PAPER P5

ADVANCED PERFORMANCE MANAGEMENT

P R A C T I C E & R E V I S I O N K I T

BPP Learning Media is the sole ACCA Platinum Approved Learning Provider – content for the ACCA qualification. In this, the only Paper P5 Practice and Revision Kit to be reviewed by the examiner:      We discuss the best strategies for revising and taking your ACCA exams We show you how to be well prepared for your exam We give you lots of great guidance on tackling questions We show you how you can build your own exams We provide you with three mock exams including the new Pilot Paper

Our Passcard and i-Pass products also support this paper.

FOR EXAMS UP TO JUNE 2014

First edition 2007 Seventh edition January 2013 ISBN 9781 4453 6655 5 (previous ISBN 9780 4453 8004 9) e-ISBN 9781 4453 6958 7 British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library

Published by BPP Learning Media Ltd BPP House, Aldine Place London W12 8AA www.bpp.com/learningmedia Printed in the United Kingdom by Ricoh Ricoh House Ullswater Crescent Coulsdon CR5 2HR

All our rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of BPP Learning Media Ltd.

We are grateful to the Association of Chartered Certified Accountants for permission to reproduce past examination questions. The suggested solutions in the exam answer bank have been prepared by BPP Learning Media Ltd, except where otherwise stated.

Your learning materials, published by BPP Learning Media Ltd, are printed on paper sourced from sustainable, managed forests.

© BPP Learning Media Ltd 2013

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Contents
Page

Finding questions
Question index ..................................................................................................................................................................v Topic index .......................................................................................................................................................................x

Helping you with your revision – the ONLY P5 Practice and Revision Kit to be reviewed by the examiner! ............................................................. xii Revising P5
Topics to revise & question practice ..............................................................................................................................xiii Passing the P5 exam...................................................................................................................................................... xiv Exam formulae ............................................................................................................................................................. xviii Exam information ............................................................................................................................................................ xx Analysis of past papers ............................................................................................................................................... xxiv Useful websites ............................................................................................................................................................. xxv

Planning your question practice
BPP Learning Media's question plan............................................................................................................................ xxvi Build your own exams..................................................................................................................................................xxxv

Questions and answers
Questions ..........................................................................................................................................................................3 Answers ........................................................................................................................................................................125

Exam practice
Mock exam 1  Questions ............................................................................................................................................................457  Plan of attack .......................................................................................................................................................465  Answers...............................................................................................................................................................467 Mock exam 2  Questions ............................................................................................................................................................485  Plan of attack .......................................................................................................................................................497  Answers...............................................................................................................................................................500 Mock exam 3 (Pilot Paper)  Questions ............................................................................................................................................................523  Plan of attack .......................................................................................................................................................531  Answers...............................................................................................................................................................533 ACCA examiner's answers  Pilot paper ...........................................................................................................................................................555

Review form

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A note about copyright
Dear Customer What does the little © mean and why does it matter? Your market-leading BPP books, course materials and e-learning materials do not write and update themselves. People write them: on their own behalf or as employees of an organisation that invests in this activity. Copyright law protects their livelihoods. It does so by creating rights over the use of the content. Breach of copyright is a form of theft – as well as being a criminal offence in some jurisdictions, it is potentially a serious breach of professional ethics. With current technology, things might seem a bit hazy but, basically, without the express permission of BPP Learning Media:   Photocopying our materials is a breach of copyright Scanning, rip-casting or conversion of our digital materials into different file formats, uploading them to facebook or emailing them to your friends is a breach of copyright

You can, of course, sell your books, in the form in which you have bought them – once you have finished with them. (Is this fair to your fellow students? We update for a reason.) Please note the e-products are sold on a single user licence basis: we do not supply ‘unlock’ codes to people who have bought them second-hand. And what about outside the UK? BPP Learning Media strives to make our materials available at prices students can afford by local printing arrangements, pricing policies and partnerships which are clearly listed on our website. A tiny minority ignore this and indulge in criminal activity by illegally photocopying our material or supporting organisations that do. If they act illegally and unethically in one area, can you really trust them?

Using your BPP Learning Media products
This Kit gives you the question practice and guidance you need in the exam. Our other products can also help you pass:      Learning to Learn Accountancy gives further valuable advice on revision Passcards provide you with clear topic summaries and exam tips Success CDs help you revise on the move i-Pass CDs offer tests of knowledge against the clock Underlying knowledge CD offers guidance on assumed knowledge for Options papers P4, P5, P6, P7

You can purchase these products by visiting http://www.bpp.com/acca

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Finding questions

Question index
The headings in this checklist/index indicate the main topics of questions, but questions often cover several different topics. Where necessary, questions have been amended to reflect the new format of the exam, from June 2013. Questions set under the old syllabus Performance Management paper are included because their style and content are similar to those which appear in the P5 exam. They have 'PM' after the question name. These questions have been amended to reflect the current exam format. Questions taken from the P3 Business Analysis syllabus (when a re-alignment of syllabuses took place in 2010) are denoted by ‘BA' after the question name. Exam questions set under the current syllabus are designated 'APM' after the question name. Time Marks allocation (Mins) Page number Question Answer

Part A: Strategic planning and control
1 2 3 4 5 6 7 8 9 Diverse holdings (PM 12/05, amended) ST University HEG (APM 12/07, amended) CTC (APM 6/08, Preparation question) AB Electronics Megasnack Ganymede (APM 6/12, amended) Budgeting (Preparation question) Business process re-engineering 25 25 25 20 25 25 25 20 25 25 25 25 25 25 25 25 45 45 45 36 45 45 45 36 45 45 45 45 45 45 45 45 3 4 5 6 7 8 9 10 10 11 12 12 13 14 14 15 125 127 131 134 137 139 142 147 149 151 155 157 160 162 164 166

10 GMB Co (APM 12/07, amended) 11 Sports Shop 12 Scott 13 MKO clothing 14 BV Entertainments 15 EEE Chemical company 16 GSC groceries

Part B: External influences on organisational performance
17 GTR panels 18 GHG (APM 6/08, amended) 19 F4U (APM 6/09) 20 CAP (APM 12/09, amended) 21 EMA (APM 6/10) 22 FGH Telecom (APM 12/10, amended) 23 SQR Sports racquets 25 25 25 25 25 25 25 45 45 45 45 45 45 45 17 18 18 19 21 22 23 169 171 173 176 180 181 185

Finding questions

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Time Marks allocation (Mins)

Page number Question Answer

Part C: Performance measurement systems and design
24 Handra 25 FDS irrigation systems 26 TREN engine components 27 KLP divisions 28 Racer deliveries 29 Auto Parts 30 CMA Supermarkets 31 Viga Drinks (Preparation question) 32 Beachy 33 Cobra Golf Club (Preparation question) 34 Bluefin School (APM 12/11, amended) 25 25 25 25 25 25 25 20 25 20 25 45 45 45 45 45 45 45 36 45 36 45 25 26 27 27 28 29 30 31 31 32 34 188 190 193 195 197 199 202 204 206 208 210

Part D: Strategic performance measurement
35 CFD (APM 12/09, amended) 36 ZTC Communications 37 Large conglomerate (Preparation question) 38 CSG (PM 6/07, amended) 39 SEC 40 CD 41 Alpha Division (APM 12/07) 42 BAG (APM 12/08, Preparation question) 43 SSA (APM 12/09, amended) 44 Seatown 45 LGHD (APM 6/10, amended) 46 CFE coffee shops 47 JIT systems (Preparation question) 48 Tench (APM 12/11, amended) 49 TAW (APM 6/08, amended) 50 Thebe (APM 6/12, amended) 51 T4UC (APM 6/09, amended) 52 SSH (APM 12/08) 53 KPG Systems 54 Universal Pottery Company (BA 12/07) 55 CCT Computer Systems (Preparation question) 56 Astrodome (PM 12/05, amended) 57 TRG (APM 6/08, amended) 58 UU (APM 6/09, amended) 25 25 20 25 25 25 25 20 25 25 25 25 20 25 25 25 25 25 25 25 12 25 25 25 45 45 36 36 45 45 45 36 45 45 45 45 36 45 45 45 45 45 45 45 22 45 45 45 36 36 37 38 38 40 41 43 44 45 46 46 47 48 49 50 51 52 53 54 55 55 57 58 213 216 219 222 225 228 230 234 236 240 243 245 247 250 253 255 259 262 265 267 272 273 274 277

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Finding questions

Time Marks
59 Elegant Hotels (BA 6/09) 60 Connie Head 61 Equiguard (BA, 12/08) 25 25 25

Page number Question
59 60 60

allocation (Mins)
45 45 45

Answer
279 282 284

Part E: Performance evaluation and corporate failure
62 YCT yachts 63 Bettaserve (APM Pilot paper) 64 Cod (APM 12/11) 65 APX Accountancy (APM 6/11, amended) 66 Eatwell Restaurant (PM 6/02, amended) 67 Amal (APM 6/12, amended) 68 B2B Deliveries 69 Glitter Fashions 70 TOC (APM 12/08, Preparation question) 71 SFS (APM 6/10, amended) 72 LOL cards (APM 12/10, amended) 73 BEG (APM 6/10, amended) 74 ENT Entertainments (APM 6/11, amended) 75 Vision (PM 12/06, amended) 76 TMC (APM 12/08, amended) 77 Joint venture 78 Callisto (APM 6/12, amended) 79 CHN Retail chain 80 BPC (APM 12/07, amended) 81 RM Batteries (APM 12/10, amended) 82 NW Clothes 83 Action Buttons 25 25 25 25 25 25 25 25 20 25 25 25 25 25 25 25 25 25 25 25 25 25 45 45 45 45 45 45 45 45 36 45 45 45 45 45 45 45 45 45 45 45 45 45 62 63 64 66 67 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 83 84 287 290 292 296 299 302 306 309 311 313 315 318 321 324 328 330 332 336 338 340 343 345

Finding questions

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Time Marks allocation (Mins)

Page number Question Answer

Part F: Current developments and emerging issues in performance management
84 Environmental management accounting (Preparation question) 85 Management accounting relevance (Preparation question) 86 School League Tables 87 BPL Leisure 88 Mentons 20 20 25 25 25 36 36 45 45 45 85 85 85 87 88 348 349 352 354 357

Section A Questions
89 Cognet 90 Armstrong Stores (Sample question, amended) 91 Robust Laptops (APM 12/10, amended) 92 RRR (APM 12/09, amended) 93 BWY houses 94 Film Productions Co (APM 12/10, amended) 95 Metis (APM 6/12, amended) 96 GWCC (PM 6/06, amended) 97 JHK Coffee Machines (APM 6/11, amended) 98 TSC (APM 12/08, amended) 99 BEC (APM 12/09, amended) 100 HFG (APM 6/08, amended) 101 SBC (APM 6/10, amended) 102 Glasburgh (APM 6/09, amended) 103 AAA Management Consultancy 104 Zed Leisure 50 50 50 50 50 50 50 50 50 50 50 50 50 50 50 50 90 90 90 90 90 90 90 90 90 90 90 90 90 90 90 90 89 90 93 95 97 99 100 103 104 106 108 111 113 116 117 119 361 365 371 376 380 387 391 400 405 411 417 423 430 435 443 446

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Finding questions

Mock exam 1
Questions 105 to 108

Mock exam 2
Questions 109 to 112

Mock exam 3 (Pilot paper)
Questions 113 to 116

Planning your question practice
Our guidance from page xxvi shows you how to organise your question practice, either by attempting questions from each syllabus area or by building your own exams – tackling questions as a series of practice exams.

June and December 2013 exams
BPP’s answers for these exams along with a small number of additional questions will be available for free after the exams on http://www.bpp.com/acca

Finding questions

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Topic index
Listed below are the key Paper P5 syllabus topics and the numbers of the questions in this Kit covering those topics. If you need to concentrate your practice and revision on certain topics or if you want to attempt all available questions that refer to a particular subject, you will find this index useful. Syllabus topic Accountability and responsibility accounting Activity based budgeting Activity based costing Activity based management Ansoff's growth vector matrix Appraisals and performance management Balanced scorecard Behavioural aspects of budgeting Benchmarking Beyond budgeting BCG matrix Branding Budgeting and types of budget Building blocks model (Fitzgerald and Moon) Business process re-engineering Business structure Controls and security over information Corporate failure Costs of quality Critical success factors Cultural differences Dimensions of performance Divisional performance measures Environmental factors and impact on performance Environmental management accounting Enterprise resource planning systems (ERPS) EVA (Economic value added) External environment Financial performance Freewheeling opportunism Gap analysis Global factors Goal congruence Governments, regulation and business performance Information for decision making Information overload Information systems and IT systems JIT Joint ventures Question numbers 27, 58, Mock 3 Qn 2 8, 71, 89 10, 70, 91 70, 71 75, 76, 90 60 62, 69, 90, 101-103, Mock 3 Qn 3 57 7, 89, 90, 97, 100 8, 91, 92 74, 93 46 8, 91, 92, Mock 2 Qn 2 65, 66, 98 9 78 31, 32, 34 80, 81, 82, 104 42, 48, 49, 96 3, 35, 36, 91, 94 18 66 97 18, 20, 22, 23, 36, 93, Mock 1 Qn 3 84, Mock 3 Qn 4 3, 13 41, 72, 100, Mock 2 Qn 3, Mock 2 Qn 1 18, 23, 36, 93 37-41, 52, 95-100, 104, Mock 1 Qn 3 Mock 1 Q1 75, 76, 90, Mock 1 Qn 1 18 6 17, 76, Mock 2 Qn 3 2, 5, 24, 25, Mock 1 Qn 2, Mock 1 Qn 4 33, 34, Mock 2 Qn 1 9, 12, 14, 30, Mock 1 Qn 2, Mock 3 Qn 1 47, 48 77

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Finding questions

Syllabus topic Kaizen costing Key performance indicators League tables Lean information systems Management accounting and information systems Mission statements Net present value Non-financial performance indicators Objectives Operational planning Performance management in complex business structures Performance management information systems Performance prism Performance pyramid Porter's Five forces Problems of performance measurement Public sector organisations Qualitative information Quality Residual income Responsibility and controllability Reward schemes Risk and uncertainty Role of management accountants Service organisations Short and long-term decision making Six Sigma Social obligations Stakeholders Strategic management accounting Strategic decision making Strategic planning Supply chain management Survival vs growth SWOT analysis Target costing Total quality management (TQM) Transfer pricing Value based management Value chain Value for money

Question numbers 48, 49, 71 35, 64, 91, 94 7, 86, 98 26, 32 12, 14, 24, 25, 85, Mock 1 Qn 2, Mock 3 Qn 1 35, 94 4,19, 37 35, 38, 50(a) 89, 101 38 Mock 1 Qn 2 77, 78 24, 26, 27, 29, 97 67, 68, 69 63, 64, 73, Mock 2 Qn 4 80, 103 56, 57 44, 45 28 42, 50, 53-55 37, 41, 100, Mock 1 Qn 3 27, Mock 3 Qn 2 59, 60, 61, 92, 99, 100, 101, Mock 2 Qn 1 5, 17, 19, 21, 40, 93, Mock 3 Qn 1 85, 87, 88, 98 14, 65, 66 41, 95 50, 51, 54, 59 22, 46 15, 16, Mock 2 Qn 3, Mock 3 Qn 1 5, 13, 18, 89, 90 4, 20 2, 89, Mock 1 Qn 1 79 38, 62, 90 1 71, 96 48 42, 43, 97, 100 72 11 45

Finding questions

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Helping you with your revision – the ONLY P5 Practice and Revision Kit to be reviewed by the examiner!
BPP Learning Media – the sole Platinum Approved Learning Partner content
As ACCA’s sole Platinum Approved Learning Partner – content, BPP Learning Media gives you the unique opportunity to use examiner-reviewed revision materials for the 2013 and June 2014 exams. By incorporating the examiner’s comments and suggestions regarding syllabus coverage, the BPP Learning Media Practice and Revision Kit provides excellent, ACCA-approved support for your revision.

Tackling revision and the exam
You can significantly improve your chances of passing by tackling revision and the exam in the right ways. Our advice is based on feedback from ACCA examiners.   We look at the dos and don'ts of revising for, and taking, ACCA exams We focus on Paper P5; we discuss revising the syllabus, what to do (and what not to do) in the exam, how to approach different types of question and ways of obtaining easy marks

Selecting questions
We provide signposts to help you plan your revision.     A full question index A topic index listing all the questions that cover key topics, so that you can locate the questions that provide practice on these topics, and see the different ways in which they might be examined BPP's question plan highlighting the most important questions and explaining why you should attempt them Build your own exams, showing how you can practise questions in a series of exams

Making the most of question practice
At BPP Learning Media we realise that you need more than just questions and model answers to get the most from your question practice.      Our Top tips included for certain questions provide essential advice on tackling questions, presenting answers and the key points that answers need to include We show you how you can pick up Easy marks on some questions, as we know that picking up all readily available marks often can make the difference between passing and failing We include marking guides to show you what the examiner rewards We include examiners' comments to show you where students struggled or performed well in the actual exam We refer to the 2012 BPP Study Text (for exams up to June 2014) for detailed coverage of the topics covered in questions

Attempting mock exams
There are three mock exams that provide practice at coping with the pressures of the exam day. We strongly recommend that you attempt them under exam conditions. Mock exams 1 and 2 reflect the question styles and syllabus coverage of the exam; Mock exam 3 is the new Pilot paper which ACCA has issued for 2013 exams. xii
Helping you with your revision

Revising P5
Topics to revise
Any part of the syllabus could be tested in the compulsory Section A question. Therefore it is essential to learn the entire syllabus to maximise your changes of passing. There are no short cuts – trying to spot topics is dangerous and will significantly reduce the likelihood of success. As this is an advanced paper it also assumes knowledge of topics covered in Paper F5 – Performance Management. That said, the main capabilities in the syllabus (which is on ACCA’s website) take you through what the examiner expects from you when you have completed your studies. There are six key areas for you to concentrate on. These six areas are the syllabus areas covered in the Study Text. However, whilst it is important that you work through your way through the Study Text and cover all the different syllabus areas, it is also important to try and think how the areas might relate to each other, and how they could be used to help managers in a business control and improve the performance of a business. Remember, this paper is about performance management, and not simply about performance measurement. Remember to come out of the detail once you have finished a chapter and practised some questions. Take some time to reflect on how the chapter has covered the syllabus and how it feeds back into the capabilities which you will need to display in order to pass this paper.

