediate Product is marketable)

Under this method, Company Profits = Total of Divisional Profits Less Inter-Divisional Mark-up, (i.e.
difference between two Transfer Pricing Rates used above X Quantity Transferred)

2. Advantages:

(a) Incentive to Transferring Division: The Transferring Division Manager is motivated to transfer the
Intermediate Product internally, since each unit transferred generates a profit (due to mark-up).

(b) No Unjust Enrichment: If the Transfer Price is set at the Transferring Division's Marginal Cost for the
Intermediate Product, that division will not have any contribution from internal transfers. All the total
contribution from inter-divisional trading will be assigned to the Recipient Division. Such unjust enrichment
is avoided through the use of mark-up.

(c) Optimal Decisions: Since Relevant Cost is used as the second Transfer Price, (for debiting Cost in
Recipient Division) the Transfer Pricing system automatically promotes goal congruence by leading to
optimal decisions.

3. Disadvantages:

(a) Confusing: Use of different Transfer Prices causes confusion, particularly when more than two
divisions are involved.

(b) Artificial: Dual Transfer Prices are considered to be artificial.

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(c) No incentive: Fixed Price with mark-up protects Transferring Divisions from competition. It gives them
little incentive to improve their productivity.

(d) Misleading: Dual Transfer Prices can result in misleading information and create a false impression of
divisional profits. There is a possibility of double-counting of profits. At the extreme, ail divisions may report
profits, when the Company as a whole is losing money.

Two Part Transfer Pricing System

1. This is another method of resolving Transfer-Pricing disputes between a Division and the Company as a
whole.

2. Under this method, Transfer Price = Marginal Cost + Lump-sum Fixed Fee.

3. This Method is most suited when there is no market for the Intermediate Product, and the Transferring
Division has no capacity constraints.

4. The Transferring Division is provided with sufficient incentive for internal transfer, since Marginal Costs
are fully recovered and the lump-sum fee received will reduce its losses by recovering Fixed Costs.

5. The Recipient Division is also interested in the internal procurement, since the Transfer Price will be less
than the Market Price or Cost of alternative option like outsourcing, etc. Moreover, the lump-sum fixed fee
constitutes a commitment of the Recipient to utilise a portion of the capacity of the Transferring Division, for
an agreed compensation.

Question 51 Write short note on Strategic profitability analysis?


Answer:- Strategic Profitability Analysis

Variance Analysis (Standard Costing) provides a means for evaluating the reasons for variation between
Budgeted and Actual Profit. The Strategic Analysis of Operating Profit under 3 major components - (a)
Growth, (b) Price Recovery, and (c) Productivity - are discussed.

Strategic Analysis of Operating Profit

Growth Component
Price Recovery Component Productivity Component
(for measuring the increase/
(for measuring the Change in (for measuring the Change in
decrease in Revenue and
the Revenue & Costs due to Operating Income due to Changes in
Costs, due to change in jSale
Changes in Prices) Product Mix and/or Yield of Inputs)
Quantity)

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Revenue Effect Cost Effect Revenue Effect Cost Effect

A C

Variable Cost Fixed Cost Variable Cost Fixed Cost Variable Cost Fixed Cost

↓ ↓ ↓ ↓ ↓ ↓

B1 B2 D1 D2 E1 E2

Formula for measuring the above: Note: CY = Current Year, LY = Last Year

Note: All Formula (whether Revenue or Cost Effect) should be carefully applied so as to correctly
recognise Favourable and Adverse impact on Operating Profit.

Component Computation Formula

Growth Component

A. Revenue Effect (Sales Quantity in CY - Sales Quantity in LY) × Selling Price in LY

Bl. Variable Cost Effect Input Prices for LY × (A - B) where -

A = Actual Units of Input used to produce LY Output, i.e. Base Year Standards.

B = Units of Input that would have been used to produce CY output, i.e.
Standard Consumption for Actual Output, assuming the same input-output
relationship in LY.

B2. Fixed Cost Effect Price pu of Capacity in LY × (A - B) where -

A = Actual Units of Capacity used to produce LY Output, i.e. Base Year


Standards.

B = Units of Capacity that would have been used to produce CY output, i.e.
Standard Capacity for Actual Output, assuming the same relationship in LY.

