ACCA Fundamentals Level Paper F5 Performance Management Course Examination 2 Question Paper
Time allowed
Reading and Planning Writing
15 minutes 3 hours
ALL FIVE questions are compulsory and MUST be attempted During reading and planning time only the question paper may m ay be annotated
Instructions: Please attempt this exam under test conditions and attach t he frontsheet complete with your name and address to your script. The completed package should be sent to BPP Marking Department. Take a few moments to review the notes on the inside of this page titled, ‘Get into good exam habits now!’ before attempting this exam.
DO NOT OPEN THIS PAPER UNTIL YOU ARE READY TO START UNDER EXAMINATION CONDITIONS
Get into good exam habits now! Take a moment to focus on the right approach for this exam.
Effective time management •
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Watch the clock, allocate time to each mark and move on if you get behind. Take a few moments to think t hink what the requirements are asking for and how you are going to answer them. Remember one mark is usually allocated for each point you give in a discursive question.
Effective planning •
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This paper is in exactly the same format as the real exam. You should read through the paper and plan the order in which you will tackle the questions. Always start with the one you feel most confident about. Read the requirements carefully: focus on mark allocation, question words (see below) and potential overlap between requirements. Identify and make sure you pick up the easy marks available in each question.
Effective layout •
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Present your numerical solutions using the standard layouts you have seen. Show and reference your workings clearly. With written elements try and make a number of distinct points using headings and short paragraphs. You should aim to make a separate point for each mark. Ensure that you explain the points you are making ie. why is the th e point a strength, criticism or opportunity? Give yourself plenty of space to add extra lines as necessary, it will also make it easier for the examiner to mark.
Common terminology State Define Describe Distinguish Explain Identify Illustrate Calculate/compute Demonstrate Prepare Analyse Compare and contrast Discuss Produce Advise Evaluate Recommend
Express, fully or clearly, the details of/facts of Give the exact meaning of Communicate the key features of Highlight the differences between Make clear or intelligible/state the meaning of Recognise, establish or select after consideration Use an example to describe or explain something To ascertain or reckon mathematically To prove with certainty or to exhibit by practical means To make or get ready for use Examine in detail the structure of Show the similarities and/or differences To examine in detail by argument To create or bring into existence To counsel, inform or notify To appraise or assess the value of To advise on a course of action
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All FIVE questions are compulsory and MUST be attempted 1
Lumsden Lumsden is a manufacturer of components. At its factory, three components are in continuous mass production. Each of these components incorporates around 40 raw material and semi-finished items which are bought from outside suppliers. Sales of the components have recently been declining. Lumsden is considering a proposal to discontinue these products and replace them with a large range of differentiated products. These new products would be highly customised and be frequently renewed to adopt the latest technologies and allow for market changes. They would be produced in short, discontinuous batches - with production lines switching frequently from one product to another. Required (a)
Explain life cycle costing, and why its use might or might not give meaningful results, having regard to changes in the character of the Lumsden operation. (6 marks)
(b)
Explain target costing and its uses for Lumsden.
(7 marks)
Lumsden has recently completed the development and testing of a new product, the Kennedy. The development of the product has cost $300,000 and $50,000 has been spent on research. The company has also bought a machine to produce the new product costing $75,000. The production machine is capable of producing 1,500 units of Kennedy per month and is not expected to have a residual value. The company has decided that the unit selling prices it will charge will change with the cumulative numbers of units sold as follows. Cumulative sales units 0 to 2,000 2,001 to 5,000 5,001 to 20,000 20,001 to 30,000 30,001 and above
Selling price $ per unit in this band 150 120 90 60 40
Based on these selling prices, it is expected that sales demand will be as shown below. Months 1–5 6 – 12 13 – 17 18 – 30 31 – 36 37 – 42 43 – 48 Thereafter
Sales demand per month (units) 150 400 800 1,200 1,000 700 300 NIL
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Unit variable costs are expected to be as follows. First 2,000 units Next 3,000 units Next 15,000 units Next 10,000 units Thereafter
$ per unit 55 45 35 25 30
Specific fixed overheads are expected to be $20,000 per month. Required (c) Calculate the profits expected in each stage of the lifecycle and in total from the sale of Kennedys. (7 marks) (Total: 20 marks)
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Cyclo Glue Cyclo Glue (CG) manufactures and sells various adhesives and glues typically for the marine industry but also for use in general woodworking. The standard glue has a strong brand image and is sold at a price of $5·99 per 100 millilitres (ml). CG is considering processing some of the glue further by adding an anti-mould chemical to protect wood as well as glue it together. Market research carried out suggests that a premium could be charged for this extra ingredient. The market research has cost $2,000. However, there are some concerns that the anti-mould chemical can cause breathing problems. Data has been prepared for the costs and revenues expected for the following month (a test month) assuming that a part of the company’s output will be further processed by adding t he anti-mould chemical. The output selected for further processing is 1,000 litres which costs $3 per litre. The labour required to produce 1,000 litres of the basic glue before any further processing is 300 hours at a cost of $15 per hour. Five litres of anti-mould chemical will be added to the 1,000 litres of output selected. This chemical costs $1,800 per litre. CG will hire additional machinery costing $10,000 per month if it further processes the glue.. The new processes will be supervised by one of the more experienced supervisors currently employed by CG. His current annual salary is $35,000 and it is expected that he will spend 10% of his time working on the new process during the test month. An extra 180 labour hours will be required to further process the glue. Labour is currently fully employed, making the standard product. However the hours required could be obtained through overtime work which would be paid at time and a half. The additional processing is expected to drive additional overheads costs of $5/hour. CG allocates fixed overhead at the rate of $15 per labour hour to all products. The new glue would be sold at $8.99 per 100 ml.
