Apm p5 Course Notes

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APM (P5) Course Notes
Business Performance Management Technology (Kingston University)
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Advanced Performance Management

Paper P5
Course Notes
For exams in September 2017, December 2017,
March 2018 and June 2018
ISBN: 9781509769063

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Improving study material and removing errors

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P5 Advanced Performance Management

Study Programme
Taught Phase Study Programme
Page
Introduction to the paper and the course................................................................................................................. 5
1 Strategic management accounting ............................................................................................................... 15
2 Performance hierarchy ................................................................................................................................. 33
3 Performance management and control ....................................................................................................... 41
Achievement Ladder Step 1 51
4 Organisational change, environmental and ethical issues .......................................................................... 53

5 External influences on organisational performance...................................................................................... 67
6 Performance measurement systems and design ......................................................................................... 87

7 Scope of strategic performance measures in the private sector .................................................................. 99
8 Divisional performance and transfer pricing issues .................................................................................... 117
9a Scope of strategic performance measures in not-for-profit organisations .................................................. 141

9b Non-financial performance indicators ......................................................................................................... 147
10 The role of quality in performance management systems.......................................................................... 151
11 Performance measurement and strategic HR issues ................................................................................. 163
12 Alternative views of performance measurement and management............................................................ 179

13 Predicting and preventing corporate failure................................................................................................ 197
14 Answers to Lecture Examples .................................................................................................................... 209

15 Appendix A: Mathematical tables and formulae ......................................................................................... 243
16 Step 4 and Step 6 Question papers ........................................................................................................... 247

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INTRODUCTION
Welcome to P5 Advanced Performance Management

Our aim is to help you confidently prepare for success in your exam in an effective and efficient way; allowing
you to personalise your learning experience, step by step, whilst being supported by BPP's team of experts.
These course notes are one of the components of your P5 programme, and are one of the tools you have at your
disposal as a student of BPP. They focus primarily on ensuring you acquire the technical knowledge and
understanding required to pass your exam. They have been written by our subject matter experts and tutors, are
will be delivered to you by our expert tutor team, be it in centre or online.
These course notes play two important roles in your programme:
1. Knowledge – the course notes will help you to learn and understand the key knowledge topics to allow
you to progress up the Achievement Ladder
2. Support – you can revisit specific elements in your course notes in the light of feedback you receive as
you attempt each step on the Achievement Ladder.
Remember, the Achievement Ladder is the unique tool to allow you to see your own progression towards being
fully prepared for the real exam.

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INTRODUCTION
Introduction to Paper P5 Advanced Performance Management
Overall aim of the syllabus

To apply relevant knowledge, skills and exercise professional judgement in selecting and applying strategic
management accounting techniques in different business contexts and to contribute to the evaluation of the
performance of an organisation and its strategic development.
Performance management systems are the systems in an organisation by which the performance
of an organisation is measured, controlled and improved.
The syllabus
The broad syllabus headings are:
A Strategic planning and control

B External influences on organisational performance
C Performance measurement systems and design
D Strategic performance measurement
E Performance evaluation and corporate failure
Main capabilities
On successful completion of this paper, candidates should be able to:
 Use strategic planning and control models to plan and monitor organisational performance
 Assess and identify key external influences on organisational performance
 Identify and evaluate the design features of effective performance management information and
monitoring systems
 Apply appropriate strategic performance measurement techniques in evaluating and improving
organisational performance
 Advise clients and senior management on strategic business performance evaluation and on recognising
vulnerability to corporate failure

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INTRODUCTION
Links with other papers
Business Analysis Advanced

(P3) Performance
Management (P5)
Performance
Management (F5)
Management
Accounting (F2)
This diagram shows where direct (solid line arrows) and indirect (dashed line arrows) links exist between this
paper and other papers that may precede it.
The Advanced Performance Management syllabus assumes knowledge acquired in Paper F5 Performance
Management, and develops and applies this further and in greater depth.

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INTRODUCTION
Assessment methods and format of the exam

The examination is a three hour and fifteen minute paper.
20% Numerical 80% Discussion
25% Knowledge 75% Application
Format of the Exam Marks

Section A 1 compulsory question 50
Section B 2 questions, from a choice of 3 for the remaining marks 50
100

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INTRODUCTION
Taught Phase Aims
Achieving ACCA's Study Guide Outcomes
A Strategic planning and control

A1 Strategic management accounting Chapter 1
A2 Performance hierarchy Chapter 2
A3 Performance management and control of the organisation Chapter 3
A4 Changes in business structure and management accounting Chapter 4
A5 Other environmental and ethical issues Chapter 4
B External influences on organisational performance

B1 Impact of risk and uncertainty on performance management Chapter 5
B2 Impact of other external factors on performance management Chapter 5
C Performance measurement systems and design

C1 Performance management information systems Chapter 6
C2 Sources of management information Chapter 6
C3 Recording and processing methods Chapter 6
C4 Management reports Chapter 6
D Strategic performance measurement

D1 Strategic performance measures in the private sector Chapter 7
D2 Divisional performance and transfer pricing issues Chapter 8
D3 Strategic performance measures in not-for-profit organisations Chapter 9a
D4 Non-financial performance indicators Chapter 9b
D5 The role of quality in management information and performance measurement systems Chapter 10
D6 Performance measurement and strategic human resource management issues Chapter 11
D7 Other behavioural aspects of performance management Chapter 11
E Performance evaluation and corporate failure

E1 Alternative views of performance measurement and management Chapter 12
E2 Strategic performance issues in complex business structures Chapter 4
E3 Predicting and preventing corporate failure Chapter 13

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INTRODUCTION
Key to icons
The following icons appear in this set of study notes
Question practice
This is a question we recommend you attempt to reinforce your learning on a key topic
Section reference in the Study Text

You could further consolidate your knowledge in this area with additional reading from the
Study Text.
Formula to learn
Formula given in exam

For further details see Appendix A

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SKILLS BANK
Key skills required to pass

Our analysis of the examination team's comments on past exams, together with our experience of preparing students
for this exam, suggests that to pass Paper P5 you will need to develop a number of key skills.
1 Planning
5 Professional
presentation
2 Analysis of
requirements
4 Disciplined time
management
3 Data analysis
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SKILLS BANK
Skill 1 – Planning
It is essential to allow time for planning each question because the requirements will be based on a scenario that is
often quite lengthy.
The examiner has emphasised how crucial it is to apply your analysis to the given scenario, so you MUST
focus carefully on the scenario before you start writing.
December 2014
The basis of this examination is analysis and application which then leads to evaluation. The candidate will
need a foundation in the techniques but should focus more on the evaluation of these techniques and
consideration of their usefulness to the given scenario.
As in previous diets, it was very clear to the marking team that those candidates that had grasped the need for
this went on to pass the paper.
Skill 2 – Analysis of the question's requirements
1 Understanding and applying the question verbs

You need to be aware of the meaning of the key verbs used by the examiner.
ACCA has a three-pronged approach to testing your ability, and these vary depending which level of exam you are
attempting. At professional level, especially those at options such as P5, you are likely to be asked to
 Apply and analyse (Level 2)
 Synthesise and evaluate (Level 3)
This means that you are most likely to be asked to use verbs such as 'explain', 'assess', or 'discuss'. These verbs
require you to do more than create brief lists or bullet points and require you to provide evidence or construct
arguments.
Intellectual level Action verb Meaning

2 Apply Apply relevant concepts & theories to prepare reports/solve problems
Analyse Recognise and interpret subtle information patterns and trends
3 Assess Using reasoned argument to make judgements from complex information
Advise/recommend Using judgement to recommend a course of action
Report Presentation and justification of valid recommendations
Evaluate Use your judgement to assess the value of…
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SKILLS BANK
2 Identifying and attempting ALL the requirements

Also look out for questions that contain a number of sub-requirements, for example by using two or more verbs.
Skill 3 – Data analysis
A key skill in this paper is to 'create information from data'.

You can expect to be presented with data, which could be substantial amounts of data in question 1 (and in most of the
optional questions), and you will then be expected to go beyond description of the obvious. The examiner is expecting
you to analyse the data, and has outlined the following plan of attack.
ACCA Examiner's Comments December 2010

1. consider the 'big picture'
2. break down the data into smaller but meaningful chunks
3. discuss the individual lines of the data table focusing on the data that explains the overall picture
The examiner has emphasized that candidates need to be selective in their choice of what calculations that
they do.
Skill 4 – Time management
At the planning stage you should write on to your exam paper the amount of time that you will spend. This will be
determined by the mark allocation; 195 minutes equates to 1.95 minutes per mark.
Allowing time for planning is crucial

To allow time to focus on the scenario (see Skill 1) your time management may need to be adapted by setting
aside about 20% of the time allowed for planning.
Planning time = 1.95  0.2 = 0.39 minutes per mark.
Writing time = 1.95  0.8 = 1.56 minutes per mark.
So, if part (a) of a question is for 10 marks then you will aim to complete this in approximately 10  1.56 =
approximately 16 minutes of writing, leaving the rest of the time for planning.
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SKILLS BANK
Skill 5 – Professional presentation
Starting each question on a new page is a really straightforward way to make the examiner think positively about you
and your script. It also affords you a second advantage – space. You may not think of all the relevant points that you
could make in answer, even if you have taken heed of all our suggestions on planning. Sometimes new ideas spring
into your mind unannounced. If you have started the next question on a further page, you will have plenty of space to
add any further points.
P5 provides you with the opportunity to earn four professional marks in section A of the exam. You will receive
professional marks for:
 Format (eg report title, introduction & conclusion)
 Structure (eg use of headings)
 Presentation (eg use of summary tables)
 Layout (eg use of appendices, underline key numbers)
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SKILLS BANK
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Strategic management
accounting
How have the syllabus learning outcomes been examined?

Syllabus learning outcomes Example past paper questions
Explain the role of strategic performance Cod Dec 2011 part a
management in strategic planning and control.
Discuss the role of performance measurement in Cod Dec 2011 part a
checking progress towards the corporate objectives.
Compare planning and control between the strategic
and operational levels within a business entity.
Discuss the scope for potential conflict between MS June 2015 Q1 aii
strategic business plans and short-term localised
decisions.
Evaluate how models such as SWOT analysis, BCG ENT June 2011
and Porter's generic strategies (covered in Chapter 4) Stokeness June 2013
and Five Forces may assist in the performance
management process. MS June 2015 Q1 ai
Apply and evaluate the methods of benchmarking Ganymede June 2012

performance. Boltzman Q1iii Dec 2014
Assess the changing role of the management HS part b Dec 2012
accountant in today's business environment as
outlined by Burns and Scapens.
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1: STRATEGIC MANAGEMENT ACCOUNTING
Overview
Introduction to strategic
management accounting
Strategic performance
measurement
Benchmarking Porter's Five Forces BCG matrix Conflict with short-term

decisions
Integrated
reporting
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1 Strategic management accounting (SMA)

1.1 Strategic management accounting is a form of management accounting in which emphasis
is placed on information about factors external to the organisation as well as on non-
financial and internally-generated information.
1.2 Traditional management accounting is more concerned with the achievement of internal
financial performance targets (eg budget).
1.3 The aim of strategic management accounting is to provide information that is relevant to the
process of strategic planning and control.
Lecture example 1
Train operates a network of accounting training centres throughout Europe, America and Australia,
the business intends enter developing markets in order to drive growth and has now decided to
enter Country X, which is 7,500 kilometres from Train's UK headquarters.
In its present form, the management accounting information provided by Train's Finance function is
largely internally focussed, covering areas such as cost and revenue variances. However the
board have suggested they will now require more externally focussed management information in
light of the move into Country X.
Advise the Board how Strategic Management Accounting could help to monitor the implementation
of Train's strategy.
Solution
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1.4 In reality, SMA will need to be supplemented by:

 Tactical information: to facilitate planning and control for shorter time periods (eg
one year ahead)
 Operational information: to facilitate day-to-day decision making
Forward-looking, external focus,

non-financial
Strategy
Medium-term
Tactics
Operations Day-to-day
Lecture example 2 Based on a previous exam question worth 10 marks
Hydra is a bicycle retailer which has a significant presence in the South of England. Each location
has a manager who is responsible for day-to-day operations and is supported by an administrative
assistant. All other staff at each location are involved in retailing operations.
The directors of Hydra are currently preparing a financial evaluation of an investment of $2m in a
new IT system for submission to its bank. They are concerned that sub-optimal decisions are being
made because the current system doesn't provide appropriate information throughout the firm.
Required
Discuss the three levels of information required to assist in decision making within Hydra,
providing two examples of information that would be appropriate at each level.
Solution
Strategic information Operational information Tactical information
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Modern Performance Management

1.5 SMA is sometimes described as modern performance measurement. In a dynamic
business environment it is important to develop information that is:
(a) Linked to the corporation's strategy;
(b) Forward looking;
(c) Monitors changes to the environment; and
(d) Includes a mix of financial and non-financial information.
1.6 Performance management systems are 'the systems in an organisation by which the
performance of an organisation is measured, controlled and improved' (source: ACCA
Examiner approach article).
1.7 Performance measurement is an essential part of performance management, and there

are many types of performance measures that you need to become familiar with in this
paper.
However, performance management is more than simply measuring. In order to manage a
company to help it to achieve its corporate objectives it is also necessary to:
 Take effective control action; this requires effective budgetary control and
appropriate information systems
 Improve business processes; information systems, environmental management,
transfer pricing, quality management, reward systems
These areas are the focus of many of the later chapters.
2 Benchmarking
2.1 Benchmarking is a business improvement technique which aims to analyse and bring about
best operational practice, it is a classic example of SMA.
2.2 Although generic definitions will earn minimal credit in the exam you should recognise the
broad classifications: Internal and External, which can be further subdivided into Competitive
and Functional.
2.3 Marks may be available for discussing the benefits and difficulties of benchmarking,
however this must be placed within the context of the scenario:
Internal benchmarking information should be easy to gather and highly relevant since
internal systems will be broadly similar, however the strong internal focus may fail to bring
about dramatic improvements as it is likely that different operating units are already in
relatively close contact, sharing information regularly.
Possible points to identify within the scenario:
 Are the business units similar or highly diversified, is internal benchmarking
information relevant?
 Is our current internal reporting adequate, can we easily collect the required
information?
 Is there evidence that the business already collaborate closely and therefore share
best practice?
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2.4 Competitive benchmarking information collected from a direct competitor will be the most
valuable. However due to its commercially sensitive nature it may be impossible to collect in
sufficient detail to be useful. It may be possible to negotiate an exchange of information with
an organisation that it not a direct competitor, however this may have less commercial
application.
Possible points to identify within the scenario:
 Is competitor information widely available, eg supermarket pricing information?
 Does the scenario indicate that a competitor may be willing to exchange information?
 Are the competitor's objectives and activities so dissimilar that they render
benchmarking information hard to apply?
2.5 You may be required to undertake some benchmarking calculations, the scenario may
provide the following information:
Admin Costs Business Unit A Business Unit B Business Unit C

$'000 $'000 $'000
Customer Support 2,100 2,150 2,300
Human Resources 1,200 1,180 1,500
IT Management 6,500 6,200 6,000
Number of Transactions 30,000 23,500 31,000

Number of Staff 8,000 7,800 8,300
The required calculations may not be complicated, you may be asked to evaluate the
organisation's benchmarked position by dividing the HR & IT costs by the number of
staff and the Customer Support costs by the number of transactions, with marks
divided between calculations and commentary.
2.6 This is not a 'number crunching' paper, you may therefore be required to comment on
calculations that have already been prepared (for example by a junior accountant).
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Lecture example 3 Benchmarking
'Subsequent' is a fashion retailer, which distributes through a portfolio of 105 stores and via
catalogue and online channels.
In response to increasing difficult trading conditions, Subsequent's board have requested a report
benchmarking the business against its main competitor 'Cavity'. The preliminary calculations have
been completed by a junior analyst; you have been asked by the Finance Director to analyse these
figures.
A sample of the report is provided below:
Cavity Subsequent
20X3 20X4 20X3 20X4
Revenue $m 2,100 1,900 1,950 2,000
Profit $m 290 190 330 250
No. of Stores 160 180 100 105
Change Year on Year
Revenue – –9.5% – +2.6%
Profit – –34.5% – –24.2%
No. of Stores – +12.5% – +5.0%
Revenue per Store $13.1 $10.6 $19.5 $19.0
Evaluate the performance of Subsequent using the data prepared by the analyst.
(1 mark per point made up to 4 for analysing the computations)
Solution
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2.7 Read the requirement carefully, you may not actually be asked to evaluate the benchmarked
performance of the organisation, you may for example be required to 'evaluate the
completeness of the benchmarking information', in this instance you would need to identify
what further benchmarking information would be useful or what further steps to take in
the benchmarking process.
2.8 Within this context you may make reference to the seven step benchmarking process
outlined below:
Description Application to the Scenario

Step 1 Set objectives and determine the Has the scenario outlined the objective
areas to benchmark. of the exercise, ie to reduce admin
costs or increase revenues?
Step 2 Establish key performance measures Have all the calculations been provided
or performance drivers which will be or does the question require you to
measured during the benchmarking calculate, for example revenue per
exercise. store and other KPIs? Are the KPIs
broad enough to be useful?
Step 3 Select organisations to compare Are you comparing against your nearest
performance against. competitor or another suitably similar
organisation? If not, criticise this.
Step 4 Measure own and others' performance, Is it plausible to measure competitor's
using the measures identified in Step 2 performance, is the data widely
above. available?
Step 5 Compare performances, and identify You may be asked to do complete this
gaps between the performance of your stage in the requirements: 'Analyse the
own organisation and those of the organisation's benchmarked position'.
comparator organisations.
Step 6 Design and implement improvement Is there narrative information on the
programme to close the performance scenario that describes how the
gaps identified. An important element of competitor is able to achieve higher
this step will also be analysing how the revenues or lower costs, is it practical to
comparator organisations achieve implement these changes, how quickly
superior performance, then assessing could this happen?
whether similar processes and
techniques could be introduced into
your own organisation.
Step 7 Monitor improvements. Benchmarking A post-project review may be required,
shouldn't be seen just as a one-off who should conduct it and can you
process; its value to an organisation make reference to people in the
comes from the ongoing improvements scenario?
in performance which result from the
initial comparisons (Steps 4 and 5
above).
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3 The use of strategic models to assist in performance

management
3.1 Strategic models that you have seen in Paper P3 can be useful in generating strategic
information.
There are three models that you need to be able to apply: SWOT (covered in the next
chapter), Porter's Five Forces and the BCG matrix.
Porter's Five Forces

3.2 Porter's Five Forces analyses the environment to identify factors that make an industry (or
company) profitable. In turn this permits plans to be put in place to mitigate forces acting on
the industry.
3.3 New
Entrants
Threat of New Entrants
Bargaining Power of Suppliers Bargaining Power of Buyers

Competition
Suppliers and Rivalry Buyers
Threat of Substitute Products or Services
Substitutes
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Lecture example 4 Exam standard question for 20 marks
F is a well known sports good manufacturer which sells its branded products worldwide. The
Marketing Director has applied Porter's Five Forces and reached the following conclusions:
 Threat of entry: Low, as F's size presents a large entry barrier.
 Power of buyers: Very important as customers worldwide have much choice from
different competitors.
 Power of suppliers: Little threat. Most of F's material suppliers are small and F could
easily find alternative sources of these. Labour is relatively cheap
as most of F's production facilities are based in developing
countries.
 Substitutes: Low, as there is little by way of a substitute for sports goods.
 Competitive rivalry: A major threat due to the constant launch of new products in this
competitive industry.
Required
Discuss the Five Forces acting on F to determine if you agree with the Marketing Director's
conclusions. Suggest performance indicators that would enable the strength of the forces to be
assessed.
Solution
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BCG matrix
3.4 This technique examines the interrelationships between the range of products and/or
services offered by an organisation.
3.5 Analysis can take place at two levels:

(a) Product/service level: the brands or products/services offered by the firm are
examined to determine their current position and prospects.
(b) Corporate level: the strategic business units of the diversified firm are examined for
their interrelationships and balance.
3.6 The BCG matrix classifies products and/or services in terms of potential cash generation
and cash expenditure requirements. The matrix presupposes that there are only two factors
that directly influence competitive position:
(a) The growth rate of the market segment the organisation serves
(b) The relative market share of the segment held by the organisation.
Relative market share
HIGH LOW
HIGH
Market STARS QUESTION MARK

Growth
LOW CASH COW DOG
3.7 (a) A question mark (or problem child) is a product in a high growth market, but holding
a relatively low market share.
Considerable expenditure may be required to turn a problem child into a rising star,
consequently they tend to be poor cash generators and show a negative cash flow.
(b) Stars are products or services with a high share of a high growth market.
In the short term, they require expenditure in excess of cash generated to main
relative market position. However, they promise high returns in the future.
(c) Cash cows hold a high share of a low growth, mature market.
They generate more cash than they incur, and finance growth of rising stars and
problem children.
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(d) A dog is a product with a low share of a low growth market.

Often they are cash cows fallen on hard times, and unless the trend can be reversed
(classified as a war horse) they should be allowed to die off.
Uses of BCG analysis

3.8 Internal balance should be checked.
(a) Proper distribution of resources between products eg largest should be stars or cash
cows
(b) Sufficient cash flows from cash cows to:
(i) Cover corporate overheads;
(ii) Permit investment in question marks and stars;
(iii) Pay interest on corporate debt; and
(iv) Provide dividends to shareholders.
(c) There should be sufficient successor products (and services) to replace declining
stars and cash cows:
(i) To provide long-term funds to finance the strategic plan
(ii) To absorb cash surpluses now
3.9 Assess trends by mapping matrix at regular intervals and superimposing on earlier
matrices to reveal direction and momentum of each product.
3.10 Evaluate competitors by creation of portfolios based on their products or business

divisions.
3.11 Evaluate risk by adjusting portfolio to reflect impact of hypothetical scenarios or changes in
key environmental variables. This can be accomplished by sensitivity analysis.
Lecture example 5 Exam standard class exercise (to be completed at home)

(to be completed at home)
The Specialist Clothing Company Ltd (SCC Ltd) is a manufacturer of a wide range of clothing. Its
operations are organised into five divisions which are as follows: fashion, industrial, leisure,
children and footwear.
The Fashion division manufactures a narrow range of high quality clothing which is sold to a
leading retail store which has branches in every major city in its country of operation. The products
have very short life cycles.
The Industrial division manufactures a wide range of clothing which has been designed for use in
industrial environments. In an attempt to increase sales volumes, SCC Ltd introduced an online
ordering facility for these products (via its website) with effect from 1 June 20X5.
The Leisure division manufactures a narrow range of clothing designed for outdoor pursuits, such
as mountaineering and sky-diving, which it markets under its own, well-established 'Elite' brand
label.
The Children's division manufactures a range of school and casual wear which is sold to leading
retail stores.
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The Footwear division manufactures a narrow range of footwear.

The management accountant of SCC Ltd has gathered the following actual and forecast
information relating to the five divisions:
Year ending 31 May 20X4 20X5 20X6 20X7 20X8
Actual Actual Actual Forecast Forecast
Fashion
Market size ($m) 200.00 240.00 280.00 305.00 350.00
Revenue ($m) 1 10.00 14.40 22.40 30.50 35.00
Industrial
Market size ($m) 150.00 158.00 166.00 174.00 182.00
Revenue ($m) 11 5.00 5.10 5.20 115.30 115.40
Leisure
Market size ($m) 1 20.00 120.50 21.00 21.50 21.80
Revenue ($m) 1 13.60 114.20 114.70 115.00 115.20
Children
Market size ($m) 1 60.00 170.00 180.00 190.00 100.00
Revenue ($m) 11 2.00 112.10 112.20 112.30 2.40
Footwear
Market size ($m) 120.00 20.20 120.40 120.60 121.00
Revenue ($m) 0.50 1110.52 10.54 0.52 1110.50
The management accountant has also collated the following information relating to the market
share held at 31 May 20X6 by the market leader or nearest competitor in the markets in which
each division operates:
(%) Market share held by
largest rival
Division
Fashion 18
Industrial 15
Leisure 20
Children 28
Footwear 33
Required
(a) Use the Boston Consulting Group (BCG) matrix to analyse SCC's business and its
performance. (13 marks)
(b) Explain the implications of the BCG analysis for the choice of performance measures used
at SCC. (6 marks)
(c) Discuss two limitations of the BCG matrix as a performance management system.
(6 marks)
(Total = 25 marks)
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Solution
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Integrated reporting
3.12 Integrated reporting (IR) links to the themes of this chapter and to much of the P5 syllabus.
IR seeks to provide stakeholders with a concise summary of:
 Strategy
– Mission & objectives (Chapter 2), business model (Chapter 4), environmental
analysis & key opportunities and risks (Chapter 5)
 Impact on the broader environment
– Social, economic, environmental (environmental issues are considered in
Chapter 4)
 Performance
– Performance over the short & long-term, using financial & strategic non-
financial measures (covered in many chapters but especially Chapter 12)
3.13 The IIRC's International Integrated Reporting Framework encourages organisations to

report on the following areas:
 Financial – returns to shareholders
 Manufactured – investment in infrastructure
 Human – skills, motivation to innovate, ethical values and loyalty
 Intellectual – investment in intangible assets, patents, copyrights, software and brand
 Natural – impact on environment
 Social – relationships with customers, suppliers and the broader community
3.14 The concept of IR is intrinsic to Strategic Management Accounting and therefore is

present in much of the P5 syllabus.
For example:
 IR encourages an organisation to report on a range of financial and non-financial
measures, which is consistent with the Balanced Scorecard approach to performance
measurement (Chapter 12).
 Rather than focusing on narrow financial performance objectives, IR should
encourage management to focus on creating and sustaining value over the longer
term, this is the ethos of Strategic Management Accounting.
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Additional notes
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4 Conflict with short-term decisions

4.1 Once strategic decisions have been taken they need to be implemented via a series of
lower-level operational plans which focus on a shorter time horizon.
4.2 If strategies are to be successfully implemented there must be a clear link between strategic
decisions and operational planning.
This is often absent in businesses due to:
(a) Unrealistic budgets – Over-ambitious
– Under-resourced
(b) Management style
(c) Inadequate performance measurement – Inappropriate
– Dysfunctional
4.3 Operational planning is considered further in Chapters 2 and 3.
5 Role of the management accountant

Traditional
5.1 Traditionally management accountants were separated from the operations of any business.
Their role was to produce and report accounting information performance measures in an
independent and objective manner.
Modern
5.2 Research by Burns and Scapens found that there has been significant change in the role
of the management accountant.
The three main forces for these changes are:
(a) Technology
– Particularly quality and quantity of information technology
(b) Management structure
– Particularly the shift to participation in budgeting, forecasting and control
(c) Competition
– The need for a commercial orientation with greater strategic focus and less
emphasis on short term earnings
5.3 Where these internal and external forces exist they have given management accounting a
more strategic focus.
5.4 Management accountancy is often no longer about short-term control – it is about

managing the business. In other words there has been shift from performance
measurement to performance management ie acting as internal business consultants.
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6 Chapter summary
Section Topic Summary
1 Strategic Management SMA can be used to support the entire process of

Accounting (SMA) planning and control, as considers factors external to
the organisation as well as non-financial and
internally-generated information.
SMA techniques are essential for effective
performance management and are covered in depth
in the rest of this paper.
2 Benchmarking Benchmarking schemes enable precise
comparisons to be drawn between firms.
Benchmarking is best for firms which have to 'catch
up' rather than innovate.
It can be difficult to establish which firm is operating
the best approach and against whom the
comparisons should be drawn.
3 Strategic models Porter's Five Forces analyses the power of suppliers,
customers and competition and the threats of new
entrants and substitutes. The forces account for the
profitability of industries and organisations.
The BCG matrix positions an organisation's products
according to market share and market growth. It
helps organisations assess the balance of their
portfolios.
Integrated Reporting encourages organisations to
report on a range of strategic and environmental issues.
IR is intrinsic to Strategic Management Accounting
and is present in much of the P5 syllabus.
4 Conflict with short-term If strategies are to be successfully implemented there
decisions must be a clear link between strategic decisions and
operational planning. This is often absent in
businesses due to:
(a) Unrealistic plans;
(b) Management style; and
(c) Inadequate performance measurement.
5 Role of the The role of the management accountant has changed,
management and continues to do so because of changes in
accountant technology, management structure and
competition according to Burns & Scapens.
END OF CHAPTER
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Performance hierarchy

Discuss the purpose, structure and CFD a December 2009
content of a mission statement and its Q1v 'Cantor' June 2014
potential impact on business
performance.
Discuss how strategic objectives are CFD b,c December 2009
cascaded down the organisation via the
formulation of subsidiary performance
objectives.
Apply critical success factor analysis in Q1 Film Productions Dec 2010
developing performance metrics from Lopten Q1 Section A – December 2013
business objectives.
IC Q1 Sept / Dec 2015
LLA a Sept / Dec 2016
Identify and discuss the characteristics Amal, June 2012
of operational performance.
Discuss the relative significance of
planning as against controlling activities
at different levels in the performance
hierarchy.
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2: PERFORMANCE HIERARCHY
Overview
Performance hierarchy
Mission Critical Success Factors

(CSFs)
Mission statements SWOT
Key performance indicators

(KPIs)
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1 Performance hierarchy
1.1 To meet corporate objectives, it is important that strategic objectives are cascaded down the
organisation. Later we look at models that create a structure for doing this (eg Lynch &
Cross, Performance Pyramid); here the foundations of such models are introduced.
Mission Vague Timeless An expression of overall purpose and scope

of the organisation in line with the values
and expectations of stakeholders.
Critical success Those areas in which an organisation

factors (CSFs) needs to excel if it is to achieve success
The key issues arising from an assessment

of organisational competences (SW) and of
SWOT its business environment (OT).
Key Specific Timebound A more precise statement of aims in line

Performance with CSFs. May be financial or non
Indicators financial.
(KPIs)
2 Mission
2.1 It has been argued that to be effective corporate mission must contain four elements.
(a) Purpose: ie why and for whom the company exists.
(b) Strategy: the range of businesses in which the firm seeks to compete and some
indication of how it intends to compete.
(c) Policies and Behaviour Standards: guidelines which help staff decide what to do on
a day-to-day basis to carry out the strategy.
(d) Values: beliefs and moral principles which lie behind the firm's culture.
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2.2
Advantages Criticisms
Communicates the nature of the organisation Generally full of meaningless phrases (eg
to stakeholders quality, best, etc).
Communicates the desired culture and May not be a true representation of the
behaviour culture or goals of the organisation.
Focus for developing performance measures Useless if it lacks detailed objectives and
programmes for implementation.
3 Critical Success Factors (CSFs) & SWOT

3.1 CSFs are those areas in which an organisation needs to excel if it is to achieve success.
3.2 CSFs can be identified by considering:

 A company's mission/strategy
 The environment
3.3 CSFs can be classified as:

 Monitoring – these relate to day-to-day activities and are generally more operational
in nature eg stock availability, defect-free production
 Building – these relate to adapting the organisation to meet environmental changes,
these are generally more strategic in nature eg innovating, developing new
competences
3.4 SWOT analysis is a critical assessment of the strengths and weaknesses,

opportunities and threats affecting an entity in order to establish its condition prior to the
preparation of a strategic plan.
SWOT analysis creates a structure for considering the design of CSFs eg if quality problems
are a weakness, this could lead to the identification of 'improving supplier relationships' as a
CSF.
Strengths & Weaknesses Involve consideration of internal factors
Opportunities & Threats Involve consideration of external factors
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4 Key Performance Indicators (KPIs)