Question practice
You should use the Passcards and any brief notes you have to revise the syllabus, but you mustn't spend all your revision time passively reading. Question practice is vital; doing as many questions as you can in full will help develop your ability to analyse scenarios and produce relevant discussion and recommendations. The question plan on page xxviii tells you what questions cover so that you can choose questions covering a variety of syllabus areas. Make sure you leave enough time in your revision schedule to practise 50 mark Section A questions, as the Section A question is compulsory in the exam. The scenarios and requirements of Section A questions are more extensive than Section B questions and will integrate several parts of the syllabus, therefore practice is essential. Also ensure that you attempt all three mock exams under exam conditions.

Revising P5

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Passing the P5 exam
Displaying the right qualities
The examiner wrote an article in Student Accountant in August 2010 where he outlined the qualities he expects students to display. He based his advice on the six main syllabus areas (A to F) and what qualities students should demonstrate under each. We reproduce the main points here. 1. The application of strategic planning and control models in performance management. The models stress the need to take an all-encompassing view of the factors that affect a business and to consider them when giving strategic advice on performance. Good candidates at Paper P5 often distinguish themselves by being able to synthesise disparate detailed points into an overall, strategic approach for an organisation. 2. Factors external to the business. Here candidates need to move beyond the internal factors associated with traditional management accounting to consider the information needs of the strategic level of management as well as the operational and tactical levels. 3. The information that management require and the systems that are needed for its delivery. Candidates are expected to be aware of the effect of information technologies on performance management decision making rather than the detail of these technologies. They should be conversant with the broad hardware and software trends and issues and how these interact with the provision of performance information throughout the organization. 4 and 5. The fourth capability is the application of the techniques and assumed knowledge to specific scenarios. You shouldn’t simply discuss theories and models in general terms; you need to apply them specifically to the scenario identified in the question. The fifth capability is being able to take this information and turn it into advice which is commercially valuable for strategic decision makers. This capability also requires the candidate to be able to recognise and advise on situations where the organisation is in danger of failing. 6. Finally, candidates are expected to be aware of new knowledge from the general technical press. The examiner stresses that articles in Student Accountant may be sources of topics for the exam, although as the syllabus is not regularly updated older articles may also remain relevant. There will be a small number of Professional marks available in the compulsory 50 mark Section A question, and it should be possible for a well-prepared student to score most of these. For example, the effective use of appropriate introductions and conclusions, and helpfully breaking the document into properly headed sub-sections, will help to demonstrate a professional approach to writing a report. However, it should be stressed that the approach taken will vary from question to question and the exam tests the candidates’ ability to apply their knowledge of professional presentation. In order to score full professional marks, the answer will have to be tailored to the specifics of the scenario in the question recognising the needs of the readers of the document. Presentation points. First: on rounding. At this final level the candidate should use their own judgment on how to round figures – the basic rule is that there should be enough detail to make a useful conclusion without obscuring it with insignificant figures. Second, short paragraphs are usually clear but single sentence paragraphs are often insufficient and unable to get to the depth required at Paper P5. Bullet points are useful for lists but not if commentary is required. Finally, reading model solutions is not a substitute for actually writing out your own answers. Summarising the advice the examiner gives: Candidates should:    Understand the objectives of the exam as explained in the Syllabus and prepare the detailed topics in the Study Guide Be very comfortable with the areas tested in Paper F5 Performance Management and Paper P3 Business Analysis Ensure that their preparation for the exam has been based on a programme of study set for the required syllabus and exam structure

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Revising P5

   

Use an ACCA-approved textbook for Paper P5. They are structured around the syllabus and the examiner reviews them so that they give an effective coverage of what is examinable Practise questions under exam conditions in order to improve speed and presentation skills, ensuring these test discursive, computational and analytic abilities Study all the relevant articles that appear in Student Accountant Be able to clearly communicate understanding and application of knowledge in the context of a Professional level exam.

The questions tend to be wide-ranging, as the examiner wants to link topics and mix ideas up. So you are better knowing something about every part of the syllabus than a lot of detail about a few areas only.

Avoiding weaknesses
Our experience of, and examiner feedback from, other higher level exams enables us to predict a number of weaknesses that are likely to occur in many students’ answers. You will enhance your chances significantly if you ensure you avoid these mistakes:         Failing to provide what the question verbs require (discussion, evaluation, recommendation) or to write about the topics specified in the question requirements Repeating the same material in different parts of answers Stating theories and concepts rather than applying them Quoting chunks of detail from the question that don't add any value Failing to make the most of the information given in the question. Remember, you need to apply your knowledge specifically to the scenario given in the question. Failing to set out workings clearly and separately Not planning and preparing the answer properly, taking into account mark allocation. Students often leave part-questions out. Not refreshing brought-forward knowledge (for example, from Paper F5).

Use of reading time
ACCA permits a 15-minute reading time in addition to the 3 hour time given to sit this paper. We recommend that you spend the first part of the 15 minutes reading time choosing the Section B questions you will do, on the basis of your knowledge of the syllabus areas being tested and whether you can fulfil all the question requirements. Remember that Section B questions can cover different parts of the syllabus, and you should be happy with all the areas that the questions you choose cover. We suggest that you should note on the paper any ideas that come to you about these questions. However don't spend all the reading time going through and analysing the Section B question requirements in detail; leave that until the three hours’ writing time. Instead you should be looking to spend as much of the reading time as possible looking at the Section A scenario, as this will be longer and more complex than the Section B scenarios and cover more of the syllabus. You should highlight and annotate the key points of the scenario on the question paper.

Choosing which questions to answer first
Spending most of your reading time on the Section A scenario will mean that you can get underway with planning and writing your answer to the Section A question as soon as the three hours start. It will give you more actual writing time during the one and a half hours you should allocate to it, and it is writing time that you'll need.

Revising P5

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Comments from examiners of other syllabuses that have similar exam formats suggest that students appear less time-pressured if they do the big compulsory question first. During the second half of the exam, you can put Section A aside and concentrate on the two Section B questions you’ve chosen. However, our recommendations are not inflexible. If you really think the Section A question looks a lot harder than the Section B questions you’ve chosen, then do one of those first, but DON'T run over time on it. You must have an hour and a half to tackle the Section A question and you will feel under much more pressure on it if you leave it till last. If you do one of the Section B questions first, and then tackle the Section A question having had initial thoughts on it during the reading time, you should be able to generate more ideas and find the Section A question is not as bad as it looks. Remember also that small overruns of time during the first half of the exam can add up to you being very short of time towards the end.

Tackling questions
You'll improve your chances by following a step-by-step approach along the following lines.

Step 1

Read the background Usually the first couple of paragraphs will give some background on the company and what it is aiming to achieve. By reading this carefully you will be better equipped to relate your answers to the company as much as possible.

Step 2

Read the requirements There is no point reading the detailed information in the question until you know what it is going to be used for. Don’t panic if some of the requirements look challenging – identify the elements you are able to do and look for links between requirements, as well as possible indications of the syllabus areas the question is covering.

Step 3

Highlight the action verbs that are used in each requirement These convey the level of skill you need to exhibit and also the structure your answer should have. A lower level verb such as define will require a more descriptive answer; a higher level verb such as evaluate will require a more applied, critical answer. The examiner has stressed that higher level requirements and verbs will be most significant in this paper, for example critically evaluating a statement and arguing for or against a given idea or position. Action verbs that are likely to be frequently used in this exam are listed below, together with their intellectual levels and guidance on their meaning. Level 1 1 1 1 3 3 3 3 Define Explain Identify Describe Assess Discuss Recommend Evaluate Give the meaning of Make clear Recognise or select Give the key features Determine the strengths/weaknesses/importance/ significance/ability to contribute Examine in detail by using arguments for and against Advise the appropriate actions to pursue in terms the recipient will understand Determine the value of, in the light of the arguments for and against

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Revising P5

Step 4

Identify what each part of the question requires Think about what frameworks of theories you could choose to support your answer (if the question doesn’t indicate a specific one you need to use). Look at how the different parts of a question fit together, and make sure you don’t end up repeating the same points in more than one part of the question.

Step 4 Step 5

Check the mark allocation to each part This shows you the depth anticipated and helps allocate time. Read the question slowly, focusing on the initial requirements Once you know what you are expected to do in the first requirement, read the question in detail, trying to focus on the information that will be needed for your first task.

Step 6

Read the scenario carefully Put points under headings related to requirements (eg by noting in the margin to what part of the question the scenario detail relates).

Step 7

Consider the consequences of the points you’ve identified You will often have to provide recommendations based on the information you've been given. Be prepared to criticize the framework or model that you’ve been told to use, if required. You may have also to bring in wider issues or viewpoints, for example the views of different stakeholders.

Step 8

Write a brief plan You may be able to do this on the question paper as often there will be at least one blank page in the question booklet. However any plan you make should be reproduced in the answer booklet when writing time begins. Make sure you identify all the requirements of the question in your plan – each requirement may have sub-requirements that must also be addressed. If there are professional marks available, highlight in your plan where these may be gained; for example, preparing a report.

Step 9

Write the answer Make every effort to present your answer clearly. The pilot paper and exam papers so far indicate that the examiner will be looking for you to make a number of clear points. The best way to demonstrate what you’re doing is to put points into separate paragraphs with clear headers.

Discussion questions
Do not be tempted to write all you know about a particular topic in a discussion question. Markers can easily spot when a student is ‘waffling’ and you will receive little or no credit for this approach. Keep referring back to the question requirement to ensure you are not straying from the point. To make it easier for the marker to determine the relevance of the points you are making, you could explain what you mean in one sentence and then why this point is relevant in another. Remember that depth of discussion will be important. Always bear in mind how many marks are available for the discussion as this will give you an indication of the depth that is required. Ask yourself the following questions as you are tackling a discussion question:    Have I made a point in a coherent sentence? Have I explained the point (to answer the ‘so what’ or ‘why’ queries)? Have I related the point to the company in the scenario?

Revising P5

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Exam formulae

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Revising P5

Revising P5

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Exam information
The exam paper Format of the paper
The format of the P5 exam has changed, with effect from June 2013. The new format is: Section A: Section B: 1 compulsory case study Choice of 2 from 3 questions (25 marks each) Number of marks 50 50 100

Time: 3 hours plus 15 minutes reading time Please note: Although the format of the exams has changed from June 2013, the underlying syllabus content and the way in which subjects are examined has not changed. The changes only relate to the number of questions in the exam, and the mark allocations for each question. Section A will be a compulsory case study question, typically with four or five sub-requirements relating to the same scenario information. The question will usually assess and link a range of subject areas from across the syllabus. It will require students to demonstrate high-level capabilities to understand the complexities of the case, and evaluate, relate and apply the information in the case study to the requirements. Professional marks will be available in Section A for presentation, logical flow of argument and quality of argument. Section B questions are more likely to assess a range of discrete subject areas from the main syllabus section headings; they may require evaluation and synthesis of information contained within short scenarios and application of this information to the question requirements. Although one subject area is likely to be emphasised in each Section B question, students should not assume that questions will be solely about content from that area. Each question will be based on a short case scenario to contextualise the question. The pass mark for Paper P5 remains at 50%.

Additional information
The Study Guide provides more detailed guidance on the syllabus.

Exams prior to 2013
Questions and answers for exams prior to 2013 are available on ACCA’s website: http://www.accaglobal.com/en/student/qualification-resources/acca-qualification/acca-exams/p5-exams/examsp51.html Please note, these questions reflect of the format of the exam prior to 2013. In the main body of this Kit, where we have used past exam questions, we have adapted them to fit the format of the exam from June 2013.

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Examiner’s comments
The following comments have been extracted from the reports the Examiner has written on past exams. They illustrate common weaknesses in candidates’ answers, and therefore highlight areas you should consider in your preparation for the exam, in order to avoid making the mistakes the Examiner has commented on.

June 2012
As has been noted in previous sittings, candidates still need to appreciate that performance management is an area which, at an advanced level, is dependent on situation and environment. Therefore a good answer will go beyond the mere repetition of how a technique or model works, and will relate it to an entity’s specific environment. Equally, good answers will evaluate how useful a technique is for a given scenario, rather than simply describing that technique. The quality of the numerical workings and the commentary on the results of these workings remains an area of concern. For example, when rounding numbers, 229.6 rounds to 230 not 229. An accountant is expected to be an expert on numerical issues in a business situation, but this sort of carelessness can dent that reputation. When commenting on numerical work, there were numerous examples of scripts that did little more than put into sentences the numbers which had been calculated. For example, simply stating that one company has a higher profit margin than another, does not add any value, and so such a comment will gain no marks. Also, as in previous sittings, candidates do not appear to be spending sufficient time reading the question and understanding its requirements. For example, if you are asked to evaluate a company’s performance report, that is not the same thing as being asked to evaluate a company’s performance.

December 2011
In general, it was encouraging to see candidates making use of the detail use of the detail provided in the scenario. The basis of this examination is analysis and application. Candidates need to appreciate that performance management is an area which, at an advanced level, is dependent on situation and environment. Therefore a good answer will go beyond the mere repetition of how a technique or model works, and will relate it to an entity’s specific environment. Some candidates are still not spending sufficient time reading the questions and understanding their requirements. Questions must not be ‘skim’ read. There were numerous examples of answers which related to a different question requirement than the one which had actually be set, and therefore only scored very few marks. For example, one of the questions asked for an evaluation of a company’s performance measurement system. It did not ask for an evaluation of the company’s performance, although a number of candidates provided an evaluation of the company’s performance. Similarly, one of the other questions asked about the suitability of the performance information which was used to assess a shop manager’s performance. Again, the focus should have been on the performance information, not the shop or the manager’s performance.

June 2011
It was encouraging to see some candidates applying good analytic reasoning, and making better use of the detail provided in the question scenario. If candidates come into the P5 examination expecting to repeat memorised material, they will probably only score between 20% and 30%. The basis of this examination is analysis and application. Candidates will need to a foundation in the techniques and models listed in the syllabus, but should focus more on the evaluation of these techniques and consideration of their usefulness to given scenarios. Performance management, at an advanced level like P5, is dependent on situation and context. A good answer will go beyond simple description of how a technique works, and will focus on relating it to the specific scenario given in the question.

Revising P5

xxi

December 2010
A large number of candidates were either inadequately prepared for the examination or else they failed to read the question requirements carefully. Candidates need to be flexible in their approach to the examination. They cannot expect there to be one standard answer to all questions on a given topic. The examination is intended to make candidates apply their knowledge to a given scenario, and the scenario will always present new challenges or details. In general, candidates appear better at description than analysis. However, candidates need to remember that the P5 examination is intended to test their ability to ‘add value’ in their work – in other words, to identify the key points in a scenario, and then apply their knowledge to them in order to address performance issues or performance improvements as required by the question.

June 2010
A large number of candidates achieved high marks. However a large number of candidates were inadequately prepared though overall performance has improved. Candidates demonstrate good descriptive skills but are weak on analysis falling to include numerical analysis and the commercial implications of their findings. Candidates should refer to any scenarios given in their answers rather than to prepared analyses which may be irrelevant.

December 2009
Many candidates continue to display their answers poorly, and would benefit from giving more thought to the presentation of their answers. This will not only improve the organisation of their answers, but it will also assist the marking in identifying the points which deserve marks. Many candidates would clearly also benefit from planning their answers. For example, in their answers to question 5 a number of candidates discussed the organisation’s mission statement in part (a) (i), although this was actually a requirement of part (a) (ii). It was also noticeable that some candidates had clearly memorised solutions to past examination questions and were determined to include them in their answers to the questions set here. Unfortunately this does not work, and you must make your answers appropriate to the specific scenario being described in the question.

June 2009
Well-prepared candidates achieved comfortable passes. However many candidates failed quite badly and few were marginal in their performance. Common errors included not answering all parts to questions and a tendency to write at length without answering the question. Candidates must set out their answers clearly and label their scripts to help markers. This is especially important as professional marks can be earned for presentation and organisation.

December 2008
Scripts suggested a significant number of candidates were unprepared for the exam. Again, many omitted to answer all parts of questions losing valuable marks. A major problem was insisting on using a memorised answer to answer a question rather than the actual question set. There was an inability to interpret numbers and ratios beyond classifying performance as either 'good' or 'bad'.

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Revising P5

June 2008
A significant number of candidates provided good answers to every question they attempted and consequently earned high marks. However, the overall performance of candidates was good. Poor candidates revealed poor presentation and/or time management or not observing the specific requirements of each question. Candidates need to give more thought to the layout and organisation of their answers now that professional marks are available for well-presented answers.