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Required (a)
Outline the financial and other factors that CG should consider when making a further (5 marks) processing decision.
(b)
Evaluate whether CG should experiment with the new anti-mould glue using the data provided. (10 marks)
At another of its factories, Cyclo Glue manufactures two products, A and B. Both products pass through two production departments, extrusion and fabrication. The organisation's objective is to maximise contribution. Product A is sold for $5.50 whereas product B is priced at $8.00. There is unlimited demand for product A but demand for B is limited to 13,000 units per annum. The machine hours available in each department are restricted to 2,400 per annum. Other relevant data are as follows. Machine hours required Product A Product B
Extrusion Hrs 0.06 0.08
Fabrication Hrs 0.04 0.12
$ 3.20 4.10
Variable cost per unit Product A Product B Required (c)
Define the variables, establish the constraints and construct an objective function for a linear programming model for Cyclo Glue. (5 marks) (Total: 20 marks)
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Budgeting Z Co is a family owned manufacturing company which has been run for 40 years by Dan Controle. He believes in strict cost control and sets tough targets for his management team. Staff turnover is very high and the company is struggling to compete against rival businesses. The budgeted and actual results of Z Co for September were as follows. The company uses a marginal costing system. There were no opening or closing inventories. Sales and production $ Sales Variable cost of sales Direct materials Direct labour Variable overhead
Fixed budget 1,000 units $ 30,000
10,000 5,000 3,000
Actual 700 units $
$ 21,200
6,600 3,800 2,200 18,000 12,000 10,000 2,000
Contribution Fixed costs Profit/(loss)
12,600 8,600 10,400 (1,800)
Required (a)
Prepare a budget that will be useful for management control purposes and briefly comment on (9 marks) the company’s performance in September.
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(b) (c)
Discuss how an awareness of the behavioural aspects of budgeting could help the performance of Z Co.
(5 marks)
Assess what benefits may be achieved by an organisation adopting a zero-based approach in (6 marks) its budgetary process, and what difficulties may be encountered. (Total: 20 marks)
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RTF Co River Tyne Foods Co (RTF) is a manufacturer of frozen meals. It is reviewing the performance of its main product, the Rumble. RTF operates a standard absorption costing system and the following budget revenue and cost data per unit of each Rumble is as follows. Selling price Material A (sauce) Material B (meat) Material C (vegetables) Labour Fixed Overheads
Rumble ($) 3.99 0.25 1.00 0.06 0.75 0.60
125g @ $2/kg 200g @ $5/kg 75g @ $0.80/kg 0.05hrs @ $15/hr 0.05hrs @ $12/hr
Quarter 2 data has just been released and is as follows: $ 2,095 (F) 2,551 (A) 14,306 (A) 11,755 (F) 3,200 (F) 5,810 (F)
Material price variance Material usage variance Material mix variance Material yield variance Sales price variance Sales volume variance Required (a)
Using the variances above comment on the performance of the purchasing, production and sales managers. Reach a conclusion as to whether the managers at RTF have performed well or not. (11 marks) Budgeted and actual sales for Quarter 3 were 225,000 Rumbles . Actual usage of materials A Sauce B Meat C Vegetables
(b)
kg 27,555 45,905 12,675
Costing ($) 58,000 239,375 10,000
Calculate the price, mix and yield variances for each of the three materials used on the Rumble in Quarter 3. (9 marks) (Total: 20 marks)
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Cordeline The following figures for the years ending 31 December 20X4 and 20X3 relate to the B and C divisions of Cordeline. The return on capital employed (ROCE) figure is the basis for awarding a 20% bonus to the manager of B division (actual ROCE/target ROCE). The below target ROCE for C division has resulted in a zero bonus award to its manager. Division B C 20X4 20X3 20X4 20X3 $'000 $'000 $'000 $'000 Sales 9,850 7,243 4,543 2,065 Profit before interest and taxes (PBIT) 1,536 1,674 924 363 Included in profit calculation: Depreciation for year 960 919 1,300 251 Net book value (NBV) of non-current assets 6,940 7,400 7,700 2,600 Original cost of non-current assets 12,600 12,100 9,500 3,100 Replacement cost of non-current assets New investment in non-current assets
15,000 500
14,500 750
9,750 6,400
3,750 2,400
Return on capital employed Target return on capital (based on NBV)
22% 15%
23% 15%
12% 15%
14% 15%
Required Cordeline's board are meeting to review the company's management performance appraisal and reward system. (a)
Prepare a short paper for the board, drawing on the above information, which explains: (i)
The possible counter-productive behaviour resulting from using the current ROCE calculation for performance appraisal.