4.1 KPIs should be designed to address the key issues identified by a CSF or SWOT
analysis, to ensure that stepping stones to achieving corporate goals are put in place.
4.2 KPI measures should be:
S – specific
M – measurable
A – agreed
R – realistic
T – time bound
4.3 The system of objectives ranges from high level general objectives to lower level goals for
particular individuals in a clear structure.
MISSION
Corporate
Objectives
Business
Objectives Vertical consistency
Operational
Time consistency
Objectives
Individual
Objectives
Horizontal consistency
4.4 CSFs and KPIs should influence the design of an entity's MIS (see later).
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Lecture example 1 Exam standard exercise
RCH, an international publishing company with a very strong brand image has recently taken over
TDM, an educational institution based in Western Europe. RCH has a very good reputation for
improving the profitability of its business units and prides itself on its customer focus. The CEO of
RCH was recently quoted as saying 'Our success is built on happy customers: we give them what
they want'. RCH continually conducts market and customer research and uses the results of these
researches to inform both its operational and longer term strategies.
TDM is well-established and has always traded profitably. It offers a variety of courses including
degrees both at Bachelor and Masters levels and courses aimed at professional qualifications.
TDM has always concentrated on the quality of its courses and learning materials. TDM has never
seen the need for market and customer research as it has always achieved its sales targets. Its
students consistently achieve passes on a par with the national average. TDM has always had the
largest market share in its sector even though new entrants continually enter the market. TDM has
a good reputation and has not felt the need to invest significantly in marketing activities. In recent
years, TDM has experienced an increasing rate of employee turnover.
RCH has developed a sophisticated set of critical success factors which is integrated into its real-
time information system. RCH's rationale for the take-over of TDM was the belief that it could
export its customer focus and control system, based on critical success factors, to TDM. RCH
believed that this would transform TDM's performance and increase the wealth of RCH's
shareholders.
Required
(i) Identify four critical success factors which would be appropriate to use for TDM.
(4 marks)
(ii) Recommend, with reasons, two key performance indicators to support each of the four
Critical Success Factors you have identified. (10 marks)
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Solution
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5 Chapter summary
1 Performance hierarchy To meet corporate objectives, it is important that

strategic objectives are cascaded down the
organisation by creating specific KPIs which relate to
CSFs which in turn link back to mission/strategy.
2 Mission An organisation's vision can be set out in a mission
statement.
Missions should be brief, distinctive, flexible and
customer focused.
3 CSFs / SWOT Higher-level goals can be described in terms of
critical success factors, and lower-level performance
measures can be described as key performance
indicators.
4 KPIs KPIs should derive from CSFs and should be SMART.
They allow for control as well as planning.
Objectives must be consistent throughout an
organisation in time and both horizontally and
vertically.
END OF CHAPTER
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Performance
management and control

Evaluate the strengths and DG – Q2a-c Dec 2012
weaknesses of alternative BEC – Q1 Dec 2009
budgeting models and compare
Albacore – Dec 2011 part a
such techniques as fixed and
flexible, rolling, activity-based, Godel – June 2014 part b
zero-based and incremental. Perkin – Sept / Dec 2015 part a
Framiltone – Sept / Dec 2016
Evaluate different types of Godel – June 2014 part a
budget variances and how these Perkin – Sept / Dec 2015 part c
relate to issues in planning and
controlling organisations.
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3: PERFORMANCE MANAGEMENT AND CONTROL
Overview
Performance management and

control
Types of variances Budget systems
Operational Planning
Zero-based budgeting Flexed Learning curves

(ZBB)
Incremental / Rolling Activity-based budgeting

flexed (ABB)
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1 The performance cycle and budgeting approaches

1.1 Budgeting is one key method to link strategy to operations. Budgets provide greater detail
about how plans will be implemented, and they communicate with and control lower level
employees.
Performance cycle stage Benefits
Planning Budget holders are forced to plan how to hit targets

that should ensure that the company's strategic
plan (eg overall sales, margins, quality levels) is
achieved.
Responsibility Allocates responsibility to clearly specify which
managers control which costs (responsibility
accounting).
Integration Ensures that the planned activities of one business
area does not conflict with another (eg production
and sales).
Motivation Involvement and participation of staff
Achievable targets
Evaluation Trends can be spotted

Financial and non financial control
Variances investigated and corrected
Advantages and disadvantages of budgeting approaches

1.2 Budgets are all designed to achieve the same end – better performance – but there are
different approaches to budgeting.
Approach Advantages Disadvantages

Incremental budgeting Easy. Can be flexed to actual Encourages slack/unlikely to
activity levels to provide more improve performance
meaningful control Does not consider alternatives
information.
Flexible budgets Highlights costs of unused Most costs fixed in modern
capacity business
Rolling budgets More up to date Time
(always budgeting one Motivating Management effort
year ahead)
Zero-based budgeting Responds to environment Time
Close to business Training
Increased efficiency Participation required
Activity-based Links to strategy/objectives Time
budgeting Identifies critical success Effort
factors
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2 Preparing budgets
2.1 Exam questions often require you to prepare or analyse a budget. The following example is
based on a past exam question.
Lecture example 1
X is a high growth non-alcoholic drinks company, currently it uses a system of incremental
budgeting. X has been receiving complaints from customers about late deliveries and poor quality
control. X's managers have explained that they are working hard within the budget and capital
constraints imposed by the board and have expressed a desire to be less controlled.
X's incremental budget for the current year is given below. You can assume that cost of sales and
distribution costs are variable and administrative costs are fixed.
Q1 Q2 Q3 Q4 Total
$'000 $'000 $'000 $'000 $'000
Revenue 8,760 8,979 9,204 9,434 36,377
Cost of sales 4,818 4,939 5,062 5,189 20,008
Gross profit 3,942 4,040 4,142 4,245 16,369
Distribution costs 789 808 829 849 3,275
Administration costs 2,107 2,107 2,107 2,107 8,428
Operating profit 1,046 1,125 1,206 1,289 4,666
The actual figures for Quarter 1 (which has just completed) are:
$'000
Revenue 8,966
Cost of sales 4,932
Gross profit 4,034
Distribution costs 807
Administration costs 2,107
Operating profit 1,120
On the basis of the Q1 results, sales volume growth of 3% per quarter is now expected.
Required
Recalculate the budget for X using rolling budgeting and assess the use of rolling budgets in this
context. (8 marks)
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Solution
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3 Types of variances
3.1 Traditional variances can be investigated further to look at the elements driven by:
 Errors in the budget, these are planning variances; and
 Elements that were within the manager's control, these are operational variances.
Advantages of revising the budget

3.2 (a) Highlights those variances which are controllable and those which aren't.
(b) Ensures that operational performance is appraised by reference to realistic targets.
(c) Should ensure that future budgets are more realistic.
Disadvantages of revising the budget

3.3 (a) Determination of revised budget:
 May be biased
 May need external information
(b) Use of revised budget may undermine original budget as a target and as a motivator.
(c) Employees may use this system to their advantage by excusing operating problems
as poor planning if this method is used.
3.4 A budget should only be revised for items that are beyond the control of the organisation.
Lecture example 2
Anzo Co makes a range of precision parts for two large vehicle manufacturers. The strategy of the
business has been to be a leader in flexible, high quality manufacturing.
The CEO has asked for your assistance in understanding the key variances from the latest
operating statement and possible action to be taken as a result of these specific variances.
Operating statement (extract) for Anzo Co for 20X4
($'000) Favourable Adverse
Sales variances Volume 1,050
Price 448
Cost variances Total 1,063
Detailed variances
Cost variances Planning 660

Operational 403
Sales price variances Planning 180

Operational 628
The budget profit for 20X4 was $17.5 million.
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Required
Advise the CEO on the implications for performance management at Anzo Co of analysing
variances into the planning and operational elements as shown above.
Solution
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Additional notes
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4 Learning curves
4.1 To assist in the production of more challenging budgets, a learning effect can be estimated.
Theory
4.2 As cumulative output doubles, the cumulative average time/unit falls to a given percentage
of the previous cumulative average time/unit (cumulative = all units produced so far).
4.3 The theory of learning curves will only hold if the following conditions apply:
(a) There is a significant manual element in the task and the task must be repetitive.
(c) Production must be at an early stage so that there is room for improvement.
(d) There must be consistency in the workforce and the workforce must be motivated.
Learning effect
Cumulative
average time
per unit
Steady state
Cumulative output
4.4 The 'experience curve' covers all costs that may reduce due to technological and
managerial learning effects, following an increase in production volumes:
(a) Material costs may decrease with quantity discounts.
(b) Variable overheads follow the pattern of direct labour.
(c) Fixed overheads per unit will decrease as production volumes rise.
4.5 The learning and experience curves are exploited through rapid growth and high market
share.
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5 Chapter summary
1 Performance cycle and Budgets are designed to achieve better performance
budgeting approaches through planning, communication, motivation,
performance evaluation and control. Traditional
budgeting approaches are criticised for their lack of
flexibility to environmental factors and their ability to
encourage inefficiency.
2 Preparing budgets Remember that budgets need to presented
professionally.
3 Planning and Planning variances represent the difference between
operational variances the original and revised budget.
Operational variances are those items which were
within a manager's control. They are the difference
between the revised budget and the actual.
4 Learning curves When new products or processes are planned,
budgets may need to incorporate the effects of
learning curves.
The experience effect is wider than learning and
covers reductions due to technology, managers and
increased volumes.
END OF CHAPTER
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Achievement Ladder Step 1
You have now covered the Topics that will be assessed in Step 1 of your Achievement Ladder.
It is vital in terms of your progress towards 'exam readiness' that you attempt this Step in the near future.
You will receive feedback on your performance, and you can use the wide range of online resources and
ongoing BPP support to help address any improvement areas. This will help you to tailor your learning
exactly to your own individual requirements.
Course notes
Topic name Subtopic/Chapter name
Chapter
Strategic management accounting 1
Strategic management and
Performance hierarchy 2
control
Performance management and control 3
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Achievement Ladder
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Organisational change,
environmental and
ethical issues

Identify and discuss the information needs of firms adopting a functional,
divisional or network form and implications for performance management.
Assess the changing accounting needs of modern service based firms Kolmog Q1i June 2013
compared with the needs of traditional manufacturing industry.
Assess the influence of business process re-engineering on systems Booxe part b June 2014
development and improvements in performance (covered in Chapter 10). Cuthbert part a March / June 2016
Analyse the role that performance management systems play in business MS June 2015 Q1v
integration using models such as the value chain and McKinsey's 7Ss.
Discuss how changing structure, culture and strategy will influence the
adoption of new performance measurement methods and techniques.
Assess the need for business to refine and develop their management Film productions Q1 Dec 2010
accounting and information systems (information systems are covered in DG – December 2012
Chapter 6).
Kolmog Q1 – June 2013
Highlight the ways in which contingent (internal and external) factors
influence management accounting and its design and use.
Discuss the ways in which stakeholder groups operate and how they Pharma Tech part b June 2011
influence an organisation, its strategy formulation and implementation and Boltzman Q1ii Dec 2014
performance (eg using Mendelow's matrix).
Discuss the ethical issues that may impact on strategy and performance
Discuss, evaluate and apply environmental management accounting using FGH Dec 2010
for example lifecycle costing and ABC. PLX June 2011
Landual June 2013
Lopten Q1 – Dec 2013
Alflonnso Sept / Dec 2016
Discuss the problems encountered in planning, controlling and measuring Forion part b June 2015
performance levels in complex business structures. Callisto part a June 2012
Discuss the impact on performance management of the use of strategic Turing part c June 2014
alliances, joint ventures and complex supply chain structures. Callisto part a June 2012
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4: ORGANISATIONAL CHANGE, ENVIRONMENTAL AND ETHICAL ISSUES
Overview
Organisational change,
environmental and ethical issues
Business integration Influence of stakeholders and

ethical issues
Environmental management
Services vs accounting
manufacturing
Value chain 7S model
Porter's
generic
strategies
Performance management
issues in:
Functions Divisions Complex

structures
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1 Performance management in different business

structures
Functional
1.1 Functional departments are based on segregation of skills and responsibilities and are
typically the first (and lowest) form of delegation.
Head office
Senior management
Production Sales Advertising Distribution Administration
1.2 Information will be needed to support each individual department, this will often take the
form of a variances report.
1.3 Performance management will become challenging as the organisation grows because of
the heavily centralised structure.
Divisional
1.4 As businesses grow they devolve power to lower level managers and create autonomous
divisions. These may be based on product ranges or market segments.
Head office
Senior management
Market 1 Market 2 Market 3
Production Sales Administration
1.5 Divisional performance measures will need to be created that reflect the areas that are
controllable by divisional management (see later). There will also be performance
management issues arising from divisions trading with each other (see later).
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More complex business structures

1.6 It is increasingly common for organisation's to form relationships with each other ie to create
a network of business relationships.
This could take a variety of forms:
(a) Informal alliances
(b) Long-term outsourcing agreements
(c) Joint ventures
1.7 This approach has the advantage of being flexible, and allows each element of the network
to work together using their individual areas of expertise.
1.8 However, this approach creates a number of challenges for performance management:
 Slow decision-making
 Differing objectives
 Different cultures and management styles
 Sharing data
 Fair allocation of rewards
 Creating reliable data to monitor service level agreements
2 Performance management in service businesses

2.1 It has been argued that performance management for modern service based firms create
extra challenges for performance management (compared to traditional manufacturing)
because services are:
Simultaneous – production and consumption occur at the same time
Heterogeneous – the service varies from day to day or employee to employee
Intangible – no physical offering to assess customer value
Perishable – services only last for a period of time and cannot be stored
2.2 These differences mean that the performance management will need to adapt, for example
it could be argued that:
 Information requirements of service businesses will be broader than that of
manufacturers.
 More qualitative information will be required concerning customer satisfaction and
employee morale.
 Most of the expenses in service businesses are overheads, making activity based
cost information more valuable.
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3 Business integration
3.1 Performance management can be enhanced by the use of the value chain (Porter) to
enhance the linkages between activities within (and outside) the organisation.
Alternatively the McKinsey 7S model could be used, this is covered in the additional notes at
the end of the chapter.
Value chain
FIRM INFRASTRUCTURE
ACTIVITIES
SUPPORT
TECHNOLOGY DEVELOPMENT
HUMAN RESOURCE MANAGEMENT
MA
RG
PROCUREMENT
MA
R IN
GI
N
INBOUND OPERATIONS OUTBOUND MARKETING AFTER-
LOGISTICS LOGISTICS & SALES SALES
SERVICE
PRIMARY ACTIVITIES
3.2 (a) Activities in the value chain affect one another. For example, more costly product
design or better quality production might reduce the need for after-sales service.
(b) Linkages require co-ordination. For example, just-in-time requires smooth
functioning of operations, outbound logistics and service activities such as installation.
3.3 An organisation can use the value chain to improve performance in the following ways:
(a) Invent new or better ways to perform activities.
(b) Combine activities in new or better ways.
(c) Manage the linkages in its own value chain.
(d) Manage the linkages in the value system with other companies.
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Value chain and Porter's generic strategies

3.4 Michael Porter (1980) argues that, to compete successfully, a firm either needs to be the
lowest cost producer (cost leadership strategy), or to differentiate its products from
competitors' products in a way which customers value (differentiation strategy).
Cost leadership Differentiation
3.5 Porter argues that if a firm tries to combine different generic strategies it risks losing its
competitive advantage and becoming 'stuck in the middle'.
3.6 Cost leadership and differentiation are industry-wide strategies. However, a firm could also
adopt a focus strategy, restricting its activities to a segment of the market and pursuing a
strategy of cost leadership or differentiation within its chosen market niche. Focusing on a
specific niche could either be due to lack of resources or as a strategy to minimise costs or
to differentiate effectively.
Cost leadership – implications for performance management

3.7 A cost leadership strategy has a number of implications for the design of the value chain
and for performance management:
 In the firm infrastructure, financial control is likely to be crucial. There may an
emphasis on variance analysis, and a focus on maximising efficiency and reducing
waste.
 Production facilities are likely to be set up to obtain economies of scale and to mass
produce goods wherever possible. Firms may try to exploit the learning curve effect.
By producing more items than its rivals, a firm can achieve lower average costs.
 The desire to be a cost leader may also encourage Kaizen costing and continuous
improvement (see later). If competitors are reducing their costs, a cost leader will also
need to reduce its costs in order to ensure that its costs remain lower than its rivals.
 This need for a firm to consider its costs relative to the costs of other firms also
suggests the potential importance of benchmarking – this has been covered in
Chapter 1.
Differentiation – implications for performance management

3.8 A differentiation strategy has different implications for the design of the value chain, and
many of the points in the previous paragraph would not be appropriate to support this type
of strategy. In this case a value chain is likely to feature the following:
 Use of marketing to build up a brand image
 Giving the product special features to make it stand out
 Improving the quality of after-sales service or speed of delivery
 Firm infrastructure will place less emphasis on variance analysis and more on non-
financial performance measures. This links back to the idea of critical success
factors and performance indicators
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4 Environmental management accounting (EMA)

4.1 EMA involves the generation and analysis of financial and non-financial information in order
to support internal environmental management processes.
4.2 EMA is becoming more important for a number of reasons:
(a) Raised profile of environmental issues
(b) Increased reputation, litigation or financial risk caused by poor behaviour
(c) Conventional systems do not identify or control environmental costs
(d) Environmental management is a key component of TQM (avoidance of waste)
4.3 Suitable management accounting techniques for EMA include:
(a) Activity-based costing (ABC)
(b) Lifecycle costing
ABC
4.4 More companies are now identifying and measuring direct environmental costs by revising
allocation bases so as to separate out indirect environmental costs using activity-based
costing, (Domil & Perez).
Using ABC, environmental costs are removed from overhead costs and traced to products
and services by identifying the resources, activities and costs used to produce the output.
4.5 Removing environmental costs from overhead costs and accurately allocating them to
specific products results in far fewer distortions in product costing and provides useful
control information for environmental management.
Lecture example 1
Fantasia, a glass manufacturer, has identified the following activities and cost drivers relating to
environmental costs :
$'000 Cost drivers '000
Preventing air pollution 2,450 Waste emissions kg 7
3
Preventing water pollution 3,520 Waste water output m 1,600
General waste recycling & disposal 2,520 Kg of general waste 3.0
Hazardous waste recycling & disposal 3,680 Kg of recycled waste 1.6
Monitoring environmental impact 275 Internal audit hours 1.1
Environmental training 835 Training time (hours) 0.5
R&D related to environment 7,420 R&D hours 140
Total 20,700
Fantasia makes two products – Products A and B.
Currently environmental costs are a part of Fantasia's general overhead pool and apportioned per
unit. Fantasia produces 82,000 units of Product A and 8,000 units of Product B.
An ABC analysis of this environmental data has been prepared by a junior financial analyst who
has now been transferred to another department. Her workings are correct but are incomplete.
Required:
Complete the ABC analysis and comment on its implications for performance management.
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Solution
Cost driver charge out rates
Waste emissions Kg $350 per kg
Waste water output m 3 $2.2 per m 3
kg of general waste $840 per kg
kg of recycled waste $2,300 per kg
Internal audit hours $250 per hour
Training time (hours) $1,670 per hour
R&D hours $53 per hour
Product A Product B
Activity Cost Cost/unit Activity Cost Cost/unit
'000 $'000 '000 $'000
Air pollution 6.3 2205 26.9 0.7 245 30.6
Water pollution 1120 2464 30.0
General waste 2.7 2268 27.7 0.3 252 31.5
Hazardous waste 0.8 1840 22.4
Monitoring 0.6 150 1.8 0.5 125 15.6
Training 0.3 501 6.1 0.2
R&D 90 4770 58.2 50
Total 173.1
Lifecycle costing
4.6 This estimates and records a product or project's costs over its whole life rather than for a
single year, or a specific phase of the product life ie the production phase.
Applying this concept to environmental issues can usefully highlight environmental costs
incurred prior to production (compliance with environmental legislation) and costs incurred
after production (cleaning up the site after production).
This can help to ensure that investment appraisal captures all the costs that are relevant to
a project.
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Lecture example 2
F Co is considering a new product which is expected to have a limited market life of three years.
The accounting team have forecast the following data associated with this product and calculated
F's traditional performance measure of product profit for the new product:
All figures are $m's
20X2 20X3 20X4
Revenue 45.0 47.5 55.1
Costs
Production costs 26.8 26.1 28.6
Marketing costs 8.0 6.0 5.0
Development costs 5.6 3.0 0.0
Product profit 4.6 12.4 21.5
Subsequently, the following environmental costs have been identified from F Co's general
overheads as associated with the production of the new product.
$m 20X2 20X3 20X4
Waste filtration 2.7 2.7 2.7
Carbon dioxide exhaust extraction 1.7 1.8 1.8
Additionally, other costs associated with closing down and recycling the equipment involved in
production and clearing up the site used for production are estimated at $18m in 20X4.
Required
Evaluate the costing approach used for performance measurement compared to a lifecycle costing
approach, performing appropriate calculations. (7 marks)
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Solution
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Additional notes
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5 Stakeholders & ethical issues

5.1 Mendelow's (power/interest) matrix can be used to identify the key stakeholders
Interest
Low High
Low
MINIMAL EFFORT KEEP INFORMED

Power
High
KEEP SATISFIED KEY PLAYERS
5.2 Stakeholders have an interest in what the organisation does.
Group Example
Internal Employees
Connected Shareholders, customers
External Government, community, pressure groups
5.3 Stakeholders can influence the strategy adopted by an organisation and its performance;
this means that some powerful stakeholders (key players in Mendelow's matrix),
notably staff, require careful management; this is covered later in the syllabus.
5.4 The need to consider stakeholder objectives is recognised in techniques such as the
balanced scorecard; this is covered later.
Ethical issues
5.5 As a business attempts to improve its performance, its operations may adversely impact on
its environment/staff/society as a whole. You may be expected to analyse whether this gives
rise to any ethical issues.
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6 McKinsey 7S model
6.1 McKinsey's 7S model provides a way of looking at an organisation as a set of
interconnected and interdependent subsystems. This interdependence highlights that
strategies adopted in any one area of an organisation (or changes to any of the strategies)
will have an impact on other parts of the organisation.
The model was designed to show how the various aspects of a business relate to one
another, and it characterizes the aspects of the business as seven 'S's.
6.2 McKinsey's 7S model describes the links between the organisation's behaviour as a
whole and the behaviour of individuals within it.
There are three 'hard' elements of business behaviour.
(a) Structure. The organisation structure refers to the formal division of tasks in the
organisation and the hierarchy of authority from the most senior to junior.
(b) Strategy. How the organisation plans to outperform its competitors, or how it intends
to achieve its objectives. This is linked to shared values.
(c) Systems. These include the technical systems of accounting, personnel, management
information and so forth. These are linked to the skills of the staff.
These 'hard' elements are easily quantified and defined, and deal with facts and rules.
'Soft' elements are equally important.
(a) Style refers to the corporate culture that is the shared assumptions, ways of
working, attitudes and beliefs. It is the way the organisation presents itself to the
outside world.
(b) Shared values are the guiding beliefs of people in the organisation as to why it
exists. (For example, people in a hospital seek to save lives.)
(c) Staff are the people in the organisation.
(d) Skills refer to those things that the organisation does well. For example, the UK
telecommunications company BT is good at providing a telephone service, but even if
its phone network is eventually used as a transmission medium for TV or films, BT is
unlikely to make those programmes itself.
All elements, both hard and soft, must pull in the same direction for the organisation to
be effective.
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7 Chapter summary
1 Performance More complex structures have led to the need a
management in number of challenges for performance management
different business eg decision making, control and reward allocation.
structures
2 Performance Services are characterised by:
management in – Simultaneity
services vs
– Heterogeneity
manufacturing
– Intangibility
– Perishability
Service businesses need the same basic information
as manufacturers but also benefit from information on
cost drivers, customer satisfaction and employee
morale.
3 Business integration The value chain enables organisations to understand
how activities link together.
The value chain represents the activities that an
organisation should undertake, or consider, to add
value to its products and services.
The value chain can be used to achieve competitive
advantage either by achieving a position of cost
leadership or differentiation (either in the whole
industry or focussing on a few segments).
4 Environmental EMA includes the analysis of both financial and non-
management financial information in order to support internal
accounting environmental management processes. ABC and
lifecycle costing could be applied here.
5 Stakeholders and Stakeholders have an interest in the actions and
ethical issues strategies of organisations. Not all stakeholders are
equal.
Corporate ethics can be embedded in mission
statements. Ethical dilemmas often exist when the
objectives of organisations and their stakeholders
conflict.
6 McKinsey 7S model McKinsey's 7S model offers an alternative view (to the
value chain) of how to integrate business activities.
END OF CHAPTER
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External influences on
organisational
performance

Assess the impact of different risk appetites
of stakeholders on performance F4U June 2009 part d
management. Mackerel December 2011 Q1 parts i-iii
MS Q1iii Section A – June 2015
Evaluate how risk and uncertainty play an
Turing Q3 June 2014 part a and b
important role in long term strategic planning
and decision-making that relies on
exogenous variables.
Apply different risk analysis techniques in
assessing business performance such as
maximin, maximax, minimax regret and EVs.
Discuss the need to consider the Albacore, Dec 2011 Q4b
environment in which an firm is operating Lopten Q1ii December 2013
when assessing its performance using
models such as PEST and Porter's Five Perkin Sept / Dec 2015 part b
Forces (covered in Chapter 1), including:
 Political climate
 Market conditions
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5: EXTERNAL INFLUENCES ON ORGANISATIONAL PERFORMANCE
Overview
External influences on
organisational performance
Assessing performance Risk and uncertainty

considering the environment
Political climate Market conditions
PEST
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1 Assessing performance considering the environment

1.1 All performance should be assessed against fair standards or targets. The performance
capability of a division will be affected by its external environment, and the performance
measures that are set should reflect this.
PEST
1.2 PEST analysis seeks to identify the main factors in the macro-environment which will
affect an organisation's performance.
Political factors
1.3 There are many ways in which the political climate can have a direct bearing on
performance:
 Is consumer spending affected by government spending and taxation decisions?
 Is the Government's corporation tax policy affecting the returns to an organisation?
 Regulations and legislation may affect the growth and profits in the industry (such as
minimum product quality standards or minimum wage legislation).
Economic environment
1.4 There are also many ways in which the economic environment can impact performance:
 Is the economy is growing or shrinking?
 Is a high inflation pushing up production costs?
Social factors
1.5 Different culture, tastes and lifestyles can influence the level of demand for a product in
different parts of the world.
Technological factors
1.6 The environment in different markets around the world can also differ due to the
technological environment eg different levels of take-up of e-commerce and m-commerce.
Market conditions
1.7 Market or industry conditions will also have a significant impact on performance. A powerful
tool for assessing market or industry conditions is Porter's Five Forces.
This has already been covered in Chapter 1.
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2 Risk and uncertainty

2.1 The possibility of changes to the external environment is a major source of risk and
uncertainty.
Performance management needs to consider the possibility (or probability) of changes in
the external environment (exogenous or uncontrollable variables).
Uncertainty
2.2 Uncertainty exists when the future is unknown and the decision maker has no past
experience on which to base predictions.
2.3 Sensitivity analysis is a method to quantify the maximum amount by which any variable can
change before a project becomes unattractive.
2.4 The smaller the %, the more sensitive the project is to this variable, and the greater the
need for accurate forecasting before a final decision is made.
Lecture example 1 Based on an extract from a past exam question
The grocery retailer has decided to make, in store, a new type of bread loaf that claims to reduce
cholesterol levels. The following information is available:
1 The number of loaves sold per year in the retailer's country of operation is 425 million. The
retailer expects this loaf to have a market share of 1%.
2 The average selling price of all loaves sold is $1.50. The retailer expects 85% of all loaves
to be sold, with the rest needing to be thrown away at the end of the day.
3 The average cost of ingredients per loaf is $0.60, of which $0.17 is caused by the special
ingredient that renders the loaf able to reduce cholesterol. There is only one supplier in the
market for this ingredient.
4 Packaging and labelling costs will be $0.12 per loaf.
5 Distribution costs are expected to be 4% of revenue.
6 Fixed overheads have been estimated to amount to $270,000 per annum to include all
wages and salaries costs as all employees are subject to fixed term employment contracts.
The finance director has stated that the target sales margin of 35% can be achieved, although she
is concerned about the effect that an increase in the cost of the special ingredient will have on the
forecast profits.
Required
Using only the above information, show how the finance director has reached her conclusion
regarding the expected sales margin and also state whether she is correct to be concerned about
an increase in the price of ingredients (assuming that all other revenue/cost data remains
unchanged).
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Solution
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Risk
2.5 Risk exists where a decision maker has knowledge that several different future outcomes
are possible, usually due to past experience. This past experience enables a decision maker
to estimate the probability of the likely occurrence of each potential future outcome.
2.6 Where there is risk, a range of possible future outcomes can be quantified (best, worst and
most likely) and probabilities assigned to them and an expected value or weighted average
of these outcomes calculated.
When faced with a number of alternative decisions, the one with the highest expected value
(EV) would be chosen.
2.7 EV = px
Where p is the probability of the outcome occurring and x is the value (profit or cost) of that
outcome.
Lecture example 2
John must decide how best to use a monthly factory capacity of 1,200 units. His demand from
regular customers is risky and as follows:
Monthly demand Probability
(units)
400 0.2
500 0.3
700 0.4
900 0.1
1.0
Regular customers generate contribution of £5 per unit. John has the opportunity to enter a special
contract which will generate contribution of only £3 per unit.
For the special contract John must enter a binding agreement now at a level of 800, 700, 500 or
300 units.
John has calculated the following contributions (in £) at various contract and demand levels.
Special contract (units)
Demand p 800 700 500 300
(units)
400 0.2 4,400 4,100 3,500 2,900
500 0.3 4,400 4,600 4,000 3,400
700 0.4 4,400 4,600 5,000 4,400
900 0.1 4,400 4,600 5,000 5,400
Required
Advise John as to the optimal level of special contract to commit to every month, assuming his aim
is to maximise profits.
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Solution

Demand p 800 700 500 300
(units)
400 0.2 4,400 4,100 3,500 2,900
500 0.3 4,400 4,600 4,000 3,400
700 0.4 4,400 4,600 5,000 4,400
900 0.1 4,400 4,600 5,000 5,400
Expected value
Limitations of EV
2.8 (a) Ignores risk preference
(b) Heavily dependent on probability estimates
(c) Long run average
(d) Inappropriate for one-off decisions.
Risk preference/attitude towards risk

2.9 (a) Risk seeker
– Interested in the best outcomes no matter how small a chance that they may
occur. For this risk appetite maximax may be appropriate. This involves
making decisions that are based on making the maximum possible return
(regardless of the probability of this).
(b) Risk averse
– Acts on the assumption that the worst outcome might occur. For this risk
appetite maximin may be appropriate. This involves selecting decisions that
minimise downside risk by selecting the option that gives the best of the worst
outcomes (regardless of the probability of the worst outcomes occurring).
Minimax regret may also be appropriate here, this is where a decision is chosen that
minimises the impact of it turning out to be the wrong decision.
(c) Risk neutral
– Only a risk neutral decision maker will be concerned with the most likely
outcome, using expected values.
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Lecture example 3 Technique demonstration
Required
Advise John as to the optimal level of special contract to commit to every month, assuming:
(a) John is a risk seeker
(b) John is risk averse
Solution
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Joint probability tables

