Answers
Part 3 Examination – Paper 3.3 Performance Management
December 2005 Answers
N.B. (i) (ii)
These answers are more detailed than would be expected of a ‘good pass’ candidate under examination conditions. Alternative explanations would be acceptable where appropriate.
1
(i)
(a)
Kickstart Ltd Budgeted Profit and Loss Statement for the year ending 31 December 2006. Project management £ 7,500,000 1,000,000 –––––––––– 8,500,000 ––––––––––
Fees receivable Government grants receivable Total revenue Less: Salaries Variable costs Other fixed costs: ABC related Attributable
Implementation Product education support & training £ £ 3,000,000 1,800,000 240,000 216,000 –––––––––– –––––––––– 3,240,000 2,016,000 –––––––––– ––––––––––
2,500,000 1,200,000
960,000 600,000
706,343 325,500 –––––––––– 4,731,843 –––––––––– Profit/(loss) before general administration costs 3,768,157 General administration costs
972,286 145,000 –––––––––– 2,677,286 –––––––––– 562,714
Total £ 12,300,000 1,456,000 ––––––––––– 13,756,000 –––––––––––
1,200,000 270,000
4,660,000 2,070,000
583,371 95,000 –––––––––– 2,148,371 –––––––––– (132,371)
2,262,000 565,500 ––––––––––– 9,557,500 ––––––––––– 4,198,500 (390,000) ––––––––––– 3,808,500 –––––––––––
Net profit Note 1: Calculation of ABC related costs: Activity: Pre-contract meetings: Cost Driver
Project management
Implementation support
Product education and training
Number of consultations: 300 1,500 1,800 Number of meetings 4 2 1 (per consultation) Total pre-contract 1,200 3,000 1,800 meetings per activity Cost: (1,200/6,000) (3,000/6,000) (1,800/6,000) * £956,000 = * £956,000 = * £956,000 = £191,200 £478,000 £286,800
Total precontract meetings
Cost (£)
6,000
956,000
Total days spent on assessment of client needs
Cost (£)
1,875
650,000
Activity: Assessment of client needs: Cost Driver
Number of consultations: Days (per consultation) Total days per activity Cost:
Project management
Implementation support
300 2·25 675 (675/1,875) * £650,000 = £234,000
Product education and training
1,500 1,800 0·5 0·25 750 450 (750/1,875) (1,800/6,000) * £650,000 = * £650,000 = £260,000 £156,000
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Activity: Post-implementation monitoring and support: Cost Driver
Project management
Number of consultations: Days (per consultation) Total days per activity Cost:
Implementation support
300 3 900 (900/2,100) * £656,000 = £281,143
1,500 0·5 750 (750/2,100) * £656,000 = £234,286
Product education and training
Total days spent on postimplementation monitoring and support
Cost (£)
2,100
656,000
1,800 0·25 450 (450/2,100) * £656,000 = £140,571
Summary of activity-based costs: Activity: Pre-contract meetings Assessment of client needs Post-implementation, monitoring and support Total (ii)
£ 191,200 234,000 281,143 –––––––– 706,343 ––––––––
£ 478,000 260,000 234,286 –––––––– 972,286 ––––––––
£ 286,800 156,000 140,571 –––––––– 583,371 ––––––––
The profit/(loss) using the previous method of allocating fixed overheads is shown in the following table: £ £ £ £ Profit/(loss) before general administration costs using an activity-based approach 3,768,157 562,714 (132,371) 4,198,500 Add: Other fixed costs (per a (i)) ABC related and attributable 1,031,843 1,117,286 678,371 2,827,500 Less: Other fixed costs (based on consultations) (235,625) (1,178,125) (1,413,750) (2,827,500) –––––––––– –––––––––– –––––––––– –––––––––– Profit/(loss) before general administration costs 4,564,375 501,875 (867,750) 4,198,500 General administration costs (390,000) –––––––––– Net profit 3,808,500 –––––––––– The proposed treatment of other fixed costs uses an activity-based approach which will give the management of the KCB Group a more accurate picture of the income streams arising from each of the three types of consultation undertaken by Kickstart Ltd. Under the previous method overheads were allocated on the basis of the total number of budgeted consultations. However, this method would have masked the true position since it pre-supposes that each consultation undertaken incurs an equal amount of fixed overhead whereas this is not the case as the results of the activity-based costing study clearly shows. Note 2: Calculation of ‘Other fixed costs’ on the basis used prior to 1 January 2006. Cost Driver
Product Total education and consultations training Number of consultations: 300 1,500 1,800 3,600 Cost: (300/3,600) (1,500/3,600) (1,800/3,600) * £2,827,500 = * £2,827,500 = * £2,827,500 = £235,625 £1,178,125 £1,413,750
(b)
(i)
Project management
Implementation support
Cost (£)
2,827,500
Pay-off table
Demand Prob
100 200 400
0·20 0·50 0·30
Purchase options 100 200 300 400 Contribution Expected Contribution Expected Contribution Expected Contribution Expected value value value value £ £ £ £ £ £ £ £ 832,000 166,400 (1,164,800) ,,(232,960) (2,662,400) (532,480) (3,328,000) (665,600) 832,000 416,000 2,163,200 1,081,600 665,600 332,800 0 0 832,000 249,600 2,163,200 648,960 3,993,600 1,198,080 6,656,000 1,996,800 –––––––– –––––––––– ––––––––– –––––––––– 832,000 1,497,600 998,400 1,331,200 –––––––– –––––––––– ––––––––– ––––––––––
On the basis of expected values Envico Ltd should contract for room B which has a capacity of 200 attendees and would give an expected value of £1,497,600.