(ii)
How the ROCE calculation could be improved to avoid some of these problems. (You should include calculations to help illustrate this). (13 marks)
After reviewing your paper, Cordeline’s FD has now suggested that a Balanced Scorecard approach maybe a more effective way of measuring performance and rewarding performance. Required (b)
Explain the balanced Scorecard and the benefits of adopting it when assessing performance (7 marks) (Total: 20 marks)
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Student self-assessment Having completed this paper take a few minutes to consider what you did well and what you found difficult. Use this as a basis to focus your future study on effectively improving your performance.
Common problems
Future emphasis if you answer Yes
Timing and planning Did you finish too early?
Y/N
Focus your planning time on generating more ideas. Use models to help develop width to your thinking.
Did you overrun?
Y/N
Focus on allocating your time better. Practise questions under strict timed conditions. If you get behind leave space and move on.
Did you waffle?
Y/N
Focus your planning time on developing a logical structure to your answer.
Was your answer difficult to follow?
Y/N
Use headings and subheadings. Use numbering sequences when identifying points. Leave space between each point.
Did you fail to explain each point clearly?
Y/N
Show why the point identified answers the question set.
Did you fail to show any workings or were your workings unclear?
Y/N
Give yourself time and space to make the markers job easy.
Interpreting the questions?
Y/N
Learn the meaning of question words (inside front cover). Learn subject jargon (study text glossary). Read questions carefully noting all the parts. Practise as many questions as possible.
Understanding the subject?
Y/N
Review your notes/text. Work through easier examples first. Contact ACCA queries for help.
Remembering the notes/text?
Y/N
Quiz yourself constantly as you study. You need to develop your memory as well as your understanding of a subject.
Layout
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ACCA Fundamentals Level Paper F5 Performance Management Course Examination 2
Guidance, Commentary, Marking scheme and Suggested solutions
ACF5CE10(J)
AC110 – F5(2)
Guidance on improving performance on the exam paper. Which questions to do first?
It is important for you to decide which order to attempt the questions. As each question carries equal marks you may prefer to attempt the questions that you are more confident about first. This means you will build up marks early on giving you a solid base to tackle the harder questions later. However do not spend too long on the questions you are confident about as you need to spend an equal amount of time on them all. You cannot pass the exam answering three or four questions well and the rest poorly. An alternative strategy is to answer all questions in strict order. You could use the time saved choosing the order by starting to plan your answers. You may prefer to use this method if you find yourself spending too long on your favourite questions as it forces you to spend an equal time on each before moving on. Strategy
Make sure your answers are focused and specific to the organisation in each scenario. Show clear workings for your calculations and write full sentences in your explanations. Most importantly, apply your skills in a practical context. Time management
Use the reading and planning phase to make sure that you get as many of the marks as possible. Write a short plan for each question containing bullet points per mark and use it to write your answer when the writing time begins. Never overrun on any question and once the 36 minutes is up move on to the next.
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Commentary This exam contains five compulsory questions all of which are worth 20 marks.
Q1 Lumsden This question begins with a substantial discussion on Lifecycle costing and Target costing worth 13 marks together. This written part requires careful planning to make sure that you are answering the question with specific reference to Lumsden, you could have used some of the reading time allocated to begin this. The final part of the question requires straightforward calculations of the profit expected at each stage of the lifecycle. You should make sure that in this numerical part of the question your answers are clear and easy to follow, a tabular format would be ideal.
Q2 Cyclo Glue This question again begins with a discussion and the numerical element (15 marks) comes in parts (b) and (c). It is important to read the question carefully for part (a) and discuss both financial and non financial factors otherwise your marks will be capped. Part (b) required calculations of incremental costs and revenues to get a net benefit / cost. It could have been easy to over run on time in this part of the question. Part (c) of the question requires you to formulate constraints and an objective function for use in linear programming. This was more straightforward and could have been done before part (b) to avoid missing out on these marks.
Q3 Budgeting This question is split evenly between calculations and discussion. The calculations in part (a) again require a clear format to make sure that you don’t get muddled and make errors. Don’t forget that part (a) also requires you to comment on the performance in September, if you just prepare the flexed budget you will be restricting the marks available. Within parts (b) and (c) you must write in full sentences and use the information in the question to make your answer relevant to Z Co.
Q4 RTF Co Part (a) requires an analysis of performance of two managers using the numerical information given. The examiner is testing that you understand what the variances mean and you must answer in the context of the performance of the two sales managers. Making a conclusion will help you pick up marks so make sure that you don’t miss out on this. Part (b) requires you to calculate materials variances. This question is very typical for this part of the syllabus. It is important that you are comfortable drawing conclusions about performance as well as calculating the variances themselves.
Q5 Cordeline This question asks you to look at the problems that using ROCE as a performance measure can cause in part (i) and then in part (ii) suggest how to improve the measure. Part (i) will need careful planning to ensure you can make enough points and structure your answer sensibly. Don’t forget marks will be available for the calculations demonstrating your alternative approach in part (ii) . Part (b) is more straightforward as it requires basic knowledge rather than application of knowledge as in part (a). It may be sensible therefore to answer part (b) first.