2.10 If two variables are uncertain or risky it may be helpful to record the range of possible
outcomes in a joint probability table.
2.11 These tables do not permit a decision to be taken but do allow the risks to be assessed.
Lecture example 4 Based on a past exam question worth 10 marks
Brown Ltd makes and sells a single product for which current profits are $25,000 per annum.
The company is confident that the product can be manufactured for a variable cost of $19, but is
contemplating a change in marketing and distribution which could have an effect on both sales
demand and sales price. Brown Ltd believes that the following circumstances could occur:
Price Prob Demand Prob
$ '000 units
28 0.2 30 0.4
29 0.35 35 0.5
30 0.45 40 0.1
Brown Ltd has fixed costs of $320,000.
Manager A has suggested that the changes should be made only if they will generate an expected
profit of at least the current level of $25,000.
Required
Complete the following analysis (which has been partially completed) and discuss the impact of the
possible changes in marketing and distribution on the profits of Brown Ltd.
Solution
Pay-off table ($'000)

Demand ('000 units)
Price 30 35 40
$
28 270 315
29 300 350
30 330 385
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Joint probability table

Demand ('000 units)
30 35 40
Price Prob 0.4 0.5 0.1
$
28 0.2 0.08 0.1
29 0.35 0.14 0.175
30 0.45 0.18 0.225
Expected value ($'000)

Demand ('000 units)
Price 30 35 40
$
28 21.6 31.5
29 42.0 61.25
30 59.4 86.625
EV = px =
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Additional notes
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Perfect information (b/f from F5)

2.12 Information may be available about uncertain variables eg. market research. If this
information is guaranteed to predict the future with certainty it is defined as perfect
information. Perfect information removes risk. It is, therefore, valuable.
2.13 Value of perfect information (VOPI)

EV (with perfect information) X
EV (no perfect information) (X)
VOPI X
John has been contacted by a market research company, which guarantees that the results of its
survey will be 100% correct. These results will enable John to ascertain the demand from his
regular customers every month, in advance of accepting the special order.
Required
What is the maximum amount that John should pay for the survey? Note the expected value of
contribution without perfect information is $4,500 (from Lecture example 2).
Demand p 800 700 500 300
units
400 0.2 4,400
500 0.3 4,600
700 0.4 5,000
900 0.1 5,400
Solution
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Breakeven analysis and margin of safety (b/f from F5)

2.14 Breakeven analysis is another application of sensitivity analysis. Most businesses need to
at least breakeven when setting prices and output levels. Margin of safety measures by how
much sales may decrease before a loss occurs (ie the breakeven point is reached).
Assumptions
2.15 Constant…
(a) Selling price per unit
(b) Variable cost per unit
(c) Total fixed costs
Fixed costs
2.16 Breakeven point =
Unit contribution
Margin of safety = Budgeted sales – Breakeven sales
Budgeted sales – Breakeven sales

Margin of safety (%) =
Budgeted sales
Lecture example 6
XYZ Co sells a single product for which data is given below:
Per unit
$
Selling price 15
Variable cost 9
Fixed cost 3
The fixed costs are based on a budgeted level of activity of 7,500 units for the period.
Required
Complete the following:
XYZ needs to make units in order to breakeven. If the fixed costs increase by 50%, they
will have a margin of safety of %.
The number of units they need to sell in order to make a profit of $9,000 for the period (assuming
fixed costs do not increase at all) is units.
If variable costs increase by 10%, selling price goes up by 20%, and fixed costs stay the same, the
% change in the number of units in order to achieve the required level of profit will be %.
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Solution
Workings:
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Lecture example 7 Homework exercise
The Creative Division (CD) of Unique Components Ltd produces wooden components. Production
involves preparation of timber, cutting it into shapes and assembly of the shapes into components.
The total component cost for Component A has been estimated as $41.21 per unit.
A redesign of Component A is being considered that is likely to result in changes in the quantity of
timber and number of cuts, in the shaping process that will be required. A data-table analysis has
been prepared to monitor the effect on unit cost for Component A of a range of values for such
changes. In addition, a set of subjective probabilities have been assigned to the likelihood of (i) the
timber required and (ii) the number of cuts required, being at the levels shown in the data-table
analysis. A matrix has been constructed showing the combined probability for each possible
combination of changes of timber and number of cuts. The data-table analysis and combined
probability matrix are as follows:
Data-table of values of total component cost for Component A per unit ($) for a range of values of
number of cuts in shaping and timber required (square metres):
Timber Number of cuts

m2 25 30 35 40 50
0.8 47.15 47.69 48.15 48.55 49.21
0.7 43.50 44.04 44.50 44.90 45.56
0.6 39.81 40.34 40.81 41.21 41.87
0.5 36.07 36.61 37.07 37.47 38.13
0.4 32.28 32.81 33.28 33.68 34.34
Combined probability matrix showing combined probability values for a range of values of number
of cuts in shaping and timber required (square metres):
Timber Number of cuts

m2 25 30 35 40 50
Prob 0.2 0.3 0.3 0.1 0.1
0.8 0.1 0.02 0.03 0.03 0.01 0.01
0.7 0.2 0.04 0.06 0.06 0.02 0.02
0.6 0.2 0.04 0.06 0.06 0.02 0.02
0.5 0.4 0.08 0.12 0.12 0.04 0.04
0.4 0.1 0.02 0.03 0.03 0.01 0.01
Note. The expected value of unit cost, based on above data-table and combined probability matrix
is $39.84.
You may assume that management attitudes vary as follows:
(i) Some of the management team are in favour of change provided that a reduction of at least
12% from the existing total unit cost is achieved;
(ii) Others in the management team are not in favour of change if it might lead to an increase in
total unit cost from the current level of $41.21; and
(iii) The remainder of the management team are of the view that they are willing to consider the
re-design change if the expected value (EV) solution is less than the current value of total
unit cost.
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Required
Discuss the impact of the possible changes in the quantity of timber and number of cuts in the
Shaping process caused by the re-design of component A on the total cost per unit of Component A.
You should incorporate an analysis of statistics from the data-table and probability information
contained in the model into your discussion with specific reference to the impact of management
attitude to risk when deciding whether or not to change from the existing quantity of timber and
number of cuts for Component A. (10 marks)
Solution
Workings:
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3 Chapter summary
1 Assessing Before performance can be assessed a wide range of
performance environmental issues should be considered.
2 Risk and uncertainty Assessing uncertainty (using sensitivity analysis)
and risk (using expected values and payoff tables)
is an essential element of strategic decision making.
Risk seekers are more likely to use maximax and if
decision makers are risk averse they are more likely
to use maximin or minimax regret.
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END OF CHAPTER
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You have now covered the Topics that will be assessed in Step 2 of your Achievement Ladder. This
mainly focuses on the shaded topics below but will also include some recap questions on earlier
topics.
Course notes
chapter
control
Organisational change, environmental
Business structures 4
and ethical issues
External influences on organisational
Business environment 5
performance
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Achievement Ladder
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Performance
measurement systems
and design

Example past
Syllabus learning outcomes paper questions
Performance management information systems Bluefin Q3b Dec '11
Discuss, with reference to performance management, ways in which the information requirements Metis June 2012 Q1i
of a management structure are affected by the features of the structure. Quark Q3 Dec '13
Evaluate the compatibility of management accounting objectives and the MIS. Discuss the Booxe Q2b June '14
integration of management accounting information within an overall IS eg the use of an ERPS.
Forion Q2a June '15
Evaluate if the MIS is lean and the value of the information that they provide.
Posie Q3b S/D '15
Evaluate how human behaviour will influence the design of a management accounting system.
Flack M/J '16 Q1v
Monza S/D '16 Q1v
Sources of management information FP Dec 2010 Q1b
Discuss internal and external sources management accounting information, their costs and Forion Q2a June '15
limitations. Demonstrate how the information might be used in planning and controlling activities eg
benchmarking (covered in Chapter 1).
Discuss the development of Big Data & its impact on perf mgt (including risks and challenges).
Recording & processing methods Bluefin, Q3c Dec '11
Demonstrate how the type of business entity will influence the recording and processing methods. Quark Q3b Dec '13
Discuss how IT developments may influence management accounting systems.
Explain how information systems provide instant access to data (eg ERPS and data warehouses).
Discuss the difficulties associated with recording and processing data of a qualitative nature.
Management reports Bluefin, Q3a Dec '11
Evaluate the output reports of an IS in light of best practice, the firm's objectives, the needs of the Metis Q1a Dec 2012
readers and avoiding the problem of information overload. Kolmog Q1ii June '13
Advise on the common mistakes in the use of numerical data used for performance measurement. Flack Q1i M/J '16
Explore the role of the management accountant in providing information for integrated reporting
(covered in Chapter 1).
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6: PERFORMANCE MEASUREMENT SYSTEMS AND DESIGN
Overview
Performance measurement
systems and design
ERPS – integrated management Lean information

accounting information
Avoiding waste Right information,

Right people,
Right time
Executive Information Systems Decision Support Systems

(EIS) (DSS) Reporting
Expert systems
Big Data
RFID
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1 Performance management information systems

1.1 A Management information system (MIS) is:
'a system to convert data from internal and external sources into information and to
communicate that information, in an appropriate form, to managers at all levels in all
functions to enable them to make timely and effective decisions for planning, directing and
controlling the activities for which they are responsible'. (Lucey)
1.2 In Chapter 4 we have already seen that the information requirements of an organisation
structure are influenced by the design of that structure. Here we look at types of MIS that
can deliver useful information to meet needs of management at a variety of levels within the
organisation.
Executive information systems (EIS)

1.3 An EIS should give executives a straightforward means of access to key internal and
external data, provide summary-level data, captured from the organisation's main systems
(eg exception reports), data manipulation facilities (drill down facility) and user-friendly
presentation of data (dashboards).
Decision support systems (DSS)

1.4 A DSS helps management to make decisions. An example of a DSS is a database
management system which uses data mining software to look for patterns and
relationships in large pools of data.
Expert systems
1.5 An expert system draws on a computerised knowledge base (such as details of the
workings of tax legislation) to give factual answers to specific queries, as well as indicating
to the user what a decision ought to be in a particular operational situation.
Integration of management accounting information

1.6 It is also important that the management accounting information does not exist in isolation,
but is also part of the wider information system in an organisation.
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An Enterprise Resource Planning System (ERPS) is a database management system

designed to integrate and automate business processes.
Operations
Controls inventory throughout the supply chain, from
procurement to distribution
Finance ERP software Accounting

Reports customer's Manages information flow among Records sales and
credit rating and all database applications payments and tracks
current selling prices business performance
Marketing Human resources

Co-ordinates sales activities and handles Recruits, trains, evaluates and
customer relationship management compensates employees
1.7 An ERPS can also be used to produce customised reports and can support performance
measures such as the balanced scorecard.
1.8 An ERPS can result in:

 Lower costs (for example, through workforce redeployment), and
 Increased flexibility and efficiency of production, because sales, production and
purchasing are closely integrated.
1.9 Disadvantages of an ERPS include cost, implementation time and lack of scope for
adaptation to the demands of specific businesses. In addition, a problem with one function
can affect all the other functions.
An ERPS that automates poorly designed and inconsistent business processes is unlikely to
add any value.
Lean information
1.10 Lean information aims to get the right information to the right people at the right time
with the minimum of waste.
Lean information is an extension of the idea of lean production (see JIT later). The key
characteristics of lean systems are that they are:
Chapter 6a (a) Developed in a collaborative manner, focused on the needs of the end-user
Section 5.5 (b) Easy for the user to understand, avoiding information overload
(c) Easy for the user to access
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2 Management reports
2.1 Past exam questions have asked you to consider the suitability of management reports.
When evaluating the design of a performance report there are a number of issues to look
for:
 Strategic relevance
Does the report give visibility to whether the entity's mission is being achieved
and whether key performance indicators that are consistent with mission are
being achieved?
Performance can be judged only by giving visibility to these issues.
This will often require non-financial information eg in the form of the balanced
scorecard or a similar model (see later).
 Audience
Who is the report being read by?
You may need to think about whether the audience will be sophisticated enough to
understand the information presented. Has the report provided the appropriate level
of detail, layout and terminology?
 Information distortion
Non-financial qualitative information (eg staff morale) is often turned into
something quantifiable as part of a report on performance assessment.
You may need to consider whether, in doing this, distortions to the information have
been introduced. For example, measuring staff morale by the level of staff turnover
may be more of an indication of the difficulties of finding a job in the local area!
– Ranking systems (eg of divisions) give no visibility to the extent of
performance differences.
– Percentages give no visibility to absolute values eg is a 5% adverse variance
significant?
– Graphical reports can be manipulated to exaggerate trends.
– Information will need to supported by adequate narrative explanations eg
simply reporting a variance without attempting to explain how it might have
been caused is not ideal.
 Layout
Does the report present too much information so that valuable information (and
assumptions made) is hard to find and interpret. To deal with this, you could
recommend:
– Using graphs and summary tables
– Narrative explanations (as noted above)
– Leaving detailed information in appendices to the main report
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Lecture example 1 Based on a previous exam question
An example of the sales information that Hydra (a bicycle retailer) currently produces for the board
is shown below. This report is produced quarterly for each retail outlet, cost information is also
provided but this is not shown below.
Sales (£) Actuals last Budget for Forecast for Latest quarter Previous
year current year current year quarter
Men's bikes x x x x x
Ladies' bikes x x x x x
Children's bikes x x x x x
Parts x x x x x
Clothing x x x x x
Servicing x x x x x
Total x x x x x
Required
Critically assess the existing performance report and suggest improvements.
Solution
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Additional notes
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3 Sources of management information

3.1 An exam question make require you to briefly comment on potential internal and external
sources of information (for example to support performance measures).
Chapter 6b 3.2 In addition, you are expected to be aware of the importance of 'big data'.
Section 4.2
This is a term used to describe the proliferation of data generated by digital interactions,
from email to online shopping, text messages to tweets, Facebook updates to YouTube
videos. A common theme in relation to Big Data is the diversity of source data eg keywords
from conversations people have on Facebook or Twitter, and content they share through
media files (tagged photographs, or online video postings).
3.3 One of the key challenges facing today's business managers is how they can use data and
information about current performance to leverage additional value throughout an
organisation's value chain .
For example, online retailers are able to compile records of each click and interaction a
customer makes while visiting a website, rather than simply recording the final sale at the
end of a customer transaction. Moreover, retailers who are able to utilise information about
customer clicks and interactions quickly – for example, by recommending additional
purchases – can use this speed to generate competitive advantage.
Big Data analytics

3.4 This refers to the process of collecting, organising and analysing 'Big Data' to discover
patterns and other useful information which an organisation can use in its future business
decisions.
3.5 Big data analytics should result in performance improvements:
 Better understanding of customer behaviour
For example, identifying what customers are saying in social media about an
organisation's products or its customer service could help the organisation identify
how well it is meeting customers' needs.
Customers' conversations could help the organisation identify potential changes
which are needed to its products, or the way they are delivered, in order to meet
customers' needs more effectively – and thereby to increase sales.
 Targeted marketing messages
Big Data could facilitate targeted promotions and advertising – for example, by
sending tailored recommendation to customers' mobile devices while they are in the
right area to take advantage of the offers.
 Decision-making
For example, trends identified by a retailer in in-store and online sales – in real time –
could be used to manage inventories and pricing.
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 New products and services

More generally, Big Data could also provide new business opportunities in their own
right. for example, Amazon makes recommendations for customers linked to the
purchases made by other customers with similar interests.
3.6 Some critics have argued that, while the data sets available through Big Data are often very
large, they are still not necessarily representative of the entire data population as a whole.
For example, if an organisation uses 'tweets' from the social networking site Twitter to
provide insight into public opinion on a certain issue, there is no guarantee the 'tweets' will
accurately represent the view of society as a whole.
4 Developments in information processing and

recording
4.1 Developments in IT systems have made it far easier for users to instantly access data via:
(a) Enterprise resource planning systems (covered earlier)
(b) Data sharing
(c) Radio frequency identification (RFID)
ERPS
4.2 This has already been introduced. A couple of extra points to note are that an ERPS is built
on a single unified corporate database. This will require working practices to be
standardised.
An ERPS will also require a data warehouse. Organisations may build a single central data
warehouse to serve the entire organisation or may create a series of smaller data marts.
Data sharing
Data sharing Features
Groupware – Scheduler
– A term used to describe software that – File sharing
provides functions that can be used
by collaborative work groups.
Intranet – Sharing ideas

– Communicating initiatives
– Internal networks, using internet
technology
Extranet – Sharing selective sales data

– Intranets that are accessible to
authorised external users
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Radio frequency identification (RFID)

4.3 Radio frequency identification (RFID) allows organisations to keep track of assets by
tagging them with small radio receivers (typically referred to as an RFID tag) applied to or
incorporated into an asset, product, animal or person.
RFID is becoming increasingly widely used in supply chain management. RFID tags
attached to materials or inventory enable an entity to track the movement of that inventory
between locations more accurately, and to get an exact count of items coming into storage
and items held in storage.
4.4 Example uses of RFID

 RFID systems are being used in some hospitals to track a patient's location, and to
provide real-time tracking of the location of doctors and nurses. In addition, the
system can be used to track the whereabouts of expensive and critical equipment,
and even to control access to drugs, paediatrics, and other areas of the hospital that
are considered 'restricted access' areas.
 RFID in retail stores offer real-time inventory tracking that allows companies to
monitor and control inventory supply at all times.
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5 Chapter summary
1 Performance Management information systems should support
management information needs at strategic, tactical and
information systems operating levels.
An ERPS can be a useful way of integrating business
processes.
Lean information aims to get the right information to
the right people at the right time with the minimum
of waste.
2 Management reports When designing or criticising a performance report
consider:
Strategic relevance
Audience
Information distortion
Layout
3 Sources of 'Big data' is a term used to describe the proliferation
management of data generated by digital interactions. Big Data
information analytics refers to the process of collecting,
organising and analysing 'Big Data' to discover
patterns and other useful information which an
organisation can use in its future business decisions.
4 Developments in Developments in IT systems have made it far easier
information processing for users to instantly access data via:
and recording (a) Enterprise resource planning systems
(b) Data sharing
(c) Radio frequency idenfication (RFID)
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END OF CHAPTER
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Scope of strategic
performance measures in
the private sector

Demonstrate why the primary financial objective
should be concerned with benefits to shareholders.
Discuss the appropriateness of, and apply different
measures of performance including: Metis June 2012
 Gross profit and operating profit Boltzman Q1c December 2014
Flack Q1ii, March / June 2016
 Return on capital employed, return on Metis June 2012
investment and residual income Boltzman Q1c December 2014
Flack Q1iv, March / June 2016
Monza Q1ii,iii Sep / Dec 2016
Also see Chapter 8
 Earnings per share (EPS), Earnings before SSH December 2008
interest, tax and depreciation (EBITDA)
 Net present value (NPV) Metis June 2012
 Internal (and modified) rate of return (IRR/MIRR) Metis June 2012
 Discuss why indicators of liquidity and gearing CCNH Dec 2012
need to be considered together with profitability.
 Compare and contrast short and long-run Metis June 2012
financial performance and the resulting
management issues.
 Assess the appropriate benchmarks to use in Metis June 2012
assessing performance.
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7: SCOPE OF STRATEGIC PERFORMANCE MEASURES IN THE PRIVATE SECTOR
Overview
Scope of strategic performance

measures in the private sector
Benefits to shareholders Measures
Dividends Capital growth
Return Liquidity / gearing Investor Advantages and

disadvantages of ratios
Profit ratios NPV/ IRR / MIRR

incl EBITDA
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1 Benefits to shareholders
1.1 Private sector organisations exist to increase long-term owner wealth.
This translates into maximising the value of shares and dividends and can be measured as
total shareholder return.
Total shareholder return = dividend yield + capital gain/(loss)

dps/share price* capital gain (loss)/share price*
* share price at the start of the year
1.2 In reality shareholders will analyse a company's accounts to assess:
(a) Financial position; and
(b) Potential future performance or identify weaknesses.
2 Measures
Financial performance
2.1 (a) Profitability – how well a company performs, given its asset base
(b) Liquidity – short term financial position
(c) Gearing – measure of risk
(d) Investor ratios – share value and dividends
Future potential or weaknesses

2.2 Review of the accounts and notes to highlight issues not disclosed by ratio analysis:
(a) Contingent liabilities
(b) Corporate governance reports
(c) Social/environmental reports
(d) Risk
Basis for benchmarking

2.3 (a) Over time
(b) With other companies
(c) With industry averages
(d) With other performance measures
(e) Against budget
Assumed knowledge
2.4 All ratios from F5 are assumed knowledge. Further detail on this can be found in the
additional notes to this chapter.
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Lecture example 1 Exam standard question for 15 marks
ARH has the following results for the last two years of trading.
ARH – INCOME STATEMENT FOR THE YEAR ENDED
31.12.X7 31.12.X8
$'000 $'000
Revenue 14,400 17,000
Less cost of sales 11,800 12,600
Gross profit 2,600 4,400
Other expenses 1,000 2,000
Finance costs 200 –
Profit before tax 1,400 2,400
Income tax expense 420 720
Profit for the year 980 1,680
ARH – STATEMENT OF FINANCIAL POSITION AS AT
31.12.X7 31.12.X8
$'000 $'000 $'000 $'000
Non-current assets 2,500 4,000
Current assets
Inventories 1,300 2,000
Trade receivables 2,000 1,600
Cash and cash equivalents 2,400 820
5,700 4,420
Total assets 8,200 8,420
Equity and liabilities
Share capital (2.4 million
ordinary shares of $1 each) 2,400 2,400
Revaluation surplus 500 500
Retained earnings 1,200 2,100
4,100 5,000
Non-current liabilities
Long-term borrowings 2,600 –
Current liabilities
Trade payables 1,080 2,700
Current tax payable 420 1,500 720 3,420
8,200 8,420
Notes:
1 Finance costs represent interest payable on debt.
2 Tax is charged at 30% of profit.
3 Long-term borrowings represent 10% loan stock.
4 Dividends amounting to $520k were paid in 20X7 and $780k was paid in 20X8.
5 The average rate of inflation during the year was 3%.
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Required
(a) Assess the performance of ARH over 20X8, calculating any ratios that you consider useful.
(b) What other financial information would be useful to enable a fuller assessment of the
business's performance?
Solution
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Earnings before interest, tax and depreciation (EBITDA)

2.5 EBITDA is earnings before interest, tax, depreciation and amortisation. EBITDA is a useful
performance measure for a number of reasons:
 Useful for evaluating companies with high intangibles (compared to ROCE)
 Removes tax and interest as unrelated to business performance
 Removes depreciation and amortisation as related to historic decisions
 Easier to assess different companies (compared to EPS) with different capital
structures (if taken as a % of capital employed)
 EBITDA is argued to be close to a cash flow measure
Lecture example 2 Discussion question
Required
Would EBITDA be a useful financial performance measure for ARH, as discussed in Lecture
example 1?
Solution
Drawbacks of EBITDA
 It is often presented as being close to cash flow: but how can this be true if it ignores interest
and tax and the need to make investments.
 Can be used as window dressing for to excuse poor performance in a loss making
company.
Net present value (NPV) and Internal rate of return (IRR)

2.6 NPV and IRR are also measures of performance. These calculations are typically used
when planning future projects, but can also be used as controls by comparing actual results
to those planned. These techniques are useful because they focus on future cash flows and
risk.
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Lecture example 3 Exam standard question
Fame Ltd is considering expanding its range of dance facilities by investing in 30 new studios.
The following estimates have been made relating to the cash outflows and inflows:
1 Initial investment of $12m.
2 Capital development/improvement costs of $2m per year at the end of each of Years 2 and 3.
3 Projected income from 30 studios of $400,000 per studio.
4 Variable costs are estimated at $120,000 per studio.
5 Total directly attributable fixed costs of $1.2m per year in each of Years 1-6.
6 Corporation tax at the rate of 30%, payable in the year in which cash flows occur. Tax
allowances are not available.
7 All cash flows are stated in current prices and with the exception of the initial investment will
occur at the end of each year.
8 The money cost of capital is 14.33%. Annual inflation during the period is estimated at 3%.
Required
Calculate the net present value (NPV) and internal rate of return (IRR) of the project and
recommend whether it should be undertaken. Evaluate the project over six years.
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Solution
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Modified IRR
2.7 IRR assumes that the cash flows after the investment phase (here time 0) are
reinvested at the project's IRR.
2.8 A better assumption is that the funds are reinvested at the investors minimum required
return (WACC) here 11%.
2.9 In the formula below the return phase is the phase of the project from when cash inflows
have commenced.
1/ n
 PV return phase 
  × 1 + i  –1 i = cost of capital
 PV investment phase 
Using the formula, calculate the modified IRR of the proposed investment.
Solution
Advantages of MIRR
2.10 Using the formula, MIRR is quicker to calculate than IRR, it makes a more realistic
assumption about the reinvestment rate, and does not give the multiple answers that
can sometimes arise with the conventional IRR.
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3 Advantages and disadvantages of ratios

3.1
Advantages Disadvantages
Easier to understand than absolute Not useful on their own – need a benchmark
measures
Easier to look at changes over time Must be carefully defined
Puts performance into context Need to adjust for inflation
Can be used as targets Different basis of calculating between companies
Based on historical data – may not be an accurate
reflection of future potential
Other problems with financial performance indicators

3.2 (a) Focus only on variables which can be expressed in monetary terms ignoring other
important variables which are harder to express in monetary terms.
(b) Focus on past results.
(c) Do not convey the full picture of a company's performance in a modern business
environment.
(d) Tendency to focus on the short term (except for NPV and IRR).
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Additional notes
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4 Profitability
Profit before interest and tax
4.1 ROCE = %
Capital employed
ROCE = PBIT  Revenue
Revenue Capital Employed
Net Profit Asset

Margin Turnover
Return on capital employed (ROCE) states profit as a percentage of capital employed and
shows how well the business utilises the funds invested in it.
There are three comparisons that can be made:
(a) The change in ROCE from year to year
(b) Comparison to other similar businesses
(c) Comparison to the market borrowing rate.
PBIT
4.2 Net profit margin =  100 %
Revenue
A high profit margin indicates that either sales prices are high or total costs are being kept
well under control.
(Revenue  COS)
4.3 Gross profit margin =  100 %
Revenue
A high gross profit margin indicates that either sales prices are high or production costs are
being kept well under control.
Revenue
4.4 Asset turnover =
(NCA + CA – CL)
The ratio of revenue to the amount of capital employed shows the revenue that is generated
from each $1 worth of assets employed.
Earnings
4.5 Return on equity =
Shareholders funds
Companies can manipulate ROE by using high levels of debt finance.
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5 Liquidity
5.1 A profitable company can still experience cash flow problems. This is likely if companies are
overtrading or growing quickly. Measuring growth over time is useful in conjunction with
measuring liquidity.
Current assets
5.2 Current ratio =
Current liabilitie s
The current ratio can be calculated by dividing the most liquid assets in the business
(receivables, inventories and cash) by the business' payables.
Profits before interest and tax

5.3 Interest cover =
Interest payable
EBITDA can be used as an alternative to PBIT.
Working capital
Average receivables
5.4 Receivables period =  365 = days
Credit sales
Average finished goods
5.5 Inventory period =  365 = days
Cost of sales
Average payables
5.6 Payables period = Credit purchases  365 = days
(cost of sales)
6 Gearing
6.1 Gearing has a considerable effect on the earnings attributable to ordinary shareholders.
High financial gearing (debt: equity) means that enough profit must be earned to cover
interest charges before any surplus can be paid to shareholders. It increases the risk of
failure.
However, debt is usually cheaper than equity so, if a company is successful, debt will permit
shareholders to reap increased rewards.
Financial risk
Long term debt (prior charge capital)
6.2 Gearing ratio =
Long term debt  equity (shareholders funds)
Business risk
6.3 Business risk refers to the variability in income which is due to the business activities of the
organisation. This can result from the organisation's products, customers, suppliers or cost
structure. It is measured by operating gearing being:
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Fixed costs
Operating gearing ratio =
Variable costs
6.4 If operating gearing is high this indicates that a large proportion of the organisation's
operating costs are fixed. Fixed costs make profit more volatile as PBIT becomes more
vulnerable to downturns in business volume. Note that other definitions of operational
gearing are possible.
7 Investor
Earnings per share (EPS)
7.1 EPS is a profitability measure, defined as
Profit after tax, minority interests and preference dividends
EPS =
Number of equity shares in issue and ranking for dividend
It is commonly used to compare results over a number of years.
7.2 EPS must be used with care when measuring performance.

