Notes ACCA Paper F5 Performance Management For exams in 2010 theexpgroup.com ExPress Notes ACCA F5 Performance Management Contents Page | About ExPress Notes Specialist Cost & Management Accounting Techniques Decision Making – Linear Programming 10 Pricing Decisions 12 Make-or-buy and other short-term decisions 16 Risk and Uncertainty in Decision Making 19 Budgeting – an Introduction 22 Budgeting and Standard Costing #1 26 Budgeting and Standard Costing #2 32 Performance Measurement & Control 35 © 2010 This material is the copyright of the ExP Group Individuals may reproduce this material if it is for their own private use It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of reproduction All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases theexpgroup.com ExPress Notes ACCA F5 Performance Management START About ExPress Notes We are very pleased that you have downloaded a copy of our ExPress notes for this paper We expect that you are keen to get on with the job in hand, so we will keep the introduction brief First, we would like to draw your attention to the terms and conditions of usage It’s a condition of printing these notes that you agree to the terms and conditions of usage These are available to view at www.theexpgroup.com Essentially, we want to help people get through their exams If you are a student for the ACCA exams and you are using these notes for yourself only, you will have no problems complying with our fair use policy You will however need to get our written permission in advance if you want to use these notes as part of a training programme that you are delivering WARNING! 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theexpgroup.com ExPress Notes ACCA F5 Performance Management Our ExPress notes fit into our portfolio of materials as follows: Notes Notes Provide a base understanding of the most important areas of the syllabus only Provide a comprehensive coverage of the syllabus and accompany our face to face professional exam courses Notes Provide detailed coverage of particular technical areas and are used on our Professional Development and Executive Programmes To maximise your chances of success in the exam we recommend you visit www.theexpgroup.com where you will be able to access additional free resources to help you in your studies START About The ExP Group Born with a desire to be the leading supplier of business training services, the ExP Group delivers courses through either one of its permanent centres or onsite at a variety of locations around the world Our clients range from multinational household corporate names, through local companies to individuals furthering themselves through studying for one of the various professional exams or professional development courses As well as courses for ACCA and other professional qualifications, our portfolio of expertise covers all areas of financial training ranging from introductory financial awareness courses for non-financial staff to high level corporate finance and banking courses for senior executives Our expert team has worked with many different audiences around the world ranging from graduate recruits through to senior board level positions Full details about us can be found at www.theexpgroup.com and for any specific enquiries please contact us at info@theexpgroup.com Page | © 2010 This material is the copyright of the ExP Group Individuals may reproduce this material if it is for their own private use It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of reproduction All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases theexpgroup.com ExPress Notes ACCA F5 Performance Management Chapter Specialist Cost & Management Accounting Techniques KEY KNOWLEDGE Activity Based Costing (ABC) ABC is a method that seeks to group overhead costs according to the activities causing those costs The activities giving rise to the costs are called “cost drivers” By linking costs to activities (cost drivers), it becomes possible to charge costs to the agents undertaking those activities EXAMPLE A factory clinic with total annual costs of $500,000 serves two Workshops A and B Workshop A has 200 employees and Workshop B has 300 employees Page | © 2010 This material is the copyright of the ExP Group Individuals may reproduce this material if it is for their own private use It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of reproduction All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases theexpgroup.com ExPress Notes ACCA F5 Performance Management A conventional way of apportioning the cost would be on the basis of employees: Workshop A: (200/500) x 500,000 = 200,000 Workshop B: (300/500) x 500,000 = 300,000 500,000 An ABC approach might look at the number of visits to the clinic by the employees of A and B Workshop A: 150 visits p.a Workshop B: 70 visits p.a In this case, the apportionment could be: Workshop A: (150/220) x 500,000 = 340,909 Workshop B: ( 70/220) x 500,000 = 159,091 500,000 The different levels of usage may reflect different degrees of occupational hazard present in the two workshops ABC advantages: provides a more precise way to determine costs per unit of output, especially since not all overhead costs are driven by production volumes Budgetary planning, pricing decisions and managing performance are all facilitated by ABC ABC disadvantages: it can be complex and costly to implement It is not a “plug-in-and-go” system! It is therefore imperative that management carefully weigh the costs against the (expected) benefits from ABC before deciding to implement it KEY KNOWLEDGE Target costing