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1
Lumsden
Marking scheme Marks
(a)
(b)
Explanation of lifecycle costing 1 mark per point eg assess profitability over products life, various stages in the lifecycle Why life cycle costing is better 1 mark per point eg considers all costs, better decision making, visibility of design costs, shortening lifecycles Problems with lifecycle costing 1 mark per point eg info may be too late or spend too much time producing when lifecycle is very short Restrict marks to a max of 4 if no reference to Lumsden
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Explanation of target costing 1 mark per point eg set price deduct profit; target cost; cost gap, close cost gap Benefits eg appropriate price; cost reduction, good tool for Lumsden to ensure can recover design costs as product life is short. (need to relate to Lumsden)
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2 2 Max 6
3 Max 7
(c)
Contribution 1 point for each phase of lifecycle Overheads Development, research & investment costs Profit (OF) Total profit for product (only if development costs are included and at right phase)
4 ½ ½ 1 1 7 20
Suggested solution Chapter reference. Life cycle costing is covered in Chapter 2c, target costing in Chapter 2b. Top tips. Parts (a) and (b) not only require you to explain lifecycle costing and target costing but you must also explain their relevance to this specific organisation. Part (c) involves relatively simple calculations. Make sure you clearly identify the stages of the lifecycle in your answer.
(a)
Life cycle costs
The costs incurred on products and services from their design stage, through development to market launch, production and sales, and their eventual withdrawal from the market are known as life cycle costs. Traditional approach to determining product probability Life cycle costing is an alternative to the traditional approach to determining product profitability where costs are reported at the physical production stage of the life cycle of a product; costs are not accumulated over the entire life cycle. Such a practice does not therefore assess a product's profitability over its entire life but rather on a periodic basis. Costs tend to be accumulated according to function; research, design, development and customer service costs incurred on all products during a period are totalled and recorded as a period expense. The life cycle approach
In life cycle costing all costs including R&D are attributed to a product and these costs are traced to individual products over complete life cycles. Actual plus projected costs and revenues and original (or revised) budgeted life cycle costs and revenues for a product are then compared (replacing the traditional comparisons between budgeted and actual costs on a month by month basis).
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Life cycle costing and Lumsden
Within the AMT environment being considered by Lumsden, the duration of product life cycles will decrease as the pace of technological change increases and consumer demand becomes more sophisticated. Increasing automation will mean that up to 90% of product life cycle costs will be determined 'up front' by decisions made early within the product's life cycle. The introduction of life cycle costing by Lumsden would ensure that the tightest cost controls were at the design stage of potential new products, the point at which the majority of costs are committed. Initial product proposals would be far more carefully costed, which would be particularly important as Lumsden has little experience of working in the new environment. The system would assist in the planning and control of their products' life cycle costs and would monitor spending and commitments to spend during the early stages of the products' life cycles. Life cycle costing increases the visibility of costs such as those associated with research, design, development and customer service, and also enables individual product profitability to be more fully understood by attributing all costs to products. This will provide Lumsden with more accurate feedback information on its success or failure in developing its new products. This will be vital in Lumsden's intended operating environment, in which the ability to produce new and updated versions of its products will be of vital importance to its survival. If Lumsden achieve the proposed degree of flexibility, however, and if product life cycles become too short, it may not be realistic to install a cost tracking system which produces reports too late for remedial action to be effective. Too much time may be spent on producing product budgets than merited by the potential benefits. If this is the case, Lumsden would be advised to rely on a range of non-financial indicators to help with the monitoring and control of costs. (b)
As Lumsden has discovered, to compete effectively in today's competitive environment, organisations must continually redesign their products with the result that product life cycles are becoming much shorter. The planning, development and design stage of a product is therefore critical to an organisation's cost management process. Cost reduction at this stage of a product's life cycle, rather than during the production process, is critical. Target costing
A target cost is an estimate of a product cost derived by subtracting a desired profit margin from a competitive market price. This may be less than the planned initial product cost but ways will be sought to close the gap between the two. Target costing (or target cost management) therefore requires managers to change the way they think about the relationship between cost, price and profit. Stages of the target costing process
The target costing process involves three main stages. (1)
Analyse the external environment to ascertain what customers require and what competitors are producing. Specify the product's target market share.
(2)
Using the resulting information, develop the product in an atmosphere of continuous improvement using value engineering techniques and close collaboration with suppliers, to enhance the product (in terms of service, quality, durability and so on) and reduce costs.
(3)
Once the product has been developed, set a selling price (using market research, functional analysis and so on) to capture the target market share.