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Note 3: Example of workings for the Pay-off table re (b)(i): If we assume that room size C was contracted for and subsequent demand was for 100 delegate places, then the resultant contribution would be calculated as follows: (100 x £80) – £14,400 = –£6,400 x 8 x 52 = (£2,662,400). (ii)
The minimum contribution for each possible decision is as follows: Room Type A B C D
Minimum contribution (£) 832,000 (1,164,800) (2,662,400) (3,328,000)
Applying a Maximin approach to this decision would result in room type A, which can accommodate up to 100 attendees being contracted for, since it is the only room size that, if contracted for, would not result in a negative contribution. Applying a Minimax regret approach then the regret matrix would appear as follows:
Demand 100 200 400 Maximum regret
100
Purchase 200
300
400
0 1,331,200 5,824,000 5,824,400
1,996,800 0 4,492,800 4,492,800
3,494,400 1,497,600 2,662,400 3,494,000
4,160,000 2,163,200 0 4,160,000
Therefore in order to minimise the maximum regret room type C, with a capacity to accommodate up to 300 attendees should be contracted for. (iii) If attendance = 100 then management would opt for room size A which would produce a contribution of £832,000 x 0·2 = £166,400. If attendance = 200 then management would opt for room size B which would produce a contribution of £2,163,200 x 0·5 = £1,081,600. If attendance = 400 then management would opt for room size D which would produce a contribution of £6,656,000 x 0·3 = £1,996,800. Therefore the expected value of perfect information would be the sum of the expected values of the three possible outcomes which amounts to £3,244,800. Thus, if the information is correct then management should be willing to pay up to £3,244,800 – £1,497,600 = £1,747,200 for the information. In practice, it is unlikely that perfect information is obtainable. The management of Envico Ltd are really buying an information system that will provide them with a signal which may prove to be correct or incorrect! For example, the consultants may predict that demand will be for 300 seminar places, however there still remains the fact that there is a likelihood of actual demand being for either 100, 200 or 400 seminar places. One should be mindful that imperfect information which may be, say only 75% reliable, might still be worth obtaining. Other than when the value of imperfect and perfect information are equal to zero, the value of perfect information will always be greater than the value of imperfect information. (c)
The following are six separate and distinct assessment criteria (including those suggested by the managing director), that would enable the management of Envico Ltd to assess the ‘value for money’ of each seminar. The assessment criteria are presented as questions that would comprise the contents of a questionnaire but other presentations would have been equally acceptable. (1) Did the course meet your objectives? ‘Value for money’ may, in part, be assessed by reference to the ‘effectiveness’ of the service provision. Effectiveness may be viewed in this context as meeting the objectives of attendees. All attendees have similar but varying objectives and hence it is vital that Envico Ltd meets the objectives of all attendees if seminars are to constitute ‘value for money’. (2) How would you rate the quality of the speakers? A primary resource of Envico Ltd is its speakers and thus it is important to gauge how they were perceived to perform by the attendees. (3) How would you rate comfort, cleanliness and facilities of the seminar rooms? Again, a principal resource, which is consumed when providing the service, is the seminar room and the facilities contained within it. Attendees will find a clean and ergonomically designed room more conducive for education and training activities.