(a) Must be compared over time.
(b) Possible dilution in the future due to existence of share options or convertible debt.
(c) Cannot be used to compare companies with different equity structures.
(d) Cannot be easily used if a company changes its equity structure during the year.
P/E ratio
7.3 The best method for assessing the relative value of quoted shares is the P/E ratio.
Price per share MV equity
P/E = or
EPS Total earnings
where the price per share is quoted ex-div.
7.4 P/E ratios are deemed to reflect the future prospects of a company. A high P/E ratio
indicates that investors believe the company will have:
(a) Higher future earnings; or
(b) Lower risk.
than others in its market.
7.5 P/E ratios of quoted companies are often used as starting points for valuing unquoted
companies in the same sector.
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8 Chapter summary
1 Benefits to The private sector exists to maximise the wealth of its
shareholders shareholders in the long-term.
Success is ultimately concerned with:
– Profitability
– Liquidity
– Gearing
– Growth.
2 Measures EBITDA, NPV, IRR and MIRR are key measures of
performance.
3 Advantages and Ratios allow for easy performance measurement, can
disadvantages of ratios assess trends and help set targets. They are limited
because they:
– Need a benchmark;
– Require standard definitions;
– Fail to consider non-financial factors; and
– Focus on short term performance.
4 Profitability Profitability can be measured by:
ROCE (net margin and asset turnover)
Margins
5 Liquidity Liquidity can be measured by:
– Quick ratio
– Current ratio
– Working capital.
6 Gearing Gearing has two forms to indicate two different risks.
Financial risk is measured by:
Debt to equity
Business risk is measured by:
Fixed costs/Variable costs.
7 Investor The markets measure:
EPS
P/E ratios
to help determine growth potential and profitability.
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END OF CHAPTER
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topics.
Course notes
chapter
control
Organisation structure, environmental
and ethical issues
performance
Management information Performance management information
systems systems 6
Financial Performance Scope of strategic performance
Measurement measures in the private sector 7
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Achievement Ladder
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Divisional performance
and transfer pricing
issues

Describe, compute and evaluate performance measures LOL cards Q3 part b Dec 2010
relevant in a divisionalised organisation structure including JHK June 2011 part a
ROI, RI and economic value added (EVA).
Stillwater Services Dec 2012
Lincoln & Lincoln Dec 2012
Cantor Q1 June 2014 part iii
Boltzman Q1c – Dec 2014
Beach Q4 part a and b – June 2015
IC Q1i Sept / Dec 2015
Flack Q1iv March / June 2016
Monza Q1iii Sept / Dec 2016
Discuss the need for separate measures in respect of Alpha Division Dec 2007
managerial and divisional performance.
Discuss the circumstances in which a transfer pricing policy JHK June 2011 part b
may be needed and the necessary criteria for its design. LAA Sept / Dec 2016 part b
Demonstrate and evaluate the use of alternative bases for JHK June 2011 part b
transfer pricing. Landual lamps June 2013
LAA Sept / Dec 2016 part b
Explain and demonstrate issues that require consideration JHK June 2011 part b
when setting transfer prices in multinational companies.
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8: DIVISIONAL PERFORMANCE AND TRANSFER PRICING ISSUES
Overview
Divisional performance and

transfer pricing issues
Investment centres Transfer pricing
Return on Economic Reasons Methods

investment value added
(ROI) (EVA)
Residual income
(RI) Cost based Opportunity
cost
Dual price
Performance Autonomy Goal congruence International

measurement issues
Tax Profit
repatriation
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1 Investment centres
1.1 In investment centres, managers have control (power over decisions concerning) over all
activities and investments (including non-current assets and working capital). The
performance measures used should cover all aspects over which a manager has control:
(a) Revenue
(b) Costs
(c) Capital invested.
Return on investment (ROI)

1.2 Similar to the ROCE figure used in corporate analysis.
Controllable Divisional Profit
ROI =
Divisional Investment
Comparator for ROI

1.3 ROI will be compared against ROCE or WACC required by the company as a whole.
Risky projects can be accommodated by adjusting the ROCE/WACC hurdle rate
appropriately.
Dysfunctional behaviour
1.4 If ROI is used as the principal performance measure then it is likely that a manager will only
take decisions that will increase divisional ROI, which may be at the expense of growth in
corporate profits.
Residual income (RI)

1.5 RI is the main alternative to ROI. It gives a hurdle figure for profit based on the minimum
return required from a division.
$
Controllable divisional profit X
Less imputed interest
(investment  cost of capital) (X)
RI X
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Lecture example 1 Preparation question
C Ltd has two divisions in different parts of town and wants to monitor their performance.
Results for the last year were:
Div A Div B
$'000 $'000
Profits 90 135
Net assets 500 750
Turnover 300 540
Division A is considering developing a new product at a cost of $8,000. This should add $1,200 to
profits from next year onwards. Division B is reliant on several long-term product lines and sees
little value in R&D expenditure.
C Ltd has a target ROCE of 12%, based on its weighted average cost of capital.
Required
Evaluate the performance of the two divisions and explain how these evaluations may lead to
dysfunctional behaviour.
Solution
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ROI vs. RI
1.6 In practice, ROI is used more frequently than RI. RI is, however, technically superior.
Reasons for using ROI

1.7 (a) Dysfunctional behaviour is not material.
(b) ROI is consistent with corporate assessment (ROCE).
(c) Ratios are more easily understood compared with, say, costs of capital and are more
appropriate for comparing divisions of different sizes.
(d) Calculation of cost of capital in RI is unwieldy and time consuming.
Problems common to ROI and RI

1.8 The calculation of 'profit':
(a) Controllable items only – often hard to determine.
(b) Transfer prices or quantities may be imposed or set at non commercial rates.
(c) Corporation tax may drive transfer prices or divisional size or location.
(d) Depreciation policy and allocated and apportioned overheads are usually controlled
by head office.
1.9 The calculation of 'investment':

(a) Historic, net book or replacement value. Using NBV discourages replacement.
Replacement value is complex to obtain and update.
(b) Cash may be controlled by treasury.
(c) Intangible assets may have no accounting value or may be complex to update.
(d) Service industries do not create value from assets but from employees. Comparison
of service divisions with others is problematic.
2 Economic value added (EVA®)

2.1 EVA® is a variation of RI. It is calculated as:
$
Net operating profit after tax (NOPAT) X
Capital charge
(WACC  net assets at start of period) (X)
EVA X
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2.2 EVA® varies from RI in the figures it considers as profits and assets.
Profit
'Economic Profit' Alternative approach
PAT PBIT less (cash) taxes paid on operating profit
Add back Add back
Goodwill amortised Goodwill amortised
R&D & advertising R&D & advertising
Non-cash items (eg provisions) Non-cash items (eg provisions)
Depreciation (charge economic deprecation) Depreciation (charge economic deprecation)
Interest (net of tax)
2.3
Assets
'Replacement value'
Not
NBV
Historic cost
Include
Goodwill previously written off against reserves
R&D
Intangibles
2.4
Calculates return in line with shareholder Complex due to adjustments required
expectations
Replaces multiple goals with one financial Short-term
measure that can be used at all levels of
decision making
Aligns decisions with creation/improvement Can be manipulated
of shareholder wealth
Inconsistent with published financial
information
Absolute measure making interdivisional
comparisons difficult
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B Division of Z Ltd has operating profits and assets as below:

$'000
Operating profit 156.0
Less: Non-cash expenses 8.0
Amortisation of goodwill 5.0
Interest @ 10% 15.0
Profit before tax 128.0
Tax @ 30% 38.4
Profits after tax 89.6
Total equity 350.0

Long-term debt 150.0
500.0
Z Ltd has a target capital structure of 25% debt/75% equity. The cost of equity is estimated at 15%.
The capital employed at the start of the period amounted to $470,000. Goodwill previously written
off against reserves on acquisitions in previous years amounted to $40,000.
Required
Calculate EVA® and residual income for B Division and comment on your results.
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Solution
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3 Assessing managers and divisions

3.1 In order to be fair and motivating, divisional managers should only be assessed on results
within their control.
3.2 By comparison, divisional performance should be based on total economic performance to

provide an assessment of the worth of the division to the organisation. This allows optimal
strategies to be determined such as outsourcing or closure.
Profit statement
3.3 A possible profit statement for a division might look as follows:
$'000
Sales revenue X
Variable costs (X)
Contribution X
Controllable fixed costs (X)
Controllable profit X
Non-controllable fixed costs (X)
Divisional profit X
3.4 Contribution should be an acceptable measure of managerial performance unless it contains

imposed transfers and transfer prices.
3.5 Controllable profit may be a more appropriate measure of managerial performance where
managers can make decisions about equipment rental or labour costs. It is more acceptable
when managers are free to secure services either in house or from third parties.
Deprecation is likely to be included and this will only be controllable to the extent that
managers control investment decisions.
3.6 Divisional profit is unlikely to be an acceptable managerial measure. It is suitable for

assessing the economic performance of the divisions provided the allocation of fixed costs is
reasonable.
4 Aims of transfer pricing

4.1 Transfer pricing is a system to charge for goods or services transferred between divisions of
a company.
Aim Achieved by
Preserve goal congruence Aligning divisional behaviour to the best
interests of the group – by setting a price
that reflects the 'true cost to the group' of
the transfer
Allow managers to retain autonomy Allowing divisions to decide where they buy
from/who they supply and in what quantities
Permit performance evaluation of divisions Preventing unfair impact on performance
measures of either division
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External sale of intermediate

product by S
WHOLE COMPANY
Costs incurred Revenue

by S Division Division earned by
Sell Receive R
Transfer?
Alternative suppliers to R
General rule
A transfer price should reflect the true cost to the company of an

internal transfer taking place
5 Cost-based methods of transfer pricing

5.1 The supplying division has its costs of manufacturing refunded and may also be allowed a
mark-up to encourage the transfer.
Actual cost v standard cost

5.2 Actual costs
(a) All inefficiencies passed on to buying division
(b) No encouragement for cost control in selling division
(c) Buying division does not know in advance what price it will be paying
Using standard costs overcomes all these problems.
Full cost v variable cost

5.3 Full cost
(a) Receiving division may not be encouraged to accept the transfer
(b) May lead to the wrong decision being made, because fixed costs are not a relevant
cost
Using variable costs overcomes these problems, but does mean that the selling division will
not cover its fixed costs.
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Standard variable cost plus %

5.4 A larger mark-up will be required as fixed costs need to be recovered. The % mark-up may
still cause problems.
Lecture example 3 Illustration
$
Division S Direct cost 20.00
Fixed overhead absorbed 8.00
28.00
Standard profit @ 10% 2.80
Transfer price 30.80
Division R, the receiving division, can buy externally @ $26.
Required
Discuss the likely outcome of setting the transfer price at $30.80.
Solution
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Standard variable/marginal cost

5.5 The selling division should transfer goods to buying division at the marginal cost of
production if:
(a) S has spare capacity as this is goal congruent provided the receiving division can
make a profit on them
(b) S has no external market so could operate as a cost centre
S may be demotivated as fixed costs will not be covered. Either fixed costs should be
included in the transfer pricing system or S should be evaluated on factors other than profit.
Dual pricing and two-part tariff systems

5.6 Fixed costs can be considered in a marginal cost based transfer pricing system in the
following ways:
(a) Dual Pricing
where an external market exists, credit the selling division with the market price
of the transfers made but debit the buying division with the variable cost.
(b) Two-Part Tariff

Transfer prices set at variable cost and once a year there is a transfer of a fixed fee
to the supplying division representing an allowance for its fixed costs. This should
allow the supplying division to cover its fixed costs and make a profit.
6 Market based approaches to transfer pricing

6.1 Where a market price exists it can be used as the basis for a transfer. If the supplying
division is at full capacity then the revenue it loses as a result of an internal transfer
shows the true cost (revenue foregone) to the division of an internal transfer.
6.2 If a division would have to incur marketing costs to sell externally then the market price
should be adjusted to reflect the fact that an internal transfer would not incur this cost. So
the transfer price becomes lower ie market price – marketing costs.
7 Opportunity cost approach to transfer pricing

7.1 The optimal transfer price (TP) should be calculated using opportunity costs.
Minimum TP = marginal cost to selling division + opportunity cost of resources used.
(i) If external market exists for the intermediate product: opportunity cost is contribution
lost from the external sale foregone.
(ii) If no external market for the intermediate product exists, the opportunity cost (or
shadow price) is:
 Nil, or
 Opportunity lost by not using resources on alternative products.
Note: If this price is above the external market price or the receiving division's net revenue
then the internal transfer will not and should not happen.
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Lecture example 4 Exam standard for 10 marks
The Creative Division (CD) of Unique Components Ltd produces wooden components that it sells
to external customers and transfers to other divisions within its own group of companies.
Production involves the preparation of timber, cutting the timber into shapes and the assembly of
the shapes into components. The total component cost for Component A has been estimated as
$41.21 per unit (variable costs account for 45% of this). Selling prices to external customers have
been set by adding a mark-up of 35% to total estimated component cost.
Required
Discuss the application and acceptability of each of the following transfer price bases at which
component A may be offered by CD to other divisions within the same group of companies:
(i) External selling price and adjusted selling price;
(ii) Marginal cost, marginal cost plus an annual lump sum; and
(iii) Dual pricing.
Include illustrative values ($) for each transfer price using data provided above and additional data
of your choice.
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Solution
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Lecture example 5 Exam standard for 10 marks
The Creative Division is based in Baseland; it makes 3 types of components.

Budget information in respect of the Creative Division for the year ended 31 December 20xx is as
follows:
Component type A B C
Sales units (000's) 140 40 120
Selling price per unit ($) 55.63 72 36
Total variable cost of sales ($'000) 2596 1280 1920
Each of the three products uses the same quantity of manufacturing capacity. This gives the
Creative Division the flexibility to alter the product mix as desired. During the year to
31 December 20xx it is estimated that a maximum of 320,000 components could be manufactured.
The following information relates to Division B which is also part of the Unique Components (UC)
group and is based in Farland:
1 Division B purchases products from various sources, including from other divisions in the UC
group, for subsequent resale to customers.
2 The management of Division B has requested two alternative quotations from the Creative
Division in respect of the year ended 31 December 20xx as follows:
Quotation 1 – Purchase of 20,000 units of Component A.
Quotation 2 – Purchase of 36,000 units of Component A.
The management of the UC Group is willing, if necessary, to reduce the budgeted sales quantities
of other components in order to satisfy the requirements of Division B. They wish, however, to
minimise the loss of contribution to the Group.
The management of Division B is aware of another supplier, that competes with the Creative
Division's Component A product and which could be purchased at a local currency price that is
equivalent to $33 per component. UC Group policy is that all divisions are allowed autonomy to set
transfer prices and purchase from whatever sources they choose. The management of the
Creative Division intends to use market price less 30% as the basis for each of Quotations 1 and 2.
Required:
The management of the UC Group have asked you to advise them regarding the appropriateness
of the decision by the management of the Creative Division to use an adjusted market price as the
basis for the preparation of each quotation (including an alternative transfer price if appropriate)
and the implications of the likely sourcing decision by the management of Division B.
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Solution
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Additional notes
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8 Practical issues
Negotiation
8.1 It is likely that transfer prices will be set by means of negotiation between the selling and
receiving divisions. This allows divisional managers to understand each other's problems
and to come to an agreement without head office intervention.
The TP will be finalised from a mixture of accounting information, politics and compromise.
Head office intervention

8.2 Divisional disputes may have to be resolved via head office intervention. If head office
imposes the transfer policy, it will achieve goal congruence but it may be de-motivating as it
results in a loss of divisional autonomy.
8.3 Many divisional companies still have an element of centrally provided services. The
allocation of these notional costs is not controllable by the division managers. Managers
should not be assessed on results that are distorted by imposed transfer pricing
mechanisms.
9 International aspects
9.1 The problems encountered in setting transfer prices are compounded when a group has
subsidiaries operating in different countries.
9.2 Double taxation agreements between countries mean that companies normally pay tax only
once, in one country, when they transfer goods from one subsidiary to another across
national borders.
9.3 If a company transfers goods from a manufacturing subsidiary in a high tax country
to a marketing subsidiary in a low tax country, the company may be tempted to set a
low transfer price. This would minimise the tax liability, as most of the profit would be
made in the low tax country. If the manufacturing division were in a low tax country
and the marketing division in a high tax country, the opposite would apply.
9.4 Setting a transfer price on this basis in unwise. If a tax authority feels that a company is
using an unrealistically high, or low, transfer price to reduce its liability, it can substitute an
'arm's length' price in place of the company's transfer price.
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The existing results of Green Group are given below. Division S is located in a higher tax country,
and Division R is in a lower tax one.
Division S Division R
$'000 $'000
Internal revenue 500
External revenue 1,100
Less: Internal costs (500)
External costs (200)
Divisional profit 300 600
Income tax expense @ 30% (90) @ 5% (30)
Profit 210 570
The new tax manager of Green Group has suggested a change in the transfer pricing policy, so
that the internal transfer is made at cost price of $200k.
Required
Evaluate the effect of this change in policy on Division S and Division R and the Green Group.
Identify other issues Green Group would face by being involved in international transfers.
Solution
Division S Division R
$'000 $'000
Internal revenue
External revenue 1,100
Less: Internal costs
External costs (200)
Divisional profit
Income tax expense @ 30% @ 5%
Profit
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Lecture example 7 Homework exercise
(a) The transfer pricing system operated by a divisional company has the potential to
make a significant contribution towards the achievement of corporate financial
objectives.
Required
Explain the potential benefits of operating a transfer pricing system within a
divisionalised company. (6 marks)
(b) A company operates two divisions, Able and Baker. Able manufactures two products,
X and Y. Product X is sold to external customers for $42 per unit. The only outlet for
Product Y is Baker.
Baker supplies an external market and can obtain its semi-finished supplies (Product
Y) from either Able or an external source. Baker currently has the opportunity to
purchase Product Y from an external supplier for $38 per unit. The capacity of division
Able is measured in units of output, irrespective of whether Product X, Y or
combination of both are being manufactured. The associated product costs are as
follows.
X Y
Variable costs per unit 32 35
Fixed overheads per unit 5 5
Total unit costs 37 40
Required
Using the above information, provide advice on the determination of an appropriate
transfer price for the sale of Product Y from division Able to division Baker under the
following conditions.
(i) When division Able has spare capacity and limited external demand for Product X.
(3 marks)
(ii) When division Able is operating at full capacity with unsatisfied external
demand for Product X. (4 marks)
(c) The design of an information system to support transfer pricing decision making
necessitates the inclusion of specific data.
Required
Identify the data that needs to be collected and how you would expect it to be used.
(7 marks)
(Total = 20 marks)
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Solution
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10 Chapter summary
1 Investment The results of investment centres should be measured

centres taking the size of the asset base into consideration:
Divisional profit
ROI is calculated as:  100%
Divisional investment
It is useful for comparing divisions but can cause
dysfunctional decision making.
RI is calculated as: divisional profit – imputed interest
It is better than ROI for decision making but less suitable for
interdivisional comparison.
2 Economic EVA® is an alternative absolute performance measure. It is
value added similar to RI and is calculated as follows:
EVA® = NOPAT less capital charge
capital charge = wacc  net assets
3 Assessing One of the problems of measuring managerial performance
managers and is segregating managerial performance from the
divisions economic performance of their department or division.
4 Transfer Transfer prices are a way of promoting divisional
pricing autonomy, ideally without prejudicing divisional
performance measurement or discouraging overall
corporate profit maximisation.
5 Cost based Cost based transfer prices should be set using standard
costs. Dual pricing and two-part tariffs help with the
recovery of fixed costs.
6 Market based Transfer prices may be based on market price (or an
adjusted market price).
7 Opportunity The best method for setting transfer prices
cost based marginal cost + lost opportunity
8 Practical Most transfer prices are determined by negotiation or via
issues head office guidance.
9 International Transfer pricing in multinational organisations must
aspects consider taxation.
END OF CHAPTER
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topics. As a reminder, Step 4 must be completed and submitted in order to be able to qualify for Pass
Assurance. It is the Step 4 Question Paper and can also be found at the back of these course notes.
Course notes
chapter
control
Organisational change, environmental
and ethical issues
performance
Management information
Performance management IS 6
systems
Financial Performance Scope of strategic performance
7
Measurement measures in the private sector
Divisional performance & transfer
Divisional performance 8
pricing issues
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Achievement Ladder
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Scope of strategic
performance measures
in not-for-profit
organisations

Highlight and discuss the potential for
diversity in objectives depending on
organisational type.
Discuss the use of benchmarking in public Essland Police Forces Dec 2013
sector performance (league tables) and its Teeland March / June 2016
effects on management and client
behaviour.
Discuss the difficulties in measuring outputs Essland Police Forces Dec 2013
when performance is not judged in terms of BLA Dec 2014
money or an easily quantifiable objective.
Discuss how the combination of politics and
the desire to measure public sector
performance may result in undesirable
service outcomes eg the use of targets.
Assess 'value for money' service provision LGHD June 2010
as a measure of performance in BLA Dec 2014
not-for-profit organisations and the public
Teeland March / June 2016
sector.
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9a: SCOPE OF STRATEGIC PERFORMANCE MEASURES IN NOT-FOR-PROFIT

ORGANISATIONS
Overview

measures in not-for-profit
organisations
Objectives Measuring performance
Value for money League tables

(VFM)
Economy Effectiveness
Efficiency
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ORGANISATIONS
1 Objectives
1.1 Not for profit organisations (NFPOs) comprise many different types of business and exist in
many different sectors.
1.2 The main difference between NFPOs and the private sector is the lack of profit motive.
Profits may be made, but as a means to an end, not an end in themselves. It is, however,
important that costs of operations are covered or the organisation's survival is at stake.
1.3 Objectives of NFPOs will be contingent on the business sector the NFPOs serve. Compared
to a 'for profit' organisation there is likely to be:
 A wider variety of different performance measures
 Greater emphasis on non financial measures
Value for money (VFM)

1.4 The objectives of NFPOs can be structured around the requirement to deliver 'value for
money'. VFM is defined as:
(a) Economy – Exercising buyer power
– Not wasting cash
(b) Efficiency – Maximising outputs
– Minimising inputs
– Operating within budget
(c) Effectiveness – Achieving non-financial objectives (eg quality, time, take-up)
Lecture example 1 Discussion question
Required
Using the value for money framework, suggest some suitable objectives for the following NFPOs
(a) A hospital
(b) A waste management service responsible for the collection and disposal of household and
commercial waste
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ORGANISATIONS
Solution
2 Performance measurement
2.1 There are a number of problems in using (mainly) non-financial performance measures
to assess performance. Some of these will also apply to 'for profit' organisations that are
using non-financial performance measures to assess performance (see later).
Problem Illustration
What measures to This is often hard to agree on. For example, are good exam
use? results alone an adequate measure of the quality of teaching?
There will be more than one measure, so then there is the issue
of how to weight the different objectives to give an overall
measure of performance.
Data collection It is often hard to quantify qualitative data. For example, a
complaint can be recorded but the seriousness of the complaint is
harder to quantify.
Lack of comparisons The diverse range of NFPOs makes it hard to find comparable
businesses to act as benchmarks.
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ORGANISATIONS
Benchmarking (league tables)

2.2 Benchmarking has been introduced in Chapter 1. Benchmarking can be especially relevant
to not-for-profit organisations because it can help to create a discipline to encourage high
standards of performance.
If, as is sometimes the case in the not for profit sector, organisations are prepared to
collaborate with each other then benchmarking can produce extremely useful data for
performance management.
2.3 Benchmarked measures are often presented in league tables.
For example, in the UK, university league tables are produced based on selected aspects of
the universities' performance, with weightings attached to each aspect of performance. For
example the Guardian's league table uses the following (with weightings in brackets):
 'Entry score' (17%);
 'Feedback' – as rated by graduates of the course (5%);
 'Job prospects' (17%)
 'Spending per student' (17%);
 'Staff/student ratio' (17%);
 'Teaching quality' – as rated by graduates of the course (10%)
 'Value added' (17%).
Problems with league tables

2.4 Organisations are likely to focus mainly on improving their performance in these areas of
activity, and less attention will be given to other areas. This highlights the adage (which
we will look at again in the next chapter in relation to non-financial performance indicators)
that, 'What gets measured, gets done.' For example, in the Guardian measure of
University performance there is no importance attached to research output.
2.5 If an organisation feels that the performance measure is not controllable (eg 'job prospects'
may be largely determined by economic conditions in the local region) then league tables
could serve to demotivate.
2.6 League tables are less useful where consumers of the service do not have the choice of
which organisation to use eg choice of police force.
2.7 If a ranking system is used this fails to show whether the differences between organisations
are serious or minor.
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ORGANISATIONS
3 Chapter summary
1 Objectives NFPOs do not exist primarily to create financial gain.

However, they must cover costs to guarantee their
long-term survival.
The performance of NFPOs can be assessed using
value for money (3 Es):
– Economy
– Efficiency
– Effectiveness.
2 Performance Measuring performance is problematic due problems
measurement with specifying and weighting performance measures,
and with data distortion.
League tables can cause NFPOs to display
dysfunctional behaviour.
END OF CHAPTER
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Non-financial
performance indicators

Discuss the interaction of NFPIs with financial Amal part a June 2012
performance indicators.
Discuss the significance of NFPIs in relation to Graviton Q2b – December 2013

employees and product/service quality eg Victoria Q3b June 2015
customer satisfaction reports etc.
Discuss the difficulties in interpreting data on Graviton Q2b – December 2013
qualitative issues. Covered in Chapter 9a
Discuss the significance of brand awareness HS part c December 2012
and company profile and their potential impact
on business performance.
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9b: NON-FINANCIAL PERFORMANCE INDICATORS
Overview
Non-financial performance
indicators (NFPIs)
Problems with financial NFPIs for Brands and performance

indicators
Employees Quality
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1 Problems with financial performance indicators

1.1 (a) Focus only on variables which can be expressed in monetary terms ignoring other
important variables which cannot be expressed in monetary terms.
(b) Focus on historic perspective, often produced at 'month-end'.
(c) Do not convey the full picture of a company's performance in a modern business
environment; eg quality, customer satisfaction.
(d) Focus on the short term.
(e) Measure success but do not measure the factors that ensure success; ie in
relation to a business' critical success factors.
2 Non-financial performance indicators (NFPIs)

2.1 NFPIs are measures of performance based on non-financial information which may originate
in and be used by operating departments to monitor and control their activities without any
accounting input.
2.2
Information can be provided quickly (eg per Too many measures can lead to
shift, daily or hourly) unlike traditional financial information overload for managers.
performance reports.
Easy to calculate and easier for non- May lead managers to pursue detailed
financial managers to understand and use. operational goals at the expense of
overall corporate strategy.
Less likely to be manipulated than traditional Need to be developed and refined over
profit related measures (counteract short time to remain relevant.
termism).
Provide better information about key areas Data collection costs.
such as quality, customer satisfaction,
employees. These are lead indicators of profit.
Employees and quality

2.3 Two areas for assessment are noted in the syllabus – employees and product and service
quality. Quality is the focus of the next chapter.
Area assessed Possible performance measures

Employees Number of complaints received
Staff turnover
Days lost through absenteeism
Days lost through accidents/sickness
Training time per employee
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3 Chapter summary

1 Problems with financial Concentration on financial indicators may ignore
performance indicators important or critical success factors.
2 NFPIs NFPIs are more appropriate to assess quality,

service and employees.
END OF CHAPTER
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The role of quality in

performance
management systems

Discuss and evaluate the application of Japanese Tench Dec 2011 part b and c
business practices and management accounting Boltzman Dec 2014 Q1iv
techniques, including Kaizen costing, target
costing, just-in-time and total quality
management.
Assess the relationship of quality management to Tench Dec 2011 part a
the performance management strategy of an Monza Sep / Dec 2016 Q1iv
organisation including the costs of quality.
Justify the need and assess the characteristics of Covered in Chapter 6 in the section on lean
quality in management information systems. information systems.
Discuss and apply Six Sigma using tools such as Thebe June 2012
DMAIC for implementation. Posie Sept / Dec 2015
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10: THE ROLE OF QUALITY IN PERFORMANCE MANAGEMENT SYSTEMS
Overview
The role of quality in performance

management systems
Influence of Japanese Approaches to quality Costs of quality

business practices management
Six Sigma & DMAIC Total quality management

(TQM)
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1 Just in time systems (JIT)

1.1 Conventional manufacturing approaches tended to involve:
(a) Long production runs determined by economic batch quantities;
(b) Standardisation of product ranges to gain efficiency;
(c) Use of inventories as a buffer to cope with fluctuations in levels of demand; and
(d) Focus on improving output per hour to gain efficiency and reduce unit cost.
1.2 JIT aims to restructure the manufacturing process to make production
(a) More flexible;
(b) Rapid; and
(c) Cost effective.
Business Process Re-engineering

1.3 This type of fundamental redesign of business processes to achieve dramatic
improvements is sometimes referred to as Business Process Re-engineering.
A re-engineered process has certain characteristics.
(a) Often several jobs are combined into one, this may require workers to be re-trained.
(b) Workers often make decisions.
(c) The steps in the process are performed in a logical order.
(d) Work is performed where it makes most sense.
(e) Checks and controls may be reduced, and quality 'built-in'.
Overview of JIT
1.4 Supplier base JIT purchasing – narrow base
– quality clause in contract
– zero materials price variance
– frequent deliveries
Raw material – zero stock

– zero defects
Work-in-progress
JIT production – zero defects
– low set-up times (short production runs)
– greater people responsibility
– quality emphasis, diminishes value of
– traditional variance analysis
Finished goods – zero stock

– produce to customer specification
Demand pull
Traditional flow
Customers JIT flow
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Essential elements of JIT

1.5
Element Detail
Close Quality of goods is the responsibility of the supplier.
relationship Establish a long-term commitment between supplier and customer.
with suppliers
Suppliers should expect to deliver material of 100% quality, on time.
Expect to purchase inputs close to the time they are needed, using
small, frequent deliveries.
Small batch Achieved by reducing set-up times.
sizes Allows poor quality to be more easily identified.
Employee Small cells of multi-skilled workers, trained to operate each machine
involvement within their cell and to perform routine preventative maintenance.
Identifying the Empowering employees to stop the production line to rectify
root cause of problems.
problems
Eliminating non eg inventory, supervision
valued added
functions
This approach is sometimes referred to as lean manufacturing.
Implications of JIT for performance management

1.6 (a) Shift from encouraging efficiency to encouraging quality, flexibility and speed of
response; extensive use of non financial indicators.
(b) Accept slack time rather than pursuit of continuous efficient working.
(c) Provide cell-based incentives linked to quality, speed of response or 'cell profit'.
Implications of JIT for costing

1.7 Absence of inventory makes much of traditional costing irrelevant. Job costing can be
simplified by a backflush accounting approach as materials are rapidly converted into
finished goods that are sold immediately.
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2 Target costing and Kaizen

2.1 In a modern environment with shortening product life cycles, organisations have to
continually redesign their products. It is essential that they try to achieve a target cost during
the product's development.
2.2 Target costing involves setting a selling price for a product by reference to the market. From
this a desired profit margin is deducted leaving a target cost.
The target costing process
The target costing process
Determine currently- Determine

achievable product
cost concept
Establish
target
price
Establish
desired
profit margin
Set target
cost
Calculate cost
gap
Try to close
the gap
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Implications
2.3 Target costing turns the traditional cost plus approach to pricing on its head, making price
the first consideration.
Attaining target cost

2.4 (a) Changing the product design
(b) Training staff in more efficient techniques
(c) Acquiring new, more efficient technology
(d) Cutting out non-value-added activities.
Once the product goes into production target costs will gradually be reduced. This means
that cost savings must be actively sought and made continuously (see Kaizen later).
The Management Accountant of Peach plc has collated the following data for a new product, the
y-pad music player: the target price is $50.
Sales required = 100,000 units
ROI = 25%
$
Investment in buildings 1,500,000
fixtures 500,000
machinery 1,400,000
Cost card materials 32.50

labour 3.75
overheads 8.00
44.25
Required
(a) Calculate the target cost and cost gap for the y-pad.
(b) Recommend how the cost gap can be closed.
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Solution
Kaizen
2.5 Kaizen costing focuses on obtaining small, incremental cost reductions during the
production stage of the product life cycle.
2.6 Current costs are reduced by:
(a) Value analysis
(i) Devising ways of achieving the purpose most economically at the required
standards of quality and reliability.
(ii) The product's value is determined by its cost, exchange, use or esteem value.
(iii) Cost value is reduced whilst maintaining other elements of value.
(iv) Value analysis requires functional analysis.
(b) Functional analysis
(i) Product's functions are determined and each valued based on what a customer
will pay.
(ii) Any function that cannot be produced for its target cost is modified, eliminated
or replaced.
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3 Quality management
3.1 Traditional views on quality management suggest that quality can be achieved by:
(a) Establishing standards;
(b) Establishing procedures to deliver the targeted quality standards (quality assurance);
(c) Monitoring actual quality (quality control simply relies on inspection); and
(d) Taking control action when standards are not achieved.
This will ensure that conformance costs are kept under control so that the costs of achieving
quality do not become too great. Too high a level of quality may not be justifiable on cost
grounds.
3.2 Modern views that follow the total quality management (TQM) philosophy believe:
(a) There is no optimal level of quality – the target should be zero defects.
(b) Failure costs are often seriously underestimated.
 Cost of scrapped items and re-working
 Management time spent sorting out problems
 Loss of confidence by customers
3.3 TQM has a number of features

(a) Customer facing culture (recognition of internal customer recognition)
(b) Defect prevention not inspection
(c) Personal responsibility for quality, no 'acceptable' defect levels
(d) All departments (not just production) must be involved
3.4 Quality requires a change in manufacturing approaches and has bought about several new
approaches
(a) Cellular manufacturing
(b) Advanced manufacturing technology
(i) Automation
(ii) CAD/CAM
(c) Input at the design stage, not at the production stage. Design is one way to prevent
poor quality:
(i) Reduce the number of parts in a product
(ii) Use components common to other products in the organisation
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Cost of quality
3.5 Cost of quality reports enable costs to be monitored.
Costs of quality
Prevention costs
Costs of conformance
Appraisal costs
Internal failure costs
Costs of non-conformance
External failure costs
Lecture example 2
20X6 20X7
$'000 $'000
Quality control training 40 120
Rework costs 125 60
Returns 35 15
Customer complaints department 50 20
Inspection of WIP 85 70
Scrap 60 20
395 305
Required
Allocate the following costs into appropriate categories of quality costs and prepare a 'cost of
quality' report. Comment on your findings.
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Solution
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4 Six Sigma
4.1 Six Sigma is a technique designed to improve a process so that there is only the tiniest
possibility of failure.
Five steps
4.2 To improve an existing process, Six Sigma recommends five key steps:
Step Explanation
1 Define Identify customer requirements, clarify the problem and set goals .
2 Select what needs to be measured, identify information sources and
Measure
gather data.
3 Analyse Develop hypotheses, identify the key variables and root causes.
4 Generate solutions and put them into action, either modifying existing
Improve
processes or developing new ones. Quantify costs and benefits.
5 Control Develop monitoring processes for continued high-quality performance.
Organisations can also apply Six Sigma to new processes and the steps become define,
measure, analyse, design and verify.
Benefits
4.3 Benefits claimed for Six Sigma include:
(a) Processes are more rigorous as they use hard, timely data, not opinions or gut feel, to
make operating decisions
(b) Customer loyalty by delivering superior value
(c) Reduced variation in service processes, such as the time from order to delivery, or
offering a consistent, high-quality service experience
(d) Improved financial performance, through cost savings from projects, increased
revenue from improved products and greater operating margins
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5 Chapter summary
1 JIT JIT aims to restructure manufacturing processes to

improve flexibility, speed and costs. It relies on close
cooperation with suppliers, preventative maintenance
and quality.
2 Target costing and Target costing is market led approach to pricing
Kaizen designed to plan for, and produce goods within an
agreed maximum costs. it operates in advance of
production when major decisions on R&D and capital
expenditure are being made
Kaizen operates during the manufacturing life of a
product to obtain small, incremental coat reductions.
It requires value analysis and functional analysis
3 Quality management Cost of quality reports separate prevention,
appraisal, internal failure and external failure costs so
that the costs of conformance and non-conformance
can be monitored.
4 Six Sigma Six Sigma is a technique to eliminate defects and
create almost perfect levels of quality.
END OF CHAPTER
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Performance
measurement and
strategic HR issues