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Benefits of target costing
Selling price is set with reference to the market place not as an internal mechanism. This ensures the product will be competitively priced and should achieve predicted volumes. Cost plus pricing may result in too high a price where sales volumes are not achieved. When a product is first manufactured, its target cost may be well below its currently-attainable cost, which is determined by current technology and processes. Target costing therefore assists in cost reduction. Management should therefore set benchmarks for improvement towards the target cost, by improving technologies and processes (reducing the number of components, training, cutting out non-value-added activities and so on). As the lifecycle of Lumsden’s products are short target costing is a very useful tool to ensure that the design costs etc can be recovered and that the products launched will make the desired returns. Any loss making products would be prevented from being launched when it is realised that product cannot be made for its target cost. (c) Development Months
Number of units produced and sold Selling price per unit Unit variable cost (W1) Unit contribution (W1) Total contribution Overheads Dev, research & investment costs Profit Cumulative Profit
Intro 1-5
Growth 6-17
Maturity 18-30
750
6,800
15,600
$ 150 55 95 71,250 (100,000)
$ 150 & 120 & 90 55 & 45 & 35 95 & 75 & 55 484,000 (240,000)
$ 90 & 60 35 & 25 55 & 35 795,000 (260,000)
(360,000)
1,641,500 (960,000) (425,000)
(28,750) (453,750)
244,000 (209,750)
535,000 325,250
(68,750) 256,500
256,500 256,500
$ 60 & 40 25 & 30 35 & 10
291,250
(425,000) (425,000) (425,000)
Workings
1
Decline 31-48 12,000
Growth – (1,250 × $95) + (3,000 × $75) + (2,550 x $55) Maturity – (12,450 × $55) + (3,150 × $35) Decline – (6,850 × $35) + (5,150 × $10)
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= $484,000 = $795,000 = $291,250
Total
32,560 $
Marking scheme Marks
(a)
(b)
1 mark per sensible point made to include both financial and non financial factors. Cap at 3 marks if only financial or only non financial factors are given
Anti mould chemical Labour variable overhead Machine hire costs Sunk costs (1/2 mark each) supervisor, fixed costs, market research (need to be mentioned as sunk to get marks, not merely omitted) Revenue from standard glue Revenue from anti mould glue Incremental revenue (OF) Net benefit (OF) Conclusion (Consistent with net benefit calculation)
Max 5
1 1 1 ½ 1½ 1 1 1 1 1 10
(c)
Statement of variables Formulation of constraints: Extrusion hours Fabrication hours B A Objective function
½ 1 1 1 ½ 1 5 20
Suggested solution Text reference. Further processing decisions are covered in Chapter 5 and linear programming in Chapter 3. Top tips Any sensible points would gain marks in part (a) but don’t forget that both financial and non financial factors are required. Don’t forget to state your assumptions in part (b) ie why you are excluding costs that aren’t relevant.
(a)
The further processing decision A product should be processed further if the sales value minus further processing costs is greater than the sales value before further processing takes place. The financial factors that should be taken into account before making a decision are the incremental costs and revenues of further processing. Incremental revenue The new glue should sell at a higher price than the standard glue. Incremental costs CG needs to determine which costs change as a result of the further processing. For example, the extra materials and labour involved are relevant to the decision. Any sunk costs such as fixed overheads already incurred, the cost of the market research, or the cost of the supervisor would not be relevant.
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Non financial factors Impact on sales volumes The standard glue has a strong brand image and customers may not be impressed with a change to a winning formula. This may have a negative impact on sales. Impact on reputation
Adding the anti-mould chemical may cause breathing problems and CG could therefore suffer from adverse publicity, which could damage its reputation and brand image. There is also the risk of litigation from customers who suffer health problems as a result of using the glue. (b)
Incremental costs
Anti-mould chemical Labour Machine hire Variable overhead
$ 9,000 4,050 10,000 900 23,950
5 ltr × $1,800 180 hrs × $15 x 1.5 180 x $5
Supervisor, fixed cost and market research are all sunk costs so have been ignored. Incremental revenues
Standard With anti-mould
$ 59,900 90,349.5 30,449.5
1,000 ltr × $59.90 1,005 ltr × $89.90
Net benefit/cost
Net benefit = 30,449.50 – 23,950 = $6,499.5 The anti-mould glue is therefore worth further processing. Based on the calculations, CG should further process the glue. However, the extra benefit is not particularly large and may not be sufficient to compensate for the risk of damage to the brand. (c)
Let A = the number of units of product A and B = the number of units of product B The constraints are: Extrusion hours: Fabrication hours:
0.06A + 0.08B 0.04A + 0.12B
Product B:
0
Product A:
0
≤
B
≤
≤
≤ ≤
13,000
A
The objective function is: Contribution (C) = 2.3A + 3.9B
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2,400 2,400
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Budgeting
Marking scheme Marks
(a)
Flexed budget (1/2 mark for sales, each cost and resulting profit) Calculation of variances (with correct signage) (1/2 mark for sales, each cost and profit) Format – to include original, flexed, actual and variance columns Comment ie better selling price but costs control adverse. Overall adverse when comparing like for like
3 3 1 2 9
(b)
Up to 2 marks per well explained point. Areas could include level of standard and motivation, employee participation, Application to Z Co
Max 4 1 5
(c)
Explanation of ZBB Benefits of ZBB (1 mark per point) eg better allocation of resource, close analysis of the business Difficulties (1 mark per point) eg time, cost, resistance, short termism
1 Max 3 Max 3 Max 6 20
Suggested solution Chapter reference. Budgeting is covered in Chapters 7 and 8. Top tips. Part (a) is a very straightforward calculation with plenty of easy marks for clearly presented workings. You need to write full written answers to parts (b) and (c) and make sure you answer the specific requirements.