Price Recovery
Component

C. Revenue Effect (Selling Price of CY - Selling Price of LY) × Sale Quantity in CY

(A - B) × C where -

A = Input Prices for LY, i.e. Standard Prices of Materials, etc. for LY.

D1. Variable Cost Effect B = Input Prices for CY, i.e. Standard Prices of Materials, etc. for CY.

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C = Units of Input that would have been used to produce the CY output, i.e.
Standard Consumption for Actual Output, assuming the same input-output
relationship in LY.

(A - B) × C where -

A = Input Prices for LY, i.e. Standard Prices of Materials, etc. for LY.

D2. Fixed Cost Effect B = Input Prices for CY, i.e. Standard Prices of Materials, etc. for CY.

C = Units of Capacity that would have been used to produce CY output, i.e.
Standard Capacity for Actual Output, assuming the same relationship in LY.

Productivity Component

Input Prices for CY × (A - B) where -

El. Variable Cost Effect A = Units of Input that would have been used to produce CY Output, i.e.
Standard Consumption for Actual Output, assuming the same input-output
relationship in LY.

B = Actual Input or Capacity used for CY.

E2. Fixed Cost Effect Price pu of Capacity in CY × (A - B) × C where -

A = Units of Capacity that would have been used to produce CY Output, i.e.
Standard Capacity for Actual Output, assuming the same relationship in LY.

B = Actual Input or Capacity used for CY.

Question 52 Write short note of Direct Product Profitability (DPP)?


Answer:- Direct Product Profitability (DPP)

1. Cost Analysis: The Traditional Absorption Costing System is not suitable for Retail Trade businesses,
for cost analysis and control. Hence, to meet the requirements of retail trade activity the concept of Direct
Product Profitability has been developed parallel to ABC. For Retail Trade Business, Costs are classified
as under -

COSTS

Costs of Purchases Other Costs

(i.e. Bought-In Costs)

Attributable Product Costs Indirect Costs

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(a) Volume / Space related Costs - e.g. storage charges, insurance etc. Incurred for an activity not
directly linked to a particular
(b) Transport Cost - e.g. Delivery Costs, Fuel, Vehicle Maintenance,
product.
Transport Labour, etc.

(c) Batch-related Cost - e.g. Shelf Stocking Costs, other time and product
related costs

(d) Inventory Financing Costs

2. DPP Statement: The Direct Product Profit Statement is presented in the following format -

Particulars / Product A B C D Total

Selling Price per unit XX XX XX XX XX

Less: Bought-in-Price per unit XX XX XX XX XX

Gross Margin per unit XX XX XX XX XX

Less: Directly Attributable Product Costs XX XX XX XX XX

1. Warehousing and Storage Costs - e.g. space, insurance XX XX XX XX XX

2. Transport Costs - e.g. fuel, vehicle maintenance, labour XX XX XX XX XX

3. Product Batch Costs XX XX XX XX XX

4. Inventory Financing Costs XX XX XX XX XX

Direct Product Profit per unit XX XX XX XX XX

Less: Indirect Costs and Common Overheads XX

Net Profit XX

3. Benefits of DPP Analysis:

(a) Better Cost Analysis,

(b) Better Pricing Decisions,

(c) Better Management of Stores and Warehouse Space, and

(d) Rationalisation of Product Ranges.

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4. DPP in Decision making: DPP per unit is used for decision-making along with the following indicators -

(a) DPP as % of Sales Value: DPP as % of Sales Value is determined to identify products with the highest
DPP return. This is used as an indicator for decisions like - where to display the stock and in what position
on the shelves, etc. Generally - (i) Stock at eye level sells more quickly than that above or below eye level,
and (ii) Goods at the front of the store tend to sell faster than goods at the back. Hence, the brand with the
greatest DPP should be placed at eye level and in front of the store.

(b) DPP per unit of time: DPP per unit of time, say hour, helps in determining the nature of movement of
products. This helps in identifying fast moving products with higher gross margin and DPP.

(c) DPP per unit of space: DPP per unit of space helps in product and inventory planning, particularly
when the showroom / shop space is the Key Factor.

Question 53 Write short note on Customer Profitability Analysis?