This is a market-oriented approach to costing which starts by identifying the likely price that a product can fetch in the market, deducts the profit that the product is expected to earn, and arrives at the maximum (target) cost of manufacturing the product Such a method usually requires successive iterations in order to close a “cost gap”, i.e where the costs are above the targeted level Product re-design, alternative materials and production processes are examined in order to achieve the desired level of costs Page | © 2010 This material is the copyright of the ExP Group Individuals may reproduce this material if it is for their own private use It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of reproduction All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases theexpgroup.com ExPress Notes ACCA F5 Performance Management KEY KNOWLEDGE Life-cycle costing A product normally “lives” beyond one accounting period and the costs connected to its development/design, launch and maintenance fall unevenly across time periods This method takes a comprehensive view of the costs relating to the product throughout its lifecycle KEY KNOWLEDGE Back-flush Accounting This is a simplified costing method which can be used in conditions of short operational cycles and low inventories Companies working on a Just-In-Time (JIT) basis may practise it, as it avoids the detailed tracking of costs during production; instead, it records costs when goods are completed These costs are then “back-flushed” through the system based on standard costs KEY KNOWLEDGE Throughput accounting This method is also consistent with a JIT environment and focuses on the bottlenecks in a production process; by eliminating these bottlenecks, it raises the amount of output that can flow through the process (assuming there is demand for the output – the idea is not to produce for inventory!) The throughput accounting approach itself considers all costs (including direct labour) as fixed and treats only direct materials as being variable in the short term Page | © 2010 This material is the copyright of the ExP Group Individuals may reproduce this material if it is for their own private use It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of reproduction All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases theexpgroup.com ExPress Notes ACCA F5 Performance Management Chapter Decision Making – Linear Programming KEY KNOWLEDGE Multi-limiting factors and the use of linear programming and shadow pricing When resources are scarce, or other limiting factors are present in a given situation, then management is concerned with achieving the most efficient allocation of available resources Whereas planning with one limiting factor involves the use of “key factor analysis” (in which typically one seeks to maximize the contribution per unit of the limited, or bottleneck, resource – see Paper F2), the presence of several limiting factors requires the use of linear programming In such cases, linear programming is typically used to either maximise contribution or to minimize costs The usual steps to be followed are: 1) 2) 3) 4) Define the variables Define the “objective function” Express the constraints as equations Solve the equations simultaneously as well as feasible values corresponding to the corner points; 5) Determine the combination of specific values that satisfies the objective function Page | 10 © 2010 This material is the copyright of the ExP Group Individuals may reproduce this material if it is for their own private use It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of reproduction All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases theexpgroup.com ExPress Notes ACCA F5 Performance Management We solve for: y = 20 X 4-.1522 = 16 (remember: this is the cumulative time per unit) Therefore, units will require 64 hrs (16x4) Conclusion: Based on the above, 64 hrs define the standard against which the time required to produce units should be compared when calculating the labour efficiency variance KEY KNOWLEDGE Behavioural Aspects of Budgeting There are numerous inter-relationships between types of budgets, budgeting processes and the motivation of employees: Top-Down budgets may be necessary from a coordination point of view; however they can be de-motivating to employees; Bottom-Up budgets allow useful employee input, but they may create exaggerated expectations on the part of the employee that his/her voice will be heard Unrealistic budgets – with unachievable targets – can be de-motivating (as can budgets which are easily achieved, since most people stop working when they reach the targets!) Page | 25 © 2010 This material is the copyright of the ExP Group Individuals may reproduce this material if it is for their own private use It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of reproduction All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases theexpgroup.com ExPress Notes ACCA F5 Performance Management Chapter Budgeting and Standard Costing #1 START The Big Picture Standard costs are useful in that they assist the budgeting and planning process before an activity commences, as well as the analysis of actual costs (including variance analysis) as the activity proceeds KEY KNOWLEDGE Basic Variances and Operating Statements Variances Variance analysis is the process by which the differences between actual and budgeted (standard) results are quantified and examined Variances can either be favorable (F) or adverse (A) Page | 26 © 2010 This material is the copyright of the ExP Group Individuals may reproduce this