(a)
We need to prepare a flexible budget for 700 units.
Sales
Original Budget
Flexed Budget
Actual
Variances
1,000 units $ 30,000
700 units $ 21,000
700 units $ 21,200
$ 200 (F)
7,000 3,500 2,100 12,600 8,400 10,000 (1,600)
6,600 3,800 2,200 12,600 8,600 10,400 (1,800)
400 (F) 300 (A) 100 (A) 200 (F) 400 (A) 200 (A)
Variable costs
Direct material Direct labour Variable production overhead Contribution Fixed costs Profit/(loss)
10,000 5,000 3,000 18,000 12,000 10,000 2,000
Workings
1
Sales $30,000 / 1,000 units = $30 selling price per unit. Flexed budget sales 700 units @ $30 = $21,000
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2
Direct material $10,000 / 1,000 units = $10 per unit. Flexed budget = 700 units @ $10 = $7,000
3
Direct labour $5,000 / 1,000 units = $5 per unit. Flexed budget = 700 units @ $5 = $3,500
4
Production overhead $3,000 / 1,000 units = $3 per unit. Flexed budget = 700 units @ $3 = $2,100
By flexing the budget in the question above we are able to compare performance on a like for like basis. The effect on profit of the difference between budgeted sales volume and actual sales volume has been removed. The sales variance however is $200 (F). This means that the actual selling price must have been different to the budgeted selling price, resulting in a $200 (F)selling price variance. Despite this the overall performance is $200 worse than it should have been. Control of material cost has been very good as this has been $400 better than expected but all other costs are worse than expected. Labour and fixed costs are the worst areas which need to be brought back into line. (b)
If budgetary control is to be successful, attention must be paid to behavioural aspects, ie. the effect of the system on people in the organisation and vice versa. The following are some of the points which should be borne in mind. Budget difficulty
It is generally agreed that the existence of some form of target or expected outcome is a greater motivation than no target at all. The establishment of a target, however, raises the question of the degree of difficulty or challenge of the target. If the performance standard is set too high or too low sub-optimal performance could be the result. The degree of budget difficulty is not easy to establish. An ideal level of difficulty is to have some achievable stretch. Some people respond positively to a difficult target. Others, if challenged, tend to withdraw their commitment. The high labour turnover in Z Co suggests this may be happening Participation
It is often suggested that participation in the budget process and discussion over how results are to be measured has benefits in terms of budget attitude and performance. Views on this point are varied however, and the personality of the individuals participating, the nature of the task (narrowly defined or flexible) and the organisation structure influence the success of participation. But a budget, when carefully and appropriately established, can extract a better performance from the budgetee than one in which these considerations are ignored. Dan Controle imposes strict targets and should consider increasing participation in the budget process. (c)
Traditional budgeting, sometimes called incremental budgeting, takes a current level of spending almost without examination and discussion takes place on any extra expenditure.Zero-based budgeting (ZBB) is an approach which takes nothing for granted. It requires that each budget centre makes a detailed case for all of its budget allocation each year. As a result all spending is subject to scrutiny, not just incremental spending. This technique would not suit expenditure planning in departments of a manufacturing company because clear relationships of input and output will exist and be defined by standard values. In less clearly defined areas such as service departments or
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service orientated industries, both private and public sector, it might have some value if selectively applied. Benefits
It is possible that economies and increased efficiency could result if departments were to justify all not just incremental expenditure. This approach prevents unnecessary cost and budgetary slack being built into the budget which so often occurs with incremental budgeting as well asidentifying inefficiencies in the business. It is argued that if expenditure were examined on a cost/benefit basis a more rational allocation of resources would take place. Such an approach would force managers to make plans and prioritise their activities before committing themselves to the budget. It should achieve a more structured involvement of departmental management and should improve the quality of decisions and management information. Difficulties
It could be expensive however, in time and effort to analyse all expenditure and difficult to establish priorities for the activities or decision packages. Managers are often reluctant to commit themselves to it because they believe they already do it. This approach will often meet with much resistance from managers at the added scrutiny to their budgets. Occasionally ZBB could result in short term decisions being taken as managers wish to maximise their short term profit and therefore delay spending which does not pay back immediately. Any system which encourages managers to examine and communicate about their spending and performance levels must be useful, providing it does not prevent individuals fulfilling their other duties and responsibilities.
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RTF Co
Marking scheme Marks
(a)
Purchasing Manager Reasons for correct variance (1 mark for each sensible point) Conclusion as to performance
Max 2 1 3
Production Manager Reasons for correct variance (1 mark for each sensible point) Conclusion as to performance
Max 3 1 4
Sales Manager Reasons for correct variance (1 mark for each sensible point) Conclusion as to performance
Max 2 1 3 1 11
RTF overall comment as to performance (b)
Materials price variance (1 for each of A,B,C) Materials mix – Actual mix/actual quantity – Standard mix/actual quantity – Monetary variance Materials yield – Actual quantity/standard mix – Standard quantity/standard mix – Monetary variance fav/adv
3 1 1 1 1 1 1 9
Materials yield – Alternative approach – Actual input ‘should yield’ – Variance in kg – Variance in $
1 1 1 20
Suggested solution Chapter reference. Variance analysis is covered in Chapter 11. Top tips. There are some long, detailed calculations in this question so time management could be an issue. A clear layout is essential.