Answer:- Customer Profitability Analysis

1. Meaning: Different customers or groups of customers differ in their profitability. Hence, using ABC,
profitability can be analysed customer group-wise, since ABC creates cost pools for activities. Customers
use some activities but not all, and different groups of customers have different 'Activity Profiles'. Hence
analysis of relative profitability based on customer category and related decision-making is called Customer
Profitability Analysis.

2. Illustrative areas of Customer Profitability Analysis:

(a) Banks: Activities such as - (i) Withdrawal of cash, (ii) Request for a statement, (iii) Stopping payment of
a cheque, and (iv) Returning a cheque because of insufficient funds, are analysed. Different customers or
categories of customers will each use different amounts of these activities and so customer profitability
profiles can be built up, and customers can be charged according to the cost of serving them.

(b) Hotels: Facilities offered and the category of customers who use them can be related or linked in order
to determine relative profitability. Such analysis will show the relative profitability and lead to strategies for
encouraging the more profitable group of guests.

(c) Manufacturing Organisation: Attributable S & D Expenses and identifiable General Administration
Expenses are analysed based on customers, in order to determine relative profitability. Some customers
may be located a long way from the factory and transport may cost more. Other customers may be
disruptive and place rush orders that interrupt production scheduling and require immediate, special
transport. Some customers may need after sales service and help with technical matters. Hence, analysis
of costs is made customer-wise to facilitate better sales decisions.

Benefits of customer profitability analysis

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1) It helps the supplier to identify which customers are eroding overall profitability and which
customers are contributing to it.
2) It can help to provide a basis for constructive dialogue between buyer and seller to improve
margins.

Question 54 Elaborate Activity based cost management along with stages in


ABM?
Answer:- Activity Based Management Model:

Cost Assignment View Continuous Improvement


Process

Resources
Activity Analysis
Process View

Cost Drivers Activities Performance Measures


Cost Driver Analysis

Cost Objects

Performance Analysis

1. The use of ABC as a costing tool to manage costs at activity level is known as Activity Based Cost
Management (ABM). ABM utilises cost information gathered through ABC.

2. Through various analyses, ABM manages activities rather than resources. It determines what drives the
activities of the Firm and how these activities can be improved to increase the profitability.

3. ABM is a discipline that focusses on the management of activities as the route to improving the value
received by the customer and the profit achieved by providing this value. This discipline includes - (a) Cost
Driver Analysis,

(b) Activity Analysis, and (c) Performance Analysis.

4. ABM seeks to satisfy the following customer needs while making fewer demands for resources - (a)
Lower Costs, (b) Higher Quality, (c) Faster Response Time, and (d) Greater Innovation.

Stages in ABM

Stage Activities

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1 Identification of the activities that have taken place in the Firm.

2 Assigning Costs to Cost Pool for each activity.

3 Spreading of Support Activities Costs across the Primary Activities.

4 Determining Cost Driver for each activity.

5 Assigning the costs of Activities to Products, according to product demand for Activities.

ABM Analysis

The various analyses under ABM are -

1. Cost Driver Analysis: This identifies the factors that cause activities to be performed, in order to
manage activity costs. An activity may be performed inefficiently due to a particular reason. Managers have
to address this Cost Driver to correct the root cause of the problem.

2. Activity Analysis: It involves identification of the activities of the Firm and the activity centres (or activity
cost pools) that should be used in an ABC system. Activity analysis also identifies Value Added (VA) and
Non Value Added (NVA) activities. The number of activity centres is likely to change over time, as
organisational needs for activity information evolve.

3. Performance Analysis: This involves the identification of appropriate measures to report the
performance of activity centres or other organisational units, consistent with each unit's goals and
objectives. This aims to identify the best ways to measure the performance of factors that are important to
the Firm, in order to stimulate continuous improvement.

Question 55 Distinction between value-added activities and non-value added


activities?
Answer:- Value Added vs Non-Value Added Activities

The difference between Value Added and Non-Value Added Activities is as under -

Particulars Value-Added Activities (VA) Non-Value-Added activities (NVA)

1. Meaning These are activities necessary for the These are additional and extraneous activities,
utility or performance of the product. not

fully necessary for product performance / utility.