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(4) How would you assess the quality of the course materials? Since Envico Ltd undertakes the provision of educational and training seminars then the quality of course materials provided assumes critical significance as they represent the ‘raison d’être’ of Envico Ltd. If they are perceived to be of high quality they may act as a good advertisement for the company. Conversely, poor quality course materials will cause Envico Ltd to be perceived poorly. (5) How strongly would you recommend Envico courses to friends and colleagues? This is a very important consideration since ‘word of mouth’ may represent the best means of advertising the services provided by Envico Ltd and is indicative of whether attendees consider that they have received ‘value for money’ from Envico Ltd. (6) Do you consider that you could have achieved your objectives in attending the course in a more expedient manner? If so, please detail below. This question acknowledges that the time of attendees is a scarce resource and hence there may well be an opportunity cost in attending seminars in addition to the explicit costs such as course fees, travel and subsistence costs etc. It is essential that Envico Ltd is flexible in its approach to meeting the needs of clients where attendance at seminars is either impracticable or undesirable. Perhaps a series of interactive CDs and/or video tuition may be more appropriate in certain instances. (d)
Environmental management accounting (EMA) involves the generation and analysis of both financial and non-financial information in order to support internal environmental management processes. It is complementary to the conventional management accounting approach, with the aim to develop appropriate mechanisms that assist the management of organisations in the identification and allocation of environmentally related costs. Organisations that alter their management accounting practices to incorporate environmental concerns will have greater awareness of the impact of environment-related activities on their profit and loss accounts and balance sheets. This is because conventional management accounting systems tend to attribute many environmental costs to general overhead accounts with the result that they are ‘hidden’ from management. It follows that organisations which adopt EMA are more likely to identify and take advantage of cost reduction and other improvement opportunities. A concern with environmental costs will also reduce the chances of employing incorrect pricing of products and services and taking the wrong options in terms of mix and development decisions. This in turn may lead to enhanced customer value whilst reducing the risk profile attaching to investments and other decisions which have long term consequences. Reputational risk will also be reduced as a consequence of adopting (EMA) since management will be seen to be acting in an environmentally responsible manner. Organisations can learn from the Shell Oil Company whose experience in the much publicised Brent Spar incident cost the firm millions in terms of lost revenues as a result of a consumer boycott.
2
(a)
Backflush accounting focuses upon output of an organisation and then works backwards when allocating costs between cost of goods sold and inventories. It can be argued that backflush accounting simplifies costing since it ignores both labour variances and work-in-progress. Whilst in a perfect just-in-time environment there would be no work-in-progress at all, there will in practice be a small amount of work-in-progress in the system at any point in time. This amount, however, is likely to be negligible in quantity and therefore not significant in terms of value. Thus, a backflush accounting system simplifies the accounting records by avoiding the need to follow the movement of materials and work-in-progress through the manufacturing process within the organisation. The backflush accounting system is likely to involve the maintenance of a raw materials and work-in–progress account together with a finished goods account. The use of standard costs and variances is likely to be incorporated into the accounting entries. Transfers from raw materials and work-in-progress account to finished goods (or cost of sales) will probably be made at standard cost. The difference between the actual inputs and the standard charges from the raw materials and work-in-progress account will be recorded as a residual variance, which will be recorded in the profit and loss account. Thus, it is essential that standard costs are a good surrogate for actual costs if large variances are to be avoided. Backflush accounting is ideally suited to a just-in-time philosophy and is employed where the overall cycle time is relatively short and inventory levels are low. Naturally, management will still be eager to ascertain the cause of any variances that arise from the inefficient usage of materials, labour and overhead. However investigations are far more likely to be undertaken using nonfinancial performance indicators as opposed to detailed cost variances.
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(b) 1. 2.
3.
4.
Raw materials inventory a/c Creditors Conversion costs Bank Creditors
Dr £ 5,575,000
Cr £ 5,575,000
4,883,000 1,735,000 3,148,000
Finished goods inventory 10,080,000 Raw materials inventory a/c Conversion costs: – labour – overheads
5,460,000 1,722,000 2,898,000
Cost of sales (206,000 x £48) 9,888,000 Finished goods inventory
9,888,000
The ledger accounts in respect of the above transactions would be as follows: Raw materials inventory 1.