(a)
Purchasing Manager
The purchasing manager on first glance, appears to have performed well as the materials price variance which he is responsible for is just over $2,000 favourable. This could mean that there has been a drop in the market rate for these goods, or that he has purchased wisely by using alternative suppliers or by obtaining discounts resulting in the material he has bought costing less than was expected. However, such variances should not be looked at in isolation when understanding performance. We can see that the materials usage variance overall is adverse, this could result from the cheaper materials bought being an inferior quality and hence causing more wastage. As the mix variance is
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adverse this is probably not the case and so we could conclude that the purchasing manager has indeed performed well. Production Manager
The production manager is responsible for the materials mix and yield variances. In total these are $2,551 adverse which implies that the production manager has not done as good a job as he could have. This could be due to wastage if the material the purchasing manger has bought is an inferior quality. However, when looking at the individual variances it can be seen that the mix variance is adverse, which means that the mix has been altered in favour of a more expensive material and less of a cheaper material has been used. The yield variance is favourable and so more output has been obtained than expected from the input to the process. One possible explanation for this would be that the production manager has decided to use more of the expensive material perhaps to take advantage of the fall in price. This may have led to a better quality product overall. This revised mix using more of meat and possibly also sauce and less of vegetables may mean that there is less wastage. Vegetables due to their nature may deteriorate quickly meaning more wastage is likely. If this is the case and this has contributed to the improvement in sales then it could be said that the production manager has actually performed well. Sales manager
The sales manger has two favourable variances, with the overall sales variance being $9,010 more than expected. This means that both the selling price achieved was higher than expected and more units were sold than expected. This looks like a very strong performance. However, such variances should not be looked at in isolation when understanding performance. This benefit may be entirely due to the efforts of the sales manager and his team but it could also be due to the efforts made by managers in other areas of the business. For example, If the reason for the adverse mix and favourable yield variance was indeed a better quality mix and product, customers may prefer the resulting better quality product and therefore not only buy more of it but also be prepared to pay more for it. RTF performance
Assuming the labour and variable overhead aren’t impacted by these variances it would seem as though the performance of RTF is good as the benefit from the favourable sales variances outweigh the adverse material variances. It would seem that the decisions taken by all managers have contributed to an overall improvement in performance. (b)
Materials price, mix and yield
Price Material A (sauce) Actual purchases (27,555kg) should cost @ $2 each Actual purchases (27,555kg) did cost
$ 55,110 58,000 2,890 (A)
Material B (meat) Actual purchases (45,905kg) should cost @ $5 each Actual purchases (45,905kg) did cost
$ 229,525 239,375 9,850 (A)
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Material C (vegetables) Actual purchases (12,675kg) should cost @ $0.80 each Actual purchases (12,675kg) did cost
Total price variance
$ 10,140 10,000 140 (F) $12,600 (A)
Mix variance Std mix Act qty
A B C (W)
26,917 (W) 43,068 16,150 86,135
Act mix Act qty
Variance
27,555 45,905 12,675 86,135
(638) A (2,837) A 3,475 F -
Std mix Act qty
Variance
26,917 43,068 16,150 86,135
1,208 F 1,932 F 725 F 3,865 F
Cost/kg
2 5 0.80
Variance
1,276 (A) 14,185 (A) 2,780 (F) 12,681 (A)
125/400 × 86,135 = 26,917 200/400 × 86,135 = 43,068 75/400 × 86,135 = 16,150
Yield variance Std mix Std qty
A B C
28,125 (w) 45,000 16,875 90,000
Cost/kg
2 5 0.80
(w) 225,000 Rumbles should use: A
@125g
=
28,125
B
@200g
=
45,000
C
@75g
=
16,875
Alternative Yield variance calculation
Actual input should yield (86,135 / 0.4) Actual input did yield
Units 215,337.5 225,000 9,662.5 (F)
@ Std cost / unit $1.31
$12,658 (F)
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Variance
2,416(F) 9,660 (F) 580 (F) 12,656 (F)
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Cordeline
Marking scheme Marks
(a)
(i)
(ii)
Problems with ROCE (up to 2 marks for each well explained point) These may include: short-termism, keeping old assets, delaying investment in new assets, manipulating profit Alternative ROCE suggestion Explanation as to why its better Calculations under new method (1/2 each year, for each product)
Max 8 1 2 2 5
(b)
Explanation of the balanced scorecard (1 mark per perspective) – merely stating the perspectives is not enough to score a mark – they must be explained Benefits (1 mark per point) These may include: financial & non financial info, internal and external measures, quantitative and qualitative measures
4 3 7 20
Suggested solution Chapter reference. Performance measurement is covered in Chapter 13. Top tips. Part (a) requires both regurgitation of book knowledge and application of the data provided in the question to illustrate your answer. The examiner needs evidence that you can apply the techniques and principles you have learnt to particular scenarios.