2. Customer These are activities that customers If eliminated, this will not reduce the actual or
Perception perceive as adding usefulness to the perceived value that customer obtain by using the

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product or service that they purchase. product or service.

3. Customer These represent work that is valued These represent work that is not valued by the
Requirement by the external or internal customer. external or internal customer.

4. Role They improve or maintain the quality NVA activities do not improve the quality or
or function of a product. Hence, function of a product or service, but they can
Customers are usually willing to pay adversely affect costs and prices. NVA activities
for such value addition. VA activities create waste, result in delay of some sort, add
result in "costs" and not in losses. cost to the products or services for which the
customer is not willing to pay.

5. Examples Making product more versatile for Expediting due to work delays, cost of re-work of
certain other uses. defectives, etc.

6. Management Management aims to simplify VA Management should focus on elimination of NVA


Focus Activities and thereby manage Activities and thereby avoid "losses".
"costs".

Question 56 Describe Activity based budgeting?


Answer:- Activity Based Budgeting (ABB)

Point Description

Meaning 1. Activity Based Budget is a quantitative expression of the expected activities of the Firm,
reflecting Management's forecast of workload and financial and non-financial requirements, to
meet agreed strategic goals and planned changes to improve performance.

2. Activity Based Budgeting (ABB) is a process of planning and controlling the expected
activities of the Firm, to derive a cost-effective budget, that meets forecast workload and
agreed strategic goals.

Focus ABB focusses on activity / business processes. Resources required are determined on the
basis of expected activities & workload. Expenses necessary to perform these activities are
estimated, with a focus on overall efficiency.

Point Description

Key Key Elements of ABB are -

Elements (a) Type of work / activity to be performed,

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(b) Quantity of work / activity to be performed, and

(c) Cost of work / activity to be performed.

The advantages of Activity Based Budgeting (ABB) over Traditional Budgeting are -

1. Better Cost Analysis: ABB focusses on outcomes (activities) rather than listing of
expense by "head of account" categories. Hence, ABB is more amenable for cost analysis, by
focusing on behaviour of costs.

2. Better Cost Control: ABB helps in focussing on NVA Costs and the variances thereof.
Investigation of expense variances will now be more meaningful for cost control purposes.

Advantages 3. Management Focus: ABB leads to increased management commitment to the budget
process, since it enables Management to focus on the objectives of each activity, and
compare the outcomes with the costs that are allocated to that activity.

4. Resource Management: ABB identifies resources requirements to meet the demand for
activities, whereas traditional budgeting adopts and incremental approach. Hence, excess
resources if any can be identified. These excessive resources can either be eliminated or re-
deployed in some other manner.

5. Realistic Approach: ABB avoids arbitrary cuts in specific budget areas in order to meet
overall financial targets. Hence, ABB leads to more realistic budgeting.

Question 57 Write short note on feedback and feed forward control?


Answer:- Feedback Control and Feed-Forward Control

1. Concept: Control is a management function of establishing Benchmarks and comparing actual


performance against the Benchmarks and taking corrective actions. Control is required at all levels of an
Entity, to ensure that the Entity achieves its intended objective. Control may be - (a) Feedback Control, or
(b) Feed-Forward Control.

2. Common Features: Feedback and Feed-Forward are two types of control schemes for systems that
react automatically to changing environmental dynamics. Each utilizes sensors to measure important
factors and a set of rules to react to changes in those factors.

3. Differences: Feedback and Feed-Forward Controls may co-exist in the same system, but the two
designs are different, as explained below –

Point Feedback Control Feed-Forward Control

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CIMA It is the measurement of differences between It is the forecasting of differences between


planned outputs and actual outputs achieved, actual and planned outcomes and the
Terminology
and the modification of subsequent action implementation of actions before the event, to
and/or plans to achieve future required results. avoid such differences. [Example: anticipated
Feedback Control is an integral part of price rise in Raw Materials, to trigger
Budgetary Control and Standard Costing immediate purchase action.]
Systems.

Comparison Feedback System compares the actual Feed-Forward System compares the
historical results with the budgeted results. budgeted results with the forecasted results.
[Note]

Source of Feedback Information is primarily obtained Feed-Forward Information is primarily


Information from the System Outputs or Outcomes (i.e. obtained from the External Environment
after comparing Actuals with Budgets). Changes / Developments / Disturbances.