Revising P5

xxiii

Analysis of past papers
The table below provides details of when each element of the syllabus has been examined and whether it was examined as part of a compulsory question (‘C’) or an optional one (‘O’). Please note that up to December 2012, the exam contained two compulsory questions, unlike exams from 2013 which will only contain one compulsory question.
Covered in Text chapter Dec 2012 June 2012 Dec 2011 June 2011 Dec 2010 June 2010 Dec 2009 June 2009

STRATEGIC PLANNING AND CONTROL 1 2 3 Introduction to strategic management accounting Performance management and control of the organisation Business structure, IT developments and other environmental and ethical issues EXTERNAL INFLUENCES ON ORGANISATIONAL PERFORMANCE 4 5, 6 Changing business environment and external factors PERFORMANCE MEASUREMENT SYSTEMS AND DESIGN STRATEGIC PERFORMANCE MEASUREMENT 7 8 9 10a 10b 11 Performance hierarchy Scope of strategic performance measures in the private sector Divisional performance and transfer pricing issues Scope of strategic performance measures in not-for-profit organisations Non-financial performance indicators The role of quality in management information and performance measurement systems Performance measurement: strategy, reward and behaviour PERFORMANCE EVALUATION AND CORPORATE FAILURE 13 14 15 Alternative views of performance measurement and management Strategic performance issues in complex business structures Predicting and preventing corporate failure CURRENT DEVELOPMENTS AND EMERGING ISSUES IN PERFORMANCE MANAGEMENT 16 Current developments, issues and trends O O O C O C C, O O O C,O O,O C O C O O C, O C C C C O O,O C,O O C O C,O C C O, O C O C O C C C, C O C C C

12

O

O,O

O

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Revising P5

Useful websites
The websites below provide additional sources of information of relevance to your studies for Advanced Performance Management.  www.accaglobal.com ACCA's website. The students' section of the website is invaluable for detailed information about the qualification, past issues of Student Accountant (including technical articles) and even interviews with the examiners.  www.bpp.com Our website provides information about BPP products and services, with a link to the ACCA website.  www.ft.com This website provides information about current international business. You can search for information and articles on specific industry groups as well as individual companies.  www.economist.com Here you can search for business information on a week-by-week basis, search articles by business subject and use the resources of the Economist Intelligence Unit to research sectors, companies or countries.  www.cfo.com This site provides useful news and insights for financial executives.

Revising P5

xxv

Planning your question practice
We have already stressed that question practice should be right at the centre of your revision. Whilst you will spend some time looking at your notes and Paper P5 Passcards, you should spend the majority of your revision time practising questions. We recommend two ways in which you can practise questions.   Use BPP Learning Media's question plan to work systematically through the syllabus and attempt key and other questions on a section-by-section basis Build your own exams – attempt questions as a series of practice exams

These ways are suggestions and simply following them is no guarantee of success. You or your college may prefer an alternative but equally valid approach. Additional questions BPP’s answers for the June and December 2013 exams, along with a small number of additional questions, will be available after the relevant exams on: http://www.bpp.com/acca

BPP Learning Media's question plan
The BPP plan below requires you to devote a minimum of 40 hours to revision of Paper P5. Any time you can spend over and above this should only increase your chances of success.

Step 1 Step 2

Review your notes and the chapter summaries in the Paper P5 Passcards for each section of the syllabus. Answer the key questions for that section. These questions have boxes round the question number in the table below and you should answer them in full. Even if you are short of time you must attempt these questions if you want to pass the exam. You should complete your answers without referring to our solutions.

Step 3

Attempt the other questions in that section. For some questions we have suggested that you prepare answer plans or do the calculations rather than full solutions. Planning an answer means that you should spend about 40% of the time allowance for the questions brainstorming the question and drawing up a list of points to be included in the answer.

Step 4

Attempt Mock exams 1, 2 and 3 under strict exam conditions.

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Planning your question practice

Syllabus section Strategic planning and control Introduction to strategic management accounting

2012 Pass cards chapters

Questions in this Kit

Done Comments

1

3

Answer in full. Note the importance in part (b) of identifying critical success factors that are specifically relevant for HEG. Applying your knowledge to specific scenarios is vital in P5.

6

Prepare an answer plan. Ensuring localised decision-making is aligned to overall strategic goals is an important aspect of performance management, and is the main focus of this question.

7

Answer in full. The focus of this question, based on one from the June 2012 exam is benchmarking. However, you need to use benchmarking to assess the performance of an organisation, rather than simply discussing, in general terms, what benchmarking is or how it could be useful for an organisation.

Performance management and control of the organisation

2

91

Answer parts (a) & (b) only, in full. This question, adapted from the December 2010 exam, looks at different aspects of costing and budgeting, in particular ‘beyond budgeting’. Note your answer should be presented as a report.

92

Answer part (a) only. This question (from the December 2009 exam) tests your knowledge of alternative budget models, in particular ‘beyond budgeting.’

Business structure, IT developments and other environmental and ethical issues

3

12

Answer in full. Information systems, and their usefulness in helping managers make decisions and control organisations, are a vital component of performance management.

Planning your question practice

xxvii

Syllabus section

2012 Pass cards chapters

Questions in this Kit
13

Done Comments Answer in full. Another question about information systems, but here also looking at the way they might be able to improve the competitiveness of an organisation. Part (b) also highlights the importance of external information (eg competitor analysis) as well as internal information when assessing an organisation’s performance.

14

Answer in full. This question highlights the difference in potential information requirements for manufacturing organisations compared to service organisations. It is important to appreciate how information requirements are likely to vary in different organisations.

15

Prepare an answer plan. It is important to appreciate the influence that different stakeholders can have on organisations’ strategies and performance.

External influences on organisational performance Changing business environment and external factors 4 17 Prepare an answer plan. Risk and uncertainty are examined in the compulsory question in the Pilot Paper (which you will cover as Mock Exam 3 later). The issue here is: how do risk and uncertainty affect planning and decision-making in an organisation? 93 Prepare an answer plan. This question combines aspects of risk and uncertainty with a discussion of the way external factors can affect an organisation’s performance. (As a minimum, you should prepare an answer plan for this question, but if you have time you should tackle the question in full, to get practice at answering 50 mark questions.)
19

Answer in full. A question from the June 2009 exam which looks at investment decisions (in particular, NPV calculations) and risk (in particular, decision rules).

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Planning your question practice

Syllabus section

2012 Pass cards chapters

Questions in this Kit 20

Done Comments Prepare an answer plan. This question (adapted from the December 2009 exam) combines an evaluation of financial performance, with a discussion of the factors that should influence a proposed business decision.

22

Answer in full. This question (based on the December 2010 exam) reminds you that performance management is not simply about financial performance management. Here the focus is on environmental performance, specifically carbon dioxide emissions.

Performance measurement systems and design Performance management information systems 5 24 Prepare an answer plan. This question looks at various issues surrounding the provision of information and how it can be used in organisations.
27

Answer in full. This question looks at some of the factors that should affect the design of information systems.

Management information, recording and processing and management reports

6

33

Answer in full. The key message here is that while managers need information for control and decision-making, having too much information may actually be a hindrance rather than a help.

34

Answer in full. This question (adapted from the December 2011 exam) looks at two different aspects of management information: controls and security; and, the usefulness of information and performance reports.

Planning your question practice

xxix

Syllabus section Strategic performance measurement Performance hierarchy

2012 Pass cards chapters

Questions in this Kit

Done Comments

7

94

Answer in full. The main focus of this question (adapted from the December 2010 exam) is on critical success factors (CSFs) and key performance indicators (KPIs). However, there is also a reference back to information systems (from the previous section), and part of the question also looks at mission statements.

95

Answer in full. This question (adapted from the June 2012 exam) combines issues around performance reports with the choice of measures which an organisation selects in order to help manage its performance. Prepare an answer plan. This question (amended from the December 2009 paper) looks at three different aspects of the performance hierarchy: mission, critical success factors, and performance measures. It is very important to recognise the link between CSFs and KPIs in the performance hierarchy.

35

Scope of strategic performance measures in the private sector

8

97

Answer parts (a) – (c) in full. This question is adapted from a compulsory question in the June 2011 exam. The examiner has highlighted the importance of being able to ‘evaluate’ performance or performance models. The focus in part (a) of this question is on evaluating the performance of a division. The focus in part (c) is on evaluating the potential impact of introducing a new executive information system.

98

Prepare an answer plan for part (a). This question has been adapted from a compulsory question in the December 2008 exam. Part (a) highlights that performance does not simply mean financial performance. Parts (b) and (c) cover topics covered in Chapter 16 (Current developments and issues).

99

Answer part (a) in full. This question is adapted from a compulsory question in the December 2009 exam. Use this to test your familiarity with financial and non-financial measures of performance.

xxx

Planning your question practice

Syllabus section Divisional performance and transfer pricing issues

2012 Pass cards chapters 9

Questions in this Kit
41

Done Comments Answer in full. This question is taken from the December 2007 exam. It covers a lot of syllabus areas, such as: short-term and long-term performance measures, comparing divisional performance, calculating EVA, and discussing the potential disadvantages of EVA.

100

Answer part (a) in full. This question is based on one from the June 2008 exam. Again it looks at a range of different financial performance measures as well as bonuses and reward schemes.

43

Answer in full. The main focus of this question from the December 2009 is transfer pricing in a strategic context.

Scope of strategic performance measures in notfor-profit organisations Non-financial performance indicators

10a

44

Prepare an answer plan. This question looks at the aspects of performance which are important when generating a profit is not an organisation’s primary objective.

10b

101

Answer in full. This question (adapted from the June 2010 exam) looks at the importance of non-financial performance indicators, particularly with reference to the balanced scorecard.

45

Prepare an answer plan. Another question the June 2010 exam, this time looking at the importance of value for money, and the measures of economy, efficiency, and effectiveness in public sector organisations.

The role of quality in management information and performance measurement systems

11

48

Answer in full. This question (adapted from the December 2011 exam) looks at a number of issues around quality management, including Kaizen, just-in-time production, and TQM.

50

Answer in full. The main focus of this question (adapted from the June 2012 exam) is Six Sigma and its role in improving performance. Part (c) looks specifically at the DMAIC methodology for implementing Six Sigma.

Planning your question practice

xxxi

Syllabus section Performance measurement: strategy reward and behaviour

2012 Pass cards chapters 12

Questions in this Kit 56

Done Comments Prepare an answer plan. This question looks at some specific problems with performance measurement, but you need to be aware of the potential problems with performance measurement in general.

60

Answer in full. Staff represent a valuable asset to many organisations. But how do appraisals and performance management help organisations achieve their goals?

61

Prepare an answer plan. This question looks at the potential problems reward management schemes can cause in organisations if they are poorly designed. Make sure you base your answer directly on the scenario rather than preparing a ‘theoretical’ answer.

Performance evaluation and corporate failure Alternative views of performance measurement 13 90 Answer in full. This question covers a range of different areas and topics: the balanced scorecard; benchmarking; and the potential conflict between strategies aimed at strategy and those focusing on survival.
64

Answer in full. This question (taken from the December 2011 exam) focuses on another multi-dimensional performance management model: the performance pyramid.

65

Answer in full. This question (adapted from the June 2011 exam) looks at a third multi-dimensional performance management model – the building block model.

67

Answer in full. This question (adapted from the June 2012 exam) looks at another different model: the performance prism.

72

Answer in full. This question (amended from the December 2010 exam) looks at value generation in respect of a company’s shareholders. Specific topics covered are value-based management, activity-based management, and EVA.

xxxii

Planning your question practice

Syllabus section Strategic performance issues in complex business structures

2012 Pass cards chapters 14

Questions in this Kit
74

Done Comments Answer in full. This question (adapted from the June 2011exam) looks at the BCG matrix, and how the matrix can be used to evaluate a company’s performance. However, note that in part (b) you also need to evaluate the model itself. How useful is BCG analysis as a performance management system?

77

Prepare an answer plan. This question looks at the performance management issues which arise in relation to joint ventures.

78

Answer in full. This question (adapted from the June 2012 exam) looks at the difficulties of performance measurement and performance management in a virtual company.

Predicting and preventing corporate failure

15

80

Prepare an answer plan. This question addresses two separate topics. Use part (a) to revise your understanding of Porter's Five forces model. Then use part (b) to make sure you understand how performance measures can be used to indicate corporate failure.

81

Answer in full. This question (amended from the December 2010 exam) looks at performance issues which can lead to corporate failure, and the models which can be used to help predict corporate failure.

83

Answer in full. This question looks specifically at Argenti’s A score model, and its usefulness for predicting corporate failure.

Current developments and emerging issues in performance management

86

Prepare an answer plan. This question looks at the use of league tables for monitoring performance. What are the advantages and disadvantages of using league tables to monitor performance?

Current developments, issues and trends

16

87

Prepare an answer plan. This question looks at the changing role of management accountants in organisations.

Planning your question practice

xxxiii

Syllabus section

2012 Pass cards chapters

Questions in this Kit 88

Done Comments Prepare an answer plan. This is a second question looks at the changing role of management accountants in organisations, but with a direct reference to the work of Burns and Scapens, which is specifically mentioned in the P5 syllabus.

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Planning your question practice

Build your own exams
Having revised your notes and the BPP Learning Media Passcards, you can attempt the questions in the Kit as a series of practice exams using the suggestions we have listed below. 1 Section A 1 Section B 2 3 4 99 20 35 43 2 95 7 50 78 3 91 34 48 64 4 97 65 67 74 5 94 22 72 81 6 101 45 71 73

Planning your question practice

xxxv

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Planning your question practice

Questions

1

June and December 2013 exams
BPP’s answers for these exams, along with a small number of additional questions, will be available for free after the exams on http://www.bpp.com/acca

2

STRATEGIC PLANNING AND CONTROL Questions 1 to 16 cover strategic planning and control, the subject of Part A of the BPP Study Text for Paper P5.

1 Diverse holdings (PM 12/05, amended)
Diverse Holdings plc has five wholly-owned subsidiary companies. These are: (i) (ii) (iii)

45 mins

(iv) (v)

Organic Foods Ltd (OFL) which is involved in the production and sale of organically grown fruit and vegetables. OFL has built up a very good reputation as a supplier of quality produce. Haul-Trans Ltd (HTL) which was acquired on 1 December 20X5 and is involved in transporting a range of products on behalf of third parties. Kitchen Appliances Ltd (KAL) which is involved in the manufacture and sale of small, manually-operated kitchen appliances. KAL has recently suffered from squeezed margins as a consequence of competition from low cost imports. Paper Supplies Ltd (PSL) which manufactures and sells a narrow range of stationery products to two distributors. Office Products Ltd (OPL) which manufactures and sells computer workstations with unique design features which are highly regarded by health and safety experts.

The management accountant of Diverse Holdings plc has gathered the following actual and forecast information relating to the five subsidiaries: Year ending 30 November 20X3 20X4 20X5 20X6 20X7 Actual Actual Actual Forecast Forecast (OFL) Market size ($m) 100.0 120.0 150.0 180.0 225.0 Revenue ($m) 5.0 8.0 10.0 13.5 18.0 Operating profit ($m) 1.0 1.8 2.5 3.0 3.6 (HTL) Market size ($m) Revenue ($m) Operating profit ($m) (KAL) Market size ($m) Revenue ($m) Operating profit/(loss) ($m) (PSL) Market size ($m) Revenue ($m) Operating profit ($m) (OPL) Market size ($m) Revenue ($m) Operating profit ($m) Unknown 40.0 4.0 252.0 37.5 1.5 60.0 2.0 0.6 200.0 15.0 1.50 Unknown 40.0 4.0 250.0 37.5 1.1 65.0 2.0 0.6 220.0 16.0 1.60 Unknown 41.0 4.0 245.0 35.5 0.7 70.0 2.0 0.6 240.0 16.5 1.65 Unknown 42.0 5.0 242.0 32.0 0.3 77.0 2.0 0.5 260.0 17.0 1.70 Unknown 42.0 5.6 240.0 29.0 (0.2) 84.0 2.1 0.5 280.0 17.5 1.75

The management accountant has also collated the following information relating to the market share held at 30 November 20X5 by the market leader in those markets in which each subsidiary operates: Subsidiary Organic Foods Ltd Haul-Trans Ltd Kitchen Appliances Ltd Paper Supplies Ltd Office Products Ltd Market Food production Transport Kitchen appliances Stationery Workstations Market share held by market leader % 6.66 Unknown 16.00 35.00 25.00 3

Questions

The management has decided not to undertake any further acquisitions during the next two years due to a shortage of funds. Required (a) (b) (c) Identify and comment on FIVE advantages that may be gained as a result of the adoption of a formal system of strategic planning. (5 marks) Explain how SWOT analysis could be used to assist the performance management process at Diverse Holdings plc. (7 marks) (i) (ii) Using ONLY the information provided in the scenario, assess the competitive position of Diverse Holdings plc. (7 marks) Explain THREE strategies that might be adopted in order to improve the future prospects of Diverse Holdings plc. (6 marks) (Total = 25 marks)

2 ST University

45 mins

ST University (STU) is university in a European country, with approximately 8,500 full time students. It employs 360 academic staff and 450 other staff. STU currently receives a significant amount of government funding, which covers its capital budget (for buildings and equipment), teaching, and research. However, a recent visit from government appointed auditors has been critical of STU’s performance in a number of areas:         For the last two financial years, STU has operated at a deficit, with its expenditure being greater than its income. The percentage of students dropping-out of courses is greatly in excess of the national average, as is the failure rate. The number of student complaints was very high, and has been increasing over the past 5 years It has had an abnormally high level of staff turnover STU’s internal control of cash receipts is weak, and in several areas there were discrepancies between the cash actually held and the expected amount It also had a large number of debtors (receivables), mainly ex-students, but was not taking any action to collect outstanding debts. STU could not accurately produce a head-count of the number of students enrolled on its courses Overall, the quality of education provided by STU has been graded as ‘Poor’, which is the lowest possible rating.