material if it is for their own private use It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of reproduction All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases theexpgroup.com ExPress Notes ACCA F5 Performance Management EXAMPLE The following is a fully-worked illustration based on the following data: Cost card (per unit) Materials (5kgs x $9 per kg) Labour (3hrs x $6 per hr) Variable O/Hs (3 hrs x $3 per hr) Fixed O/Hs (3 hrs x $5 per hr) Budget Production: Sales: Sales Price: 1,100 units 1,000 units $120 / unit Actual results Production: Sales: Materials: Labour: Variable O/Hs: Fixed O/Hs: Sales price: 1,000 units 950 units 4,900 kg, $45,025 3,100 hrs, $19,050 $9,250 $17,000 $115 / unit 45 18 15 87 Variances analysis is best performed by asking a series of parallel questions in a systematic way: Material variances (i)   Page | 27 Material price variance Materials used (4,900 kg) should have cost @ $9 Materials (4,900 kg) did cost Materials price variance 44,100 45,025 $925 (A) © 2010 This material is the copyright of the ExP Group Individuals may reproduce this material if it is for their own private use It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of reproduction All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases theexpgroup.com ExPress Notes ACCA F5 Performance Management (ii)   Material usage variance 1,000 units should have used @ kg 1,000 units did use Materials usage variance @ standard $9 Materials total variance: 5,000 kg 4,900 kg 100 kg (F) $900 (F) $ 25 (A) Labour variances (i)   (ii)   Labour rate variance Labour (3,100 hrs) should have cost @ $6 Labour (3,100 hrs) did cost Labour rate variance 18,600 19,050 $450 (A) Labour efficiency variance 1,000 units should have taken @ hrs 1,000 units did take Labour efficiency variance @ standard $6 Labour total variance: 3,000 hrs 3,100 hrs 100 hrs (A) $600 (A) $ 1,050 (A) Note: Labour variances can be influenced by “learning curve” effects: as work processes are mastered, the time required to produce a given level of output should decline Variable O/H variances (i) Variable O/H expenditure variance   3,100 hrs should have cost @ $3 3,100 hrs did cost Variable O/H expenditure variance (ii)   Variable O/H efficiency variance 1,000 units should have taken @ hrs 1,000 units did take Variable O/H efficiency variance @ standard $3 Variable O/H total variance: Page | 28 9,300 9,250 50 (F) 3,000 hrs 3,100 hrs 100 hrs (A) $300 (A) $ 250 (A) © 2010 This material is the copyright of the ExP Group Individuals may reproduce this material if it is for their own private use It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of reproduction All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases theexpgroup.com ExPress Notes ACCA F5 Performance Management Fixed O/H variances Fixed O/H total variance   Overhead actually incurred Overhead absorbed (1,000 units x $15) Fixed O/H total variance $17,000 $15,000 $ 2,000 (A) This can be broken down into two components: (i)   (ii)   Fixed O/H expenditure variance Budgeted O/H should have cost (1,100 units x $15) 16,500 Actual O/H cost 17,000 Fixed O/H expenditure variance $500 (A) Fixed O/H volume variance Budgeted production Actual production Fixed O/H volume variance @ standard $15 1,100 units 1,000 units 100 units (A) $1,500 (A) Sales volume variance The absorption costing system calculates sales volume variances as follows:   Budgeted sales volume Actual sales volume Sales volume variance @ standard margin ($120-$87) 1,000 950 50 (A) $1,650 (A) Sales price variance   Page | 29 950 units should have sold @$120 Actual revenues (950 units x $115) Sales price variance 114,000 109,250 4,750 (A) © 2010 This material is the copyright of the ExP Group Individuals may reproduce this material if it is for their own private use It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of reproduction All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases theexpgroup.com ExPress Notes ACCA F5 Performance Management Operating statement A reconciliation between profit budgeted (absorption costing) and that realized follows: Budgeted profit 33,000 Sales volume variance Sales price variance 1,650 (A) 4,750 (A) 26,600 Cost variances: Materials Price Usage Labour 900 Rate Efficiency Variable Expenditure Efficiency Fixed F Expenditure Volume A 925 450 600 50 950 300 500 1,500 4,275 Actual profit 3,325 (A) 23,275 Note: Closing inventory is valued at standard cost Page | 30 © 2010 This material is the copyright of the ExP Group Individuals may reproduce this material if it is for their own private use It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of reproduction All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases theexpgroup.com ExPress Notes ACCA F5 Performance Management Marginal costing A marginal approach to costing focuses on the variable (marginal) costs generated in a business and considers fixed costs as period costs This allows the company to be able to quantify the amount by which its costs rise, if it produces/sells an additional unit of output Based on the data above, an Operating Statement based on Marginal costing follows: Budgeted contribution Sales volume variance Sales price variance 48,000 2,400 (A) 4,750 (A) 40,850 Cost variances: Materials Price Usage F 900 A 925 Labour Rate Efficiency Variable Expenditure Efficiency 450 600 50 950 300 2,275 Actual contribution Fixed O/Hs Budgeted Fixed O/Hs Expenditure variance 1,325 (A) 39,525 16,500 500 Actual profit (17,000) 22,525 Absorption costing and Marginal costing Operating Statements compared When preparing the