Scope It is primarily a Corrective Control. According It is primarily a Preventive Control. According


to Norton Bedford, to be effective, such to John Camillus, Preventive Management
Feedback Control Reports should be - Control should include -

• be in standardized format, • Indicators, "leading" & "early warning",

• be available in a timely manner, • Trend Analysis,

• disclose variations from standards, • Adaptive Mechanisms,

• disclose trends and relationships, • Congruent System Design,

• disclose both accomplishment and • Policy Directives, and


responsibility.
• Contingency Plans.

Happening Feedback is a reaction after an action has It involves measuring the amount of error,
of Error taken place. So, there has to be an error, in before it has actually taken place, and placing
order to take corrective actions. a control mechanism therefor.

Advantages • It is simple and easy to implement. • It identifies errors even before they occur.

• It does not involve much investment. • It eliminates inefficiencies, defects, etc.

Limitations • It is only as effective as the Error Detection • There is a high cost of implementation.
System.
• There may be multiple variables or estimates
• There may be time lags between the error in an uncertain future.
detection, error confirmation, and error
• Forecasting Tools have not evolved
revision during which actual results may

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change again. adequate for applying this control.

Question 58 What are types of feedback?


Answer:- Types of Feedback

Feedback may be classified in many ways -

1. Positive vs Negative Feedback

Positive Feedback Negative Feedback

↓ ↓

(a) It is taken to reinforce a deviation from (a) It is taken to reverse a deviation from standard.
standard.

(b) The Inputs or Process are not altered. (b) It involves amending the Inputs or Process, so that
the system reverts to a steady state.

2. Primary vs Secondary Feedback

Primary Feedback Secondary Feedback

↓ ↓

(a) It is the reporting to the immediate Line (a) It is the Feedback sent to a higher level in an
Management in the form of Control Reports, Entity, and can lead to a plan being reviewed and
comparing actual and budgeted results. possibly changed.

(b) It is not escalated to higher levels in the Entity, e.g. (b) It is required to, when the Variances are
if the variances are minimal, or can be corrected beyond the control of the immediate Line
easily. Management.

Question 59 Describe concept and characteristics of beyond budgeting?


Answer:- Concept of Beyond Budgeting

Point Description

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Meaning Beyond Budgeting (BB) is a leadership philosophy that relates to an alternative approach
to budgeting which should be used instead of Traditional Annual Budgeting.

CIMA BB is an idea that Companies need to move beyond budgeting because of the inherent flaws
in budgeting especially when used to set contracts. It is argued that a range of techniques,
Definition
such as rolling forecasts and market related targets, can take the place of Traditional
Budgeting.

Features of 1. Focus of the Managers shifts to improving future results, and not merely compliance with
BB Budgets.

2. Rolling Budgets may incorporate KPIs.

3. Benchmarking can be incorporated in Budgets.

Benefits of 1. BB helps Managers to work in coordination to beat the competition. Internal Rivalry
BB between Managers is reduced as target shifts to Competitors.

2. BB eliminates some behavioural issues by making rewards team-based. Divisional


Performance is secondary,and Organisational Performance is primary now.

3. BB allows Operational Managers to react to the environment. BB ensures proper


delegation of authority to Operational Managers who are close to the concerned action, and
can react quickly.

4. BB encourages a culture of innovation. Operational Managers do not restrict themselves


to budget iimits and focus on achieving key ratios.

5. BB ensures more timely allocation of resources.

6. BB is a more adaptive process than Traditional Budgeting.

7. BB is a decentralised process, unlike Traditional Budgeting where leaders plan and


control organisations centrally.

8. BB helps in motivating individuals by defining clear responsibilities and challenges.

9. BB creates Information Systems which provide fast and open information throughout the
Entity.

10. BB establishes customer-orientated teams.

Suitability BB is suitable in the following situations -


of BB
Industries Why BB is required?

1. Industries where there is rapid change in Flexible Targets are to be set in response to
the business environment external environment changes.

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2. Industries using Management Methods Continuous Improvement is the key. Mere


such as TQM, TPM, etc. compliance with Budgets is not sufficient.

3. Industries undergoing radical change, e.g. Traditional Budgets may be hard to achieve in
using BPR. such circumstances.