Following the visit, the government has instructed STU to prepare a new strategic plan for the next five years, which addresses the criticisms identified by the audit. Although STU’s senior management team were disappointed at the level of the auditors’ criticism overall, they were particularly surprised at the comments about its computing facilities. Over the past two years, STU has made a major capital investment in upgrading all the computing facilities across the university. The auditors’ report made reference to this investment, but pointed out that some department faculties are making much better use of them to promote learning than others.

4

Questions

Required (a) (b) Discuss the extent to which the criticisms made about the University are strategic or operational. (6 marks) Advise STU how control measures could assist in the successful implementation of the new strategic plan, and recommend controls the university could use to assist in the improvement of any TWO of the areas which were criticised in the recent audit. (10 marks) Advise STU how it could use information systems to support the successful implementation of the strategic plan. (9 marks) (Total = 25 marks)

(c)

3 HEG (APM 12/07, amended)

45 mins

The directors of The Healthy Eating Group (HEG), a successful restaurant chain, which commenced trading in 1998, have decided to enter the sandwich market in Homeland, its country of operation. It has set up a separate operation under the name of Healthy Sandwiches Co (HSC). A management team for HSC has been recruited via a recruitment consultancy which specialises in food sector appointments. Homeland has very high unemployment and the vast majority of its workforce has no experience in a food manufacturing environment. HSC will commence trading on 1 January 20X8. The following information is available: (1) HSC has agreed to make and supply sandwiches to agreed recipes for the Superior Food Group (SFG) which owns a chain of supermarkets in all towns and cities within Homeland. SFG insists that it selects the suppliers of the ingredients that are used in making the sandwiches it sells and therefore HSC would be unable to reduce the costs of the ingredients used in the sandwiches. HSC will be the sole supplier for SFG. The number of sandwiches sold per year in Homeland is 625 million. SFG has a market share of 4%. The average selling price of all sandwiches sold by SFG is $2·40. SFG wishes to make a mark-up of 331/3% on all sandwiches sold. 90% of all sandwiches sold by SFG are sold before 2 pm each day. The majority of the remaining 10% are sold after 8 pm. It is the intention that all sandwiches are sold on the day that they are delivered into SFG's supermarkets. The finance director of HSC has estimated that the average cost of ingredients per sandwich is $0·70. All sandwiches are made by hand. Packaging and labelling costs amount to $0·15 per sandwich. Fixed overheads have been estimated to amount to $5,401,000 per annum. Note that fixed overheads include all wages and salaries costs as all employees are subject to fixed term employment contracts. Distribution costs are expected to amount to 8% of HSC's revenue. The finance director of HSC has stated that he believes the target sales margin of 32% can be achieved, although he is concerned about the effect that an increase in the cost of all ingredients would have on the forecast profits (assuming that all other revenue/cost data remains unchanged). The existing management information system of HEG was purchased at the time that HEG commenced trading. The directors are now considering investing in an enterprise resource planning system (ERPS).

(2) (3)

(4) (5) (6) (7) (8)

(9)

Required (a) Using only the above information, show how the finance director of HSC reached his conclusion regarding the expected sales margin and also state whether he was correct to be concerned about an increase in the price of ingredients. (6 marks) Explain the concept of critical success factors, and explain FIVE critical success factors to the performance of HSC on which the directors must focus if HSC is to achieve success in its marketplace. (13 marks) Explain how the introduction of an ERPS could impact on the role of management accountants. (6 marks)

(b) (c)

(Total = 25 marks)
Questions

5

4 CTC (APM 6/08, Preparation question)

36 mins

The Children's Toy Company (CTC) manufactures electrically-operated toy versions of animals. The activities of CTC are confined to the country of Stableland, which has a zero-inflation economy. The government of Stableland has granted tax-exempt status to CTC since it provides goods or services exclusively for children. However, no tax allowances are available on investments made by CTC. CTC has a total production capacity of 400,000 units which cannot be exceeded. The products to be manufactured together with forecast sales volumes are as follows: Product Bruno the Bear Kong the Ape Leo the Lion 20X8 180 150 60 Forecast sales units ('000) 20X9 20Y0 120 100 48 24 72 76 20Y1 60 0 30

Other relevant information relating to the products is as follows: 1 Selling prices per unit and contribution to sales ratios (%) for 20X8 and 20X9: Selling price per unit ($) Product: Bruno Kong Leo 2 Product-specific fixed overheads: Year Bruno Kong Leo 3 20X8 $000 3,800 2,400 2,040 20X9 $000 2,400 1,340 2,100 40 50 60 Contribution to sales ratio (%) 70 65 60

The company's other fixed overheads are estimated at $1·65 million per annum.

Required (a) (i) (ii) (b) Prepare a statement of product profitability for each of years 20X8 and 20X9 which also shows the net profit or loss of CTC. (4 marks) Comment on the figures in the statement prepared in (a)(i) above. (4 marks)

The marketing director of CTC has suggested the introduction of a new toy 'Nellie the Elephant' for which the following estimated information is available: 1 Sales volumes and selling prices per unit Year ending 31 May Sales units (000) Selling price per unit ($) 2 3 20X9 80 50 20Y0 180 50 20Y1 100 50

4 5

6

Nellie will generate a contribution to sales ratio of 50% throughout the three year period. Product specific fixed overheads during the year ending 31 May 20X9 are estimated to be $1·6 million. It is anticipated that these fixed overheads would decrease by 10% per annum during each of the years ending 31 May 20X0 and 31 May 20X1. Capital investment amounting to $3·9 million would be required in June 20X8. The investment would have no residual value at 31 May 20X1. Additional working capital of $500,000 would be required in June 20X8. A further $200,000 would be required on 31 May 20X9. These amounts would be recovered in full at the end of the three year period. The cost of capital is expected to be 12% per annum.

Assume all cash flows (other than where stated) arise at the end of the year. 6
Questions

Required (i) (ii) (iii) Determine whether the new product is viable purely on financial grounds. (4 marks)

Calculate the minimum target contribution to sales ratio (%) at which 'Nellie the Elephant' will be financially viable, assuming that all other data remain unchanged. (4 marks) Identify and discuss an alternative strategy that may assist in improving the performance of CTC with effect from 1 May 20X9 (where only the products in (a) and (b) above are available for manufacture). (4 marks) (Total = 20 marks)

5 AB Electronics

45 mins

AB Co manufactures, markets and distributes a large range of electronic components, and it is has established a significant market share across Europe and the United States of America. AB has three different divisions: the Domestic Electronic Components division (DEC), the Industrial Electronic Components division (IEC), and the Specialist Components (SC) division. The DEC division and the IEC division supply standard electronic components for domestic and industrial use, while the SC division supplies specialist components which are often unique and made to specific customer requirements. Each division has its own factory, with DEC and IEC’s factories based in the same Eastern European country and SC’s factory based in a Western European country. All three divisions have been profitable over the past five years, although the Board has traditionally taken a relatively cautious approach to providing strategic direction for the company. However, AB’s institutional shareholders are now looking for increased growth and profitability. In the past, the institutional shareholders have been critical of AB’s board for being overly cautious in their attitude to risk. In AB’s most recent annual report, published in March 20Y0, the Board stated that AB’s overall strategic aim is to: ‘Achieve growth and increase shareholder returns by continuing to produce and distribute high quality electronic components, and develop our international presence through expansion into new overseas markets.’ Two years earlier, in 20X8, AB established a separate trading company with a local partner in Asia to sell the IEC division’s products. The ownership of the company is shared: 50% by AB and 50% with a local entrepreneur. AB chose this structure because of local legal requirements. A further legal requirement is that, in the case of the company ceasing to trade, AB will be required to reimburse the local entrepreneur the full amount of his original investment (which was $500,000). This expansion was initially very successful, with good levels of demand being experienced for IEC’s products. Recently, however, a number of environmental factors have rapidly changed. These include a forecast of declining demand for IEC’s products in Asia due to adverse world economic factors (which have slowed the growth in demand for electronic components in total) and a move towards protectionism in some Asian countries. The trading company had originally been forecast to make a profit of $2 million in 20Y1, but this figure has now been reforecast to $1.6 million. IEC has also been unfortunate in that its direct labour costs in Asia have increased by more than the planned level. Economic intelligence suggests that this inflation will continue increasing for the next two years. However, analysis by AB’s management accountant shows that the trading company’s costs (and in particular its wage costs) are proportionally much higher than its competitors. Required (a) (b) (c) Advise the Board of AB how strategic management accounting could help it manage the performance of the trading company in Asia. (8 marks) Discuss the factors which AB should consider before withdrawing from the trading company it has established with its partner in Asia. (12 marks) Briefly discuss how the Board’s attitude to risk means it may respond to potential new opportunities in a different way than the institutional shareholders would like. (5 marks) (Total = 25 marks)

Questions

7

6 Megasnack

45 mins

Megasnack Co operates an extensive chain of fast-food outlets in a number of countries. Most outlets are owned and managed by the company but some are operated under a franchising agreement. The company’s strategy is based on conformity – providing a range of standard products at a standard price, in similarly-designed stores, using the same service procedures. This means that customers visiting a Megasnack outlet in any country will know what service, what eating environment and what products to expect, and (depending on currency rates) how much they will pay for their food. The financial strategy of the company has been to achieve targets for gross contribution and net operating profit at all outlets, and to achieve sales growth by meeting customer needs and expectations better than rival fast-food companies, with support from extensive advertising. Two key performance indicators which Megasnack uses to measure the performance of its outlets are: revenue per outlet; and staff costs as a percentage of revenue. The senior operations management team at head office have become concerned recently by a number of reported incidents in which some local outlets have been deviating from company strategy in order to meet targets for sales growth or profit margins. Several incidents are itemised below: (1) Some outlets have been offering special discount prices or special deals (‘two-for-the-price-of-one’) in order to increase sales, and, for the same reason, some outlets have offered a home delivery service, which is against company policy. Some outlets have cut training costs for staff in order to save costs, and head office managers are concerned that this could affect the quality and speed of service given to customers. Other outlets have taken on temporary staff without training them, in order to meet the demand from customers. There have been reports that in one country, outlets have been offering extra products on their menu, in addition to the standard Megasnack product range. There has been adverse publicity in the media about one outlet that was disposing of food waste in a way that was contrary to health and safety laws, and in breach of the company’s health and environmental policies. Another adverse media story has been the decision by the manager of one outlet to dismiss all the staff after they took unofficial strike action. The manager took this action without consulting head office or referring to the company’s industrial relations policy.

(2)

(3) (4)

(5)

Another source of concern has been a problem with the quality of the pre-preparation of food products. Megasnack’s products are pre-prepared at a number of large processing centres, and they are then transported to the outlets each day from these processing centres. Each outlet then finishes the preparation of the products for serving to customers in their own kitchen. Recently, during a period of high demand for products from the Megasnack outlets, the managers of some processing centres had resisted demands to produce more pre-prepared output, on the grounds that this would stretch their resources and damage the quality of the food items produced. Senior management have recognised that a problem exists with the processing centres and are considering what action to take. Required (a) (b) (c) Briefly evaluate the choice of revenue per outlet, and staff costs as a percentage of revenue as key performance indicators for Megasnack’s outlets. (5 marks) With reference to the experiences at Megasnack, discuss the reasons for conflict between the strategic business plans of a large organisation and short-term decision making at local level. (10 marks) Recommend the measures that senior management at Megasnack should take to reduce the scope for such conflict and the risk that this conflict might occur. (10 marks) (Total = 25 marks)

8

Questions

7 Ganymede (APM, 6/12, amended)

45 mins

Ganymede University (GU) is one of the three largest universities in Teeland, which has eight universities in total. All of the universities are in the public sector. GU obtains the vast majority of its revenue through government contracts for academic research and payments per head for teaching students. The economy of Teeland has been in recession in the last year and this has caused the government to cut funding for all the universities in the country. In order to try to improve efficiency, the chancellor of the university, who leads its executive board, has asked the head administrator to undertake an exercise to benchmark GU’s administration departments against the other two large universities in the country, AU and BU. The government education ministry has supported this initiative and has required all three universities to cooperate by supplying information. The following information has been collected regarding administrative costs for the most recent academic year: GU $’000 Research Contract management Laboratory management Teaching facilities management Student support services Teachers’ support services Accounting Human resources IT management General services Total Drivers: Student numbers Staff numbers Research contract value 14,430 41,810 26,993 2,002 4,005 1,614 1,236 6,471 17,049 115,610 AU $’000 14,574 42,897 27,263 2,022 4,100 1,571 1,203 6,187 16,095 115,912 BU $’000 4,719 42,646 26,723 2,132 4,441 1,611 1,559 6,013 8,644 118,488

($m)

28,394 7,920 185

22,783 7,709 167

29,061 8,157 152

The key drivers of costs and revenues have been assumed to be research contract values supported, student numbers and total staff numbers. The head administrator wants you to complete the benchmarking and make some preliminary comment on your results. The education ministry in Teeland is also keen that potential students should have as much information as possible to help them choose which University to apply to. To this end, the ministry has proposed that summary league tables are published showing:     The value of research funding secured by each university The proportion of students gaining first class and upper second (2:1) class degrees The proportion of students completing their courses The proportion of graduates who have secured full time employment within one year of graduating.

However, the chancellors of a number of universities in Teeland have written to the minister for education expressing their concern at the proposal to introduce the league tables. Required (a) (b) (c) Assess the progress of the benchmarking exercise to date, explaining the actions that have been undertaken, and those that are still required. (7 marks) Evaluate, as far as possible, Ganymede University’s benchmarked position. (10 marks)

Evaluate the usefulness of the proposed league tables for students choosing where to study in Teeland. (8 marks) (Total = 25 marks)

Questions

9

8 Budgeting (Preparation question)

36 mins

Budgeting may be viewed as a relevant technique in facilitating the assessment of business performance from initial planning to actual results. It will be necessary, however, to consider how to overcome factors that may limit its effectiveness. Required (a) (b) (c) Critically discuss the arguments for the use of budgeting in the implementation of FOUR aspects of the performance cycle. (8 marks) Highlight THREE advantages that may be claimed for the use of activity based budgeting rather than a traditional incremental budgeting system. (6 marks) Suggest FOUR reasons why advocates of a 'Beyond Budgeting' philosophy may not regard a major annual budget preparation exercise as an effective use of resources. (6 marks) (Total = 20 marks)

9 Business process re-engineering

45 mins

FCI is one of several insurance companies which offer insurance policies covering general risks relating to individuals and families. Cost efficiency is a major factor in the success of the companies in this industry, because competition within the industry is fierce. Over the past three years FCI has seen the volume of business increase, but profits have remained static due to declining margins. Although some of the processes within FCI are computerised, most of the processes which involve communication with customers are still paper-based. Responses to telephone enquiries from customers involve paper-based communications, both with the enquirers and internally within FCI. Additionally, sales staff visit potential customers in their homes to try to sell them insurance policies for their homes and their possessions. These transactions are again paper-based. This process is often slow and has led to complaints from both customers and the company’s sales staff. FCI has also been receiving a regular, and increasing, number of complaints from current and potential customers about errors in the paperwork that they receive. The Board of Directors of FCI has announced that there is a need for a business process re-engineering programme to be conducted, with the intention of modernising the business, and has asked the management accountant to help with the planning and implementation of the programme. The intention is to streamline the business model as much as possible, and to increase the profitability of the company. FCI intends to computerise almost all of the work done within the company. However, while some of the staff are enthusiastic about the BPR programme, a number have expressed concern about business process reengineering and its implications for them. Required (a) (b) Briefly explain the principles of business process re-engineering (BPR). (7 marks)

(i) Discuss the improvements that the Board of Directors might expect from introducing BPR to FCI’s business model. (10 marks) (ii) Recommend, with reasons, TWO performance targets which FCI could introduce to help ensure that the re-engineered processes enable it to achieve its business objectives. (5 marks)

(c)

Explain why FCI’s staff might be concerned about BPR and its implications for them.

(3 marks) (Total = 25 marks)

10

Questions

10 GMB Co (APM 12/07, amended)

45 mins

GMB Co designs, produces and sells a number of products. Functions are recognised from design through to the distribution of products. Within each function, a number of activities may be distinguished and a principal driver identified for each activity. Each sales order will normally comprise a number of batches of any one of a range of products. The company is active in promoting, where possible, a product focus for design, dedicated production lines and product marketing. It also recognises that a considerable level of expenditure will relate to supporting the overall business operation. It is known that many costs may initially be recognised at the unit, batch, product sustaining (order) or business/facility sustaining (overall) levels. A list of expense items relating to Order Number 377 of product Zeta is shown below. The methods of calculating the values for Order Number 377 shown below are given in brackets alongside each expense item. These methods also indicate whether the expense items should be regarded as product unit, batch, product sustaining (order) or business/facility sustaining (overall) level costs. The expense items are not listed in any particular sequence. Each expense item should be adjusted to reflect its total cost for Order Number 377. Order Number 377 comprises 5,000 units of product Zeta. The order will be provided in batches of 1,000 product units. Order Number 377 $ Production scheduling (rate per hour x hours per batch) 60,000 Direct material cost (per unit material specification) 180 Selling – batch expediting (at rate per batch) 60,000 Engineering design & support (rate per hour x hours per order) 350,000 Direct labour cost (rate per hour x hours per unit) 150 Machine set-up (rate per set-up x number of set-ups per batch) 34,000 Production line maintenance (rate per hour x hours per order) 1,100,000 Business/facility sustaining cost (at 30% of all other costs) 1,500,000 Marketing (rate per visit to client x number of visits per order) 200,000 Distribution (tonne miles x rate per tonne mile per batch) 12,000 Power cost (rate per Kilowatt hour x Kilowatts per unit) 120 Design work (rate per hour x hours per batch) 30,000 Administration – invoicing and accounting (at rate per batch) 24,000 Required (a) Prepare a statement of total cost for Order Number 377, which analyses the expense items into sections for each of four levels, with sub-totals for each level where appropriate. The four levels are: (i) (ii) (iii) (iv) (b) Unit-based costs; Batch-related costs; Product sustaining (order level) costs; and Business/facility sustaining (overall level) costs.