Creditors
£5,575,000
3.
––––––––––– £5,575,000 –––––––––––
Finished goods Balance c/fwd
£5,460,000 £115,000 ––––––––––– £5,575,000 –––––––––––
Finished goods inventory 3.
Raw materials Conversion costs
£5,460,000 £4,620,000 –––––––––––– £10,080,000 ––––––––––––
4.
Cost of sales Balance c/fwd
£9,888,000 £192,000 –––––––––––– £10,080,000 ––––––––––––
Finished goods Balance c/fwd
£4,620,000 £263,000 ––––––––––– £4,883,000 –––––––––––
Conversion costs 2.
Bank Creditors
£1,735,000 £3,148,000 ––––––––––– £4,883,000 –––––––––––
3.
Cost of sales 4.
Finished goods
£9,888,000 ––––––––––– £9,888,000 –––––––––––
To Profit and Loss a/c
£9,888,000 ––––––––––– £9,888,000 –––––––––––
The inventory balances as at 30 November 2005 are: £ Raw materials account 115,000 Finished goods account 192,000 –––––––– 307,000 –––––––– The balance of £263,000 on the conversion costs account would be debited to the profit and loss account.
3
(c)
In a ‘perfect’ just-in-time manufacturing system there would not have been any inventories of raw materials or finished goods at the end of November 2005. The quantity of fuel pumps manufactured during November 2005 would have been 206,000 which would be equal to the quantity sold during the period. The debit entry to the finished goods account in respect of November 2005 would have been £9,888,000 and would match the cost of sales for the period. Since a lower volume of finished goods would be manufactured in a perfect just-in-time system one would expect that reductions would also occur in the amount of raw materials purchased and conversion costs consumed.
(a)
The management of an organisation need to exercise control at different levels within an organisation. These levels are often categorised as being strategic, tactical and operational. The information required by management at these levels varies in nature and content. Strategic information 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
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summary in nature and would be used by management when, for example, undertaking SWOT analysis. In Moffat Ltd strategic information might relate to the development of new services such as the provision of a home-based vehicle recovery service or the provision of twenty-four hour servicing. Other examples would relate to the threats posed by Moffat Ltd’s competitors or assessing the potential acquisition of a tyre manufacturer in order to enhance customer value via improved efficiency and lower costs. Tactical information 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. In Moffat Ltd this might involve the consideration of whether to open an additional outlet in another part of the country or whether to employ additional supervisors at each outlet in order to improve the quality of service provision to its customers. Operational information 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 Moffat Ltd, the manager at each location within Moffat Ltd would require information relating to the level of customer sales, the number of vehicles serviced and the number of complaints received during a week. Operational information might be used within Moffat Ltd 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 certain types of vehicle. (b)
One approach that the directors of Moffat Ltd could adopt would be to ignore the qualitative benefits that may arise on the basis that there is too much subjectivity involved in their assessment. The problem that this causes is that the investment will probably look unattractive since all costs will be included in the evaluation whereas significant benefits and savings will have been ignored. Hence such an approach is lacking in substance and is not recommended. An alternative approach would involve attempting to attribute values to each of the identified benefits that are qualitative in nature. Such an approach will necessitate the use of management estimates in order to derive the cash flows to be incorporated in a cost benefit analysis. The problems inherent in this approach include gaining consensus among interested parties regarding the footing of the assumptions from which estimated cash flows have been derived. Furthermore, if the proposed investment does take place then it may well be impossible to prove that the claimed benefits of the new system have actually been realised. Perhaps the preferred approach is to acknowledge the existence of qualitative benefits and attempt to assess them in a reasonable manner acceptable to all parties including the company’s bank. The financial evaluation would then not only incorporate ‘hard’ facts relating to costs and benefits that are quantitative in nature, but also would include details of qualitative benefits which management consider exist but have not attempted to assess in financial terms. Such benefits might include, for example, the average time saved by location managers in analysing information during each operating period. Alternatively the management of Moffat Ltd could attempt to express qualitative benefits in specific terms linked to a hierarchy of organisational requirements. For example, qualitative benefits could be categorised as being: (1) (2) (3) (4) (5)
(c)
Essential to the business Very useful attributes Desirable, but not essential Possible, if funding is available Doubtful and difficult to justify.