.Part (b) mainly involves knowledge rather than application. The verb here is explain, so your points need to be fully made to gain all the marks available. Merely stating balanced scorecard perspectives, for example, will not be sufficient to gain a mark. Paper for board meeting to review the company's performance appraisal and reward system
(a)
(i)
Possible counter-productive behaviour resulting from using the current ROCE calculation for performance appraisal
Under the current method of performance appraisal, managers are judged on the basis of the ROCE that their divisions earn, the ROCE being calculated using the net book value of noncurrent assets. The use of ROCE as a method of appraising performance has disadvantages. As managers are judged on the basis of the ROCE that their divisions earn each year, they are likely to be motivated into taking decisions which increase the division's short-term ROCE and rejecting projects which reduce the short-term ROCE even if the project is in excess of the company's target ROCE and hence is desirable from the company's point of view. Suppose that the manager of B division was faced with a proposed project which had a projected return of 20%. He would be likely to reject the project because it would reduce his division's overall ROCE to below 22%. The investment would be desirable from Cordeline's point of view, however, because its ROCE would be in excess of the company's target ROCE of 15%. This is an example of a lack of goal congruence in decision making.
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A similar misguided decision would occur if the manager of C division, say, was worried about the low ROCE of his division and decided to reduce his investment by scrapping some assets not currently being used. The reduction in both depreciation charge and assets would immediately improve the ROCE. Equally he may choose to write down his assets to nil as quickly as possible to improve future ROCE levels. Alternatively he could look to improve his ROCE by manipulating and overstating his profit. The current method bases the calculation of ROCE on the net book value of assets. If a division maintains the same annual profits and keeps the same asset without a policy of regular replacement of non-current assets, its ROCE will increase year by year as the assets get older. Simply by allowing its assets to depreciate a divisional manager is able to give a false impression of improving performance over time. The method used to calculate ROCE therefore also provides a disincentive to divisional mangers to reinvest in new or replacement assets because the division's ROCE would probably fall. From the figures provided it is obvious that C division has replaced assets on a regular basis, the difference between original and replacement costs of its assets being small. The manager of B division, on the other hand, has not replaced assets, there being a marked difference between original and replacement cost of the division's assets. The level of new investment in non-current assets by C division was over three times that of B division in 20X3 and nearly 13 times that of B division in 20X4. B division is using old assets that have been depreciated to a much greater extent than those of C division and hence the basis of the ROCE calculation is much lower. Consequently it is able to report a much higher ROCE. (ii)
Instead of using the net book value of non-current assets to calculate ROCE, it could be calculated using the replacement value of non-current assets. This would remove the problems of ROCE increasing over time as assets get older, writing off assets prematurely and failing to reinvest in new assets. Using this approach, the ROCE for the two divisions would be as follows: B
20X3 20X4
11.5% 10.2%
C
20X3 20X4
9.7% 9.5%
Although B division still has a higher ROCE, the difference between the ROCE of the two divisions is much less. Clearly the ROCE target would need to be revised down if replacement cost was to be used. (b)
The balanced scorecard assesses the key areas of business performance not just the financial aspects and as such is a more ‘balanced’ view of performance. The balanced scorecard approach focuses on four different perspectives: customer, financial, internal and innovation and learning. The financial perspective focuses on shareholder value and long-and short-term profitability.. The customer perspective focuses on customer needs and customers' perception of the company. The customers' perspective is considered important because it has an impact on long-term profitability. Even if the company is profitable in the short-run, it will not be able to sustain profitability if it cannot maintain and increase a satisfied customer base.
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The innovation and learning perspective considers our own ability to improve our internal procedures and staff training and they continue to keep up with new developments and innovations to add value to our customers in a fast changing competitive environment. The internal business perspective focuses on the business processes at which we must excel. This perspective looks at our ability to design our systems and processes and serve our customers in an efficient and effective manner The driving philosophy of the balanced scorecard is that all four perspectives are required to ensure the company's long-term success. Benefits include:
(i)
It looks at both financial and non financial measures
This provides a much more holistic view of a businesses performance than financial measures alone can give. (ii)
It looks at both internal and external matters affecting the organisation
As well as looking internally, the balanced scorecard looks outside the organisation to consider competitors, suppliers and customers. So relationships with customers and suppliers are monitored. Action is taken to ensure competitiveness is maintained by comparisons with competitors. (iii)
It is related to the key elements of a company’s strategy and looks at the longer term
Strategy considers the objectives of the organisation and how t hese are to be achieved. The balanced scorecard looks at longer-term strategic perspectives such as customers and markets and balances these against traditional financial perspectives. Therefore it also gives equal weight to long-term measures that relate to these perspectives as well as the traditional short-term performance measures used to measure financial goals. (iv)
It links quantitative and qualitative measures
The balanced scorecard uses traditional quantitative measures such as growth, profitability and shareholder value. However it gives equal balance to qualitative measures relating to customers, internal processes and innovation which are not financial. These factors such as quality, customer satisfaction etc are hugely important if we are to deliver the desired financial results.
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