(6 marks)

Identify and discuss the appropriateness of the cost drivers of any TWO expense values in EACH of levels (i) to (iii) above and ONE value that relates to level (iv). In addition, suggest a likely cause of the cost driver for any ONE value in EACH of levels (i) to (iii), and comment on possible benefits from the identification of the cause of each cost driver. (12 marks)

(c)

Discuss the practical problems that may be encountered in the implementation of an activity-based system of product cost management. (7 marks) (Total = 25 marks)

Questions

11

11 Sports Shop

45 mins

SPS is a medium-sized retailer of sports equipment and leisure clothing. SPS was established in 1991, and currently operates from three retail shops in town centre locations. The management team at SPS is very careful about how it recruits staff. In addition to the specific skills required to do the job, any applicant must also have a 'passion' for sport. This has resulted in SPS gaining a reputation for excellent customer service and enthusiastic staff. A large proportion of staff time is also devoted to training, both on the product range and customer service techniques. According to a recent survey conducted by the store managers, the customers believe that SPS employees are 'helpful and knowledgeable'. The customers also praised the SPS shops for being 'well designed' and said that it was 'very easy' to find what they were looking for. Another feature of SPS that is appreciated by the customers is the range of goods stocked. By developing close relationships with the major manufacturers of sports goods and clothing, SPS is able to stock a far wider range of items than its rivals. Control of this stock was made easier, last year, by the development of a sophisticated computerised stock control system. Using the system, any member of staff can locate any item of stock in any of the shops or the warehouse. If the required item is not 'in stock' at SPS, it is also possible to automatically check the availability of stock with the manufacturer. At a recent management meeting, one of the store managers suggested that SPS consider developing its very basic website into one capable of e-retailing. At present, the website only gives the location of stores and some very basic details of the range of stock carried. Although the development of the website would be expensive, the managers have decided to give the suggestion serious consideration. Required (a) (b) Using the value chain model, analyse the activities that add value in the SPS organisation, BEFORE the eretail investment. (10 marks) Identify those activities in the value chain of SPS that may be affected by the e-retail investment, explaining whether the value added by each of them may increase or decrease as a result of the e-retail investment. (15 marks) (Total = 25 marks)

12 Scott

45 mins

Scott is a well-established, global publishing conglomerate. The corporation is structured to allow each country of operation to function as an autonomous business unit, that reports back to head office. The data from each business unit is entered onto the mainframe computer at head office. Each business unit can make use of any service offered by other business units and can also offer services to the other units. The services include translation into different languages, typesetting, printing, storage and so forth. In each country of operation there is at least one, and usually several, retail outlets. The core business was traditionally based upon the provision of fictional stories for the mass market. For the past decade Scott has diversified into publishing textbooks and technical literature. The organisation currently enjoys a good reputation in both areas of the business and global sales are increasing annually at a rate of 5% for fictional books and 2% for textbooks. Last year seven hundred million fictional works and twenty-five million textbooks were sold. The corporate management team wish to increase the growth in sales of textbooks but realise that they cannot afford to allocate significant resources to this task as the market, and profit margin, for textbooks is very much smaller than for fiction. They also wish to improve the sales performance of the fictional books. Scott is currently having trouble in maintaining a corporate image in some countries of operation. For example, several business units may be unaware of additions to the product range. Another example is that a price change in a book is not simultaneously altered by all the business units leading to pricing discrepancies. Some members of the corporate management team see possible advantages to upgrading the existing computer system to one that is fully networked. Other members are more sceptical and are reluctant to consider enhancing the system. 12
Questions

Required (a) (b) Discuss the issues involved in upgrading the existing information system and the proposed changes, with reference to both the wider business environment and the decision making process. (8 marks) Explain what is meant by the terms open systems and closed systems as applied to systems theory. Identify, with justification and where possible, any examples of these from the information given in, or inferred from, the case study. (7 marks) Management Information Systems (MIS) allow managers to make timely and effective decisions using data in an appropriate form. List three types of MIS and how they would be used in an organisation. (5 marks) Once the new system is established, it will be able to measure and report customer profitability. Explain the costs of obtaining data for the system, and for producing information, and briefly discuss how the value of such a system should be assessed. (5 marks) (Total = 25 marks)

(c) (d)

13 MKO clothing

45 mins

MKO manufactures a variety of clothing items which are sold through retailers, mainly in the domestic market. Most retailers are independent organisations, operating either as single outlets or as retail chains. MKO has a small number of its own shops where it sells its own products exclusively. In the past couple of years, there has been a noticeable change in the buying habits of retailers. Whereas previously, retailers would often place a large order for items at the beginning of each season, they now make smaller orders throughout the season when they have established which items are selling well and which are less popular. Retailers are also expecting prompt deliveries when they place an order. The operations director of MKO refers to this new retailer buying behaviour as ‘just in time purchasing’. The market for clothing is very competitive and retailers do not show much loyalty to their suppliers. Retailers buy items they think will sell well, and which are available quickly at a good price. Occasionally, retailers may ask for a specially-produced batch of items, subject to the items being available at a satisfactory price. In order to maintain or increase market share, MKO has a large sales force that travels round retail outlets and the central purchasing departments of large retail organisations. MKO’s sales staff receive a bonus based on the amount of sales they achieve. MKO has recently introduced an enterprise resource planning (ERP) system to coordinate the information systems of all the functions within the company, to replace the separate – and incompatible - manufacturing, inventory, accounting and sales systems that were used previously. The CEO of MKO believes that this will enable the company to be more effective and competitive. In addition, the CEO, who is a management accountant by training, believes that MKO should use strategic management accounting methods to improve decision-making, and he wants to establish an IT system for competitor analysis as a stage in the creation of a strategic information system. Required (a) Explain: (i) (ii) (b) How the introduction of an ERP system in MKO should improve the competitiveness of the company. (12 marks) The potential impact of introducing an ERP system on the role of management accountants in an organisation. (5 marks)

Describe the nature and purpose of strategic management accounting. Indicate the information that may be required for competitor analysis and discuss whether an IT system for competitor analysis will help to improve decision-making in MKO. (8 marks) (Total = 25 marks)

Questions

13

14 BV Entertainments

45 mins

Charles Lee has recently joined BV Entertainments (BVE) as senior management accountant. Previously he worked for DAS, a manufacturer of popular kitchen equipment. BVE arranges entertainment events for corporate clients, such as visits to major sporting events, the theatre and opera, as well as dinners, lunches and formal receptions. Charles is aware of significant differences between BVE and the company where he worked before. BVE’s customers are very demanding, and the entertainment services they require vary considerably. Arrangements are often altered at a late stage, due to changing requirements of the client or even, in the case of sporting events, unexpected weather conditions. Clients expect a very high quality of service. Some clients approach BVE to arrange an event specifically for them. However, for major sporting events, BVE sells tickets and then either hires a hospitality suite or erects a marquee to provide customers with high-quality meals before, during and after the event. For these events, advertising costs can be high. Cash flows are often a critical problem for BVE, because it usually has to pay for tickets and venues well in advance of receiving payment from clients. It is also important for BVE that each individual event should be profitable. Despite wanting high quality, clients are often reluctant to pay high prices and negotiate with BVE’s representatives to obtain the best deal they can get. Representatives may therefore be asked to reduce the quoted price, or provide more in the entertainment package: prices are commonly negotiated and agreed on the spot at meetings between BVE representatives and clients. For major sporting events, BVE buys a block of tickets which it then tries to sell within an entertainment package. Sometimes it is unable to sell all the tickets. On other occasions demand is strong, and BVE then tries to obtain additional tickets to sell. Required (a) (b) (c) With reference to BVE, explain how the characteristics of intangibility, heterogeneity, simultaneity and perishability can be used to distinguish services from manufactured products. (6 marks) Discuss how the accounting information requirements of BVE will differ significantly from those in a manufacturing company such as DAS. (10 marks) Discuss how an IT system that provides instant access for management and representatives to a central database can help to improve the quality of information available and the performance of the company. (9 marks) (Total = 25 marks)

15 EEE Chemical company

45 mins

EEE is an established chemical company extracting flavours and oils from plant materials and supplying them to the flavours and fragrances industries. The shareholders include institutional investors (20%), employees and pensioners of the company (20%) and the descendants of the family (30%) who founded the business approximately 100 years ago. The remainder of the shares are in public ownership. The company is reasonably successful but, recently, there has been pressure on margins and its future is not guaranteed. The majority of the Board of Directors are members of the founding family who have always taken an active part in the management of the business. When the company was originally started, the surrounding area was mainly used as agricultural land but, over time, a residential area has developed around the factory. Although many of the workers in the factory live locally, some of the housing is quite expensive and has attracted affluent residents from the local city. The chemical engineers at EEE have recently developed, and patented, a new process which would allow EEE to extract onion oil and garlic oil at far better yields than those obtained by existing processes. The market for these oils is very profitable and presents a significant opportunity for EEE to gain a real competitive advantage in its industry. The Directors are considering a business case to develop the new extraction process commercially, with a view to it eventually replacing EEE’s existing process. 14
Questions

Unfortunately, as with all extraction processes, there will be some leakage from the new process and, although perfectly safe and compliant with all safety legislation, the smell of the oils will offend some of the more affluent residents living near to EEE’s factory. They have duly complained to local government officers. There is very little other industry in the area and EEE is a large contributor to the local economy. One of the trade union representatives working in EEE is also an elected council member serving in the local government. Required As management accountant you have been asked to: (a) (b) (c) Advise the Board of Directors of the advantages to EEE of analysing stakeholders’ likely reactions to the proposed investment decision. (5 marks) Analyse the principal stakeholders in EEE in the context of the proposed investment in the new process. (15 marks) Recommend an acceptable course of action to the Board of Directors in the light of the stakeholder analysis conducted in (b). (5 marks) (Total = 25 marks)

16 GSC groceries

45 mins

GSC is a chain of shops which sells groceries. It was established over 150 years ago by a group of ethically motivated investors, who stated that GSC’s mission was ‘... to sell the best quality groceries at the cheapest prices’. Because of their religious beliefs, the original investors restricted GSC from selling any alcohol or tobacco products. At the time GSC was founded, this restriction was considered to represent responsible business practice. However, the restriction was an informal one, and did not appear in GSC’s mission statement or any legal documents (such as the company’s memorandum and articles of association). More recently, GSC has become a ‘Public Limited Company’ (Plc) and was floated on the London Stock Exchange in 20X7. Its current market value is £450 million, and its most recent reported profit was £40 million. Its current shareholders are: % of share capital GSC charitable trust 10 Number of investors 1 Motive for investing Uses funds to benefit health of the population Part of remuneration Part of remuneration Long-term security for pensioners Medium/long-term investors Seeks short-term profits GSC is a client Many and varied

GSC employees GSC directors Pension funds Investment trusts RCB : private equity fund UK clearing bank Private investors

10 2 15 15 25 20 3

5,080 6 2 4 1 1 15,000

In 20Y0, GSC decided to become a ‘24/7/365 grocer’. This means that all of its shops are always open: 24 hours a day, 7 days a week, and every day of the year. Since the change in opening hours, GSC has also found that many of its customers wanted to buy alcohol and tobacco products, particularly those customers using its shops between 2am and 6am. GSC’s Board of Directors has decided to implement a new retailing strategy from 1 June 20Y1 and start selling alcohol and tobacco products. GSC believes that this will give a substantial boost to its profits, and the Managing Director has announced in a statement to the Stock Exchange that ‘...this widening of our product portfolio should increase profits by at least £10 million a year by the end of 20Y2'. However, this announcement has attracted criticism from the GSC charitable trust which stated: ‘...the decision to sell alcohol and tobacco product is contrary to the whole ethos of GSC’.
Questions

15

Required (a) (b) (c) Evaluate, using Mendelow’s matrix, the levels of power and interest of GSC’s shareholders in the decision to sell alcohol and tobacco. You should justify your evaluations. (15 marks) Advise GSC’s Board of THREE other stakeholders who would be interested in the decision to sell alcohol and tobacco. You should state the reason for the interest of these stakeholders. (6 marks) With references to their respective motives for investing in GSC, discuss why the pension funds and RCB (private equity fund) could have conflicting views about the decision to start selling alcohol and tobacco products. (4 marks) (Total = 25 marks)

16

Questions

EXTERNAL INFLUENCES ON ORGANISATIONAL PERFORMANCE Questions 17 to 23 cover economic, fiscal and environmental factors, the subject of Part B of the BPP Study Text for Paper P5.

17 GTR panels

45 mins

GTR manufactures and installs solar panels in domestic homes and business premises. Its business is currently restricted to the east of the country in which it is based. GTR was established ten years ago as a window manufacturer, and it took a decision to switch to solar panelling about six years ago, when management saw a gap in the regional market. The owners of the company have now retired, and have been replaced by a professional management board of directors. Most sales are to domestic customers because the government in GTR’s country currently provides substantial cash grants to individuals who have solar energy panels installed in their homes. The high value of the grants available makes the cost of solar energy for these domestic users compare fairly well with the cost of energy from other sources, although it is still more expensive. Until this year, GTR’s board of directors prepared a rolling five-year business plan each year. This year it was agreed to abandon five year plans due to the level of risk and uncertainty in the industry, which the directors agreed made planning a pointless waste of time and effort. The plans seemed to get out of date much too quickly for them to be of much practical value. Conditions in the industry are changing continually. It has been reported that the government in GTR’s country will soon cut grants to domestic buyers of solar panels, in order to cut spending and reduce its budget deficit. There is production over-capacity in the solar panel industry worldwide, and imports from both China and the USA, where the surplus capacity exists, have been increasing. There is also uncertainty about future prices of other energy sources in GTR’s country, because the government has announced a reduction in its programme to construct nuclear energy reactors. The board of GTR is facing another problem. A new and more efficient type of solar panel has recently come on to the market. GTR could obtain a licence to make the new type of panel, but the board is concerned about the risk of investing in the new machine technology that will be required to manufacture the new solar panels. The board members are willing to take the risk, but they are aware that the company’s shareholders and lenders may have a lower appetite for risk. Required (a) (b) (c) (d) Assess how risk and uncertainty in the solar panelling industry, and the risk appetites of the company’s shareholders and lenders, may affect long-term strategic planning and decision-making in GTR. (8 marks) With reference to GTR, evaluate how a national government can help to improve business performance. (5 marks) Explain two methods or techniques that could be used by the management of GTR to assess the risk and uncertainty facing the company. (6 marks) Recommend potential alternatives to fixed annual budgets that GTR might use for planning and performance management purposes. (6 marks) (Total: 25 marks)

Questions

17

18 GHG (APM 6/08, amended)

45 mins

The Global Hotel Group (GHG) operates hotels in most of the developed countries throughout the world. The directors of GHG are committed to a policy of achieving 'growth' in terms of geographical coverage and are now considering building and operating another hotel in Tomorrowland. Tomorrowland is a developing country which is situated 3,000 kilometres from the country in which GHG's nearest hotel is located. The managing director of GHG recently attended a seminar on 'the use of strategic and economic information in planning organisational performance'. He has called a board meeting to discuss the strategic and economic factors which should be considered before a decision is made to build the hotel in Tomorrowland. Required (a) Discuss the strategic and economic factors which should be considered before a decision is made to build the hotel. (14 marks)

GHG has always used local labour to build and subsequently operate hotels. The directors of GHG are again considering employing a local workforce not only to build the hotel but also to operate it on a daily basis. Required (b) (c) Explain TWO ways in which the possibility of cultural differences might impact on the performance of a local workforce in building and operating a hotel in Tomorrowland. (6 marks) Advise the Board of GHG how strategic management accounting could help it manage the performance of the hotel in Tomorrowland. (5 marks) (Total = 25 marks)

19 F4U (APM 6/09)

45 mins

Franchising For You Ltd (F4U) markets a range of franchises which it makes available to its customers, the franchisees. F4U supplies the franchisee with information of the mode of operation, detailed operation schedules and back-up advice (by telephone, internet) and undertakes national advertising. Each franchisee must arrange for its own premises, equipment and undertake local marketing. F4U is considering the introduction of a Dance and Drama franchise which would have an expected life of six years. From this project, the only income F4U will receive from franchisees comes from the initial franchise fee. The following estimates have been made relating to the cash outflows and inflows for F4U in order that F4U can evaluate the financial viability of the Dance and Drama franchise proposal: 1. 2. 3. 4. 5. 6. 7. 8. Initial investment of $6m. This will include a substantial element relating to the 'intellectual capital' requirement of the proposal. Development/improvement costs of $1m per year at the end of each of years two and three. 300 franchises will be sold each year at a fee of $20,000 per franchisee. Variable costs, payable in full on the issue of each franchise, are estimated at $6,000 per franchise. Directly attributable fixed costs of $0·6m per year in each of years one to six. No further fixed costs will be payable by F4U after this period. Corporation tax at the rate of 30%, payable in the year in which cash flow occurs. Tax allowances are not available on the initial investment or development/improvement costs payable by F4U. All cash flows are stated in current prices and with the exception of the initial investment will occur at the end of each year. The money cost of capital is 15·44%. Annual inflation during the period is estimated at 4%.