Operating Statements, note that Marginal Costing:   Starts with standard contribution (not profit); and Recognizes only Fixed O/H expenditure variance Variance analysis can also be applied to the Activity-Based Costing (ABC) system Page | 31 © 2010 This material is the copyright of the ExP Group Individuals may reproduce this material if it is for their own private use It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of reproduction All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases theexpgroup.com ExPress Notes ACCA F5 Performance Management Chapter Budgeting and Standard Costing #2 KEY KNOWLEDGE Mix and Yield Variance Mix and yield variance When materials are combined in the production process in standard proportions, with the possibility of substituting one for the other, then the materials usage variance can be broken down into two further measures: Mix: This examines the (monetary) impact of altering the proportions of the two materials Yield: This focuses on the total amount of inputs to produce the output achieved The sum of the mix and yield variances is equal to the materials usage variance EXAMPLE One unit of product requires the following standard inputs: Material X: kg @ $8 Material Y: 10kg @ $3 Page | 32 $ 40 30 70 © 2010 This material is the copyright of the ExP Group Individuals may reproduce this material if it is for their own private use It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of reproduction All examples presented in these course materials are 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The analysis is made on the basis of actual usage: 195 kg (50 kg of X and 145 kg of Y): The standard mix of actual input should have been: X 65 Y 130 (X:Y = 5:10) The actual mix was: 50 145 Mix variances (kg): Cost ($): Variance ($): 15 (F) $8 $120(F) Mix variance 15 (A) $3 $45(A) $75(F) Interpretation: More of the cheaper material (Y) and less of the more expensive one (X) were used, resulting in an overall favorable variance relating to the mix Yield variance: Important! The analysis is made on the basis of standard mix (X:Y = 5:10): The yield (12 units) should have used 180 kg X 60 Actual input (195 kg) expressed in standard mix 65 Yield variances (kg): Cost ($): Variance ($): Yield variance Y 120 130 (A) 10 (A) $8 $3 $40(A) $30(A) $70(A) Interpretation: This analysis eliminates the (distorting) influence of the differing mixes by “normalizing” them (according to standard) It permits focus to be placed only on the impact of having used a greater amount of materials than the standard The sum of the mix and yield variances (above) equal the materials usage variance: $5 (F) Page | 33 © 2010 This material is the copyright of the ExP Group Individuals may reproduce this material if it is for their own private use It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of reproduction All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases theexpgroup.com ExPress Notes ACCA F5 Performance Management Note: Some prefer an alternative approach to calculating the yield variance 1) The actual usage (195 kg) should, according to the standard, produce 13 units (195/15 = 13) 2) The actual number of units produced: 12 units 3) The difference of unit (13-12) is adverse and valued at standard cost: $70 (A) KEY KNOWLEDGE Planning and Operational Variances Due to changing market and technical circumstances, standards may become outdated In such cases, it may be necessary to alter a standard, even during a budget period already in progress Planning and operational variances capture these changes in two steps: Planning variance: Compares results based on the revised standard compared to the initial standard The result is usually considered to be outside the area of control of management Operational variance: Compares actual results with the budget based on the revised standard This is often considered to be within the control of management The distinction above between “controllable” and “uncontrollable” factors is critical insofar as it relates to the idea of “responsibility accounting”, i.e expecting people who have delegated authority to take responsibility for decisions within their area of control KEY KNOWLEDGE Behavioural Aspects of Standard Costing Standard costing in the “wrong” environment can be like a duck out of water  If products are non-standard; or  Standards are changing rapidly (due to technical or market developments); or  Manufacturing processes involve a high degree of automation with little labour input, then standard costing may not be very useful Page | 34 © 2010 This material is the copyright of the ExP Group Individuals may reproduce this material if it is for their own private use It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of reproduction All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases theexpgroup.com ExPress Notes ACCA F5 Performance Management Chapter Performance Measurement and Control KEY KNOWLEDGE The scope of performance measurement Balanced scorecard The balance scorecard addresses a number of parameters (or “perspectives”) in monitoring business performance by asking the following questions: Page | 35  Financial perspective: “To succeed financially how should we appear to our shareholders?”  Customer perspective: “To achieve our vision how should we appear to our customers?”  Internal business processes: “To satisfy our shareholders and customers what business processes must we excel at?”  