One of the main qualitative benefits that may arise from an investment in a new IT system by Moffat Ltd is the improved level of service to its customers in the form of reduced waiting times which may arise as a consequence of better scheduling of appointments, inventory management etc. This could be assessed via the introduction of a questionnaire requiring customers to rate the service that they have received from their recent visit to a location within Moffat Ltd according to specific criteria such as adherence to appointment times, time taken to service the vehicle, cleanliness of the vehicle, attitude of staff etc. Alternatively a follow-up telephone call from a centralised customer services department may be made by Moffat Ltd personnel in order to gather such information. Another qualitative benefit of the proposed investment may arise in the form of competitive advantage. Improvements in customer specific information and service levels may give Moffat Ltd a competitive advantage. Likewise, improved inventory management may enable costs to be reduced thereby enabling a ‘win-win’ relationship to be enjoyed with its customers.
4
(a)
The following are some of the advantages that may be gained as a consequence of the adoption of a formal system of strategic planning: (1) Managers are forced to consider the future. Strategic planning can assist management to form a ‘vision’ of the future and, in so doing, encourages creativity and the use of initiative on the part of those involved in the strategic planning process. (2) The identification of risks which may have gone unnoticed in the absence of formal planning systems. (3) A strategic plan focuses management attention on the need to give due consideration to an ever-changing environment in which organisations can get left behind. A strategic plan highlights the need to anticipate change and assists in helping an organisation to become more ‘adaptive’ thereby increasing its chances of longer term prosperity.
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(4) Greater consistency will be achieved between long term, medium term and short term objectives, plans and controls. The plans should identify whether the business objectives are leading an organisation in the right direction or whether organisational objectives require re-assessment. It is vital that strategic and operational considerations are reflected in systems of performance measuremnent and budgetary control. (5) Strategic planning should help to identify the opportunities for investment and the need for long term finance well in advance of requirements. (6) All markets have a cycle. Strategic planning should help to identify the need for and timing of the launching of new products. (7) Strategic planning will entail the review of management resources. Management does not remain unaltered for decades. The strategic plan may identify the need for new or additional management expertise. N.B. Only four reasons were required. (b)
The use of SWOT analysis will focus management attention on current strengths and weaknesses of each subsidiary company which will be of assistance in the formulating of the business strategy of Diverse Holdings Plc. It will also enable management to monitor trends and developments in the constantly changing environments of their subsidiaries. Each trend or development may be classified as an opportunity or a threat that will provide a stimulus for an appropriate management response. Management can make an assessment of the feasibility of required actions in order that the company may capitalise upon opportunities whilst considering how best to negate or minimise the effect of any threats. A SWOT analysis should assist the management of Diverse Holdings Plc as they must identify their strengths, weaknesses, opportunities and threats. These may be classified as follows: Strengths which appear to include both OFL and HTL. Weaknesses which must include PSL and its limited outlets, which generate little growth and could collapse overnight. KAL is also a weakness due to its declining profitability. Opportunities where OFT, HTL and OPL are operating in growth markets. Threats from which KAL is suffering. If these four categories are identified and analysed then the group should be strengthened.
(c)
(i)
Organic Foods Ltd (OFL) with a market share of 6·66% is the market leader at 30 November 2005 and is forecast to have a market share of 8% by 30 November 2007. Operating profits appear to be healthy and therefore it seems reasonable to regard OFL as a current ‘strength’ of Diverse Holdings Plc. This is supported by the fact that OFL has built up a very good reputation as a supplier of quality produce. Haul Trans Ltd was acquired on 1 December 2005 and has a demonstrable record of recent profitability. It is noticeable that the profitability of HTL is forecast to increase by 40% (excluding inflation) during its first two years of ownership. No one organisation appears to dominate the market. Forecast profits are expected to grow significantly from an almost static turnover and thus more information is required regarding how this increase in profitability is to be achieved. Management may have identified opportunities for achieving significant cost savings and/or forming business relationships with new and more profitable customers, while ceasing to service those customers who are less profitable. Kitchen Appliances Ltd (KAL) has been identified as both a weakness and threat. KAL’s market is slowly contracting, but its share is falling more quickly. It was almost the market leader at 30 November 2005. Judging by its fall in the level of operating profit KAL is carrying heavy fixed costs which must make it more difficult to compete. Indeed, it is forecast to make a loss during the year ending 30 November 2007. KAL has suffered from squeezed margins as a consequence of competition from low cost imports. The situation may be further exacerbated as competition from abroad intensifies. Paper Supplies Ltd (PSL) has stood still in a growing market, one which is dominated by a single supplier. PSL appears to be struggling to achieve any growth in turnover, profits and therefore cash flow. PSL cannot really compete with a narrow range of products and only two customers. Office Products Ltd (OPL) is growing but appears unable to increase its operating profit in % terms. It appears to be operating in a high-growth market but unable to achieve a reasonable market share in spite of the fact that its products are highly regarded by health and safety experts.