18

Questions

Required (a) (b) (c) Calculate the net present value (NPV) of the Dance and Drama franchise proposal and recommend whether it should be undertaken by F4U. (6 marks) Discuss the elements to be considered as 'intellectual capital' and issues associated with its valuation for inclusion in the initial investment of $6m. (6 marks) Discuss ways in which reliance solely on financial performance measures can detract from the effectiveness of the performance management system within an organisation. (6 marks)

F4U has identified key variables as follows: 1. The number of franchises taken up each year. It is estimated that a flexible pricing policy will result in the following outcomes: Fee per franchise $ 22,000 20,000 18,000 2. Number of franchises sold each year 270 300 355

The variable cost per franchise may be $7,000, $6,000 or $5,000. The NINE possible outcomes of a spreadsheet model used in calculating the NPV and incorporating the variables 1 and 2 above, have been identified as follows: Payoff Matrix: NPV values Fee per franchise ($000) 18 20 22 Variable cost 5 4,348,226 4,007,630 4,274,183 per franchise 6 3,296,822 3,119,120 3,474,524 ($000) 7 2,245,419 2,230,610 2,674,865

Required (d) State the franchise fee pricing strategy ($ per franchise) which will result from the operation of each of the following decision rules: (i) (ii) (iii) Maximax; Maximin; Minimax regret. (7 marks) (Total = 25 marks)

Your answer should explain the basis of operation of each of the three decision rules.

20 CAP (APM 12/09, amended)

45 mins

Cundy Aquatic Pursuits (CAP) was founded in 1978 by its managing director, Jody Cundy. CAP owns and operates a chain of Aqua Parks in the country of Lizland. Each Aqua Park has a number of large indoor and outdoor swimming pools together with a range of attractions such as water-slides, toboggan runs and surfing rides. Jody Cundy firmly believes that growth in the number of Aqua Parks is the key to success for CAP, and therefore CAP pursued organic growth which has been financed from retained profits and public share issues. At present, Jody Cundy owns 55% of the ordinary share capital of CAP. Jody has stated on many occasions that 'I always want to control this business'. The following information is available: Year ended 30 November Revenue ($m) Operating costs Profit before tax ($m) Number of Aqua Parks 20X6 330 270 60 56 20X7 320 264 56 58 20X8 308 256 52 60 20X9 280 240 40 62

Questions

19

Summary Income Statement for year ended 30 November 20X9 Revenue Operating costs Profit before tax Taxation Profit after tax $m 280 240 40 (10) 30

Summary Statement of Financial Position at 30 November 20X9 Non-current assets Net current assets 9% Redeemable preference shares (20X0) Financed by: Ordinary shares $1 Retained profits Other information: (1) Jody Cundy considers that it is becoming more and more difficult to earn profits in Lizland and is considering a proposal to expand operations into the country of Robland. CAP would begin construction of forty new Aqua Parks within Robland, on 1 December 20X9. Each Aqua Park will require a capital outlay of $3 million. Robland is a country which is 3,200 kilometres from Lizland. A market research study commissioned by Jody Cundy indicated 'reasonable' future prospects for Robland. During recent years Robland has experienced some significant variations in its currency, the 'Rob'. CAP's price earnings ratio at the end of 20X9 was 10 compared to an industry average of 12. Dividends were paid during the year ended 30 November 20X9 as follows: Preference Ordinary (5) $m 9 14 $m 30 5 10 (15) 30 $m 220 30 250 (100) 150 28 122 150

(2)

(3) (4)

Net current assets at 30 November 20X9 were as follows: Inventories Trade and other receivables Bank Trade and other payables

(6) (7)

No provision has been made for redemption of the preference shares which are redeemable at a premium of 10% on 30 November 20X0. Revenue during the year ended 30 November 20X5 amounted to $325 million.

Required: (a) (b) (c) Evaluate the financial performance of CAP. (6 marks)

Discuss the principal financial, economic and social considerations that should be considered by Jody Cundy prior to a decision to proceed with the proposed expansion into Robland. (14 marks) Discuss the difficulties which CAP may experience in managing the performance of its operations in Robland, if the proposed expansion goes ahead. (5 marks) (Total = 25 marks)

20

Questions

21 EMA (APM 6/10)

45 mins

The Equine Management Academy (EMA) which was founded in 1990 is a privately owned organisation located in Hartland, a developing country which has a large agricultural sector and where much transportation is provided by horses. EMA operates an Equine College which provides a range of undergraduate and postgraduate courses for students who wish to pursue a career in one of the following disciplines: Equine (Horse) Surgery Equine Dentistry, and Equine Business Management. The Equine College which has a maximum capacity of 1,200 students per annum is currently the only equine college in Hartland. The following information is available: (1) A total of 1,200 students attended the Equine College during the year ended 31 May 20Y0. Student mix and fees paid were as per the following table: Student category Surgery Dentistry Business Management (2) (3) % of total number of students 30 25 45 Fee ($) per student, per annum 12,000 10,000 6,000

Total operating costs (all fixed) during the year amounted to $6,500,000. Operating costs of the Equine College are expected to increase by 4% during the year ending 31 May 20Y1. This led to a decision by the management to increase the fees of all students by 5% with effect from 1 June 20Y0. The management expect the number of students and the mix of students during the year ending 31 May 20Y1 to remain unchanged from those of the year ended 31 May 20Y0. EMA also operates a Riding School at which 240 horses are stabled. The Riding School is open for business on 360 days per annum. Each horse is available for four horse-riding lessons per day other than on the 40 days per annum that each horse is rested, i.e. not available for the provision of riding lessons. During the year ended 31 May 20Y0, the Riding School operated at 80% of full capacity. Horse-riding lessons are provided for riders in three different skill categories. These are 'Beginner', 'Competent' and 'Advanced'. During the year ended 31 May 20Y0, the fee per riding lesson was as follows: Skill category of horse rider Beginner Competent Advanced Lesson mix 50% 25% 25% Fee ($) per lesson 15 30 50

(4)

(5)

(6) (7)

Total operating costs of the Riding School (all fixed) amounted to $5,750,000 during the year ended 31 May 20Y0. It is anticipated that the operating costs of the Riding School will increase by 6% in the year ending 31 May 20Y1. The management have decided to increase the charge per lesson, in respect of 'Competent' and 'Advanced' riders by 10% with effect from 1 June 20Y0. There will be no increase in the charge per lesson for 'Beginner' riders. The lesson mix and capacity utilisation of the Riding School will remain the same during the year ending 31 May 20Y1.

(8)

Questions

21

Required (a) Prepare a statement showing the budgeted net profit or loss for the year ending 31 May 20Y1. (7 marks)

Some time ago the government of Hartland, which actively promotes environmental initiatives, announced its intention to open an academy comprising an equine college and riding school. The management of EMA are uncertain of the impact that this will have on the budgeted number of students and riders during the year ending 31 May 20Y1, although they consider that due to the excellent reputation of the instructors at the riding school capacity utilisation could remain unchanged, or even increase, in spite of the opening of the government funded academy. Current estimates of the number of students entering the academy and the average capacity utilisation of the riding school are as follows: Equine College Student Fees Probability No change 0.20 Decrease by 10% 0.60 Decrease by 20% 0.20 Required (b) (i) Prepare a summary table which shows the possible net profit or loss outcomes, and the combined probability of each potential outcome for the year ending 31 May 20Y1. The table should also show the expected value of net profit or loss for the year; (9 marks) Comment briefly on the use of expected values by the management of EMA; (3 marks) Riding School Capacity utilisation Probability 90% 0.10 80% 0.60 70% 0.30

(ii) (iii)

Suggest three reasons why the government of Hartland might have decided to open an academy comprising an equine college and a riding school. (6 marks) (Total = 25 marks)

22 FGH Telecom (APM 12/10, amended)

45 mins

FGH Telecom (FGH) is one of the largest providers of mobile and fixed line telecommunications in Ostland. The company has recently been reviewing its corporate objectives in the light of its changed business environment. The major new addition to the strategic objectives is under the heading: ‘Building a more environmentally friendly business for the future’. It has been recognised that the company needs to make a contribution to ensuring sustainable development in Ostland and reducing its environmental footprint. Consequently, it adopted a goal that, by 20Y7, it would have reduced its environmental impact by 60% (compared to year 20X1). The reasons for the board’s concern are that the telecommunications sector is competitive and the economic environment is increasingly harsh with the markets for debt and equities being particularly poor. On environmental issues, the government and public are calling for change from the business community. It appears that increased regulation and legislation will appear to encourage business towards better performance. The board have recognised that there are threats and opportunities from these trends. It wants to ensure that it is monitoring these factors and so it has asked for an analysis of the business environment with suggestions for performance measurement. Additionally, the company has a large number of employees working across its network. Therefore, there are large demands for business travel. FGH runs a large fleet of commercial vehicles in order to service its network along with a company car scheme for its managers. The manager in charge of the company’s travel budget is reviewing data on carbon dioxide emissions to assess FGH’s recent performance. Recent initiatives within the company to reduce emissions have included (a) (b) the introduction in 20Y0 of a home-working scheme for employees in order to reduce the amount of commuting to and from their offices and a drive to increase the use of teleconferencing facilities by employees.

22

Questions

Data on FGH Telecom: Carbon Dioxide emissions Measured in millions of kg Commercial Fleet Diesel Commercial Fleet Petrol Company Car Diesel Company Car Petrol Other road travel (Diesel) Other road travel (Petrol) Rail travel Air travel (short haul) Air travel (long haul) Hire Cars (Diesel) Hire Cars (Petrol) Total Required (a) (b) Briefly evaluate how well FGH’s environmental strategy is aligned to the interests of THREE different stakeholder groups. (5 marks) Perform an analysis of FGH’s business environment to identify factors which will affect its environmental strategy. For each of these factors, suggest performance indicators which will allow FGH to monitor its progress. (8 marks) Evaluate the data given on carbon dioxide emissions using suitable indicators. Identify trends from within the data and comment on whether the company’s behaviour is consistent with meeting its targets. (9 marks) Suggest further data that the company could collect in order to improve its analysis and explain how this data could be used to measure the effectiveness of the reduction initiatives mentioned. (3 marks) (Total 25 marks) 20X1 Base year 105.4 11.6 15.1 10.3 0.5 3.1 9.2 5.0 5.1 0.6 6.7 172.6 20X9 77.7 0.4 14.5 3.8 1.6 0.5 9.6 4.4 7.1 1.8 6.1 127.5 20Y0 70.1 0.0 12.0 2.2 1.1 0.3 3.4 3.1 5.4 2.9 6.1 106.6

(c)

(d)

23 SQR Sports racquets

45 mins

SQR Co is a small, family-owned firm, established fifty years ago, which specialises in the manufacture of sports racquets. It manufactures all its racquets at its factory workshop in the UK. SQR sells a small quantity of racquets directly to the public from its own shop next to the factory, but the majority of its business comes through a major UK sports retailer. SQR supplies its racquets to the retailer, which then sells them to consumers from its nationwide chain of stores. However, SQR faces intense competition from other producers, both nationally and from abroad - particularly from the Far East. It does not have a website. When SQR was first established, it employed only five members of staff to produce and assemble wooden squash racquets, and to string them with the latest nylon. As SQR began to establish a favourable reputation for the quality of its racquets, revenue and profits grew steadily, and the firm moved into larger premises. The early 1990s saw significant growth in the popularity of squash, and the demand for SQR’s racquets from players at newly-opened squash clubs across the UK increased enormously. Nonetheless, SQR had sufficient surplus production capacity at its factory to accommodate this growth in output, although it needed to recruit additional members of staff to help satisfy the demand. However, the managing director realised that the rapid growth of the squash market would not continue indefinitely, and in the mid-1990s SQR began to diversify and established new assembly lines for tennis and badminton racquets, alongside squash racquets in its workshop. This diversification proved to be very successful as SQR was able to benefit from its reputation for well-made, reliable products, using only the finest materials and best craftsmen. 23

Questions

Revenue and earnings grew impressively over the next few years, particularly as a result of the growth in the tennis and badminton markets. Despite the tough economic climate – bordering on recession – in recent years, SQR has remained in a relatively strong financial position. However, when next year’s budget was discussed at the most recent board meeting, the directors expressed their concerns over the forecast reductions in profit margins. The last two decades have seen immense changes take place in the technology used in the production of sports racquets. In particular, carbon fibres are now used to produce racquet shafts, along with high quality, expensivelyproduced strings. To keep pace with this changing technology, SQR, which has grown into one of the largest producers of sports racquets in the UK, has had to make substantial changes to its production process and its traditional methods of production. The firm is also reinvesting much more money into research and development in an attempt to remain competitive. Firms in France, Germany and the Far East have been very quick and successful at incorporating the new technology and materials into the products. This has led to the market becoming increasingly competitive, with a number of new racquet producers emerging. The emergence of new materials and technology has helped lengthen the useable life-span of consumers’ racquets, as the materials used to make them are no very durable. However, increased consumer knowledge and awareness (particularly amongst more experienced players) about the capabilities, qualities and performance of different racquets, has meant that racquets which are not made from the latest materials and technologies are rapidly discarded by players in favour of the latest product range. Required (a) With reference to appropriate models, discuss why it is important for the directors to consider the external environment when reviewing SQR’s budgeted performance. (20 marks)

When the directors were discussing SQR’s profit margins at the most recent board meeting, the finance director suggested that the sports racquets’ positions in their product life cycles was another factor which had contributed to SQR’s lower profit margins. Required (b) Briefly discuss how product life cycles could be affecting SQR’s performance. (5 marks) (Total 25 marks)

24

Questions

PERFORMANCE MEASUREMENT SYSTEMS AND DESIGN Questions 24 to 34 cover performance measurement systems and design, the subject of Part C of the BPP Study Text for Paper P5.

24 Handra

45 mins

Handra manufactures equipment for metal testing. It also manufactures the electronic chips that go into the manufacture of the testing equipment. The company has a well-established cost and management accounting system. The cost accounting system records the actual manufacturing costs for the electronic chips and the testing equipment, and also produces standard unit costs for the purposes of budgeting and variance analysis. The management accountant of Handra is pleased with the management information system that is in place within the company, and is particularly proud of the budgetary control reporting system that provides monthly control reports to the board within one week of the end of each month. The market for metal testing equipment is growing at a reasonable rate, but there are three other competitors in the market. Competition between them is strong and consequently profit margins are fairly low at the moment, although Handra is operating at a profit. Handra’s senior management are not sure what any competitor might do next, although they suspect that at least one of them may be in financial difficulty. Handra’s sales director is certain that although low prices are one factor in the buying decisions of customers, customers are much more concerned about the quality, reliability and functional features of the equipment that Handra produces. At a recent board meeting, the board made two important decisions. The first was a decision not to invest in new equipment for manufacturing electronic chips that would significantly reduce the water and energy consumption in the production process. This decision was taken because the discounted cash flow return on investment was considered insufficient. The second decision was an agreement that costs needed to be reduced to improve profitability. In relation to this, the board decided that employees in the manufacturing units should be empowered more, and should be given some authority to take decisions affecting production operations. The board also discussed the current lack of sufficient strategic information within Handra. They were aware that the decision not to invest in the new equipment had not taken into consideration the probability of rising water and energy costs in the future, and they felt they needed more information to help them predict the long term prospects for their industry. Required (a) (b) (c) (d) Explain the difference between strategic, tactical and operational information, and give examples of each that should be used by a company such as Handra. (9 marks) Discuss why it will be important for Handra to monitor non-financial aspects of performance as well as financial performance. (5 marks) Evaluate the compatibility of the current management accounting system in Handra and the information it provides with the objectives of management accounting. (7 marks) Discuss the ways in which the information requirements for a performance management system in Handra would be changed by the delegation of authority to employees working at factory floor level. (4 marks) (Total 25 marks)

Questions

25

25 FDS irrigation systems

45 mins

FDS Co installs irrigation systems. Its customers include farmers, local government bodies, sports centres and building contractors. Its annual sales turnover is currently $25 million, and annual pre-tax profit is $1.2 million. The company is currently working at close to capacity, and its activities are restricted by a shortage of skilled engineers to install and maintain the pumping equipment for the irrigation systems. Prices for the installation of irrigation systems are negotiated between customers and sales representatives of FDS. The sales representatives have authority to offer discounts on price in order to win large contracts or in return for more favourable payment arrangements. The installation of irrigation systems typically takes several months for large contracts, and FDS usually sets up a site office on the customer’s premises with a compound for holding system parts and other inventory. Delivering inventory to a site can be difficult, especially where the customer is a farmer in a remote location. Sports centres often insist on minimum disruption to sporting activities during the installation of a new irrigation system. This can limit the size of the site office and inventory compound, which sometimes delays progress on a contract when the installation team has to wait for more inventory to be delivered. The installation teams all fill in time sheets on a daily basis. The management accountant of FDS is not satisfied with current reporting arrangements, and thinks that some types of contract are much more profitable than others. It seems likely, for example, that farmers negotiate much better prices than local government bodies (such as local councils). Some contracts are more complex and difficult to negotiate than others, and winning a contract from a local government body can take much longer than contract negotiations with other customers. The management accountant thinks that the company would benefit from the introduction of a customer profitability reporting system, where the profitability of each type of customer is measured and assessed separately. A benefit of this type of reporting system is that FDS should be able to put more resources into selling to more profitable types of customer, thereby helping to increase the company’s profitability. The management accountant is particularly concerned that, as FDS is working close to its capacity, there is a danger it could turn down contracts (due to lack of capacity) which would have been more profitable than contracts it has accepted. This issue has been highlighted recently as FDS has been asked to undertake three new installations, but only has sufficient resources to carry out two of them. Basic price ($) Discount negotiated Installation team time budgeted (@ $1,500 per day) Sports centre 200,000 4% 56 days Farm 200,000 5% 50 days Building contractor 200,000 3% 45 days