Learning and growth: “To achieve our vision how will we sustain our ability to change and improve?” © 2010 This material is the copyright of the ExP Group Individuals may reproduce this material if it is for their own private use It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of reproduction All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases theexpgroup.com ExPress Notes ACCA F5 Performance Management Fitzgerald and Moon This is another model of performance management Qualitative measures Service quality is an area that can be difficult to assess in “objective” terms Certain actions can be measured numerically and serve as an indication for quality; for example, measuring the turn-around time (in days or minutes) in responding to customer requests: naturally, the quicker (one reacts), the better To be fully useful, however, such a measure assumes two things: (1) that the action being measured is of value (or relevance) to the customer; and (2) that one has a rule or a benchmark as to what constitutes a maximum acceptable turnaround time (from the client’s point of view) Purely qualitative factors, such as client satisfaction, can be measured by employing a scale; e.g a scale of 1-5, with = Very satisfied, to = Dissatisfied (Note: to avoid confusion, it may be better to use the labels without numbers, and to assign numbers when analyzing the results.) KEY KNOWLEDGE Divisional Performance and Transfer Pricing There are various bases on which transfer prices can be determined:  Market price  Outlay cost (standard) + opportunity cost to the seller  Outlay cost (actual) + opportunity cost to the seller  Outlay cost + notional mark-up  Production cost (full absorption)  Best bargain (negotiation between divisions) Divisional performance and internal (transfer) pricing Divisional objectives may not be aligned with one another or with corporate objectives Page | 36 © 2010 This material is the copyright of the ExP Group Individuals may reproduce this material if it is for their own private use It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of reproduction All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases theexpgroup.com ExPress Notes ACCA F5 Performance Management Return on Investment (ROI) at the Divisional Level Earnings can be measured at the divisional level in relation to the financial resources they use The ROI measure is very similar to ROCE (return on capital employed) with the only exception being the use of profit in the formula: ROI = Net Profit Capital Employed ROI as defined above is commonly used for investment appraisal and for business sector (divisional) performance, whereas ROCE is common at the overall corporate level EXAMPLE A division head with an actual ROI of 20% may be reluctant to accept a project offering a 15% ROI, especially if his bonus is based on ROI achieved If the corporate overall ROI target is 12%, then the division head is missing a value-creating opportunity Residual Income (RI) Convert results into monetary magnitudes: Residual Income = Divisional EBIT (minus) Imputed interest Where Imputed interest = Capital Employed X Capital charge (or cost of capital) A positive result adds profits to the division beyond the incremental capital cost An investment should be accepted if the RI is positive Page | 37 © 2010 This material is the copyright of the ExP Group Individuals may reproduce this material if it is for their own private use It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of reproduction All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases theexpgroup.com ExPress Notes ACCA F5 Performance Management Drawbacks of RI and ROI EXAMPLE A division of a corporation currently generating an ROI of 12% is examining a new project which requires an investment of $4.5m Cash inflows are expected to be $1.5m p.a and the cost of capital: 10% ROI and RI computations will be as follows: Year NBV initial 4500 3375 2250 1125 Net cash inflow 1500 1500 1500 1500 -1125 -1125 -1125 -1125 375 375 375 375 -450 -337.5 -225 -112.5 RI -75 37.5 150 262.5 ROI 8% 11% 17% 33% Depreciation Profit Capital charge(10%) From both RI and ROI points of view, the project does not look favorable to the division, even if it would be from the corporate point of view (Eg, at a cost of capital of 10%, the project has a positive net present value) Performance analysis in not for profit organisations and the public sector Not-for-profit organizations share many similar issues with profit-making firms in terms of careful management of costs and ensuring that organizational objectives are being fulfilled Page | 38 © 2010 This material is the copyright of the ExP Group Individuals may reproduce this material if it is for their own private use It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of reproduction All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases theexpgroup.com ExPress Notes ACCA F5 Performance Management External considerations and behavioural aspects Performance management systems which are completely internal (introverted) in focus risk losing touch with the external world A system of external bench-marking serves to counteract the tendency of individuals to perform only to a sufficient level rather than to a superior level Organizations that figure out how to motivate and actualize the true potential in people will win (end of ExPress notes) Page | 39 © 2010 This material is the copyright of the ExP Group Individuals may reproduce this material if it is for their own private use It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of reproduction All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases theexpgroup.com ... 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