Advise on the relationship of HR management to performance Booxe June 2014 Q2 part c
measurement (performance rating) and suitable remuneration Victoria part c June 2015
methods.
Advise on the link between achievement of the corporate strategy APX June 2011
and the management of HR (eg through the building block model). Kolmog Hotels Q1 – June 2013
Discuss and evaluate different methods of reward practices. RRR Dec 09 part c
Albacore Dec 11 part b
Cuthbert Mar / June 2016 part b
Assess the benefit and problems of linking reward systems to RRR Dec 09 part c
performance measurement eg impact on risk appetite. TRG June 2008
Discuss the accountability issues that might arise from performance Albacore Dec 11 part b
measurement systems. Navier Q2 – June 2013
Evaluate the statement 'what gets measured gets done'.
Demonstrate how management style needs to be considered when Albacore Dec 11 part b
designing an effective performance measurement system. Beach Q2 part c June 2015
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11: PERFORMANCE MEASUREMENT AND STRATEGIC HR ISSUES
Overview
Performance measurement and

strategic HRM issues
Link to strategy – Reward systems

building block model
Problems Management
styles
'What gets
measured
gets done'
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1 Link to strategy
Human resource management (HRM) and performance measurement
1.1 Performance management requires that the strategic objectives of the organisation are
broken down into layers of more and more detailed sub-objectives, so that individual
performance can be judged against personal goals that support and link directly back to
corporate strategy. This kind of cascade of goals and objectives was discussed earlier.
1.2 Intimately linked with the definition of goals is the creation of suitable performance
indicators against which to rate or measure employees' performance. Targets are set for
individuals that are achievable and controllable. Performance against targets will be
reviewed as part of the appraisal process.
1.3 In addition to providing a performance rating, a staff appraisal scheme will:

(a) Set motivating challenges;
(b) Identify training needs;
(c) Provide a forum for exchanging feedback; and
(d) Identify future aspirations and expectations (career management).
Performance measurement and corporate strategy

1.4 Fitzgerald and Moon (1996) focused on performance measurement in service businesses.
The diagram below shows their building blocks for dimensions, standards and rewards.
This framework is also known as the results and determinants framework.
Dimensions
Profit
Competitiveness
Quality
Resource utilisation
Flexibility
Innovation
Standards Rewards
Ownership Clarity
Achievability Motivation
Equity Controllability
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1.5 Performance of the organisation is viewed over six dimensions:

Profit and Competitiveness are the results of the four determinants:
(a) Quality – reliability, courtesy, competence and availability
(b) Resource utilisation – best use of inputs to create outputs
(c) Flexibility – the ability to deliver at the right time in response to customer needs
(d) Innovation – developing new products or services, and to improve
1.6 The dimensions of performance should be set according to these standards:
Ownership – Employees need to participate in the creation of standards to take
ownership of them but this can sometimes lead to the inclusion of
some budgetary slack.
Achievement – The standards set must be challenging but achievable.
Equity – Each division or department must have appropriate standards set for
it in order to ensure fairness in measurement.
1.7 Achievement of standards should be supported by rewards. This should involve:
Clarity – The objectives of the organisation need to be clearly understood.
Motivation – Individuals need to be motivated to achieve the objectives.
Controllability – Managers should not be held responsible for costs over which they
have no control.
2 Reward systems
2.1 The rewards provided for employees may be seen as extrinsic or intrinsic.
(a) Extrinsic rewards include pay and other material benefits as well as such matters as
working conditions and management style.
(b) Intrinsic rewards derive from job content and satisfy higher-level needs, such as
those for self-esteem and personal development.
2.2 Reward systems should:
 Support the overall strategy of the organisation;
 Support recruitment and retention policies;
 Be affordable;
 Increase motivation;
 Align the risk preferences of employees with those of the organisation;
 Encourage ethical behaviour; and
 Be fair.
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Lecture example 1 Exam standard
The RRR Group (RRR) provides roof repair services to individual customers on a nationwide basis.
RRR operates a number of regional divisions, each of which offering similar services. Table A shows
actual results for Alpha division for 20X8 and 20X9, together with data representing an average of a
number of similar competitor company divisions.
As an incentive to support the strategic goals of RRR, a set of KPIs will be introduced in 20Y0 and
used on the basis of the data in Table B. Divisional staff will be paid a bonus as a percentage of
salary based on the overall weighted percentage score deduced from the analysis as per table B.
Required
(a) Apply the KPI appraisal process explained in Table B, using data for 20X8 and 20X9 to
show the bonus (as a % of salary) that would have been achieved by Alpha division for
20X9. (12 marks)
(b) Briefly discuss potential benefits that may be derived from the application of the KPI
appraisal and bonus approach, both for Alpha division and throughout the RRR Group.
(3 marks)
Table A: Summary of financial and other operating information
$m Alpha division Alpha division Competitors
20X9 20X8 20X9
Sales revenue 90.0 80.0 85.0
Less costs:
Cost of sales 60.0 50.0
Marketing 8.5 8.0
Staff training 4.0 4.0
Remedial work on orders 0.8 0.5
Customer enquiry costs 1.5 1.4
Customer complaint related costs 0.2 0.1
Total costs 75.0 64.0 69.5
Net profit 15.0 16.0 15.5
Number of
Customer enquiries 15,000 16,000
Customer orders placed 10,000 8,800
Orders placed requiring remedial work 300 440
Customer complaints 100 132
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Table B: Staff bonus calculation for 20X9 using Key Performance Indicators
KPI Weighting Factor KPI Total Score % Weighted Score %
(A) (B)* (A) × (B)
Revenue 20X9 versus previous year 0.15
Revenue 20X9 versus competitor 0.20
Profit 20X9 versus previous year 0.15
Profit 20X9 versus competitor 0.20
Quality items 20X9 vs 20X8:
No. orders requiring remedial work 0.075
No. of complaints investigated 0.075
% of enquiries converted into orders 0.15
Total 1.000 Bonus (%) = ?
(B)* – each KPI score value is positive (+) where the 20X9 value shows an improvement over the
previous year or negative (–) where the 20X9 value shows poorer performance than in the
previous year.
Each KPI score value is the % increase (+) or decrease (–) in 20X9 as appropriate.
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Solution
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3 Problems with linking rewards to performance

Problem Explanation
Tunnel vision 'What gets measured gets done' leads to focus on
performance measures to the detriment of other areas
Myopia Short-sightedness leading to the neglect of longer-term
objectives
Measure fixation Measures and behaviour in order to achieve specific
performance indicators which may not be effective
Misrepresentation 'Creative' reporting to suggest that a result is acceptable
Ossification Unwillingness to change the performance measure
scheme once it has been set up
Lecture example 2 Problems with performance management
Identify possible solutions for the problems that have been identified in the previous section.
Solution
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4 Management styles
4.1 Hopwood identified three distinct management styles.
Style Content Effect

Budget-constrained Meeting budget High tension
High manipulation
Poor staff relations
Profit-conscious General effectiveness Medium tension
Little manipulation
Good staff relations
Non-accounting Budgets not important Medium tension
(other factors considered) Little manipulation
Good staff relations
4.2 Hopwood believed that the profit-conscious style was often optimal, but appreciated that
style could be contingent on the organisation and activity undertaken.
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Additional notes
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5 Different reward methods

5.1 (a) Individual performance-related pay
– where payments can be linked directly to performance, incentives can be built into
payment schemes.
Performance-related pay takes many forms. As well as merit pay, it can also
include commissions, piecework, and knowledge-related pay.
Commissions and piecework can cause problems eg pressurising a customer to
buy something before they have time to think about the purchase, or producing
substandard goods.
Knowledge-related pay reflects a situation where an employee receives a pay
increase, or a bonus, in return for increasing their competences or knowledge.
Many reward schemes are based on employees achieving pre-determined targets, so
some consideration of target setting is required.
Managers whose rewards depend on fixed targets may be tempted to 'always
negotiate lowest targets and highest rewards,' which suggests that management
plans will understate the potential that the organisation can make. It may be sensible
to base rewards on relative targets and benchmarks. A relative target might be
market share, for example, where rather than setting an absolute target for a sales
manager, a market share (%) target is provided. If the market rises, then more is
expected in absolute terms. This adds to controllability, since the sales manager
could not be held responsible for a rise (or fall) in the overall market, which is outside
of his control, but would be able to control whether or not he achieves the expected
share of the market.
(b) Group profit or performance related rewards
– annual bonus paid based on the achievement or increase in the profits, and
preferably strategic objectives, of the firm or division.
The logic of group performance-related pay schemes is that rewarding employees for
the success of their organisations should help motivate them to increase their
performance – in order to contribute to the success of the organisation overall. They
may also encourage loyalty to an organisation, since in many cases employees lose
their entitlement to a bonus when they leave the organisation.
However, a significant disadvantage of performance-related pay is that it could lead
a conflict between short-term and long-term performance, and hence between
the directors or managers of a company and its shareholders.
To deal with this issue of short-termism, share options or performance shares are
often used.
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Share options
5.2 Share options tend to be most appropriate for the directors and senior management
of an organisation, because they are the people who have most influence over the
organisation's share price. Share options give directors – and possibly other
managers and staff – the right to purchase shares at a specified exercise price after a
specified time period in the future.
The options will normally have an exercise price that is equal to, or slightly higher
than, the market price on the date that the options are granted. The time period
(vesting period) that must pass before the options can be exercised is generally a few
years. If the director or employee leaves during that period the options will lapse.
In this respect, share options can be seen as a way of rewarding directors and
employees for remaining with a company. In turn, this could mean that they are
concerned with the longer-term success of the company, rather than simply focusing
on short-term performance.
The upside risk of share options is unlimited – because there is no restriction on how
much the share price can exceed the exercise price. However, there is no
corresponding downside risk for the directors. If the share price is less than the
exercise price, the intrinsic value of options will be zero and the options will lapse. In
these circumstances it will make no difference how far the share price is below the
exercise price.
If directors hold options, the value of their options will rise if a strategic investment
succeeds and they will not suffer any loss on their options if the investment fails.
Therefore, granting the options might encourage the directors to take actions they
would not otherwise be prepared to take.
However, the absence of downside risk for the directors means that share options
still leave a mismatch between the risks faced by the organisation (and its owners)
and the risk borne by the directors who hold the options. The directors (option
holders) benefit if share prices increase, but do not bear any losses if the share price
falls. However, although an organisation's shareholders benefit if the share price
rises, they will incur losses if the share price falls.
This could be a particular issue if the exercise price looks like it may not be met.
Directors may be motivated to implement high-risk strategies in the hope that the
strategies will increase the share price if they are successful. The directors can afford
to do this, safe in the knowledge that they will not lose out if the share price falls any
further below the exercise price. However, shareholders could suffer significant losses
following a subsequent fall in the price of the shares which they already hold.
Another significant issue with share options as a reward scheme is that share prices
may be determined by external factors and market movements as much as by the
performance of the directors and senior management of a company. If share prices
are rising across a stock market, a company's price may rise as a result of this
general movement, rather than because of any strategies introduced by the directors.
In this respect, share options do not reflect the principle of 'controllability' which is
one of the characteristics of an effective reward scheme.
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Performance shares
5.3 To deal with the issues of downside risk and controllability, many firms are now
using performance shares instead of share options.
Here is an example how how performance shares might work;
 If a company achieves a total shareholder return (TSR) performance
condition, comparing the company's TSR performance to that of a selected
group of other similar listed companies, measured over three years then
directors will be awarded 'performance shares' for up to 200% of their salary;
 If the company is ranked below median, none of the award will vest;
 For a ranking position of median, 30% of the award will vest;
 For a ranking position of upper quartile or better, full vesting (100%) will occur;
and
 For a ranking between median and upper quartile, there will be vesting
between 30% – 100%.
Awards vest on the third anniversary of the date of grant provided the participant
remains an employee with the Group.
5.4 With this approach director's care about downside risk because the shares that they
are awarded are worth less if a strategy fails.
They are also less exposed to an uncontrollable downturn in the stock market;
these will reduce the value of performance shares but will not mean that they are
worthless (which might well be the case with share options).
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6 Chapter summary
1 Link to strategy – Reward systems should link to corporate strategy by

Building block model linking KPIs to CSFs.
Fitzgerald and Moon's building blocks for
dimensions, standards and rewards is a possible
structure for achieving this.
2 Reward systems Reward systems should also support recruitment,
motivation, risk alignment, and ethical behaviour –
while also being affordable.
3 Problems with linking Over emphasis on measuring performance can cause
rewards to dysfunctional behaviour, including short-term
performance thinking and focus on less important issues. These
problems can be reduced by participation, flexibility
and management review.
4 Management styles Hopwood defined three management styles. He
suggested the profit-conscious style was often
optimal.
5 Different reward A mixture of individual and group performance
methods incentives may be used.
Share options and performance shares are
mechanisms for encouraging managers to work in the
best interests of shareholders over the long-term.
END OF CHAPTER
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You have now covered the Topics that will be assessed in Step 5 in your Achievement Ladder. This
topics.
Course notes
chapter
Strategic mgt accounting 1
control
Business structures Structure, environment & ethics 4
Business environment
performance 5
systems
Financial Performance
Private sector 7
Measurement
Divisional performance Divn performance & transfer pricing 8
measures in not for profit organisations 9a
Non-financial performance indicators 9b
measurement
The role of quality in performance
measurement systems 10
Rewards and behaviour Performance measurement & HRM 11
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Achievement Ladder
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Alternative views of
performance measurement
and management

Apply and evaluate the Armstrong stores (sample question)
'balanced scorecard' approach SBC June 2010 Q1
as a way in which to improve
Kolmog Hotels Q1 – June 2013
the range and linkage between
performance measures. Victoria Q3 June 2015
Soup Q4 Sept / Dec 2015
Monza Q1i,ii Sep / Dec 2016
Apply and evaluate the BEG Q5 June 2010
'performance pyramid' as a way Cod Q2 Dec 2011
in which to link strategy, Graviton Q2 Section B – December 2013
operations and performance.
Apply and evaluate Fitzgerald Covered in Chapter 11.
and Moon model using building
blocks for dimensions,
standards and rewards.
Discuss and evaluate the Robust laptops Dec 2010
application of activity based SFS June 2010
management.
Dibble Mar / June 2016
Evaluate and apply the value- LOL cards part c Dec 2010
based management approaches Cantor Q1iv June 2014
to performance management.
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12: ALTERNATIVE VIEWS OF PERFORMANCE MEASUREMENT AND MANAGEMENT
Overview
Alternative views of performance

measurement & management
Performance Activity based Value based

pyramid management management
(ABM) (VBM)
Balanced
scorecard
Building
blocks
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1 The performance pyramid (Lynch & Cross)

1.1 Measuring operating performance needs more than financial statistics. Three models
permit a range of measures to be produced and linked.
(a) Performance pyramid
(b) Balanced scorecard
(c) Building blocks.
1.2 The performance pyramid derives from the Anthony hierarchy of Strategic, Tactical and
Operational Management and identifies the areas to focus upon at each level. From the
vision at the top of the pyramid, managers develop financial and market objectives.
Corporate vision
Objectives Business
units Measures
Market Financial
Business
Customer
Flexibility Productivity
operating
satisfaction systems
Departments
and work
Quality Delivery Cycle time Waste centers
Operations
External effectiveness Internal efficiency
1.3 The diagram shows the linkages both between measures and to objectives. Customer
satisfaction and flexibility lead to achieving the market objective and flexibility and
productivity enable financial objectives to be met.
1.4 At the lowest level, operations contribute to the higher level objective. Budgetary control
and variances ensure quality and delivery in order to achieve customer satisfaction. Delivery
and cycle time provide flexibility. Improving cycle time and waste should ensure rising
productivity.
1.5 This model ensures that both internal and external aspects are considered and that the
interlocking nature of each area of the business is not overlooked.
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2 The balanced scorecard

2.1 The balanced scorecard (developed by Kaplan and Norton 1992) views the business from
four perspectives and aims to establish goals for each together with measures which can be
used to evaluate whether these goals have been achieved.
How do we look to shareholders?
Financial perspective
Goals Measures
How do customers see us? What must we excel at?
Customer perspective Internal business

perspective
Goals Measures Goals Measures
Innovation and
learning perspective
Goals Measures
Can we continue to
improve and create value?
Features/benefits
2.2 (a) The balanced scorecard focuses on both internal and external factors and links
performance measures to key elements of a company's strategy.
(b) It requires a balanced consideration of both financial and non-financial measures and
goals to prevent improvements being made in one area at the expense of another.
(c) It attempts to identify the needs and concerns of customers to identify new products
and markets and focuses on comparison with competitors to establish best practice.
Problems
2.3 (a) Conflicting measures make it difficult to make decisions.
(b) The number of measures used can be confusing and make interpretation difficult.
(c) Stakeholders' needs (including staff) are not explicitly included.
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Lecture example 1 A sample question written by the examiner – giving you a feel for Section A
Armstrong Stores (Armstrong) is a listed business with a chain of 126 general department stores in
South Postland. The company is known for the high quality of its products, mainly food and
clothing. The majority of its goods are sourced from trusted manufacturers and branded under the
company's own 'Strongarm' label.
Currently, Armstrong faces a tough competitive environment with all the major players in its market
trying to secure their positions. Poor economic conditions worldwide have significantly affected
South Postland. Consumer spending is falling throughout the economy and there is no immediate
likelihood of a resumption of growth.
Armstrong's chief executive officer (CEO) has recently conducted a strategic review of the
business in the context of the current economic recession. He has identified the following strategy
as critical for Armstrong's success:
 Focus on key customers – those who are occasional shoppers but not currently loyal to the
business.
 Ensure Armstrong's offering addresses their needs.
 Cut out costs that do not address these customers' priorities.
 Amend current processes to meet this new focus.
 Build for the future with a programme of sustainable development.
The company now needs to address the impact of this new strategy on its performance
measurement systems. Armstrong uses a balanced scorecard to assess its strategic performance
and the scorecard is used to connect the business strategy with its more detailed performance
measures. The CEO has asked you to consider the implications of the new strategy for the
performance measures used by the business.
Currently, Armstrong uses Economic Value Added (EVA®), earnings per share (EPS) growth and
share price performance to monitor its financial performance. The company has supplied data in
appendix 1, which the CEO wishes to see used to assess the financial performance from the
shareholders' perspective. She has asked that you explain the problems of capturing performance
with these particular metrics, and also, how they may affect management's behaviour.
Finally, in order to aid refocusing the company, the CEO has requested a report to the board
comprehensively benchmarking the current performance of Armstrong. The board needs to have
benchmarking exercise explained and then the results described. Appendix 2 contains data
analysing Armstrong, its two main competitors and statistics provided by the government of South
Postland. A junior analyst has already correctly completed the preliminary calculation work for
benchmarking in appendix 3. The CEO has requested a critical assessment of these different
sources as well as the comments on the results of the analysis.
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APPENDIX 1 – Financial data for Armstrong Stores

20X8 20X9
$m $m
Operating profit 505.7 435.1
Interest 40.2 77.6
Profit before tax 465.5 357.5
Profit for the year 353.8 271.7
Average number of shares in issue 1,600.0 1,600.0
20X8 20X9
Economic value added (EVA®) $306m $110m
Stock market information 20X8 20X9

South Postland market index 1,115.2 724.9
Retailing sector index 2,450.7 1,911.5
Armstrong Stores (average share price) $2.45 $2.08
APPENDIX 2
(a) Comparative data
BS stores CS Stores Armstrong
20X8 20X9 20X8 20X9 20X8 20X9
Revenue:
– Food $m 1,542 1,538 2,100 1,978 1,985 2,025
– Clothing $m 1,234 1,222 2,723 2,610 2,450 2,475
Total $m 2,776 2,760 4,823 4,588 4,435 4,500
Profit for the year $m 142 127 294 193 354 272
No of stores 81 83 167 186 119 126
No of suppliers 3,400 3,100 4,200 4,200 4,122 4,468
No of warehouses 6 6 8 9 7 7
(b) Government statistics
Market totals – revenue
$m $m
– Food Retail 12,403 12,656
– Clothing Retail 25,792 22,500
(c) Armstrong data for 20X9
Region by region (South Postland is split into three large regions)
Acelon Baselon Caselon
Revenue:
– Food $m 648 810 567
– Clothing $m 792 1,114 569
Total $m 1,440 1,924 1,136
Profit for the year $m 87 111 73
No of stores 37 51 38
No of warehouses 2 3 2
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APPENDIX 3 – Junior analyst's working papers

(a) Comparative data
Revenue:
– Food –0.3% –5.8% 2.0%
– Clothing –1.0% –4.1% 1.0%
Total –0.63% –4.9% 1.5%
Profit for the year –10.3% –34.5% –23.2%
No of stores 2.5% 11.4% 5.9%
No of suppliers –8.8% 0.0% 8.4%
No of warehouses 0.0% 12.5% 0.0%

20X8 20X9 20X8 20X9 20X8 20X9
Market share
– Food 12.4% 12.2% 16.9% 15.6% 16.0% 16.0%
– Clothing 4.8% 5.4% 10.6% 11.6% 9.5% 11.0%

Revenue per shop $m 34.27 33.25 28.88 24.67 37.27 35.71
(b) Regional data for Armstrong
Acelon Baselon Caselon Total
Revenue per shop $m 38.92 37.72 29.90 35.71
Profit margin 6.0% 5.8% 6.5% 6.0%
Required
(a) Describe the four perspectives of the balanced scorecard showing how the new strategy of
the business as outlined by the CEO links to the different perspectives. Illustrate your
answer by suggesting appropriate performance measures for Armstrong for each of the
detailed points within the strategy. (8 marks)
(b) (i) Assess the financial performance of the company using the three shareholder
performance indicators. (5 marks)
(ii) Critically evaluate the use of these performance metrics and how they may affect
management's behaviour. (6 marks)
(c) Prepare a report to the board on a benchmarking exercise using the information given in the
appendix:
(i) Evaluate the benefits and difficulties of benchmarking in this situation. (4 marks)
(ii) Evaluate the performance of Armstrong using the data given in the question. Indicate
what further information would be useful and conclude as to the performance of the
company. (8 marks)
Professional marks for appropriateness of format, style and structure of the report. (4 marks)
(Total = 35 marks)
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Solution
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3 Activity based management (ABM)

Activity based costing (ABC)
3.1 Traditional cost analysis analyses costs by type for each responsibility centre (eg function).
ABC analyses costs on the basis of activities and therefore provides information on why
costs are incurred and on the output of the activity in terms of cost drivers. The total costs
of an organisation can be controlled or reduced by controlling or reducing cost drivers. Cost
drivers operate at different levels in organisations.
Classification Cause of cost Examples of cost Necessity of cost

of level
Unit level Production of a single unit Direct materials Once for each
of product or delivery of Direct labour unit produced
single unit of service
Batch level A group of things being Purchase orders, Once for each
made in a single set-ups, inspection batch produced
production run
Product Development, production Production planning Supports a
sustaining and sale of individual Product specific R&D product type
level product line and marketing
Facility Existence of facility. Building depreciation Supports the
sustaining and maintenance overall production
Organisational process
advertising
3.2 If most overheads cost are product sustaining or facility sustaining then ABC will offer less
benefit as a mechanism for product costing .
Activity based management (ABM)

3.3 ABM uses ABC information to focus management attention on key value-adding activities,
key customers and key products in order to maintain or increase competitive advantage –
it does not have to track costs back to a batch or unit level..
Activity Based
Management
Control of product Control of business Control of resources

design processes – customer account
– target costing – costing activities in profitability analysis
the value chain – ABB / ABC
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3.4 ABM can be useful at two levels:

 Operational: 'doing things right'. ABM can be used uses to help control resource
consumption.
 Strategic: 'doing the right things'. ABM can help to focus on which products or
markets to focus on over the long-term.
Lecture example 2 Class / homework exercise
MNOP is an IT consultancy that provides IT advice to a range of clients.

MNOP plc classifies its customers into four main categories.
M N O P
$'000 $'000 $'000 $'000
Sales value 1,000 3,000 850 1,200
MNOP employs ten full-time IT specialists who each deliver 1,500 chargeable hours per year and
who are paid $60,000 per year.
MNOP plc has estimated its other costs as follows:
Costs
$'000
Telephone support 1,000
After-sales service 1,500
Client meetings 280
2,780
MNOP has reviewed its existing client database and determined the following four average profiles
of typical clients:
M N O P Total
'000 '000 '000 '000 '000
Number of telephone queries 20 480 50 250 800
Number of visits 3 21 4 8 36
Number of meetings 70 90 20 100 280
Chargeable hours 4 6 2 3 15
Previously MNOP plc used a single cost rate of $200 per hour for both in-house profit reporting
and quotations for new contracts.
Required
(a) Prepare calculations to show the profit attributed to each customer group using the current
system of attributing costs.
(b) Prepare calculations to show the profit attributed to each customer group using an activity
based system of attributing costs.
(c) Discuss the differences between the costs attributed using ABC and those attributed by the
current system and advise whether the change to the ABC system should be adopted.
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Solution
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4 Value Based Management (VBM)

4.1 Management decisions designed to lead to higher profits do not necessarily create value
for shareholders. Often long term value is sacrificed to meet short term profit targets. VBM
starts with the view that companies only create value when they create returns in
excess of their cost of capital.
4.2 There are four essential management processes involved in the implementation of VBM
Step 1 A company or business unit develops a strategy to maximise value. Critical
success factors are identified.
Step 2 This strategy translates into short- and long-term performance targets defined
in terms of the key value drivers.
These targets are likely to involve a structured mix of financial and non-
financial KPIs (eg balanced scorecard, performance pyramid, building blocks
models).
A key financial measure is likely to be EVA® (because this embeds the WACC
into the performance measure).
Step 3 Plans are drawn up to define the steps that will be taken to achieve these
targets.
Step 4 Finally performance metrics and incentive systems are cascaded through
the organisation that are compatible with these targets.
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Additional notes
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Lecture example 3 Class / homework exercise
Bettaserve Limited has identified and defined a market in which it wishes to operate. This will
provide a 'gold standard' focus for an existing range of services. Bettaserve plc has identified a
number of key competitors and intends to focus on close co-operation with its customers in
providing services to meet their specific design and quality requirements.
Efforts will be made to improve the effectiveness of all aspects of the cycle from service design to
after-sales service to customers. This will require inputs from a number of departments in the
achievement of the specific goals of the 'gold standard' range of services. Efforts will be made to
improve productivity in conjunction with increased flexibility of methods.
An analysis of financial and non-financial data relating to the 'gold standard' proposal for each of
the years 20X7, 20X8 and 20X9 is shown below.
Required
(a) Prepare an analysis (both quantitative and discursive) of the 'gold standard' proposal for the
period 20X7 to 20X9. You should use the information provided in the question, together with
the data in Schedule 1 below.
Your analysis should include the following:
(i) Discussion and, where possible, quantification of the proposal in both marketing and
financial terms. (6 marks)
(ii) Discussion of the external effectiveness of the proposal in the context of ways in
which each of Quality and Delivery are expected to affect customer satisfaction and
hence the marketing of the product. (6 marks)
(iii) Discussion of the internal efficiency of the proposal in the context of ways in which the
management of each of Cycle Time and Waste are expected to affect productivity and
hence the financial aspects of the proposal. (3 marks)
(b) Discuss the links, both vertical and horizontal, of the performance measures investigated in
(a). The discussion should include comment on the hierarchy and inter-relationships
between the measures, including internal and external aspects of the expected trends in
performance.
(Note. A diagram may be used to illustrate the links, together with relevant discussion).
(5 marks)
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Schedule 1
'Gold Standard' proposal – estimated statistics
20X7 20X8 20X9
Total market size ($m) 240 250 260
Bettaserve plc – sales ($m) 30 36 40
Bettaserve plc – total costs ($m) 28.2 25.448 25.1
Bettaserve plc – sundry statistics:

Services achieving design quality
standards (%)
and accepted without further rectification 95 97 98
Rectification claims from customers ($m) 0.9 0.54 0.2
Cost of after sales rectification service 3 2.5 2
($m)
Sales meeting planned completion dates 90 95 99
(%)
Average cycle time: (customer enquiry to 6 5.5 5
service finalisation) (weeks)
Service enquiries not taken up by 7.50 5.00 2.50
customers
(% of enquiries)
Idle capacity of service personnel (%) 10 6 2
Analysis of total cost: $'000 $'000 $'000

Target cost – variable 12,000 14,400 16,000
Target cost – fixed 4,000 4,000 5,000
Internal failure costs 3,200 1,840 1,050
External failure costs 4,000 2,208 1,050
Appraisal costs 1,000 1,000 1,000
Prevention costs 4,000 2,000 1,000
Total cost 28,200 25,448 25,100
(Total = 20 marks)
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Solution
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5 Chapter summary
1 Performance pyramid The performance pyramid highlights the links
between an organisation's vision and its functional
objectives.
2 Balanced scorecard The balanced scorecard approach to performance
measurement focuses on four different perspectives
and uses financial and non-financial indicators.
3 Activity based ABM can help cost activities and help managers
management (ABM) focus on value and non-value added activities.
Activity based costing supports this analysis.
4 Value Based VBM focuses on value drivers and on creating value
Management (VBM) by creating returns in excess of their cost of
capital.
END OF CHAPTER
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Predicting and
preventing corporate
failure

Discuss how long-term survival necessitates Culam Q4 Dec 2014
consideration of lifecycle issues.
Assess the potential likelihood of corporate failure, BPC Dec 2007
utilising quantitative and qualitative performance RM Q5 Dec 2010
measures (such as Z-score and Argenti). CCNH Q4b Dec 2012
Culam Q4 Dec 2014
Assess and critique quantitative and qualitative RM Q5 Dec 2010
corporate failure prediction models. Culam Q4 Dec 2014
Identify and discuss performance improvement RM Q5 Dec 2010
strategies that may be adopted to prevent corporate Culam Q4 Dec 2014
failure.
Identify and discuss operational changes to
performance management systems required to
implement performance improvement strategies.
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13: PREDICTING AND PREVENTING CORPORATE FAILURE
Overview
Predicting and preventing

corporate failure
Causes of corporate failure Prediction models Prevention strategies
Industry/company Management
Finance
Z-score A-score
Working capital Equity Defects Symptoms
Retained earnings Debt Mistakes
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1 Causes of corporate failure