The inventory delivery costs for the sports centre and the building contractor’s installations were expected to be the same, but the costs for the farm installation expected to be $25,000 higher. All other costs were expected to be the same for the three contracts. FDS has not yet decided which two contracts to accept. Despite the management accountant’s concerns about the current reporting arrangements, the CEO is not convinced that a customer profitability reporting system would be useful for FDS. The CEO wants to know where the information will come from and how it will be collected, as well as what the costs and benefits of the reporting system would be. Required (a) (b) (c) Discuss the information requirements for a customer profitability reporting system within FDS and where the data for this system might be obtained. (10 marks) Discuss how the information in a customer profitability reporting system might improve management control and decision-making within FDS. (10 marks) Explain what the direct and indirect costs of obtaining data and producing information for this system might be, and how the value of such a system should be assessed. (5 marks) (Total: 25 marks)

26

Questions

26 TREN engine components

45 mins

TREN manufactures standard engine components. It operates a costing system based on absorption costing and standard costs, and the management control system is based on monthly variance analysis reports. TREN has recently appointed a new CEO, who has begun to introduce changes to the manufacturing systems. He believes in lean manufacturing principles, and has begun to establish a just-in-time manufacturing system, with a focus on reducing inventories and production cycle times, and eliminating waste. Discussions are in progress with major suppliers to introduce just-in-time purchasing arrangements. The CEO has informed the management accountant that changes will be needed to the company’s internal accounting systems, and has indicated that TREN will need a lean management accounting system to support its lean manufacturing system. The CEO is dissatisfied with many of the features of the current management accounting system. There are many errors in data capture for the cost accounting system, and monthly variance reports are not produced until two weeks after the end of each month. He also considers that the wrong information is being reported. Required (a) Explain the main principles of a lean information system and discuss why an organisation may not experience the improvements in productivity and profitability they expect if they implement a lean information system. (11 marks) Discuss the reasons why TREN’s current cost and management accounting systems do not fulfil the requirements of lean information systems. (6 marks) Identify the changes that should be made to TREN’s management accounting system in order to turn it into a lean information system. (8 marks) (Total: 25 marks)

(b) (c)

27 KLP divisions

45 mins

KLP has been growing its business successfully for a number of years, and the business has now grown to a size where the board considers it necessary to establish four divisions as investment centres and delegate more decision-making authority to the management of these divisions. The authority delegated authority to the divisional managers will include decision-making responsibility for new capital investment projects for their divisions, within overall budget guidelines. The board has also decided that a reward system should be introduced and that divisional managers should receive annual bonuses based on the profitability and return on investment of their division. The board considers that an incentive system of this kind will be necessary to provide the motivation for divisional managers to work for the long-term growth and development of the company. At the moment, the board receives performance reports for the company as a whole. The most recent annual report is summarised below. $m $m Revenue 620.2 Manufacturing costs Direct manufacturing costs 142.6 186.3 Manufacturing overhead costs 328.9 Gross profit 291.3 Administration costs 69.8 Selling and distribution costs 105.3 11.5 Finance costs 186.6 104.7 Net profit before taxation The four divisions are largely independent operating units, although there are transfers of components and services between some divisions. As there is no external market price for most of the services and components transferred,

Questions

27

the board has decided that transfers will be priced at cost plus a suitable margin for profit, although the divisional managers should have the freedom to negotiate the transfer prices between themselves. The group management accountant has been asked to design a performance reporting system that will be appropriate for the new divisional structure and the requirements for responsibility accounting. Several issues have not yet been fully considered. (1) One of the divisions produces high-technology components. The rate of innovation for new components is rapid, and it has been estimated that an 80% learning curve applies to the manufacturing work in this division. The group management accountant is concerned about giving too much emphasis to profit and return on investment within the performance reporting system. The problems of controllability within a responsibility accounting system have not yet been properly addressed. It is already clear that the managers of the new investment centres will respond to the bonus incentives on offer and that the performance reporting system that is introduced will need to encourage them to take decisions that are in the long-term interests of KLP.

(2) (3) (4)

Required (a) (b) (c) Assess how the requirements for responsibility accounting should affect the design of the new performance reporting system. (12 marks) Assess how the expected behaviour of the divisional managers should affect the design of the new performance reporting system. (8 marks) Management control systems have an important role to play in developing accountability. Briefly discuss the categories of control mechanism which KLP could use to cope with the problem of organisational control. (5 marks) (Total: 25 marks)

28 Racer deliveries

45 mins

RACER operates a parcel and cargo delivery service for business, government and domestic customers. It has grown successfully over the past twenty years, and now has a sophisticated management accounting system that measures and reports the costs of delivering different types and weights of package between any two locations, and the profitability of its services. However, the board of directors is concerned about the lack of other information about the company’s operations and performance. The directors believe that the success of the company has been built on a reputation for reliable service and strong brand recognition, although they have no firm evidence to support this opinion. The directors are also aware that RACER’s main competitors have introduced cost-saving automated calling systems, whereby the entire process consists of recoded messages and voice recognition, so that customers can request parcel or cargo deliveries without having to speak to anyone. RACER’s directors are convinced that automated calls may provide short-term benefits through cost reduction, but that the quality of the service to customers is reduced. The directors believe that RACER’s success is built on its high-quality personal service for callers. RACER does not have an automated calling system; instead it operates a call centre which is staffed by full-time employees. Whenever customers have specific questions to ask or specific problems to handle, the call centre staff are able to use their knowledge to assist them and provide a better service. The directors’ views, however, are a matter of opinion, and there is some concern within the business that unless RACER introduces automated calling systems, it may lose business to its competitors. The management accountant of RACER has suggested that the board would benefit from the provision of more qualitative information about its services and performance. The directors have opinions about reputation, service quality, reliability, experience and customer satisfaction, but they do not have any evidence on which to base their views or to make decisions about the company’s operational systems. The management accountant has suggested 28
Questions

that they should use customer surveys to get feedback about how well RACER is performing in key areas of the business, by asking customers to score RACER’s performance in each area between 1 (very poor) – 5 (excellent). Required (a) (b) (c) Discuss the qualitative information that may be of benefit to the directors of RACER. (10 marks)

Discuss the difficulties that would have to be addressed when introducing a reporting system for the board and the company’s management to provide information of a qualitative nature. (10 marks) Briefly evaluate the usefulness of introducing the customer surveys which the management accountant has suggested. (5 marks) (Total: 25 marks)

29 Auto Parts

45 mins

Auto Parts (AP) is a manufacturing company employing 1,300 people which makes components for the automotive industry. AP has had ‘preferred supplier’ status with a major car manufacturer, CDM, since September 20Y0. This means AP is guaranteed a minimum amount of business with CDM each week. The preferred supplier status is reviewed annually. CDM insists on a year-on-year reduction of 3% in the prices charged by AP. AP’s current level of guaranteed business with CDM is $2 million per week, and this constitutes 90% of AP’s revenue. CDM operates a just-in-time production and purchasing system and it has a policy of not inspecting the components supplied to it by AP. However, if there are two reports of any of AP’s components failing in a year, either during production or later in a vehicle driven by one of CDM’s customers, AP will lose its preferred supplier status. AP has a number of competitors which would like to replace it as CDM’s preferred supplier. AP’s Managing Director, K, has the following objectives, which have been imposed upon him by AP’s Board of Directors:    Maintain the preferred supplier status with CDM; Keep AP's expenditure within the limits set each year in the budget which is approved by its Board of Directors; Develop the management skills of AP's 32 operational managers

K is held responsible for the successful achievement of the objectives and he may lose his job if any are not met. K believes that the best way to achieve his objectives is by the use of a performance management system (PMS) which he has designed. K’s PMS is based exclusively on budgetary control. This PMS uses quarterly reports prepared by AP’s budget accountant. These reports compare budgeted and actual expenditure for each of AP’s 2,000 cost centres. The quarterly reports are reviewed by K and later discussed with AP’s operational managers. The operational managers are shown the aggregate amount of under or overspending in the cost centres but are not allowed to know the detail underlying this. This is because K believes that the details of AP’s finances should only be known to members of the Board of Directors. Recently, the Board of Directors have begun to express some concerns about the information they are provided from the PMS, and have suggested that AP needs to purchase a new performance management system. However, K has expressed his concerns about the cost of introducing a new system relative to the benefits it would offer AP.

Questions

29

Required (a) (b) Evaluate the effectiveness of AP's performance management system in assisting K achieve his objectives. (10 marks) Recommend, with reasons, THREE improvements AP could make to its current performance management system. Note: Your answer to part (b), must NOT include introducing the balanced scorecard (or any other specific performance management model) as one of the recommendations. (6 marks) (c) (d) Recommend, with reasons, TWO performance measures which would show AP’s operational managers the progress they are making towards maintaining AP’s preferred supplier status with CDM. (4 marks) Using your answers from parts (a) and (b), evaluate whether the benefits of a new performance management system could justify the costs. (5 marks)

(Total = 25 marks)

30 CMA Supermarkets

45 mins

The board of CMA Supermarkets is considering an upgrade of its company-wide IT system. The company has been opening new supermarket stores at a rapid rate in recent years, and has ambitions to rival the established supermarket chains in its country. The board believes that CMA could gain a significant competitive advantage from having a unified corporate database and from replacing its bar code technology with RFID, the radio frequency technology for labelling and identifying inventory. The management accountant at CMA has been asked to explain to the board how a new network system and RFID technology may help to improve the management accounting system within the company, and also the company’s performance. At the moment, management accounts are prepared for each individual store, and monthly sales and profitability reports are presented to the store manager. Regional reports and a national report on company performance are also prepared each month, and presented to senior management and the board. Because the company is trying to increase market share rapidly, it keeps its prices as low as possible, and whereas rival companies achieve a gross profit margin of about 55% on its sales, CMA’s average gross margin is slightly below 50%. In addition, a number of CMA’s stores have reported an increase in out-of-stock products in recent weeks. The store managers are concerned that if customers keeping finding items out-of-stock they will stop shopping at CMA and will revert to one of the established supermarket chains. The management accountant thinks that new technology will help to improve profitability and will influence the nature of performance reporting system. The benefits of improved IT will only be obtained however, if there is a radical re-thinking of how information is used within CMA. Required (a) Explain how RFID technology for tracking inventory and inventory movements may help to improve the quality of management information in CMA Supermarkets, and may also help to improve CMA’s operational performance. (12 marks) Assess the changes which may be required to performance reporting in CMA Supermarkets in order to obtain the greatest value from a new IT system and RFID technology. (8 marks) Suggest how the IT system for a supermarket might exploit information about individual customers to improve sales and profits. (5 marks) (Total = 25 marks)

(b) (c)

30

Questions

31 Viga Drinks (Preparation question)

36 mins

The Viga Drinks Company plc (Viga) has recently experienced several incidents that have called into question the adequacy of its procedures for protecting the confidentiality of sensitive information. The union representatives at one of the company’s production centres called a strike because they received information that Viga’s board had decided to close down the centre. This was not true. The board had discussed the possibility of merging two production centres, but had subsequently decided against the idea. Following assurances from the board that the production centre was not going to be closed, the strike was called off. Even so the directors were aware that information about their deliberations about the merger of the two centres must have been ‘leaked’. In another incident, a member of the accounts department resigned from the company following disclosure of confidential information about his private life. This employee had recently reported a suspicion of fraud by a small group of managers. The board suspected that the identity of the whistle blower had been revealed, and the disclosure of the information about his private life was an act of retaliation or victimisation. In yet another incident, confidential information about the results of a health and safety inspection of the company’s production centres by government health and safety inspectors had been given to the press, and had been reported as an ‘exclusive’ in a national newspaper. Most recently, within the past week, a railway company has returned a laptop computer that had been left on a train by Viga’s company secretary. The laptop contained a lot of confidential information, including the company’s draft budget for next year.

Viga’s Chief Executive Officer (CEO) is seriously concerned the breaches of confidentiality and secrecy. At the back of his mind is the thought that the commercial success of Viga is based on the success of a unique soft energy drink, the recipe for which is a closely-guarded secret (and which has not been patented in order to protect its secrecy). The CEO is now wondering whether there is anyone in the company who might have access to the secret, and would be prepared to sell it to a rival drinks producer. Required (a) (b) With reference to Viga, explain the reasons why confidential information may be improperly released, and the potential consequences for an organisation when this occurs. (10 marks) Recommend procedures that should be taken by Viga’s senior management to ensure the security of highly-confidential information. (10 marks) (Total = 20 marks)

32 Beachy
Beachy Co is a large holiday travel company, with a number of offices located across Arcadia.

45 mins

Beachy’s finance director has recently had to address the Board of Directors about the findings of an internal audit that had been conducted on the company’s information and reporting systems. The internal audit report had concluded that far too much information, both routine and non-routine, was generated and distributed internally within the company. As a result, management were suffering from ‘information overload’ on a large scale, and they were spending an excessive amount of time preparing and reading information, much of it of limited use or relevance, instead of getting on with other aspects of their work. The internal audit report had referred to examples of some managers who were receiving over 1,000 e-mails a day, many of them from internal sources. The internal auditors also found that the sources of much of the information that was circulated by e-mail were not identified, and much of the information was often out-of-date. There were also frequent differences between the information produced and used in local offices of the company and comparable information that was circulated at head office. The finance director concluded his address to the board by suggesting that instead of providing much-needed support for managers, internally-produced information was a source of inefficiency and contributed to a lack of coordinated decision-making within Beachy Co. He recommended that measures should be taken to deal with problems surrounding the amount and quality of information produced, and that guidance on this matter should come initially from the Board.
Questions

31

Required (a) (b) With reference to Beachy, assess the possible risks to a company from uncontrolled generation and distribution of internal information. (10 marks) Recommend suitable measures that should be taken and controls that should be introduced to deal with the risks you have identified in part (a). (10 marks)

One of the suggestions which the finance director made to the Board was that, rather than simply looking at the way internal information was distributed, Beachy would benefit from making its management information systems leaner overall. Required (c) Explain how lean thinking can be applied to management information systems. (5 marks) (Total = 25 marks)

33 Cobra Golf Club (Preparation question)

36 mins

The Cobra Golf Club is one of the largest and most successful members’ golf clubs in its country. It is administered by a general manager, who is supported by an accountant. Monthly performance reports are prepared for the board of directors, which consists of the general manager and non-executive directors who are elected from the club membership. The board of directors has recently been accused by the membership of failing to control the club’s finances, and there is strong opposition to rumoured plans for a large increase in annual subscriptions next year. At a recent board meeting, the directors agreed that financial control could be improved, but argued that it was very difficult to monitor the club’s income and expenses because the monthly management accounts were not as helpful as they could be. The monthly management accounts consist of a nine-page report. An example of the first page of a report is as follows. Current month Year to date (YTD) Budget % increase on YTD This year Last year This year Last Current Year to Annual year month date INCOME Subscriptions 127,800 129,200 383,400 387,600 129,200 383,400 1,550,400 (1.1) Entrance fees 9,000 3,000 15,000 12,000 7,500 22,500 90,000 25.0 Green fees 16,800 12,100 45,900 44,300 14,000 42,000 48,000 2.5 2,000 4,400 5,600 7,200 3,000 9,000 36,000 Hire of rooms (22.3) 155,600 148,700 449,900 451,100 153,700 456,900 1,724,400 (0.3) Bar and catering Total sales 52,800 50,700 142,300 140,200 50,000 150,000 720,000 1.5 Cost of sales 27,100 26,800 74,000 74,500 25,000 75,000 360,000 (0.1) Gross profit 25,700 23,900 68,300 65,700 25,000 75,000 360,000 4.0 23,900 23,200 70,200 68,900 24,000 72,000 300,000 Wages 1.9 1,800 700 (1,900) (3,200) 1,000 3,000 60,000 Net (59.3) contribution

32

Questions

EXPENDITURE Course expenditure (see page 3) Club house expenditure (see page 4) Administration Staff costs Golf professional Insurance Stationery, postage Telephone Prizes and competitions Marketing Training IT costs Miscellaneous Depreciation Course improvements Course machinery Clubhouse building Fittings and furniture Net income

73,200

64,700

132,100

127,400

50,000

150,000

600,000

3.7

52,200

53,600

116,000

116,300

45,000

145,000

540,000

(0.3)

18,500 8,000 1,800 700 3,800 500 100 1,200 1,500 9,400 45,500 4,000 8,200 3,100 800 16,100 (29,600)

18,200 7,600 1,600 2,100 3,400 700 900 0 1,400 7,300 43,200 3,900 8,000 2,900 700 15,500 (27,600)

55,500 24,000 5,400 1,800 10,500 2,100 3,500 1,200 4,200 31,800 140,000 12,000 24,600 9,000 2,300 47,900 12,000

54,600 23,000 4,800 2,600 9,100 2,000 3,900 1,000 4,000 25,000 130,000 11,700 24,000 8,700 2,100 46,500 27,700

18,000 7,800 1,750 800 3,300 700 1,000 700 1,200 8,000 43,250 4,000 8,000 3,000 700 15,700 750