(ii)
The forecast situation of Diverse Holdings Plc is not without its problems. KAL and OPL require the immediate attention of management. The position of KAL is precarious to say the least. There is a choice of strategies for it: (i) (ii) (ii)
Outsource the manufacture of appliances Set up a manufacturing operation overseas Withdraw from the market.
Each alternative must be assessed. Whatever decision is taken it is unlikely to affect the other four subsidiaries. PSL is also independent of the other subsidiaries. A strategic decision to widen its range of products and outlets must surely help. Hence management should endeavour to find new markets for its products, which are separate and distinct from those markets served by its appointed distributors.
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In order to improve the prospects of OPL management need to adopt appropriate strategies since at the present time the company appears to be in a high growth market but is unable to capture a reasonable market share. Perhaps the answer lies in increased or more effective advertising of the endorsement of the product range by health and safety experts. Management should endeavour to develop a strategy to integrate further its subsidiaries so that they can benefit from each other and also derive as much synergy as possible from the acquisition of HTL. It is of paramount importance that management ensure that sufficient funds are channelled into growing OFL and HTL, which are both showing a rising trend in profitability. The group has depleted cash reserves which must to some extent be attributable to the purchase of HTL. It is possible that the divestment of KAL would provide some much needed funding.
5
(a)
Candidates may choose FOUR problems with performance measures from those listed below: Tunnel vision may be seen as undue focus on performance measures to the detriment of other areas. For example ‘There is no point whatsoever in encouraging staff to focus on interaction with customers in efforts to create a ‘user friendly’ environment. What we need is to maintain the quality of our grass surfaces at all costs since that is the distinguishing feature of our business.’ Sub-optimisation may occur where undue focus on some objectives will leave others not achieved. For example, ‘We should focus our attention upon maximising the opening hours of our facilities. Everything else will take care of itself.’ This strategy ignores the importance of a number of other issues, such as the possible need to increase the availability of horse-riding and bowling equipment for hire. Misinterpretation involves failure to recognise the complexity of the environment in which the organisation operates. Management views have focused on a number of performance measures such as ‘spend the money on increased advertising of our facilities which will surely attract more customers.’ This fails to recognise the more complex problems that exist. The town is suffering from high unemployment which may cause population drift and economic decline. This will negate many of the initiatives that are being suggested by management. This may to some extent be offset by the good transport links to the ‘365 sports complex’. Myopia refers to short-sightedness leading to the neglect of longer-term objectives. An example would be ‘We should reduce the buildings maintenance budget by 25% and spend the money on increased advertising of our facilities which will surely attract more customers.’ Measure fixation implies behaviour and activities in order to achieve specific performance indicators which may not be effective. For example, ‘Buy more equipment which can be hired out to users of our facilities. This will improve our utilisation ratios which will lead to increased profits.’ Problems of unemployment and lack of complaints from customers may mean that more equipment will not improve profit levels. Misrepresentation refers to the tendency to indulge in ‘creative’ reporting in order to suggest that a performance measure result is acceptable. For example ‘Recent analysis of customer feedback forms indicate that most of our customers are satisfied with the facilities. In fact, the only complaints are from three customers – the LCA University who use the cricket pitch for matches, the National Youth Training Academy who hold training sessions on the tennis courts, and a local bowling team.’ This ignores the likely size of capacity share occupied by these three customers. In this regard it should be acknowledged that complaints represent a significant threat to the business since ‘bad news often travels fast’ and other customers may then ‘vote with their feet’. Gaming is where there is a deliberate distortion of the measure in order to secure some strategic advantage. This may involve deliberately under performing in order to achieve some objective. For example, ‘We should hold back on our efforts to overcome the shortage of bowling equipment for hire. Recent rumours are that the National Bowling Association are likely to offer large financial grants next year to sports complexes who can show they have a demand for the sport but have deficiencies in availability of equipment.’ Ossification which by definition means ‘a hardening’ refers to an unwillingness to change the performance measure scheme once it has been set up. An example could be ‘Why change our performance management system? Our current areas of focus provide us with all the information that we need to ensure that we remain a profitable and effective business.’ This ignores issues/problems raised in the other comments provided in the question.