1.1 Failure is the last stage of business decline. Decline arises from a number of factors.
Financial instability
1.2 We have already seen many ratios that allow analysis of finance:
 Interest cover
 Gearing
 Working capital ratios
 Current ratio
 Quick ratio
However, these alone seem to be poor predictors of failure.
Company weakness
1.3 Research from previous recessions has identified some key symptoms of corporate decline.
 Declining profitability
 Decreasing sales volume
 Frequent changes of management
 Falling market share
 Lack of planning
Management weakness
1.4 Management must take action when confronted with evidence of decline but, frequently,
they do not. Management paralysis may be sue to a range of factors:
(a) Crisis denial
(b) Blame culture, leading to inaction
(c) Ineffective scrutiny by non executive directors
Industry conditions
1.5 Industries reach the end of their life cycle when overtaken by new products or suffer
temporary difficulties due to economic factors.
1.6 As the competitive environment changes pressure is placed on margins. Unless a company
has the lowest cost base, a superior advantage or a loyal niche of customers it is likely to
lose market share.
1.7 General economic conditions will clearly be important too. In a severe recession most
industries will experience a downturn.
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2 Prediction models
2.1 Many models have been developed from research into failed businesses over the last 40
years to help predict future corporate failures. Two of the best known prediction models are:
(a) Altman's Z-score
(b) Argenti's A-score.
Z-score
2.2 Altman researched the financial results of manufacturing businesses, some of which had
failed and some of which had survived, and determined five key indicators of success or
failure.
2.3 The model emerged as

Z = 1.2X1 + 1.4X2 + 3.3.X3 + 0.6X4 + 1.0X5
Where
Factor Calculation Measure of
X1 working capital/total assets Liquidity
X2 retained earnings/total assets Profitability
X3 earnings before interest and tax/total assets Solvency
X4 market value of equity/book value of total debt Gearing
X5 revenue/total assets Activity
2.4
Z-score Prediction
> 2.7 Non-failure
< 1.8 Failure
1.8 < Z < 2.7 Uncertain future
Altman also adapted this quantitative model to allow relative scoring from 0 to 100. A
score of 75, for example, would indicate that 25% of companies have higher Z-scores than
the company under consideration. Relative measurement over time permits trends to be
identified more easily.
Weaknesses of the model

2.5 The weaknesses of Z-scores include:
(a) Based on a sample.
(b) Requires a market value for equity which limits its use to quoted companies.
(c) Based on visible factors so fails to include post balance sheet events, creative or
fraudulent accounting, or internal weakness not apparent in financial information.
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Lecture example 1
Zorro is a manufacturer of fancy dress costumes. It has expanded rapidly in the last few years
under the leadership of its autocratic chairman and chief executive officer, Sally Maysmith.
The company has developed a major new product range linked to the relaunch of a major film
franchise, which has necessitated a large investment in new equipment. However, the recent
share price performance has caused concern at board level and there has been comment in the
financial press about the increased gearing and the strain that this expansion is putting on the
company.
A junior analyst in the company has correctly prepared a spreadsheet calculating the Z-scores as
follows:
20X8 20X9 20Y0
X1 WC/TA –0.28 –0.25 –0.20
X2 RE/TA 0.12 0.21 0.21
X3 PBIT/TA 0.16 0.09 0.05
X4 MVE/Total long-term debt 1.62 0.95 0.60
X5 Revenue/TA 1.50 0.72 0.84
Z 2.832 1.581 1.419
Required
Comment on the results in the junior analyst's spreadsheet.
[Note – formula would be provided]
Solution
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A-score
2.6 Argenti developed a qualitative model based on more than financial results. He argued that
symptoms were only obvious in the later stages of failure and failure could be better
predicted by looking at root causes, which he believed lay in the ability of management to
lead a business. Thus failure follows a predictable system.
Defects
Mistakes
Symptoms
Failure
2.7 A score is given to each element as follows:
Factor Illustration Score if

present
Defects Management Chief Executive is an autocrat 8

Chief Executive also the Chairman 4
Passive Board of Directors 2
Unbalanced skills in Board of Directors 4
Weak Finance Director 2
Lack of management in depth 1
Poor response to change 15
Accounting No budgets or budgetary controls 3
No/out of date cash flow forecasts 3
No costing system 3
Total 45
Mistakes Overtrading Company expanding faster than funding; 15
capital base too small or unbalanced
High gearing Inability to service debt levels 15
Failure of project Not able to meet obligations 15
Total 45
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Factor Illustration Score if

present
Symptoms Deteriorating Financial analysis (eg poor Z-score) 4

ratios
Creative Gaming and misrepresentation 4
accounting
Declining morale Untidy offices or factory, high staff 4
and quality turnover, rumours
Total 12
2.8 In order for a firm to be considered not at risk, it needs to score below a certain level.
Factor Maximum permitted score

Defects 10
Mistakes 15
Symptoms 0
Total permitted 25
Companies not at risk often score between 0 and18, whilst those at risk usually score well
above 25 (often 35–70).
Weaknesses of the model

2.9 The weaknesses of A-scores include:
(a) Subjective scores chosen
(b) Lack of formal testing to prove the model's validity
(c) Lack of PESTEL factors incorporated
(d) Lack of industry considerations.
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3 Prevention strategies
3.1 Any strategy must be directed at the underlying cause of failure, not at its symptoms.
3.2 Z-score analysis may identify specific weaknesses that need to be addressed, however
Z-score analysis ignores qualitative factors which may also need to be addressed.
3.3
Cause of crisis Possible strategy
Declining industry Closure
Divestment
Focus
Declining company Marketing
Cost reduction
Sale/closure of poor division
Sale of redundant non-current assets
Management weakness New board
Restructuring
New leader
Corporate governance
Financial instability Asset sale
New equity issue to reduce gearing
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4 Chapter summary
1 Corporate failure Corporate decline is caused by:
– Industry conditions;
– Company weaknesses;
– Poor management; and
– Financial instability.
2 Predicting failure Failure can be predicted using Z-scores and
A-scores. These models include quantitative and
qualitative reasons for failure.
3 Preventing failure Strategies can be implemented to prevent failure or to
turn around failing companies. These can include:
– Contraction;
– New management; or
– Refinancing.
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END OF CHAPTER
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In the final run up to your exam, you should attempt Step 6 as the final check that you are fully prepared
to move onto the revision phase of your studies. As a reminder, Step 6 must be completed and submitted
in order to be able to qualify for Pass Assurance. It is the Step 6 Question Paper and can also be found at
the back of these course notes.
It covers all the Topics in your course. As ever, you will receive feedback on your performance, and you
can use the wide range of online resources to help address any final areas where you need to fine tune
your knowledge or technique.
Course notes
chapter
control
Business structures Structure, environment & ethics 4

performance
systems
Financial Performance
Private sector 7
Measurement
Divisional performance Divn performance & transfer pricing 8
Strategic measures in NFP organisations 9a

Non-financial performance indicators 9b
measurement
The role of quality 10
Rewards and behaviour Performance measurement & HRM 11
Performance measurement Alternative views of performance

12
systems measurement and management
Corporate failure Predicting & preventing corporate failure 13
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Achievement Ladder
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Answers to
Lecture Examples
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14: ANSWERS TO LECTURE EXAMPLES
Chapter 1
Answer to Lecture Example 1
Train X will require an analysis of features of its new market as opposed to traditional management
accounting information. Country X is likely to be very different to Train's domestic markets. Train's board
will lack local knowledge and therefore be unable to make decisions without information on external
factors such as:
 Where are the most desirable locations?
 What courses are suitable for this market (online? day release? weekend?)
 When should course be run (are there religious festivals to be avoided?)
 Who are the key local rivals, and what are their strengths and weaknesses?
Train's board will no doubt be familiar with their main competitors in their current markets,
however they will need to develop a familiarity with the incumbent competitors in Country X.
Typically SMA will provide competitor information, which will help Train's Board develop their
pricing strategies and product offerings by positioning itself relative to the competition.

Strategic information is required by the management of an organisation in order to enable management
to take a longer term view of the business and assess how the business may perform during that period.
The length of this longer term view will vary from one organisation to another, being very much dependent
upon the nature of the business and the ability of those responsible for strategic direction to be able to
scan the planning horizon.
Strategic information tends to be holistic and summary in nature and would be used by management
when, for example, undertaking SWOT analysis. In Hydra strategic information might relate to the
development of new services such as the provision of car parts. Other examples would relate to
the threats posed by Hydra's competitors or assessing the potential acquisition of a bicycle
manufacturer in order to enhance customer value via improved efficiency and lower costs.
Tactical information is required in order to facilitate management planning and control for shorter
time periods than strategic information. Such information relates to the tactics that management adopt in
order to achieve a specific course of action.
For Hydra this might involve information to support consideration of whether to open an
additional outlet in another part of the country or whether to employ additional staff at each outlet
in order to improve the quality of service provision to its customers.
Operational information relates to a very short time scale and is often used to determine immediate
actions by those responsible for day-to-day management.
In Hydra, the manager at each location would require information relating to the level of customer
sales, the number of bicycles sold or serviced and the number of complaints received during a
week. Operational information might be used within Hydra in order to determine whether staff are
required to work overtime due to an unanticipated increase in demand, or whether operatives
require further training due to excessive time being spent on servicing.
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Although Subsequent's revenue increase of 2.6% seems nominal, this is an encouraging result in
comparison to Cavity's poor revenue performance of –9.5%, which could indicate Subsequent has been
able to take market share from its nearest competitor.
Subsequent has experienced a significant fall in profit, which may have been the result of offering
significant discounts in order to grow or stabilise revenues. Since Cavity has experienced an even
greater fall in profits this may be the case across the industry, perhaps as a result of adverse economic
conditions.
Cavity has seen a dramatic increase in the number of stores, however since revenue has fallen by 9.5%
this may have caused significant operational disruption to its supply chain, resulting in poor stock
availability and lost sales. In contrast Subsequent has a more modest increase in outlets and been able to
bring about modest increases in revenue.
Subsequent's revenue per store is significantly above Cavity, this may be as a result of larger store
formats, which may be more cost effective, since subsequent generates significantly more profit that
Cavity from a similar revenue base. Also it may indicate that Subsequent has been more successful in
generating online sales.

Forces Performance indicator
Threat of entry:  Brand valuation
Low  Number of new entrants
 Brands are significant barriers  Brand awareness
Power of buyers:
High
 Retail stores  Profit/product
 End users  Sales
different powers  Number of stores/chains sold to
Attracted by  Market share
 Price  Product quality
 Quality
 Fashion
Lots of choice available
Power of suppliers
May be increasing  Global economics
 Depends if competition uses same suppliers  Wage levels
 Some low cost economies are being  Sole supply agreements
replaced by new ones/are exercising power
through Government and economic actions.
Substitutes
May vary globally  Customer loyalty
 Many exist – other casual clothing types  Fashion trends
 Fewer exist for serious sports players
 New technologies may be included here
Competitive rivalry
Probably high as many exist of similar size  R+D spend
Little differentiation unless niche eg  New product launches
 Speedo swimwear  Market share
 Skiing products  Marketing spend
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The requirement in part (a) to 'use' the BCG matrix to analyse SCC's performance is important because
it highlights your primary focus should be on SCC, not on describing the matrix in general terms.
In other words, you need to use the data provided in the scenario to analyse market growth rates and
SCC's relative market share for each of the divisions, and then consider what impact this will have on
their performance.
Part (b) provides a good example of the difference in the way models are examined in Paper P5
compared to Paper P3. Whereas in P3 the focus is on an organisation's strategy (for example, whether
to acquire new business units or to divest existing ones), in P5 the focus is on how performance is
managed and measured.
The key issue in part (b) is to recognise that the performance measures which would be appropriate for
one division (eg in a fast growing market) may not be appropriate for one in a mature or declining market.
Whereas the focus in part (a) is on SCC's performance, the focus in part (c) is on the BCG matrix itself.
This highlights another important aspect of the P5 syllabus – the need to be able to assess the
advantages or disadvantages of different models which could be used in performance management.
Here, you need to focus specifically on the limitations of the BCG matrix, but note you can discuss them
in general terms – there is no requirement to link your answer specifically back to SCC.
(a) The BCG matrix can be used to classify business units in relation to the growth rates of the
markets they operate in, and their relative market share.
The four categories of classification are:
Stars, which are in a high growth market, with a high relative market share
Cash cows, which are in a low growth market, but with a high relative market share
Question marks, which exist in a high growth market but have a low relative market share.
Dogs, which are in markets with low growth, and have a low relative market share.
Five-year market Market share – own at Relative market share
Division growth 31 May 20X6 At 31 May 20X6 (*)
% %
Fashion 75 8.0 8.0 / 8 = 1
Industrial 21 3.1 3.1 / 15 = 0.21
Leisure 9 70.0 70.0 / 20 = 3.5
Children 67 2.8 2.8 / 28 = 0.1
Footwear 5 2.6 2.6 / 33 = 0.08
*Relative market share is the division's market share divided by the market share of the market
leader (as given in the question).
Analysis of SCC's business and performance
Star
Fashion is operating in a market with high growth and it appears to be the market leader (or at
least the joint market leader). As such it is a star according to the BCG matrix. By 20X8 it is
predicted to have 10% of the market, so it is increasing its market share in a growing market.
However, the short life cycles of individual products means that the division's ability to achieve the
growth it wants is likely to depend on its ability to continue to produce popular designs and
products – which appeal to the retail store's customers – and which maintain the quality standards
expected of them.
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Question Marks
Industrial is operating in a market with a reasonably high level of growth (21% over five years),
but it only has a relatively low market share. Therefore it should be classified as a question mark.
Although it has only been a year since the online ordering facility was introduced, it appears to
have little impact on revenues so far. In addition, the Industrial division's overall market share in
20X8 (3.0%) is forecast to be marginally lower than in 20X6 (3.1%), which might suggest that the
e-commerce facility has not been very successful.
The children's clothing division also has a low relative market share, but it is operating in a
market with very high growth. Currently the market leader controls over a quarter of the market
(28%), and SCC appears to be struggling to break into the market. Its market share is expected to
fall from 3.3% in 20X4 to 2.4% in 20X8, despite it selling to the leading retail stores. It seems likely
that the division will need additional investment – for example, in marketing and promotions – to
help it increase its market share.
Cash cow
Leisure. The leisure division earns 70% of the sales in its market, therefore it is a clear market
leader (high relative market share). However, the market itself is only growing slowly, meaning
that the division should be classified as a cash cow.
The Leisure division's ability to generate cash to support the growth of other divisions (particularly
the Fashion division) is likely to be crucial for the group's continuing success.
Dog
The Footwear division has a very low relative market share, and it is operating in a market with
low growth, meaning that it should be classified as a dog. The fact that SSC only manufactures a
narrow range of footwear limits its opportunities for growth, and the division's revenue as well as
its market share is forecast to decline over the next two years.
Overall portfolio
SCC should review its overall product portfolio in the light of this analysis. Within its five divisions,
it currently has one dog and two question marks. These will require management's attention to
decide about their future. SCC will need consider whether it can convert the question marks into
stars, and what strategies will be required to help them increase their market share. Similarly,
management will need to consider whether there is anything which can be done to improve the
performance of the footwear divisions, or whether it should be disposed of, or closed.
The leisure division (as a cash cow) is likely to be the key source of funds to invest elsewhere in
the group, but it may not produce sufficient cash to sustain the growth of the fashion division (star)
as well as the industrial and children's clothing divisions (question marks).
(b) Context – The differences in the opportunities for growth between the divisions suggest that it
would also be appropriate to focus on different strategies across the divisions. Some of SCC's
divisions should be focusing on growth strategies, while others should be focusing on controlling
costs.
Performance measures – By recognising these differences in context, managers can then also
tailor the performance measures used in each division to their particular circumstances.
The financial performance measures for the high growth divisions (in particular, Fashion, but also
Children's clothing) should be based on profit or return on investment. By contrast, the financial
performance measures for the low growth divisions (in particular leisure) should focus on
maintaining margins and cash control.
As the amount of net cash generated by the Leisure division is likely to be crucial for supporting
growth in the other divisions, this could be a specific measure applied to the Leisure division.
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Market share – The BCG analysis also highlights the importance of market share as a
performance measure in its own right – particularly in relation to stars or question marks which are
pursuing a 'build' strategy. If SCC is investing in divisions in order to promote their growth, it will
be important to monitor whether this investment is paying off (and whether the divisions are
growing).
The fast-moving nature of the Fashion division's market means that market share is likely to be a
particularly important indicator for it. If the new product ranges are not successful, this is likely to
be reflected in a fall in the division's market share.
Market share will also be an important metric for the Leisure division, where SCC should adopt a
'hold' strategy. Since there is relatively little growth in the market as a whole, SCC will only be
able to maintain its revenues if it also maintains its market share. In turn, this also highlights other
aspects of performance such as brand reputation and brand loyalty, or customer retention which
are likely to be important in the Leisure division.
(c) Limitations of the model as a performance management tool.
Note: Only two were required, but for tutorial purposes we have included a range of limitations
you could have included here.
Problems of definition – Although the BCG matrix can be useful in providing a context for
performance management, its usefulness is limited by its simplicity. For example, a business unit
is only considered to have a high relative market share if it is greater than 1. By definition,
however, this means that only the market leader can have a high market share, and therefore
there can only be one star or one cash cow in each market sector.
Choice of axis – The axes themselves are also too simplistic. A high market share is assumed to
indicate competitive strength, but this is not necessarily true. A strong brand may yield competitive
strength despite a relatively low market share.
Equally, the matrix uses market share to estimate costs associated with given products or
business units. The implication here is that there is a link between higher market share and lower
costs (for example, due to economies of scale). However, this is not necessarily always the case.
Assumptions behind axes – Similarly, high market growth is deemed to indicate an attractive
industry. However, fast-growing industries are likely to require significant investment, so
they may not be attractive to a firm with limited capital available. Conversely, markets which are
declining or not growing significantly can still provide profit potential for firms, particularly if there
are high barriers to entry into the markets. However, if a firm focuses its attention on high growth
markets this may lead to the profit potential of declining markets being ignored.
Focus on cash resources – The BCG matrix appears to assume that cash is the critical resource
for organisations (meaning that 'cash cows' are needed to generate cash to fund the growth of
question marks or stars). However, cash is not the only resource organisations need to grow
successfully. Question marks and stars are also very demanding on the innovative capacity of
managers, designers, engineers etc. to underpin growth.
Overlooks possible synergies and relationships between business units – Another issue
which arises from the simplicity of the model is that it treats business units in isolation, and in
doing so can overlook possible synergies between them. For example, adults who buy SCC's
Fashion range may also look to clothes its Children's ranges for their children.
Assumptions about behaviour – The model makes assumptions about behaviour that do not fit
every business case. Organisations may choose to stay in certain markets and sectors to avoid
risk or to benefit from the interrelationship between businesses.
Defining the market – Although in the scenario, the markets SCC operates in appear to be
clearly defined, that is not always the case. Even in this scenario, we could suggest that instead of
operating in a range of different 'sub-markets' SCC operates in one large market for 'clothing'.
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Chapter 2
(i) Four critical success factors which could be appropriate for TDM are:
Monitoring CSFs
– Customer satisfaction with courses
If students are happy with the level of tuition they receive, they are more likely to book on
subsequent courses with TDM than if they are dissatisfied with the courses. Similarly, they may
share their experiences with their peers, in turn influencing their decision about where to book
courses. Consequently, TDM needs to ensure that student satisfaction levels are maintained as
high as possible, and it is important that TDM knows how its students (its customers) feel about
the services it offers.
– Employee satisfaction
The quality of TDM's teaching staff is crucial in maintaining customer satisfaction, so it is
important for TDM to retain its best staff. TDM has been experiencing an increasing rate of
employee turnover, and this could be indicative of dissatisfaction amongst the staff. The
management at TDM should be keen to prevent this upward trend in staff turnover from
increasing, making this an important issue to look at.
– The quality of its materials
Customers will only continue to use TDM if they feel it is providing materials which are high
quality, and also which offer value for money.
Building CSF
– Reputation and brand image
TDM has never seen the need for market and customer research, and has always had a good
reputation. However, given the continuing entrance of new competitors into the market, TDM
needs to ensure that its brand reputation is maintained. This is important if TDM is to ensure
potential customers will choose to come on its courses rather than going to one of its competitors.
(ii) KPIs for each of the CSFs could be:
Customer satisfaction
Student satisfaction rating – At the end of a course, or at the end of a module within a course, students
could be asked to complete a questionnaire rating their satisfaction with various aspects of the course (for
example, the knowledge levels of the staff, the approachability / availability of staff to ask them
questions).
Client retention – A number of the students attending the courses aimed at professional qualifications
are likely to have been funded by their employers. If employers continue to send their students to TDM
rather than one of its rivals in the market, this suggests they are happy with the level of tuition and service
their students are receiving. The pass rates that students achieve are likely to be a significant influence
on client satisfaction in this respect.
Employee satisfaction
Staff turnover – The percent of staff leaving each year is one way of measuring staff satisfaction.
Staff absenteeism – High levels of absence are likely to also indicate dissatisfaction among the staff. If
absenteeism is rising, in conjunction with employee turnover, then there is a danger that the quality of
service provided to students will suffer. For example, if an experienced lecturer phones in 'sick' at short
notice, their classes may have to be taken by an inexperienced lecturer who is not such an expert in a
subject, meaning the students could receive lower quality tuition.
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Quality of materials
Market share – TDM currently has the largest market share in its sector, despite carrying out relatively
little marketing activity, and despite new entrants continually entering the market. It will important to
monitor TDM's market share, because the share of the market TDM can capture will have a direct impact
on its revenues and consequently on the wealth of RCH's shareholders. If market share starts to fall, it
may be an indication TDM is not delivering high quality materials.
Accreditations – TDM's courses will be accredited by academic and professional bodies. TDM has
always concentrated on the quality of its courses and learning materials, so external accreditations will
provide an independent corroboration of this quality. The quality of course tuition and learning materials,
in turn, is likely to feed back into the level of customer satisfaction with TDM's courses.
Reputation and brand image
Brand reputation – This can be assessed by asking customers to rank TDM against its key rivals.
Pass rates – TDM's students consistently achieve passes on a par with the national average. However, if
some of TDM's rivals regularly achieve passes rates above the national average the competitors will be
able to use this as a marketing message to try to win business away from TDM – particularly in respect of
the professional qualifications business. If students, or their employers, think that selecting one tuition
provider in preference to another can affect their chances of passing their exam, they are likely to select
the tuition provider with the highest pass rate.
Chapter 3
A rolling budget is one where the budget is kept up to date by adding another accounting period when the
most recent one expires. The budget is then rerun using the new actual data as a basis.
For X, with its quarterly forecasting, this would work by adding another quarter to the budget and then re-
budgeting for the next four quarters.
Rolling budgets are suitable when the business environment is changing rapidly (which is likely to be the
case here) or when the business unit needs to be tightly controlled (which may not be valid here since
managers are complaining about control).
The new budget at X would be:
Current year Next year
Q1 Q2 Q3 Q4 Total Q1
$'000 $'000 $'000 $'000 $'000 $'000
Revenue 8,966 9,235 9,512 9,797 37,510 10,091
Cost of sales 4,932 5,080 5,232 5,389 20,633 5,551
Gross profit 4,034 4,155 4,280 4,408 16,877 4,540
Distribution costs 807 831 856 882 3,376 908
Administration costs 2,107 2,107 2,107 2,107 8,428 2,107
Operating profit 1,120 1,217 1,317 1,419 5,073 1,525
Based on the assumptions that cost of sales and distribution costs increase in line with sales and that
administration costs are fixed as in the original budget.
The budget now reflects the rapid growth of the division. Using rolling budgets like this will avoid the
problem of managers trying to control costs using too small a budget and as a result, choking off the
growth of the business. This may explain some of the quality issues that X is experiencing.
The rolling budgets will require additional resources as they now have to be done each quarter rather
than annually but the benefits of giving management a clearer picture and more realistic targets more
than outweigh this.
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Poor budgeting is probably at the core of the managers' desire to be less controlled. Rolling budgets
could be seen as a tightening of control, so it may also be worth considering changing the style of control
being used (see Hopwood later).
Indicative marking scheme
Explanation of rolling budgets – up to 2 marks
Actual figures in Q1 – 1 mark
Revised budget figures for Q2–Q4 – 1 mark per item (revenue, cost of sales, distribution, admin) to a max
of 4 marks
Inclusion of Q1 next year – 1 mark
Comments on the use of rolling budgets – 1 mark per point, max 3 marks.

Planning variances result from the assumptions or standards used in the original budget setting process
not being accurate. For example, if the original budget assumed that industry sales volumes would rise by
2%, but in fact they increased by 3%, the resulting sales volume variance should be treated as a
favourable planning variance. So a planning variance is the difference between the original budget and
the budget as it would have been with the benefit of hindsight.
Operational variances are the differences between this 'revised' budget, and actual performance.
Operational variances result from the decisions of operational managers, rather than issues with the
original budget-setting process.
Total cost variance
The total cost variance considers a number of costs together, and as such is hard to interpret or to action
on. However, the total variance is over 5% of budget profit and as such should be investigated.
Although the variance is favourable there is the danger that the company is compromising on quality to
drive down its input costs – perhaps as an attempt to deal with its adverse sales volume variance. If so,
this would be potentially very damaging given Anzo's precision manufacturing strategy.
However, the favourable planning variance suggests that the budget costs have been set too high, and
therefore most of the apparent cost improvements are due to this.
The budget setting process should be reviewed to investigate whether there is an issue with managers
padding their budgets by making overly conservative assumptions.
Sales price variance
The sales price variance indicates the extent to which sales prices were incorrectly estimated in the
budget (planning variances) and how effective the sales managers have been in negotiating higher prices
with customers (operational variances).
The adverse planning variance suggests that the original budget was too optimistic. The initial price-
setting process should be examined, to identify why prices were budgeted too high. For example, market
intelligence about the prices being set by competitors, or the commercial situation of its customers may
have been faulty.
However, the favourable operational variance suggests that the sales managers may have been quite
successful in their price negotiations with customers.
We should also assess whether the higher prices indicated by the favourable operational variance are
linked to the significant adverse sales volume variance.
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Chapter 4
Product A Product B
Activity Cost Cost / unit Activity Cost Cost / unit
'000 $'000 '000 $'000
Air pollution 6.3 2205 26.9 0.7 245 30.6
Water pollution 1120 2464 30.0 480 1056 132.0
General waste 2.7 2268 27.7 0.3 252 31.5
Hazardous waste 0.8 1840 22.4 0.8 1840 230.0
Monitoring 0.6 150 1.8 0.5 125 15.6
Training 0.3 501 6.1 0.2 334 41.8
R&D 90 4770 58.2 50 2650 331.3
Total 173.1 812.8
Implications for performance management:
Under the existing costing system the environmental cost per unit is $20,700,000 / 90,000 = $230 per unit.
Under the revised costing Product B will see a significant cost increase and as a result will be correctly
seen as a less profitable product.
This may affect the R&D spending being targeted at Product B.
It may also affect B's pricing – which may need to increase.
Finally it provides clear visibility to the environmental impact of Product B which can be used to control
the activities that are driving these costs. For example it may be sensible from an environmental and a
costing viewpoint to amend the formulation of Product B to reduce its use of hazardous chemicals.

F Co's traditional performance measure of product profit suggests it will generate a profit of $41.5m over
five years. However, this ignores the environmental costs (of waste filtration, and carbon dioxide exhaust
extraction) as well as the cost of decommissioning at the end of the project.
By contrast, a lifecycle analysis would include all of these costs:
Product profit $ million

Traditional view:
Revenue: 147.6
Production, marketing & development costs 109.1
Product profit (over 3 yrs) 38.5
Profit margin 26.1%
Adjusted for environmental costs:
Revenue 147.6
Production, marketing & development costs 109.1

Waste filtration 8.1
Carbon dioxide exhaust extraction 5.3
Decommissioning costs 18.0
140.5
Revised product profit 7.1
Profit margin 4.8%
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When the environmental costs are all included, the forecast profit margin is reduced from 26.1% to 4.8%,
which makes it a much less attractive investment. Moreover, if the actual costs of decommissioning in
three years' time are higher than the forecast ($18.0m) – for example, due to changes in environmental
legislation in the next five years – then the profit margin will be reduced even further.
Importantly, also, lifecycle costing makes the post-production costs visible at the start of the project and in
the design stage of the product. This should help F Co appreciate early in the project the need to
minimise the costs of decommissioning.
Chapter 5
Forecast Income Statement for the bread loaves
$'000
Turnover 425 m  1%  $1.50 6,375
Materials – special 5 m  $ 0.17 850
Materials – other 5 m  $ 0.43 2,150
Packaging 5 m  $ 0.12 600
Distribution 4%  $6,375 255
Fixed costs 270
Profit 2,250
Profit/sales (%) 2,250/6,375 35.3%
Target rate of return (%) 35%
Target return ($'000) 35%  6,375 2,231
W1 Production volume
Sales level 425 million  1%
Gross up for wastage 0.85
Production volume 5 million
The special ingredient can increase by the excess profit over target (2,250,000 – 2,231,000) =
$19,000. The special ingredient could increase in costs to $869,000 an increase of 2.2%.
The finance director is correct to be concerned with an increase in the cost of the special
ingredient as the success of the product depends primarily on this ingredient and the % return is
very sensitive to an increase in the cost.

800 700 500 300
1  4,400 0.2  4,100 0.2  3,500 0.2  2,900
0.8  4,600 0.3  4,000 0.3  3,400
0.5  5,000 0.4  4,400
0.1  5,400
EV 4,400 4,500 4,400 3,900
John should commit to a special contract of 700 units, based on expected value.
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(a) Using maximax – the possibility of the best of the best options (5,400) is created by choosing 300
units for the special contract.
(b) Using maximin – the best of the worst outcomes (4,400) is created by choosing 800 units for the
special contract.
Alternatively using MINIMAX regret
Demand Regret table 800 700 500 300
units
400 Best option = 800 unit 0 300 (4,400-4,100) 900 1,500
special contract
500 Best option = 700 unit 200 (4,600-4,400) 0 600 1,200
special contract
700 Best option = 500 unit 600 (5,000-4,400) 400 0 600
special contract
900 Best option = 300 unit 1,000 (5,400-4,400) 800 400 0
special contract
Maximum regret 1,000 800 900 1,500
The decision with lowest maximum regret is 700 units for the special contract.

Contribution generated ($'000)
Demand ('000)
30 35 40
28 270 315 360
Price ($)
29 300 350 400
30 330 385 440
Joint probability
Demand ('000)
30 35 40
28 0.08 0.1 0.02
29 0.14 0.175 0.035

30 0.18 0.225 0.045
Expected value of contribution ($)
Demand ('000)
30 35 40
28 21,600 31,500 7,200
Price
$ 29 42,000 61,250 14,000
30 59,400 86,625 19,800
$
EV contribution =  px 343,375
Fixed costs 320,000
EV profit 23,375
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An expected profit of only $ 23,375 will be achieved so manager A will reject this opportunity.
However, there is a 50% chance of achieving the desired profit (which requires contribution to be
345,000; so it depends to the manager's attitude to risk).

EV with perfect information
Demand Contract Contribution p EV
Units Units $
400 800 $4,400 0.2 880
500 700 $4,600 0.3 1,380
700 500 $5,000 0.4 2,000
900 300 $5,400 0.1 540
4,800
... VOPI = EV with PI – EV without PI
= $4,800 – $4,500
= $300
This is the maximum John would be willing to pay each month for the survey.