Question 60 What are steps required for implementation of beyond


budgeting?
Answer:- Implementation of Beyond Budgeting

According to Hope and Fraser, effective implementation of the Beyond Budgeting approach involves the
following -

1. Define the case for change (from Traditional Budgeting to BB), and provide an outline Vision thereof.

2. Be prepared to convince the Board and Top Management, for changing to BB Approach.

3. Establish a framework for BB Approach, i.e. "Get Started".

4. Design and implement New Processes.

5. Train and Educate People, so that the implementation process will be smooth and acceptable.

6. Rethink the Role of Finance - from "Number Providers" to "Facilitators of Strategy".

7. Change Behaviour to accept BB - Focus on New Processes, not compliance with Management Orders

8. Evaluate the Benefits of implementing BB Approach.

9. Consolidate the Gains achieved by implementing BB Approach.

Question 61 Write short note on planning and operational variances?


Answer:- Planning and Operational Variances

1.Basis When the current environmental conditions are different from the anticipated environmental
conditions (which were prevailing at the time of setting Standards or Plans), the use of routine analysis of
variance for measuring the performance of a Manager is neither suitable nor desirable.

2. Points of Difference

Meaning Planning Variance Operational Variance

Comparison Comparison between Original Standard and Comparison between Revised Standard and
Revised Standard. Actual Results.

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Item

Control by These are Non-Controllable by Operational These are Controllable by Operational


Management, since they arise due to factors Management, since they arise due to
Operational
beyond the control of Management / efficiency or inefficiency of the Cost Centre /
Management
Department. Department.

Example:- In case of material purchase price variance, suppose the standard price of raw material
determined was Rs. 5 per unit, the general market price per unit at the time of purchase was Rs.5.20 and
actual price paid per unit was Rs.5.18 on the purchase of say 10,000 units of raw material. In this case the
variances to be computed should be:

Material purchase price variance

Planning variance

= (Standard price p.u. – General market price p.u.) x Actual Quantity Purchased

= (Rs. 5 – Rs. 5.20) x 10000 units

= Rs. 2000(A)

Uncontrollable

Operational variance

= (General Market price p.u. – Actual price paid p.u.) x Actual Quantity purchased

= (Rs. 5.20 – Rs. 5.18) x 10,000 units

= Rs. 200(F)

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Question 62 Write short on variance analysis in activity based costing ?


Answer:- Variances in ABC System

1. Setting Standards: In ABC System, Costs are collected around Activity Pools and are assigned to
products and services using appropriate Cost Drivers. Therefore, Standards can be set for carrying out
each type of activity. Such Standards can be set for all levels of Costs, viz. Unit Level, Batch Level, Product
Level and Facility Level.

2. Variances: OH Variances can be calculated using ABC Concepts as under -

Total OH Variance = Efficiency Variance + Price Variance, as computed below -

Efficiency Variance = Expenditure (or Price) Variance =

(Resources Allowed - Actual Resources)×Std ABC (Std Rate - Actual Rate) × Actual Cost Driver Units
Rate used

↓ ↓

This Variance recognises the Cost Impact of paying


This Variance recognises the Cost Impact of
more or less than the Standard, for the Actual Activities
undertaking more or less activities than Standard.
undertaken.

Question 63 Write short on Learning Curve – Impact on Variances?

Answer: Impact described as below:-

1. Learning curve is a geometrical progression, which reveals that there is steadily


decreasing cost for the accomplishment of a given repetitive operation, as the
identical operation is increasingly repeated.

2. The amount of decrease will be less and less with each successive unit produced.
As more units are produced, people involved in production become more efficient than
before.

3. Each additional unit takes less time to produce. The amount of improvement or
experience gained is reflected in a decrease in man-hours or cost. Where learning
takes place with a regular pattern it is important to take account of reduction in a labour
hours and cost per unit`.

4. Automated manufacturing is unlikely to have much variation or to display a regular


learning curve. In less-automated processes, however, where learning curves do
occur, it is important to take the resulting decline in labour hours and costs into account

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in setting standards, determining prices, planning production, or setting up work


schedules.

5. With the help of the learning curve theory the standard time of any batch or unit can
be computed then compare the actual data with the standard and compute the
variances.

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