(b)
Trying to focus on and improve the measurement of customer satisfaction. This is a vital goal. Without monitoring and improvement of levels of customer satisfaction, an organisation will tend to underachieve and is likely to have problems with its future effectiveness. Positive signals from performance measures made earlier in the value chain are only relevant if they contribute to the ultimate requirement of customer satisfaction. Tunnel vision and sub-optimisation are examples of measurement problems that may be reduced through recognition of the need for a management focus on customer satisfaction. For example undue focus on the importance of maximising opening hours may lead to lack of focus on other quality issues seen as important by customers. Involving staff at all levels in the development and implementation of performance measures. People are involved in the achievement of performance measures at all levels and in all aspects of an organisation. It is important that all staff are willing to accept and work towards any performance measures that are developed to monitor their part in the operation of the organisation and in the achievement of its objectives. This should help, for example, to reduce
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gaming. At the sports complex an example of gaming might be, a deliberate attempt to understate the potential benefits of maintaining the buildings in order to ensure that funds would be used for other purposes such as an increased advertising budget. The directors of Astrodome Sports Ltd must recognise that leisure facilities that appear dated and in a poor state of repair will cause customers to look for more aesthetically appealing alternatives. Being flexible in the extent to which formal performance measures are relied on. It is best to acknowledge that measures should not be relied on exclusively for control. A performance measure may give a short-term signal that does not relate directly to actions that are taking place to improve the level of performance in the longer term. To some extent, improved performance may be achieved through the informal interaction between individuals and groups. This flexibility should help to reduce measure fixation and misrepresentation. For example the percentage increase in the quantity of bowling equipment purchased is seen as necessarily implying increased demand for use of the bowling greens. Giving consideration to the audit of the performance measurement system. Actions that may be taken may include: – Seeking expert interpretation of the performance measures in place. It is important that any audit is ‘free from bias’ and conducted independently on an ‘arm’s length’ basis. Thus it is essential that such audits should be ‘free from the influence’ of those personnel involved in the operation of the system. – Maintaining a careful audit of the data used. Any assessment scheme is only as good as the data on which it is founded and how this data is analysed and interpreted. The above actions should help, in particular, to reduce the incidence and impact of measure fixation, misinterpretation and gaming. For example, an audit may show that the directors of Astrodome Sports Ltd are fixated on equipment availability and misinterpret this as being the key to customer volume and high profitability. The audit may also provide evidence of gaming such as a deliberate attempt to underplay the benefits of one course of action in order to release funds for use on some alternative.
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Part 3 Examination – Paper 3.3 Performance Management
1
(a)
(i)
(ii)
(b)
(i)
(ii)
December 2005 Marking Scheme Marks 1 1 0·5 0·5 6 0·5 0·5
Fees Subsidies Salaries Variable costs Other fixed costs (ABC related) Attributable Profit/(loss)
2 3
5
Contribution Expected values Pay-off table Recommendation
3 3 2 1
9
Maximin – principle Recommendation Minimax – regret table Recommendation
1 1 3 1
6
3 2
5
6x1
6
(c)
Criteria
(d)
Explanation Benefits
2 2
Total
(a)
(b)
(c)
Explanation Circumstances
(a)
6
T accounts Ledger accounts Inventory values Conversion costs balance w/off
4 1 1
6
Manufacturing and sales quantities differ Zero inventories Accounting entries
1 1 1
Strategic Tactical Operational
3 ––– 15
4 3 3
10
(b)
Comments (on merit)
3x2
6
(c)
Qualitative benefits
2x2
4 ––– 20
Total
4
4 ––– 45
3 3x1
Total
3
10
Profit/(loss) Comments (on merit)
(iii) Calculation Comments (on merit)
2
Marks
(a)
Advantages
4x1
4
(b)
Usefulness
3x1
3
(c)
(i)
Comments (on merit)
7x1
7
(ii)
Strategies
3x2
6 ––– 20
Total
25
5
(a)
Problem explanation and illustrative comment
(b)
Comments (on merit) Total
26
Marks 4x3
Marks 12
4x2
8 ––– 20 –––