XYZ needs to make 3,750 units in order to breakeven. If the fixed costs increase by 50%, they will
have a margin of safety of 25% .
The number of units they need to sell in order to make a profit of $9000 for the period (assuming fixed
costs do not increase at all) is 5,250 units.
If variable costs increase by 10%, selling price goes up by 20%, and fixed costs stay the same, the %
change in the number of units in order to achieve the required level of profit will be 26% .
Workings:
Contribution per unit = 15 – 9 = 6
Total fixed cost 3  7,500 = 22,500
Breakeven point = 22,500 / 6 = 3,750
Fixed costs at new level 22,500  1.5 = 33,750.
New BEP = 33,750/6 = 5,625
MOS = (7,500 – 5,625) / 7,500 = 25%
Required profit = 22,500 + 9,000 = 31,500/6 = 5,250.
Variable cost 9  1.1 = 9.90
Selling price 15  1.2 = 18
New contribution = 8.10
New target profit output = 31,500 / 8.10 = 3,889 units
5,250 – 3,889 = 1,361/5,250 = 26% fall
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Expected values and risk attitude of management
(i) A reduction of 12% on existing total cost reduces the cost of $41.21 to $36.26. A cost of
$36.26 or less is achieved (looking at the first table) if 25 cuts are made and 0.5m² of timber, or if
the timber required is reduced to 0.4m². Reading from the second table, the probability of
achieving costs at or below $36.26 is only 18% so there is an 82% chance of not meeting this
target reduction. If management were to proceed with the redesign given these probabilities, their
approach to risk can be seen as risk taking.
(ii) The probability of total unit cost exceeding $41.21 is 32% (using the same approach as
above) and the probability of remaining below this cost level, is 66%. Management here are taking
a risk-averse approach to making a decision as it is unlikely [at 32%] that costs will rise above the
existing level.
(iii) The expected value solution is $39.84. This is a weighted average of the outcomes and their
probabilities. It covers a range of outcomes from the most risky to the least risky and so could be
said to be risk-neutral. As it is less than the current cost of $41.21 management should proceed
with the redesign.
Chapter 6
The existing performance report has some good elements and many weaknesses.
 The current report shows clearly the calculation of revenue from the main product lines of the
business and shows how this has changed over the past year along with a forecast of the next
year. There is also a breakdown of the performance in the last two quarters which gives a
snapshot of more immediate performance. The report does not seem over-detailed.
However, there are a number of weaknesses with the existing report.
 The style of presentation could easily be confusing to a non-accountant as it shows a large table
of numbers with few clear highlights. The use of more percentage figures rather than absolute
numbers may help (eg change on comparative period %s). Also, the numbers are given to the last
£ where it would probably be sufficient to work in thousands of pounds.
 Only financial sales data is reported. Retail outlets are customer-facing and so a measure of
customer satisfaction based on number of complaints received or changes over time in average
scores in customer surveys would be helpful.
 The timescales reported in the current format are possibly not helpful for board meetings. There is
likely to be a high level of seasonality in this business which may make quarterly comparisons
meaningless and the figures for last year may not be particularly relevant to current market
conditions and will not reflect recent management initiatives. It may be useful to consider reporting
the last quarter's monthly performance giving comparative figures from the previous year and
possibly reporting more frequently since the board would not want to continue ordering sales lines
that were not selling well.
 The current report does not give much benchmark data to allow comparisons in order to better
understand the results. It would be helpful to have variance figures against budget figures for
internal comparison and competitor figures for an external comparison of performance (ideally
some market share data).
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Chapter 7
(a) Revenue growth is 18.1% ($17m / $14.4m). This is substantial when compared to inflation at 3%
suggesting growth in volume.
During the year the loan stock has been redeemed ($2.6m). As these were classified as non-
current liabilities at 31.12.20X7, this seems unexpected. Gearing has decreased from 38.8%
 $2.6m 
  to nil.
 $6.7m 
Both these issues are likely to have put pressure on liquidity yet the business still has a positive
cash balance.
Liquidity ratios 20X7 20X8
Trade receivables
2,000 1,600
 365  365 51 days 34 days
14,400 17,000
Inventories
1,300 2,000
 365  365 40 days 58 days
11,800 12,600
Trade payables
1,080 2,700
 365  365 33 days 78 days
11,800 12,600
Cash operating cycle 58 days 14 days

Revenue growth can also be achieved by reducing margins or by increasing investment.
Profitability ratios 20X7 20X8
ROCE
1,600 2,400
23.9% 48%
6,700 5,000
Profit margin
1,600 2,400
11.1% 14.1%
14,400 17,000
Asset turnover
14,400 17,000
2.1x 3.4x
6,700 5,000
Operating gearing
Assumption: Cost of sales is all variable cost
Expenses are fixed costs
20X7 20X8
1,000 2,000
0.085 0.16
11,800 12,600
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The business has increased the proportion of fixed cost to variable cost. This has helped margins
in 20X8 as revenue has grown. However, expenses have doubled over the past year despite only
an 18.1% increase in revenue. Expenses might have been expected to rise by the rate of inflation
only.
Generally the financial performance of the business seems sound, with increasing returns,
margins and dividends coupled with reduced debt and tight working capital management.
However, this is a very short term analysis and could be systematic of a business that has
emphasised profits before strategy.
The lower debt could increase cost of capital and the increase in trade payables days (136%
increase) could reduce sources of supply and damage the company's credit rating.
(b) Other information that would be useful:
(i) Revaluation of non current assets. No revaluation has been performed this year
(ii) Industry averages for both margins and credit periods
(iii) Specific rates of inflation applicable to ARH's costs rather than an average operating in the
economy
(iv) Details of business dealings with large customers or suppliers
(v) Market share statistics

EBITDA is most useful when businesses have large investments, especially in intangible assets, and are
highly geared.
We have no information on ARH's industry or products.
ARH has redeemed its debt this year, so has no interest. Non-current assets have increased from
$2,500k to $4,000k (an increase of 60%).
This may have caused larger charges to amortisation or depreciation than in previous years, so there
may be merit in assessing performance before these items.
This is particularly valid if managers are to be assessed on financial performance, particularly if
investment decisions are outside their control.

NPV of the proposal
Time 0 1 2 3 4 5 6
$'000 $'000 $'000 $'000 $'000 $'000 $'000
Net cash flows (W1) – 7,200 7,200 7,200 7,200 7,200 7,200
Taxation at 30% – (2,160) (2,160) (2,160) (2,160) (2,160) (2,160)
Net cash flow 5,040 5,040 5,040 5,040 5,040 5,040
Capital costs (12,000) – (2,000) (2,000)
Net cash flow (12,000) 5,040 3,040 3,040 5,040 5,040 5,040
Discount factors (W2) 1.0 0.901 0.812 0.731 0.659 0.593 0.535
Present value (12,000) 4,541 2,468 2,222 3,321 2,989 2,696
Net present value ('000) 6,237
The NPV of the proposal is positive so the proposal should go ahead on this basis.
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Workings
1 Annual cash flows
$'000
Revenues 30  $400,000 12,000
Variable costs 30  $120,000 (3,600)
Fixed costs (1,200)
Net cash flow 7,200
2 The relationship between the nominal or money rate of interest and the real rate is expressed as
follows (from your F9 study text)
(1 + i) = (1 + r)(1 + h) h = rate of inflation r = real rate of interest i = nominal
(money) rate
Using the data in the question:
(1 + 0.1433) = (1 + r) (1+ 0.03)
1.1433/1.03 = (1 + r)
1.11 = (1 + r) therefore r = 11%. This is the discount rate you should use in the NPV calculation.
IRR of the proposal
Now try any other cost of capital eg 15%
Time 0 1 2 3 4 5 6
$'000 $'000 $'000 $'000 $'000 $'000 $'000
Net cash flow (12,000) 5,040 3,040 3,040 5,040 5,040 5,040
Discount factors 1.0 0.870 0.756 0.658 0.572 0.497 0.432
Present value (12,000) 4,385 2,298 2,000 2,883 2,505 2,177
Net present value ('000) 4,248
The proposal is also giving a return above 15%. Now we can estimate the IRR using the formula:
NPVa
IRR = a + (b-a)
NPVa - NPVb
Where a is the lower discount rate (11%) giving NPVa , b is the higher rate (15%) giving NPVb
6,237
IRR = 11 + (15-11) = 11 + (3.136  4) = 23.5%
6,237 - 4,248
The IRR > cost of capital so accept.

1/ n
 PV return phase 
  × 1 + i  – 1 i = cost of capital
 PV investment phase 
Investment phase = 12,000
so PV of return phase = project NPV (at 11%) + 12,000 = 6,237 +12,000 = 18,237
1/ 6
 18,237 
 
12,000 
 
 1  0.11  1 = 0.19 or 19%
The proposal is still acceptable because the MIRR is above the cost of capital
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Chapter 8
Performance Div A Div B
Profit margin
90 135
30% 25%
300 540
Asset turnover
300 540
0.6 0.72
500 750
ROCE (ROI)
90 135
18% 18%
500 750
Both divisions have 18% ROI. However, if they communicated and shared knowledge on margins and
asset turnover, ROI could become 30% x 0.72 = 21.6%. However, there may well be a trade off between
increasing both margins and revenues simultaneously.
As both exceed the target of 12% there is little incentive to do so.
$'000 $'000
RI:
Profits 90 135
12% x $500k 60
$750k 90
30 45
Division B appears to be outperforming Division A, but that is only because it is larger.
ROI takes size into account so is more equitable for comparing performance.
Decision making
The NPV of the new product (assuming that profit is equivalent to cash flow over the long term) is:
Time 0 1 onwards
($8,000) $1,200
d.f. 1.0 1 / 0.12
PV ($8,000) $10,000
NPV $2,000
The new product is generating a positive NPV and therefore from the group's perspective it is value
creating and should be accepted by the division.
New product – divisional analysis:
$1,200
ROI = = 15%
$8,000
$
RI profit 1,200
$8,000  12% 960
240
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Using ROI the new product would be unlikely to be developed as Division A's performance would appear
to fall. However, under RI measurement the product would be launched as it exceeds the minimum
required return.
RI is better for decision making than ROI.
Division B sees little value in R&D. Given the ways its performance is assessed this is not surprising.
(i) R&D increases either capital or expenditure and decreases ROI.
(ii) The short term nature of the measures discourages long term or risky investments.
(iii) High levels of depreciation or amortisation will depress returns early in a product's life. This may
also be when sales are low.

PAT $'000 $'000
Net profit 89.6
Add back:
Non-cash expenses 8
Amortisation of goodwill 5
Interest (net of 30% tax) 15  0.7 10.5 23.5
NOPAT 113.1
Alternative approach:
PBIT 143.0
Less tax (42.9)
Add
Non-cash expenses 5.0
Amortisation of goodwill 8.0
NOPAT 113.1
$'000
Assets
At start of period 470
Amortised goodwill 40
510
WACC
Equity 15%  75% 0.1125
Debt (10%  0.7)  25% 0.0175
WACC 0.13
$'000
EVA® NOPAT 113.1
Capital charge
13%  $510 66.3
46.8
RI $'000
PBIT 143
Capital charge
13%  $500 65
78
The business is creating value as its return (however calculated) is greater than the group's WACC.
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$30.80
S R
$20 $26
$ 8
$28
Transfer @ $30.80
S wishes to sell R declines and buys externally
Goal congruence?
From the group perspective the decision is to make or to buy.
If these absorbed overheads are general:
Cost to make $20
Cost to buy $26
Extra cost if bought $ 6
The item should be made in house and transferred from S to R.
The transfer price needs to be amended $20  TP  $26
If these absorbed overheads are specific:
Cost to make ($20 + $8) $28
Cost to buy $26
Saving if bought $ 2
The item should be purchased externally.
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Goal congruence Autonomy Performance evaluation
Market based transfer prices
External selling price Reflects the revenue Receiving Fair price should not distort
forgone by the supplying division can performance.
division from the transfer as buy from If supplying division cannot make
41.21  1.35 = $55.63 long as there is no spare whoever they good profits at this transfer price it
capacity. want. should close down.
Adjusted selling price As above, but reflects net As above As above
eg less say $5 selling revenue foregone which is
cost = $50 more accurate.
Use if: there is an external market price as long as the supplying division does not have spare capacity
Cost based transfer prices – standard costs not actual
Marginal cost Reflects the 'true cost' of the As above Supplying division's performance
supplying division from the will be unfairly depressed.
transfer if there is spare Receiving division will be unfairly
45% of 41.21 = $18.54 capacity. inflated.
Use if: the supplying division has spare capacity
Marginal cost + lost Reflects the 'true cost' of As above Supplying division is not guaranteed
contribution (not asked the supplying division to cover its overheads and therefore
for here) from the transfer in any may be loss making.
$18.54 if spare capacity situation.
or $55.63 if not
Use if: overheads are insignificant
Full cost If based on ABC then can As above Will penalise the supplying division
(not asked for here) be argued to show the long- unless a profit margin is added on.
run marginal cost. Can result in the receiving division
= $41.21
May result in incorrect use to increase its prices.
of external suppliers.
Use if: ABC is being used

Conflict Marginal costing best Marginal costing worst
Solve the conflict via:
Dual pricing – supply @ full cost +, receive @ marginal cost; can result in divisions showing a profit but
company showing a loss, also little incentive for cost control at the supplying division
Marginal cost + lump sum – this appears to be a sensible and underutilised method; lump sum depends on
capacity used and therefore stimulates discussion of capacity issues.
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Quotation 1
The Creative Division intends to use a transfer price of $38.94 per unit (W1) which would mean a cost to
Division B of $778,000 for the 20,000 units. Division B has an alternative supplier which would charge
$33 per unit, resulting in a cost of $660,000. Clearly Division B would choose the lower cost to
maximise its reported profits and the Creative Division would lose this potential revenue.
The two divisions will need to agree an internal price that will encourage the Creative Division to sell to
Division B if this supports the overall aim of group profit maximisation.
There is spare capacity, however – as a maximum of 320,000 components can be manufactured and
the number budgeted for is 300,000 (140,000 + 40,000 + 120,000). So the Creative Division could
transfer the 20,000 units at its marginal cost of $18.54 per unit ($2,596,000 VC/ 140,000 units). It does
encourage Division B to buy in-house at a cheaper cost than $33/unit from the external supplier so there
are savings of $14.46/unit for Division B or $289,200 overall for the group.
The price quoted is lower than that Division B would be paying by buying outside. Therefore this
encourages Division B to buy in-house.
Quotation 2
There is spare capacity to manufacture 20,000 units only. The Creative Division will need to switch
existing production of 16,000 units to supply the full 36,000 units. The product with the lowest
contribution per unit is Component C at $20/unit (W2) so production should be transferred from
production of Component C to Component A.
If the Creative Division quoted the adjusted market price of $38.94/unit this would make Division B go to
an external supplier where it can get the product for $33/unit.
The price that the Creative Division should charge is the $18.54/unit marginal cost for the 20,000 units.
For the extra 16,000 units the cost will be the marginal cost plus the $20/unit opportunity cost of
switching production from Component C, ie $38.54/unit; the external supplier is now cheaper.
So Division B would only buy the first 20,000 units from the internal division and the balance from
the external supplier.
Workings
1 Division A – basis for setting a transfer price.
Market price less 30%
Selling price of component 55.63
Less 30% ($) 16.69
Transfer price to division B 38.94
2 Contribution per product
A B Ct Total
Sales units ('000)(from question) 140 40 120 300
Revenue ($'000)(sales units  price) 7788 2880 4320
Variable cost of sales ($'000) (2596) (1280) (1920)
Contribution ($'000) 5192 1600 2400
Contribution per unit ($) 37.1 40 20
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(a) Division S profit will be reduced to zero, so the manager of division S will be demotivated
(assuming performance evaluation is based on profit).
(b) Original group PAT = $780k
Revised profits:
S R
Profit before tax – 900 (1,100 – 200)
Less tax – (45) (5%  900)
PAT – 855
Group PAT has improved.
It is unlikely that the tax authority in S would accept such a policy as an 'arm's length' transaction
and could charge tax on profits as previously stated. This would increase the group's tax charge
and reduce its profits.
(c) Note these issues relate to other chapters of the P5 material - Currency risk, import tariffs,
Government policies (repatriation of funds), transportation risks and delays.

(a) Potential benefits of operating a transfer pricing system within a divisionalised company
(i) It can lead to goal congruence by motivating divisional managers to make decisions,
which improve divisional profit and improve profit of the organisation as a whole.
(ii) It can prevent dysfunctional decision making so that decisions taken by a divisional
manager are in the best interests of his own part of the business, other divisions and the
organisation as a whole.
(iii) Transfer prices can be set at a level that enables divisional performance to be measured
'commercially'. A transfer pricing system should therefore report a level of divisional profit
that is a reasonable measure of the managerial performance of the division.
(iv) It should ensure that divisional autonomy is not undermined. A well-run transfer pricing
system helps to ensure that a balance is kept between divisional autonomy to provide
incentives and motivation, and centralised authority to ensure that the divisions are all
working towards the same target, the benefit of the organisation as a whole.
(b) (i) Division Able has spare capacity and limited external demand for Product X
In this situation, the incremental cost to the company of producing Product Y is $35. It
costs division Baker $38 to buy Product Y from the external market and so it is cheaper by
$3 per unit to buy from division Able.
The transfer price needs to be fixed at a price above $35 both to provide some incentive to
division Able to supply division Baker and to provide some contribution towards fixed
overheads. The transfer price must be below $38 per unit, however, to encourage division
Baker to buy from division Able rather than from the external supplier.
The transfer price should therefore be set in the range above $35 and below $38 and at a
level so that both divisions, acting independently and in their own interests, would choose
to buy from and sell to each other.
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(ii) Division Able is operating at full capacity with unsatisfied external demand for
product X
If division Able chooses to supply division Baker rather than the external market, the
opportunity cost of such a decision must be incorporated into the transfer price.
For every unit of Product Y produced and sold to division Baker, division Able will lose $10
($(42-32)) in contribution due to not supplying the external market with product X. The
relevant cost of supplying Product Y in these circumstances is therefore $45 ($(35 + 10)).
It is therefore in the interests of the company as a whole if division Baker sources Product
Y externally at the cheaper price of $38 per unit. Division Able can therefore continue to
supply external demand at $42 per unit.
The company can ensure this happens if the transfer price of Product Y is set above $38,
thereby encouraging division Baker to buy externally rather than from division Able.
(c) Data to be collected for an information system to support transfer pricing decision making
Type of data How it would be used

Unit variable costs To show the incremental cost of making various
products/providing various services
External selling prices To provide guidance as to market value transfer prices
To indicate contribution that could be earned if products
were sold externally rather than transferred internally
Capacity levels To give guidance as to whether opportunity costs of lost
sales need to be incorporated in transfer prices
Limiting factors To highlight how capacity can be expanded
Shadow prices To determine whether or not additional resources should
be obtained
Availability/prices of external To make or buy decisions
prices
Chapter 9a
(a) Primary goals are likely to relate to effectiveness:
Quality – death rates, re-admission rates
Speed – % patients waiting more than x hours
Take-up – % patients attending post operation care appointments
Secondary goals will relate to economy and efficiency
Economy could be measured by monitoring the cost of inputs eg premises costs per square
metre, agency costs per hour, electricity costs per KwH etc
Efficiency could be measured as
 Maximising outputs eg patients per doctor, ward capacity levels
 Minimising inputs eg agency staff costs as % of total staff costs
 Operating within budget
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(b) Primary goals are likely to relate to effectiveness:

Quality – cleanliness of streets, no. accidents, % completion of waste collection
Speed – % collections on time
Take-up – tonnes of waste recycled
Secondary goals will relate to economy and efficiency
Economy could be measured by monitoring the cost of inputs eg premises costs per square
metre, staff costs per hour, cost of buying and maintaining vehicles etc
Efficiency could be measured as
 Maximising outputs eg tonnes of waste collected per vehicle
 Minimising inputs eg cost per tonne of waste collected
 Operating within budget
Chapter 10
(a) Investment = 1,500,000 + 500,000 + 1,400,000
= 3,400,000
Return required = 3,400,000  25%
= $850,000
$850,000
Profit per unit =  $8.50
100,000 units
 target cost = 50 – 8.50 = $41.50

Cost gap = 44.25 – 41.50 = $2.75
(b) Materials are largest element so start here:
Bulk discounts
Cheaper materials
Less material (simpler product)
Labour Learning curve effects
Overheads May be linked to labour
Cost savings to be identified
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20X6 20X7
$'000 % $'000 %
Prevention costs
Quality control 40 10.1 120 39.3
Appraisal costs
Inspection of WIP 85 21.6 70 23.0
Internal failure costs

Rework 125 60
Scrap 60 46.8 20 26.2
External failure costs

Returns 35 15
Complaints 50 21.5 20 11.5
395 100 305 100
Total costs of quality are falling. Also more is being spent on improving conformance. Failure is falling.
However, reduced appraisal costs could cause future failures to increase.
A longer period of assessment would be helpful.
If the costs were expressed as a % of sales that would also be more helpful, because if the company's
activity levels are changing then this will have an impact on costs.
Chapter 11
(a) Bonus as a percentage of salary for Alpha division for the year ended 30 November 20X9
KPI Weighting KPI total Weighted
factor score score
Revenue 20X9 versus previous year $(90/80) 0.15 12.50 1.875
Revenue 20X9 versus competitor $(90/85) 0.20 5.88 1.176
Profit 20X9 versus previous year $(15/16) 0.15 (6.25) (0.938)
Profit 20X9 versus competitor $(15/15.50) 0.20 (3.23) (0.646)
Quality items 20x9 versus previous year
Number of orders needing remedial work (W1) 0.075 31.82 2.387
Number of complaints investigated (W1) 0.075 24.20 1.815
Percentage of enquiries converted into orders (W2) 0.15 21.30 3.195
Total 1.000 Bonus % 8.864
Workings
1 The KPI score is positive if performance has improved. The quality items both show fewer
remedial works or complaints in 20x9 which means the score should be positive. The
calculations are 140/440  100% and 32/132  100%.
2 This is calculated as (customer orders placed/enquiries) as a percentage and compared
year on year. Therefore 20X9 is 10,000/15,000 = 0.667 and 20X8 8,800/16,000 = 0.55.
The percentage increase year on year is (0.667 – 0.55)/0.55 = 21.27 or 21.30 %
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(b) Potential benefits from applying the KPI appraisal and bonus approach for Alpha and the
Group
Alpha. The KPI approach is clear to understand as the calculation involves a few key
performance measures. The measures are both financial and non-financial, the latter based on
customer service and the quality of service provided. The use of a broad range of measures
provides a rounder picture of performance than if just financial measures were used.
The calculation is easy to do and the factors making up the bonus calculation are clearly shown.
Where a factor adds to or reduces the bonus percentage is also transparent, which will direct
staff efforts in these areas. The factors are based on actual results, which can be updated over
time as they relate to comparisons over two years in some cases.
Group. The KPI measures are uniform across the divisions which allow comparisons between
divisions to be made easily. The approach also minimises the possibility of bias against certain
divisions or complaints being made about unfairness.

Problem Solution
Tunnel vision Consideration of the dimensions of performance
Measuring customer satisfaction
Myopia Fostering a long-term view/perspective amongst staff
Measure fixation Sensible number of measures
Misrepresentation Don't place too much emphasis on results
Involvement of staff at all levels to ensure that standards are fair
Ossification Keeping the performance measurement system under constant
review; all staff to input suggestions for change
Chapter 12
Indicative Marking scheme

Marks
Part (a)
0.5 mark per explanation of each perspective, up to 2.
1.5 marks for comments discussing each of the performance measures
Including the link to the new objectives, up to 6
Total: 8
Part (b)
(i) Comments: 1 mark per point up to a maximum of 2 on EPS and
share price (together) and a maximum of 1 on EVA. (Maximum 3)
Workings: 5
1 mark for calculation on EPS and 0.5 each other calculation, up to
maximum of 2.
(ii) Up to 2 marks on each metric and 2 marks on impact on management
behaviour (Maximum of 6)
Total: 6
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Part (c)
(i) 1 mark per point made; 2 for explaining benchmarking and 2 for 4
advantages/disadvantages (maximum 4)
(ii) 1 mark per point made up to 5 for analysing the computations, 8
1 mark per point made up to 3 for suggesting further work and
1 mark for a conclusion (maximum 8)
Professional marks (format, style and structure of report) are available up to 4
a maximum of 4.
35
(a) The four perspectives of the balanced scorecard are:

Financial – how do we optimally serve our shareholders' interests?
Customer – how should we present ourselves to our customers?
Internal business process – what processes are critical to achieving our customer and
shareholder goals and how can we optimise these?
Learning and growth – how do we maintain our ability to change and grow?
The new strategy addresses these perspectives in different ways. Ultimately all of the
perspectives will have financial effects whether in the short- or long-term interests of our
shareholders.
Focus on key customers: this directly addresses the customer perspective and will require the
collection of the profiles and needs of these customers in order to generate market growth and so
improve our financial position. Suitable performance measurement would segment our market (for
example, by customer age or gender) and identify our changing market share within each
segment.
Ensuring we meet key customer needs: again addresses the customer perspective but will also
impact on the products/services that Armstrong offers and so affect the process perspective.
Suitable performance measures from the customer perspective would be levels of repeat
business and customer satisfaction and from the process perspective, Armstrong will measure its
product range and quality. Range would be measured against competitors while quality could be
measured subjectively against competitors or internally by level of customer complaints or returns.
Cost cutting: this connects to the process perspective as it seeks to focus the business on value
added activities. Suitable performance measures would be efficiency savings generated by
removing or reducing unnecessary processes/products. Armstrong could possibly look to simplify
its supply chain by cutting the number of suppliers with which it deals.
Amend current processes to meet the new focus: clearly, this takes the process perspective
and measurement of this objective will be by way of the achievement of goals in a specific change
programme to assist the other objectives.
Programme of sustainable development: this objective looks to the future and this is the
learning and growth perspective. Suitable measures for this area would include the company's
carbon footprint (its CO2 output), the efficiency of energy use of the business and the level of
packaging waste generated.
(b) (i) Armstrong's financial performance. The year-on-year performance of Armstrong has
declined with earnings per share falling by 23%. Normally, this would imply that the
company would be heavily out of favour with investors. However, the share price seems to
have held up with a decline of only 15% compared to a fall in the sector of 22% and the
market as a whole of 35%.
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The sector comparison is the more relevant to the performance of Armstrong's

management as the main market index will contain data from manufacturing, financial and
other industries. Shareholders will be encouraged by the implication that the market views
Armstrong as one of the better future prospects for investment.
This view is substantiated by the positive EVA for 2009 ($110m), which Armstrong
generated. EVA has fallen by 64% from 2008 but it has remained positive and so the
company continues to create value for its shareholders even in the poor economic
environment.
(ii) Evaluating the financial metrics. The indicators each have strengths and weaknesses.
EVA is a widely used indicator, which aims to capture the increase in shareholder wealth
that the company generates. It uses amended traditional profit based information in order
to approximate the net present value method of appraising an investment. Thus, EVA
provides a clear focus on the major objective of most commercial entities. However, its
calculation requires a large number of adjustments to the traditional accounting figures, for
example the need to calculate the economic rather than accounting depreciation, the need
to distinguish between cash flow and accruals and to distinguish between expense and
investment. This makes the method less easily understood than the two other measures
currently used by Armstrong.
EPS growth is important to shareholders as it relates to dividend growth which is a
fundamental variable used in the calculation of share value (Dividend valuation method). It
is a widely used measure by equity analysts and so is a key driver of share prices.
However, it is based on accounting profit and only captures year-on-year change and so
can be subject to short-term manipulation if the trend over a number of years is not
considered.
Share price performance reflects the capital performance of an investment but tends to be
volatile and subject to significant fluctuations outside of the control of management. It will
be the figure that most shareholders turn to in order to get a quick impression of their
investment performance but it can lead to judgements being formed on the basis of that
short-term volatility which are more appropriate for speculators rather than investors. The
use of an average share price in this instance should help to ameliorate such problems but
the averaging method and time period should be further investigated.
The impact of these metrics on management is intended to focus their activities on
improvement of financial performance for shareholders. The danger of EPS growth and
share price is that these may be manipulated in the short term in order to demonstrate
improvement but at the risk of impairing long-term performance. EVA partially tackles this
issue through its use of adjusted accounting figures (eg depreciation) but suffers from lack
of clarity in its calculation compared to these other metrics.
Workings:
1 2008 2009
Economic value added (EVA®) $306m $110m (down 64%)
2
EPS (profit for year/av no of shares) 0.221 0.170 (down 23%)
3
Stock market information
EPS (profit for year/avg no of shares)

Main market index 1,115.2 724.9 (down 30%)
Retailing sector index 2,450.7 1,911.5 (down 22%)
Armstrong Stores share price $2.45 $2.08 (down 15%)
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(c) To: Boad of Armstrong Stores

From: A Accountant
Date: Today
Subject: Benchmarking performance
This report describes the benefits and problems associated with benchmarking the company's
performance. Then, the performance of Armstrong and its two main competitors is calculated and
evaluated.
(i) Benchmarking methods. Benchmarking is a business improvement technique. There are
different types of benchmarking:
Internal benchmarking is where similar operations in different parts of the company
under consideration are compared with each other and also with an internally generated
target.
External benchmarking is where the company's results are compared to those of other
companies. There are different types of external benchmarking: one where competitors
are used as comparators and another where a company with similar operations (eg
warehousing), which is not a direct competitor, is compared. The aim of benchmarking is
to identify where best practice lies and then to analyse what constitutes the best
operational practice so this can be implemented across the business.
The main advantages and disadvantages concern the availability of benchmark
information and its applicability to the business. Internal comparison between regions in
Armstrong will be easy but may not yield dramatic improvements as the regions are
probably already in relatively close contact. Any improvements identified from this exercise
should be easily applicable as the systems will be broadly the same.
External benchmarking in this case means comparison to competitors where the possibility
of radical new ideas is greater but the difficulty will lie in obtaining sufficiently detailed
information to identify the best practice business process. Of course, it will be difficult to
negotiate an information sharing arrangement with a competitor due to the commercially
sensitive data being exchanged. However, there are some government schemes which
require subscriber companies to supply data and then provide them with anonymised
industry data in return.
It would be easier to obtain information from a company which is not in direct competition
with Armstrong but which has similar functions such as purchasing and warehousing.
However, there are likely to be more significant differences in the objectives and functions
of the activities being compared and so it may be harder to apply the lessons from the
competitor to Armstrong's operations. Data has not been supplied to allow this analysis in
this case. Armstrong could seek out companies which have industry awards in these
functional areas and then negotiate an information sharing agreement.
(ii) Armstrong's performance.
Comparing Armstrong to its competitors, it is clear that Armstrong has done well to
increase its total revenues but this has come at the cost of a significant fall in profit
compared to BS Stores. Armstrong should look into its pricing policy as it may have been
buying sales by offering heavy discounts and these may not be sustainable in the long
term. The CS Stores drop in profit is greatest of all but this may be explained by problems
in the range or quality of its products. CS Stores opened 19 new stores in the period but
there has been an overall fall in revenue of 4.9%. Armstrong should analyse CS's offering
to its customers in order to avoid making the same mistakes. BS has increased profitability
and this seems due to a reduction in suppliers and presumably the overhead costs of
managing those relationships. Armstrong should examine BS Stores's sourcing policy to
see if it can simplify its supply chain in a similar manner.
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In terms of market share in food, Armstrong has maintained its position against slight falls
in its competitors. In clothing, all the companies have made gains and this may indicate a
trend to consolidation or failure of smaller stores of which Armstrong may be able to take
further advantage.
In revenue per shop, Armstrong has outperformed its competitors, however, this may be
due to Armstrong having a larger average store. This question could be answered by
finding out the average store area for the three companies. Regionally, the Caselon area
stands out with poor revenue per shop and it has an unusual mix of food and clothing
compared to the other regions where clothing predominates. Further work will be needed
to identify if this is due to a different range being offered by managers or if there are
regional variations in customer preferences.
Conclusion
In conclusion, Armstrong appears to be performing well with increased market share
during the decline. The company must guard against the danger of eroding margins too
far.

(a) Current costing system ($'000)
M N O P Total
Sales ($'000) 1,000 3,000 850 1,200
Less: $200/hour (800) (1,200) (400) (600) 3,000
Margin from customer 200 1,800 450 600
Net margin/$ sales 20% 60% 52.9% 50%
(b) ABC system ($'000)
M N O P
Sales ($'000) 1,000 3,000 850 1,200
Less customers specific costs:
Direct costs (W1) 160 240 80.0 120.0
Telephone support (W2) 25 600 62.5 312.5
After sales service (W3) 125 875 166.7 333.3
Client meetings (W4) 70 90 20.0 100.0
Total cost 380 1,805 329.2 865.8
Net margin from customer 620 1,195 520.8 334.2
Net margin/$ sales 62% 39.8% 61.2% 27.9%
10 staff × $60,000
(W1) = $40/hour
10 ×1,500hrs
(W2) telephone support ÷ telephone queries: OAR = 1,000/800 = 1.25 per query
(W3) after sales service ÷ no. of visits: OAR = 1,500/ 36 = 41.667 per visit
(W4) client meetings ÷ no. of meetings: OAR = 280/280 = 1 per meeting
(c) The ABC system highlights that:
• M & O are more profitable than believed. M costs less than previously thought because M
customers require little support.
• N & P are less profitable than believed, due to higher costs as they use a high proportion of
support services, especially expensive after-sales service visits.
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Also the previous system has recovered only $3,000 of costs from a total of $3,380. Any under-recovery
could lead to losses, especially if this cost is used to set prices and quotations.
ABC systems provide better cost analysis, both for reporting of profitability and for decision making. The
ABC system should be adopted.

(a) (i) Market satisfaction and financial measures are objectives set at the corporate level.
Market satisfaction would cover objectives set for growth in markets. Financial objectives
would relate to improved revenues, margins and profitability.
The data in the schedule suggests a growth in total market size of 8% from 20X7 to
20X9. Bettaserve's share of this market is anticipated to increase from 12.5% to 15.4%
over this period. So Bettaserve is expecting to enjoy an increased share of an expanding
market.
Profits (sales less total costs) are projected to grow by $13m in the period covered and
net margins from 6% to 37.25%. This improvement in margins comes about partly from a
fall in the costs of rectification and paying out on rectification claims. Bettaserve is
therefore anticipating a fall in certain costs of quality, particularly external costs that
impact on their reputation with customers.
(ii) Quality and delivery are operational activities that affect customer satisfaction and hence
external effectiveness.
In terms of marketing, the proposal will be successful if customers are satisfied, and if
customers are satisfied there will be high levels of customer satisfaction.
Quality measures in the schedule cover rectification costs, which are costs of quality.
These external costs are expected to fall over the three years. Thus rectification claims are
projected to fall from $0.9m to $0.2m, which is a drop of 78%, and cost for after sales
rectification is expected to fall by $1m. Services not requiring further rectification should
increase from 95% to 98% in the period, which shows an improvement in the quality of
services to customers.
Delivery effectiveness is measured by how long it takes the customer to get the goods or
services ordered. Sales attaining the planned completion date are projected to increase
from 90% to 99% in the period covered.
(iii) In financial terms the proposal can be successful if productivity is high.
Relevant measures, therefore, include average cycle time, which is anticipated to fall
from 6 to 5 weeks over the period covered, and idle capacity, which is a measure of
waste and is expected to fall from 10% to 2% from 20X7 to 20X9.
Appraisal and prevention costs, which are internal quality costs related to processes and
incurred before products and services go to the customer, are expected to fall or remain
constant in total.
(b) Performance pyramid
The performance pyramid derives from the idea that an organisation operates at different levels,
each of which has different concerns, which should nevertheless support each other in achieving
business objectives. The pyramid therefore links the overall strategic view of management with
day to day operations.
It includes a range of objectives for both external effectiveness (such as related to customer
satisfaction) and internal efficiency (such as related to productivity), which are achieved through
measures at the various levels. So for Bettaserve, the attainment of market satisfaction and
financial objectives are immediately linked to the achievement of customer satisfaction and
productivity and so on further down the hierarchy. Each level relates to that above and below it
and all are dependent on each other for success.
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(i) At corporate level, financial and market objectives are set.

(ii) At strategic business unit level, strategies are developed to achieve these financial and
market objectives.
(1) Customer satisfaction is defined as meeting customer expectations.
(2) Flexibility indicates responsiveness of the business operating system as a whole.
(3) Productivity refers to the management of resources such as labour and time.
(iii) These in turn are supported by more specific operational criteria at departmental level.
(1) Quality of the product or service, consistency of product and fit for the purpose
(2) Delivery of the product or service (the method of distribution, its speed and ease of
management)
(3) Process time of all processes from cash collection to order processing to recruitment
(4) Cost, meaning the elimination of all non value added activities
The pyramid highlights the links running between the vision for the company and functional
objectives. For example, a reduction in process time should lead to increased productivity and
hence improved financial performance.
Chapter 13
The Z-score for Zorro in 20Y0 is 1.419 which is below the danger level of 1.8 and so suggests a likelihood
of insolvency in the next two years. It has fallen over the past three years between 2.832 and 1.419.
During this period the variables making up the model have been mostly static or declining. Roughly half
the decline in the Z-score arises from variable X4 which has fallen from 1.62 to 0.60 or 63%. This
represents the market value of equity to total long term debt. This is due to the increase in gearing and
may also be due to recent falls in the share price.
The other variable that has seen most decline is variable X3 (PBIT/TA) falling from 0.16 to 0.05 which is
likely to reflect a sharp fall in profits and an increase in total assets. The company has failed to extract
profit from available assets. Maybe this will improve in future periods as revenue from the new
investments is earned.
It is likely at the early stage of the project that costs will be high and revenues low. So a longer-term view
needs to be taken before concluding the company is definitely failing.
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END OF ANSWERS TO LECTURE EXAMPLES

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Appendix A:
Mathematical tables
and formulae
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15: APPENDIX A: MATHEMATICAL TABLES AND FORMULAE
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Formulae given in the exam

No formulae will be included with the P5 exam, but questions will include these where required. Based
on previous papers, we would expect you to be provided with the following, if necessary.
Z-score
Z = 1.2X1 + 1.4X2 + 3.3.X3 + 0.6X4 + 1.0X5
END OF APPENDIX A
246

lOMoARcPSD|6246510
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ACCA PAPER P5 RESULTS

Question Maximum Score
Advanced Performance Management Q1 18
Q2 12
Step 4 Q3 20
Total 50
Date received: .........................................................................................
% Mark 100%
Date returned: .........................................................................................
Marker's comments (completed by BPP Professional Education)

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Sept17/Dec17/Mar18/June18 EDITION
lOMoARcPSD|6246510
Marker's assessment
Ticks in the left-hand boxes indicate a good aspect of your performance. Relevant to How to
Tick in the right-hand boxes highlight areas you need to work on. question improve
(Note: Boxes may be left empty if the comments are not applicable to your script)
Approach Good Improvement

performance needed
Careful reading
Questions correctly interpreted
Review the definitions of
question words
Logical coherent answers Practise planning and full
written answers
Technical content
Understanding of principles Reading your Study Text
More question practice

Principles applied well to specific required
problems
Computation
Check your workings
High standard of accuracy
Layout your workings clearly

Workings are easy to follow
Label and cross reference
Appearance/Layout Neat handwriting

Use plenty of space
Text layout is clear and easy to follow Use headings and
subheadings
Use short paragraphs
Calculations are easy to follow Neat diagrams and tables

Workings labelled
Written style
Short concise sentences
Concise business style
Think before you write

Answering the question set

lOMoARcPSD|6246510
ACCA P5 Advanced Performance

Management
Achievement Ladder
Step 4 Questions
Time allowed: 1 hour and 38 minutes
All questions are compulsory and must be attempted
Sept17/Dec17/Mar18/June18 EDITION 249

lOMoARcPSD|6246510
250 Sept17/Dec17/Mar18/June18 EDITION

lOMoARcPSD|6246510
1 Maxwell 36 mins
Maxwell Electricity Generation (Maxwell) is an electricity-generating firm producing power for
industry and the general public in the country of Deeland. In the past, the company has been
dominated by the need to make suitable returns on capital for its shareholders.
All power stations work in broadly the same way by taking in fuel (coal, gas or nuclear) and
producing electricity and waste products.
Maxwell has the following mix of power stations:
Details for each type of station Totals for Maxwell
Maximum Operating Number Total
Power station generating cost of Capital of capital Total CO2
type power electricity cost stations invested emissions
(MW) ($/MWh) ($m) ($m) (million tonnes)
Coal (small) 300 25 1,320 4 5,280 3.15
(large) 600 25 2,640 4 10,560 12.61
Gas (small) 300 50 300 8 2,400 3.15
(large) 900 50 900 2 1,800 7.10
Nuclear 1,200 20 6,000 2 12,000 0.50
32,040 26.51
Notes:
1. Maximum generating power is the output of the station measured in megawatts (MW) at 100%
operating capacity. The electricity produced by a station is measured in megawatt hours
(MWh).
2. It is assumed that the same load factor applies across all the different types of station, ie they
are working at the same percentage of capacity throughout the year.
3. Operating cost of electricity is the cost before the cost of financing the capital invested in a
station.
4. The CO2 (carbon dioxide) emissions are estimated based on industry standard figures for
similar stations.
5. Capital costs and CO2 emission figures are current best estimates.
The business has two alternative plans (plans 1a and 1b) to maintain current generating capacity
while plan 2 will grow the business.
Plan 1a
Build a new nuclear power station (the same as the existing nuclear type) to replace one of the 300
MW coal stations, one of the 600 MW coal stations and, also, one of the 300 MW gas stations. The
stations being replaced are all reaching the end of their useful lives.
Plan 1b
Replace the gas and coal stations mentioned in plan 1a with equivalent gas and coal stations, thus
maintaining the current generating mix.
Plan 2
In order to grow the business, a new nuclear station is being considered in combination with one of
plan 1a or 1b. This new nuclear station would be the same as the existing stations.

lOMoARcPSD|6246510
Maxwell is trying to raise finance for either plan 1a or plan 1b and, in addition to one of these plans,
plan 2. A nuclear plant takes about five years to build (assuming no regulatory difficulties or
problems over the design choice). It has a working life of 40 years and costs about $1bn at current
prices to decommission although this estimate is uncertain as each site is unique in the
decommissioning difficulties which it presents.
The government of Deeland has joined the international community in pledging to have greater
concern for the environment. Initially, it has stated that there is a national goal to reduce carbon
dioxide emissions by 20% in the next five years. The government is aware that electricity demand is
estimated to rise by around 10% over the next five years, nevertheless, it is strongly encouraging
businesses to help achieve this reduction in CO2 emissions. There is a proposal to raise a carbon tax
on CO2 emissions in order to encourage reductions. The government is also concerned that there
are other pollutants emitted by power stations but has decided to focus efforts on CO2 initially, as it is
a key cause of climate change.
In order to join the wider community in achieving these aims and as one of the major electricity
generators in Deeland, Maxwell has stated its own environmental goal as:
'to help reach national targets for reduction in CO2 emissions while maintaining our ability to
contribute to the electricity needs of the people of Deeland.'
Required
(a) Using Maxwell's stated environmental goal, assess the proposed investment plans 1a and 2.
(12 marks)
(b) Discuss the lifecycle costing issues associated with plan 2. (6 marks)
(Total = 18 marks)
2 SSA (APM 12/09, amended) 23 mins

You are the management accountant of the SSA Group which manufactures an innovative range of
products to provide support for injuries to various joints in the body. The group has adopted a
divisional structure. Each division is encouraged to maximise its reported profit.
Division A, which is based in a country called Nearland, manufactures joint-support appliances which
incorporate a 'one size fits all people' feature. A different appliance is manufactured for each of knee,
ankle, elbow and wrist joints.
Budget information in respect of Division A for the year ended 31 December 20X0 is as follows:
Support appliance Knee Ankle Elbow Wrist
Sales units (000's) 20 50 20 60
Selling price per unit ($) 24 15 18 9
Total variable cost of sales ($'000) 200 350 160 240
Each of the four support products uses the same quantity of manufacturing capacity. This gives
Division A management the flexibility to alter the product mix as desired. During the year to
31 December 20X0 it is estimated that a maximum of 160,000 support products could be
manufactured.
The following information relates to Division B which is also part of the SSA group and is based in
Distantland:
1. Division B purchases products from various sources, including from other divisions in SSA
group, for subsequent resale to customers.

lOMoARcPSD|6246510
2. The management of Division B has requested two alternative quotations from Division A in
respect of the year ended 31 December 20X0 as follows:
Quotation 1 – Purchase of 10,000 ankle supports.
Quotation 2 – Purchase of 18,000 ankle supports.
The management of the SSA Group has decided that a minimum of 50,000 ankle supports must be
reserved for customers in Nearland in order to ensure that customer demand can be satisfied and
the product's competitive position is maintained in the Nearland market.
The management of the SSA Group is willing, if necessary, to reduce the budgeted sales quantities
of other types of joint support in order to satisfy the requirements of Division B for ankle supports.
They wish, however, to minimise the loss of contribution to the Group.
The management of Division B is aware of another joint support product, which is produced in
Distantland, that competes with the Division A version of the ankle support and which could be
purchased at a local currency price that is equivalent to $9 per support. SSA Group policy is that all
divisions are allowed autonomy to set transfer prices and purchase from whatever sources they
choose. The management of Division A intends to use market price less 30% as the basis for each
of quotations 1 and 2.
Required
(a) The management of the SSA Group have asked you to advise them regarding the
appropriateness of the decision by the management of Division A to use an adjusted market
price as the basis for the preparation of each quotation and the implications of the likely
sourcing decision by the management of Division B.
Your answer should cite relevant quantitative data and incorporate your recommendation of the
prices that should be quoted by Division A for the ankle supports in respect of Quotations 1 and
2, that will ensure that the profitability of SSA Group as a whole is not adversely affected by the
decision of the management of Division B. (8 marks)
(b) Advise the management of Divisions A and B regarding the basis of transfer pricing which
should be employed in order to ensure that the profit of the SSA Group is maximised.
(4 marks)
(Total = 12 marks)
3 Bluefin School 39 mins

Bluefin School (Bluefin) is a school for 12 to 17-year-old pupils. It currently has 1,000 pupils
attending drawn from its local area. The school is run by an executive group comprising the head of
school and two deputy head teachers. This group reports to a board of governors who are part-time
and selected from the local community and parents. The school is wholly funded by the government.
The school's ethos is 'to promote learning, citizenship and self-confidence among the pupils. This is
developed from a consensus, led by the board of governors and the head of school and informed by
the views of the pupils' parents.'
The school information systems are highly decentralised. Each department keeps its own records on
a stand-alone PC using basic word processing and spreadsheet packages. The school's
administrative department has a small network in its own offices with compatible applications and
also a database and financial recording and reporting package for use in schools (provided by the
government).

lOMoARcPSD|6246510
The school is broken down into 11 academic departments such as mathematics, science and history.
Each department head must prepare information for reporting to the board by inputting and
processing the data. They obtain some help from an administrator who visits each department to
spend a few hours per week helping in the recording and preparation of the departmental
information. The department heads have different approaches to reporting their performance, with
some using average marks in the annual exams for each class and some using pass rates of the
annual exams. Some department heads present graphs of their data while most use tables of
figures.
The information is passed from each department to the school administration office on a memory
stick (USB flash drive). The school administration office prints out the information for each
department and adds it to a financial report creating a governors' pack of usually about 13 pages for
the annual review board meeting. The financial report is a detailed income and expenditure
statement for the period under review (usually a two page print-out from the reporting package). An
example of one of the 11 departments' report is given in the Appendix on the next page.
The board of governors meets every quarter and reviews the governors' pack once a year. The
board are concerned that the information that they are receiving is not meeting their needs and that
there are a number of problems with the control and security of some of the data.
It has been suggested that the school should consider improving its information systems by installing
a network across the school to link the departmental computers and the administration department.
A single database would be created to store all the performance information. The computers would
then be linked to the internet in order to facilitate data transfer to other schools in the region and to
the government.

lOMoARcPSD|6246510
Appendix
Bluefin School
Mathematics department
Year 20Y0/20Y1 Average marks
Current yr Previous yr
Class % %
Year 1 A 63 59
B 60 61
C 51 55
D 47 44
Year 2 A 61 70
B 58 62
C 49 47
D 45 43
Year 3 A 67 67
B 61 57
C 50 50
D 42 41
Year 4 A 62 58
B 59 59
C 50 54
D 46 47
Year 5 A 57 58
B 51 49
C 47 48
Year 6 54 53
Notes:
Each year contains pupils of the same age.
Annual national exams are set in Years 4, 5 and 6.
Each year group is divided into different classes in order to ensure that classes do not exceed 35
pupils.
(Not all pupils take every subject each year.)
Average marks are for the annual examinations.
Required
(a) With reference to the current situation at Bluefin School, discuss the controls and security
procedures that are necessary for management information. (6 marks)
(b) Using the limited information available, evaluate the usefulness of the pack that is provided to
the board of governors. (5 marks)
(c) Discuss the usefulness of the different ways the heads of department could use to present
their performance information to the board. (4 marks)
(d) Evaluate the improvements suggested to the information systems at Bluefin. (5 marks)
(Total = 20 marks)

lOMoARcPSD|6246510

lOMoARcPSD|6246510
DETACH THIS SHEET AND STAPLE IT TO YOUR SCRIPT. YOU ARE ADVISED TO PHOTOCOPY YOUR SCRIPT BEFORE SENDING THE ORIGINAL IN FOR MARKING.
MARKING & SOLUTIONS REQUEST FORM

Your details (MUST be completed by student) BPP Student no*:
* Failure to provide may result in a delay to the marking of this paper
Return address:
Company: .........................................................................
Student name: ........................................................................................
Date of birth: ........................................ 19......................
Address: ..................................................................................................
................................................................................................................. Date of sitting: ..................................................................
Postcode: ................................................................................................ Date sent: .........................................................................
Printed solutions will be sent to you with your marked script London In-centre students return to:
The Marking Dept, BPP Professional Education, Marcello
Tick here if you do not want us to mark your exam and fill in your House, 236-240 Pentonville Road, London N1 9JY
name and address in the space provided above. You'll receive
the solutions and a mark of 0%. Other students return to:
Your local Study Centre (addresses can be found at
Alternatively, please contact your local BPP centre quoting the
www.bpp.com)
Exam Identification Code.
Sending your exam to the wrong centre WILL result in
a delay to marking your script.
Exam details (completed by BPP Professional Education)
ACCA PAPER P5 RESULTS

Question Maximum Score
Advanced Performance Management Q1 20
Q2 19
Step 6 Q3 25
Q4 16
Date received: .........................................................................................

Total 80
Date returned: ......................................................................................... % Marks 100%
Marker's comments (completed by BPP Professional Education)

.........................................................................................................................................................................................................................
.........................................................................................................................................................................................................................
.........................................................................................................................................................................................................................
.........................................................................................................................................................................................................................
.........................................................................................................................................................................................................................
Marked by:
ACCA P5 – Step 6
Sept17/Dec17/Mar18/June18 EDITION
lOMoARcPSD|6246510
Marker's assessment
Ticks in the left-hand boxes indicate a good aspect of your performance. Relevant to How to
Tick in the right-hand boxes highlight areas you need to work on. question improve
(Note: Boxes may be left empty if the comments are not applicable to your script)
Approach Good Improvement

performance needed
Careful reading
Questions correctly interpreted
Review the definitions of
question words
Logical coherent answers Practise planning and full
written answers
Technical content
Understanding of principles Reading your Study Text
More question practice

Principles applied well to specific required
problems
Computation
Check your workings
High standard of accuracy
Layout your workings clearly

Workings are easy to follow
Label and cross reference
Appearance/Layout Neat handwriting

Use plenty of space
Text layout is clear and easy to follow Use headings and
subheadings
Use short paragraphs
Calculations are easy to follow Neat diagrams and tables

Workings labelled
Written style
Short concise sentences
Concise business style
Think before you write

Answering the question set

lOMoARcPSD|6246510
ACCA P5 Advanced Performance

Management
Achievement Ladder
Step 6 Questions
Time allowed: 2 hours and 36 minutes
All questions are compulsory and must be attempted

lOMoARcPSD|6246510

lOMoARcPSD|6246510
1 Auto Parts 39 mins

Auto Parts (AP) is a manufacturing company employing 1,300 people which makes components for
the automotive industry. AP has had 'preferred supplier' status with a major car manufacturer, CDM,
since September 20Y0. This means AP is guaranteed a minimum amount of business with CDM
each week. The preferred supplier status is reviewed annually.
CDM insists on a year-on-year reduction of 3% in the prices charged by AP. AP's current level of
guaranteed business with CDM is $2 million per week, and this constitutes 90% of AP's revenue.
CDM operates a just-in-time production and purchasing system and it has a policy of not inspecting
the components supplied to it by AP. However, if there are two reports of any of AP's components
failing in a year, either during production or later in a vehicle driven by one of CDM's customers, AP
will lose its preferred supplier status. AP has a number of competitors which would like to replace it
as CDM's preferred supplier.
AP's Managing Director, K, has the following objectives, which have been imposed upon him by AP's
Board of Directors:
 Maintain the preferred supplier status with CDM
 Keep AP's expenditure within the limits set each year in the budget which is approved by its
Board of Directors
 Develop the management skills of AP's 32 operational managers
K is held responsible for the successful achievement of the objectives and he may lose his job if any
are not met. K believes that the best way to achieve his objectives is by the use of a performance
management system (PMS) which he has designed. K's PMS is based exclusively on budgetary
control. This PMS uses quarterly reports prepared by AP's budget accountant. These reports
compare budgeted and actual expenditure for each of AP's 2,000 cost centres.
The quarterly reports are reviewed by K and later discussed with AP's operational managers. The
operational managers are shown the aggregate amount of under or overspending in the cost centres
but are not allowed to know the detail underlying this. This is because K believes that the details of
AP's finances should only be known to members of the Board of Directors.
Required
(a) Evaluate the effectiveness of AP's performance management system in assisting K achieve
his objectives. (10 marks)
(b) Recommend, with reasons, three improvements AP could make to its current performance
management system.
Note. Your answer to part (b), must not include introducing the balanced scorecard (or any
other specific performance management model) as one of the recommendations. (6 marks)
(c) Recommend, with reasons, two performance measures which would show AP's operational
managers the progress they are making towards maintaining AP's preferred supplier status
with CDM. (4 marks)
(Total = 20 marks)

lOMoARcPSD|6246510
2 F4U 37 mins
Franchising For You Ltd (F4U) markets a range of franchises which it makes available to its
customers, the franchisees. F4U supplies the franchisee with information of the mode of operation,
detailed operation schedules and back-up advice (by telephone, internet) and undertakes national
advertising. Each franchisee must arrange for its own premises, equipment and undertake local
marketing.
F4U is considering the introduction of a Dance and Drama franchise which would have an expected
life of six years. From this project, the only income F4U will receive from franchisees comes from the
initial franchise fee.
The following estimates have been made relating to the cash outflows and inflows for F4U in order
that F4U can evaluate the financial viability of the Dance and Drama franchise proposal:
1. Initial investment of $6m. This will include a substantial element relating to the 'intellectual
capital' requirement of the proposal.
2. Development/improvement costs of $1m per year at the end of each of years two and three.
3. 300 franchises will be sold each year at a fee of $20,000 per franchisee.
4. Variable costs, payable in full on the issue of each franchise, are estimated at $6,000 per
franchise.
5. Directly attributable fixed costs of $0.6m per year in each of years one to six. No further fixed
costs will be payable by F4U after this period.
6. Corporation tax at the rate of 30%, payable in the year in which cash flow occurs. Tax
allowances are not available on the initial investment or development/improvement costs
payable by F4U.
7. All cash flows are stated in current prices and with the exception of the initial investment will
occur at the end of each year.
8. The money cost of capital is 15.44%. Annual inflation during the period is estimated at 4%.
Required
(a) Calculate the net present value (NPV) of the Dance and Drama franchise proposal and
recommend whether it should be undertaken by F4U. (6 marks)
(b) Discuss ways in which reliance solely on financial performance measures can detract from the
effectiveness of the performance management system within an organisation. (6 marks)
F4U has identified key variables as follows:
1. The number of franchises taken up each year. It is estimated that a flexible pricing policy will
result in the following outcomes:
Fee per franchise Number of franchises
$ sold each year
22,000 270
20,000 300
18,000 355

lOMoARcPSD|6246510
2. The variable cost per franchise may be $7,000, $6,000 or $5,000. The NINE possible
outcomes of a spreadsheet model used in calculating the NPV and incorporating the variables
1 and 2 above, have been identified as follows:
Payoff Matrix: NPV values
Fee per franchise ($'000)
18 20 22
Variable 5 4,348,226 4,007,630 4,274,183
cost
per 6 3,296,822 3,119,120 3,474,524
franchise
($'000) 7 2,245,419 2,230,610 2,674,865
Required
(c) State the franchise fee pricing strategy ($ per franchise) which will result from the operation of
each of the following decision rules:
(i) Maximax;
(ii) Maximin;
(iii) Minimax regret.
Your answer should explain the basis of operation of each of the three decision rules.
(7 marks)
(Total = 19 marks)
3 LGHD 49 mins
A local government housing department (LGHD) has funds which it is proposing to spend on the
upgrading of air conditioning systems in its housing inventory.
It is intended that the upgrading should enhance the quality of living for the occupants of the houses.
Preferred contractors will be identified to carry out the work involved in the upgrading of the air
conditioning systems, with each contractor being responsible for upgrading the systems in a
proportion of the houses. Contractors will also be required to provide a maintenance and operational
advice service during the first two years of operation of the upgraded systems.
Prior to a decision to implement the proposal, LGHD has decided that it should carry out a value for
money (VFM) audit.
You have been given the task of preparing a report for LGHD, to help ensure that it can make an
informed decision concerning the proposal.
Required
(a) Prepare a detailed analysis which will form the basis for the preparation of the final report. The
analysis should include a clear explanation of the meaning and relevance of each of (i) to (iii)
below:
(i) Value for Money (VFM) audit (including references to the roles of principal and agent).
(6 marks)
(ii) Economy, efficiency and effectiveness as part of the VFM audit. (6 marks)
(iii) The extent (if any) to which each of intangibility, heterogeneity, simultaneity and
perishability may be seen to relate to the decision concerning the proposal, and any
problems that may occur. (8 marks)

lOMoARcPSD|6246510
Note: Your analysis should incorporate specific references to examples relating to the upgrading
proposal.
The Finance Director is keen to introduce some performance measures which can be used to judge
the success of initiatives such as the air conditioning upgrade. The Finance Director has asked the
management accountant to recommend some possible new performance measures which could be
used but reminded him, when doing so, to remember the adage that 'What gets measured, gets
done.'
(b) Briefly discuss the importance of the quote 'What gets measured, gets done' for LGHD.
(5 marks)
(Total = 25 marks)
4 GMB Co 31 mins
GMB Co designs, produces and sells a number of products. Functions are recognised from design
through to the distribution of products. Within each function, a number of activities may be
distinguished and a principal driver identified for each activity.
Each sales order will normally comprise a number of batches of any one of a range of products. The
company is active in promoting, where possible, a product focus for design, dedicated production
lines and product marketing. It also recognises that a considerable level of expenditure will relate to
supporting the overall business operation.
It is known that many costs may initially be recognised at the unit, batch, product sustaining (order)
or business/facility sustaining (overall) levels. A list of expense items relating to Order Number 377 of
product Zeta is shown below.
The methods of calculating the values for Order Number 377 shown below are given in brackets
alongside each expense item. These methods also indicate whether the expense items should be
regarded as product unit, batch, product sustaining (order) or business/facility sustaining (overall)
level costs. The expense items are not listed in any particular sequence. Each expense item should
be adjusted to reflect its total cost for Order Number 377.
Order Number 377 comprises 5,000 units of product Zeta. The order will be provided in batches of
1,000 product units.
Order Number 377
$
Production scheduling (rate per hour × hours per batch) 60,000
Direct material cost (per unit material specification) 180
Selling – batch expediting (at rate per batch) 60,000
Engineering design & support (rate per hour × hours per order) 350,000
Direct labour cost (rate per hour × hours per unit) 150
Machine set-up (rate per set-up × number of set-ups per batch) 34,000
Production line maintenance (rate per hour × hours per order) 1,100,000
Business/facility sustaining cost (at 30% of all other costs) 1,500,000
Marketing (rate per visit to client × number of visits per order) 200,000
Distribution (tonne miles × rate per tonne mile per batch) 12,000
Power cost (rate per Kilowatt hour × Kilowatts per unit) 120
Design work (rate per hour × hours per batch) 30,000
Administration – invoicing and accounting (at rate per batch) 24,000

lOMoARcPSD|6246510
Required
(a) Prepare a statement of total cost for Order Number 377, which analyses the expense items
into sections for each of four levels, with sub-totals for each level where appropriate. The four
levels are:
(i) Unit-based costs;
(ii) Batch-related costs;
(iii) Product sustaining (order level) costs; and
(iv) Business/facility sustaining (overall level) costs. (5 marks)
(b) Identify and discuss the appropriateness of the cost drivers of any two expense values in
each of levels (i) to (iii) above. Suggest a likely cause of the cost driver for any one value in
each of levels (i) to (iii) and a possible benefit from knowing the cause of each cost driver.
(11 marks)
(Total = 16 marks)

lOMoARcPSD|6246510
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APM (P5) Course Notes

Business Performance Management Technology (Kingston University)

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Advanced Performance Management

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Improving study material and removing errors

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P5 Advanced Performance Management

Achievement Ladder Step 1 51

4 Organisational change, environmental and ethical issues .......................................................................... 53

Achievement Ladder Step 2 85

6 Performance measurement systems and design ......................................................................................... 87

Achievement Ladder Step 3 115

8 Divisional performance and transfer pricing issues .................................................................................... 117

Achievement Ladder Step 4 139

9a Scope of strategic performance measures in not-for-profit organisations .................................................. 141

Achievement Ladder Step 5 177

12 Alternative views of performance measurement and management............................................................ 179

Achievement Ladder Step 6 207

14 Answers to Lecture Examples .................................................................................................................... 209

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Welcome to P5 Advanced Performance Management

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Introduction to Paper P5 Advanced Performance Management

Overall aim of the syllabus

A Strategic planning and control

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Links with other papers

Business Analysis Advanced

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Assessment methods and format of the exam

20% Numerical 80% Discussion

25% Knowledge 75% Application

Format of the Exam Marks

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Taught Phase Aims

Achieving ACCA's Study Guide Outcomes

A Strategic planning and control

B External influences on organisational performance

C Performance measurement systems and design

D Strategic performance measurement

E Performance evaluation and corporate failure

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Section reference in the Study Text

Formula given in exam

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Key skills required to pass

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Skill 2 – Analysis of the question's requirements

1 Understanding and applying the question verbs

Intellectual level Action verb Meaning

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2 Identifying and attempting ALL the requirements

Skill 3 – Data analysis

A key skill in this paper is to 'create information from data'.

ACCA Examiner's Comments December 2010

Skill 4 – Time management

Allowing time for planning is crucial