54,000 23,400 5,250 2,400 9,900 2,100 3,000 2,100 3,600 24,000 129,750 12,000 24,000 9,000 2,100 47,100 (11,950)

216,000 93,600 21,000 9,600 39,600 8,400 12,000 8,400 14,400 96,000 519,000 48,000 96,000 36,000 8,400 188,400 (63,000)

1.6 2.7 12.5 (30.8) 15.4 5.0 (10.3) 20.0 5.0 27.2 7.7

(56.7)

Page 2 of the report provides a more detailed analysis of bar and catering services. Page 3 and page 4 provide a detailed analysis of expenditure of the golf course and the club house, analysed in the same columns as page 1. Page 5 provides a balance sheet as at the end of the month and page 6 provides a review of capital expenditure (budget and actual for the year to date). Page 7 provides a cash flow analysis, month by month. Page 8 provides a rolling forecast of results for the year, which is prepared by adding actual results for the year to date to the budget for the rest of the year. Finally page 9 provides a list of aged debtors (receivables), who are mainly companies who have hired for golf society days at the course. Required (a) (b) Explain the nature of information overload in management reporting. (5 marks)

Analyse the weaknesses in the reporting system used by the Cobra Golf Club and recommend changes that might be made. (15 marks) (Total: 20 marks)

Questions

33

34 Bluefin School (APM, 12/11, amended)

45 mins

Bluefin School (Bluefin) is a school for 12 to 17-year-old pupils. It currently has 1,000 pupils attending drawn from its local area. The school is run by an executive group comprising the head of school and two deputy head teachers. This group reports to a board of governors who are part-time and selected from the local community and parents. The school is wholly funded by the government. The school’s ethos is ‘to promote learning, citizenship and self-confidence among the pupils. This is developed from a consensus, led by the board of governors and the head of school and informed by the views of the pupils’ parents.’ The school information systems are highly decentralised. Each department keeps its own records on a stand-alone PC using basic word processing and spreadsheet packages. The school’s administrative department has a small network in its own offices with compatible applications and also a database and financial recording and reporting package for use in schools (provided by the government). The school is broken down into 11 academic departments such as mathematics, science and history. Each department head must prepare information for reporting to the board by inputting and processing the data. They obtain some help from an administrator who visits each department to spend a few hours per week helping in the recording and preparation of the departmental information. The department heads have different approaches to reporting their performance, with some using average marks in the annual exams for each class and some using pass rates of the annual exams. Some department heads present graphs of their data while most use tables of figures. The information is passed from each department to the school administration office on a memory stick (USB flash drive). The school administration office prints out the information for each department and adds it to a financial report creating a governors’ pack of usually about 13 pages for the annual review board meeting. The financial report is a detailed income and expenditure statement for the period under review (usually a two page print-out from the reporting package). An example of one of the 11 departments’ report is given in the Appendix on the next page. The board of governors meets every quarter and reviews the governors’ pack once a year. The board are concerned that the information that they are receiving is not meeting their needs and that there are a number of problems with the control and security of some of the data. It has been suggested that the school should consider improving its information systems by installing a network across the school to link the departmental computers and the administration department. A single database would be created to store all the performance information. The computers would then be linked to the internet in order to facilitate data transfer to other schools in the region and to the government.

[Question continues on the next page]

34

Questions

Appendix Bluefin School Mathematics department Year 20Y0/20Y1 Class A B C D A B C D A B C D A B C D A B C Average marks Current yr Previous yr % % 63 59 60 61 51 55 47 44 61 70 58 62 49 47 45 43 67 67 61 57 50 50 42 41 62 58 59 59 50 54 46 47 57 58 51 49 47 48 54 53

Year 1

Year 2

Year 3

Year 4

Year 5

Year 6 Notes: Each year contains pupils of the same age.

Annual national exams are set in years 4, 5 and 6. Each year group is divided into different classes in order to ensure that classes do not exceed 35 pupils. (Not all pupils take every subject each year.) Average marks are for the annual examinations. Required (a) (b) (c) (d) With reference to the current situation at Bluefin School, discuss the controls and security procedures that are necessary for management information. (9 marks) Using the limited information available, evaluate the usefulness of the pack that is provided to the board of governors. (6 marks) Discuss the usefulness of the different ways the heads of department could use to present their performance information to the board. (5 marks) Evaluate the improvements suggested to the information systems at Bluefin. (5 marks) (Total = 25 marks)

Questions

35

STRATEGIC PERFORMANCE MEASUREMENT Questions 35 to 61 cover strategic performance measurement, the subject of Part D of the BPP Study Text for Paper P5.

35 CFD (APM 12/09, amended)

45 mins

The 'Care For Dogs Company' (CFD) is a very profitable organisation which was established in 1998. CFD offers accommodation, care and supervision for pet dogs owned by inhabitants of Barkland. CFD provides temporary accommodation for dogs whose owners are unable to care for them due to holidays, work commitments, illness etc. As part of the service offered to dog owners, CFD collects and returns dogs at the beginning and end of all dog stays. When CFD was formed, the directors created a mission statement which was 'to provide very high value for money to all of our clients'. The directors have always attempted to manage CFD in a socially responsible manner. Indeed, they are now considering the creation of a 'Dog Sanctuary' for homeless dogs which would involve an allocation of 20% of the total accommodation available for dogs to the Dog Sanctuary. The Dog Sanctuary would accommodate homeless dogs until such time as a new owner was found for them. CFD would not receive any revenue whatsoever in respect of any homeless dog. Required (a) (b) (i) (ii) (i) (ii) (c) Discuss the purpose, potential benefits and potential problems of mission statements. Advise the directors of CFD regarding the appropriateness of its mission statement. (8 marks) (4 marks)

Explain what ‘critical success factors’ are, and explain the relationship between critical success factors and key performance indicators. (4 marks) Discuss THREE critical success factors for CFD, and highlight a key performance indicators for each critical success factor. (6 marks)

Excluding the number of complaints by clients, identify and briefly explain THREE quantitative non-financial performance measures that could be used to assess the 'quality of service' provided by CFD. (3 marks) (Total = 25 marks)

36 ZTC Communications

45 mins

ZTC, a telecommunications company, has recently been privatised by the government of Zeeland after legislation was passed which removed the state monopoly and deregulated the communications market, opening it up to competition from both national and overseas companies. Prior to the deregulation, ZTC was the sole supplier of telecommunications in Zeeland and was required to provide 'the best telecommunications service the nation can afford'. At that time the government dictated the performance levels required for ZTC, and the level of resources it would be able to bring to bear to meet its objectives. Following the privatisation, ZTC’s shares were floated on the Zeeland Stock Exchange, with 80% being made available to the population of Zeeland and up to 20% being made available to foreign nationals. The government of Zeeland retained a 'golden share' to prevent the acquisition of ZTC by any foreign company. However, the privatisation meant that many of the traditional ways in which the industry had operated would need to change under the new regulations. Apart from the money received from the flotation, the government privatised ZTC in recognition of both the changing global environment for telecommunications companies, and the overseas expansion opportunities that might exist for the privatised company. The government recognises that foreign companies will enter the home market but feels that this increased competition is likely to make ZTC more effective in the global market. You have recently been appointed as the management accountant for ZTC and have a background in the commercial sector. The Board of Directors remains unchanged from the time ZTC's was a state monopoly.

36

Questions

Required (a) (a) (b) (c) With specific reference to ZTC, discuss how the external environment can affect an organisation’s performance. (5 marks) Explain to the Board of Directors why the objectives of ZTC will need to change as a result of the privatisation of ZTC and the deregulation of the market. (10 marks) Recommend TWO examples of suitable strategic objectives for ZTC, following its privatisation and the deregulation of the market, and explain why each would be an appropriate long term objective. (4 marks) Explain the link between objectives and critical success factors, and recommend, with reasons, TWO Critical Success Factors (CSFs) which would be appropriate for ZTC as a company. (6 marks) (Total = 25 marks)

37 Large conglomerate (Preparation question)
Project X data (1) (2) (3) (4)

36 mins

A large conglomerate with diverse business activities is currently considering whether it should commence Project X and has gathered the following data.

An initial investment of $54 million will be required on 1 January year 1. The project has a three-year life with a nil residual value. Depreciation is calculated on a straight line basis. The project is expected to generate annual revenue flows of $80m in year 1, $90m in year 2 and $100m in year 3. These values may vary by  5%. The incremental costs will be $50m in year 1, $60m in year 2 and $70m in year 3. These may vary by  10%. The most likely cost of capital is 10%. This may vary from 8% to 13% for the life of the project.

Additional information Assume that all cash flows other than the initial investment take place at the end of each year. Use the written down value of the asset at the start of each year to represent the value of the asset for the year. Note. Ignore taxation. Required (a) Prepare two tables showing net profit, residual income and return on investment for each year of the project and also net present value (NPV) for: (i) (ii) (b) The BEST OUTCOME The WORST OUTCOME (8 marks)

Explain the distinctive features of residual income, return on investment and net present value in measuring financial performance. Your answer should include a critique of the strengths and weaknesses of each measure. (8 marks)

(c)

What broader issues are likely to be considered when deciding whether the company should proceed with a particular project? (4 marks) (Total = 20 marks)

Questions

37

38 CSG (PM 6/07, amended)

36 mins

The Chemical Services Group plc (CSG), which operates a divisionalised structure, provides services to industrial and domestic customers in Swingland, a country whose economic climate is subject to significant variations. There have been a number of recent changes at board level within CSG and therefore the managing director called a meeting of the board of directors at which each of four recently appointed directors put forward their view as to what their primary focus should be. These were as follows: The research and development director stated that 'my primary focus is upon ensuring that we continue to develop the products and services that satisfy the requirements of our existing and potential customers'. The finance director stated that 'my primary focus is upon keeping our investors satisfied'. The human resources director stated that 'my primary focus is upon ensuring that we take all the steps necessary to establish and maintain our reputation as a responsible employer'. The corporate affairs director stated that 'my primary focus is upon the need to ensure that we are recognised as a socially responsible organisation'. After the meeting, the managing director spoke to the finance director and said that whilst he agreed, in principle, that it was important to keep CSG’s investors satisfied he was concerned that the investors consistently seem to want growth whereas he felt it was more important for CSG to focus on survival. Required (a) Discuss the criteria that should be considered in deciding upon suitable performance measures in respect of the primary focus of each of the FOUR directors of CSG providing THREE appropriate quantitative measures for each primary focus. Note: your answer may include financial or non-financial quantitative measures. (b) (c) (12 marks)

Compare and contrast strategies which focus on business survival with strategies which focus on business growth. (5 marks) Explain how growth may be assessed, and critically discuss the advantages and issues that might arise as a result of a decision by the directors of CSG to pursue the objective of growth. Note: your answer should refer to financial and non-financial factors. (8 marks) (Total = 25 marks)

39 SEC

45 mins

The Success Education Centre (SEC), which commenced trading in 20X3, provides tuition for students preparing for accountancy examinations in Homeland. In 20X5, SEC established a similar semi-autonomous operation in the neighbouring country of Awayland. Divisional managers have no control over acquisition and financing policy with regard to operations under their control.

38

Questions

Financial data (all stated on an actual basis) in respect of the two divisions for the two years ended 30 November 20X6 and 20X7 are as follows: Income statement Homeland $000 4,500 1,500 500 1,000 3,000 250 20X6 Awayland $000 1,000 600 150 300 1,050 75 50 125 1,175 (175) 2006 250 150 400 Combined $000 5,500 2,100 650 1,300 4,050 325 150 400 875 4,925 575 Homeland $000 5,000 1,575 510 1,040 3,125 300 350 650 3,775 1,225 20X7 Awayland $000 1,300 630 155 300 1,085 100 100 200 1,285 15 2007 500 200 700 Combined $000 6,300 2,205 665 1,340 4,210 400 125 450 975 5,185 1,115

Revenue Salaries Tuition materials & consumables Other operating costs Marketing Interest (Group) Depreciation and amortisation

350 600 3,600 900 Profit Summary statements of financial position 2,750 750 3,500

Non-current Assets Net Current Assets 10% Loan stock Capital and Reserves

3,000 900 3,900 1,500 2,400 2,400

2,750 1,315 4,065

3,250 1,515 4,765 1,250 3,515 3,515

Currently, SEC’s board of directors receive a summary of the financial data at their board meetings, but they have now also asked for some key non-financial indicators to be included in their board pack. Required (a) (b) (c) (d) (e) Provide an assessment of the financial performance of SEC and of the respective contributions of the operations in Homeland and Awayland during the two years ended 30 November 20X7. (8 marks) Identify FOUR items of additional information that would be useful in order to provide a more comprehensive assessment of the financial performance of each operation. (4 marks)

Discuss the factors that should be taken into consideration when assessing the comparative financial performance of the two operations. (4 marks) Discuss the advantages of using Earnings Before Interest, Taxation, Depreciation and Amortisation (EBITDA) as a measure of financial performance. (4 marks) Identify, and briefly evaluate, TWO non-financial performance measures which SEC should include in the board pack. (5 marks) (Total = 25 marks)

Questions

39

40 CD

45 mins

The Creative Division (CD) of Unique Components Ltd produces wooden components that it both sells to external customers and transfers to other divisions within its own group of companies. The production involves the preparation of timber, cutting the timber into shapes and the assembly of the shapes into components. The total component cost for component A has been estimated as $41.21 per unit. Selling prices to external customers have been set by adding a mark-up of 35% to total estimated component cost. Required (a) (b) With reference to CD, explain the criteria for designing a transfer pricing system (5 marks)

Discuss the application and acceptability of each of the following transfer price bases at which component A may be offered by CD to other divisions within the same group of companies: (i) (ii) (iii) External selling price and adjusted selling price; Marginal cost, marginal cost plus an annual lump sum; and Dual pricing.

Your answer should incorporate illustrative values ($) for each transfer price using data provided above and additional data of your choice. (10 marks) (c) A redesign of component A is being considered that is likely to result in changes in the quantity of timber and number of cuts, in the shaping process that will be required. A data-table analysis has been prepared to monitor the effect on unit cost for component A of a range of values for such changes. In addition, a set of subjective probabilities have been assigned to the likelihood of (i) the timber required and (ii) the number of cuts required, being at the levels shown in the data-table analysis. A matrix has been constructed showing the combined probability for each possible combination of changes of timber and number of cuts. The datatable analysis and combined probability matrix are as follows: Data-table of values of total component cost for component A per unit ($) for a range of values of number of cuts in shaping and timber required (square metres) Timber (square metres) 0.8 0.7 0.6 0.5 0.4 25 47.15 43.50 39.81 36.07 32.28 30 47.69 44.04 40.34 36.61 32.81 Number of cuts 35 48.15 44.50 40.81 37.07 33.28

40 48.55 44.90 41.21 37.47 33.68

50 49.21 45.56 41.87 38.13 34.34

Combined probability matrix showing combined probability values for a range of values of number of cuts in shaping and timber required (square metres) Timber (square metres) Prob. 0.1 0.2 0.2 0.4 0.1 25 0.2 0.02 0.04 0.04 0.08 0.02 30 0.3 0.03 0.06 0.06 0.12 0.03 Number of cuts 35 0.3 0.03 0.06 0.06 0.12 0.03

0.8 0.7 0.6 0.5 0.4

40 0.1 0.01 0.02 0.02 0.04 0.01

50 0.1 0.01 0.02 0.02 0.04 0.01

Note: The expected value of unit cost, based on above data-table and combined probability matrix is $39.84.

40

Questions

You may assume that management attitudes vary as follows: (i) Some of the management team are in favour of change provided that a reduction of at least 12% from the existing total unit cost is achieved; (ii) Others in the management team are not in favour of change if it might lead to an increase in total unit cost from the current level of $41.21; and (iii) The remainder of the management team are of the view that they are willing to consider the re-design change if the expected value (EV) solution is less than the current value of total unit cost. Required Discuss the impact of the possible changes in the quantity of timber and number of cuts in the Shaping process caused by the re-design of component A on the total cost per unit of component A. You should incorporate an analysis of statistics from the data-table and probability information contained in the model into your discussion with specific reference to the impact of management attitude to risk when deciding whether or not to change from the existing quantity of timber and number of cuts for component A. (10 marks) (Total = 25 marks)

41 Alpha Division (APM 12/07)
(1) (2) (3) (4)

45 mins

Alpha Division, which is part of the Delta Group, is considering an investment opportunity to which the following estimated information relates: An initial investment of $45m in equipment at the beginning of year 1 will be depreciated on a straight-line basis over a three-year period with a nil residual value at the end of year 3. Net operating cash inflows in each of years 1 to 3 will be $12·5m, $18·5m and $27m respectively. The management accountant of Alpha Division has estimated that the NPV of the investment would be $1·937m using a cost of capital of 10%. A bonus scheme which is based on short-term performance evaluation is in operation in all divisions within the Delta Group.

Required (a) (i) Calculate the residual income of the proposed investment and comment briefly (using ONLY the above information) on the values obtained in reconciling the short-term and long-term decision views likely to be adopted by divisional management regarding the viability of the proposed investment. (6 marks) A possible analysis of divisional profit measurement at Alpha Division might be as follows: Sales revenue Less: variable costs 1. Variable short run contribution margin Less: controllable fixed costs 2. Controllable profit Less: non-controllable avoidable costs 3. Divisional profit Required Discuss the relevance of each of the divisional profit measures 1, 2 and 3 in the above analysis as an acceptable measure of divisional management performance and/or divisional economic performance at Alpha Division. You should use appropriate items from the following list relating to Alpha Division in order to illustrate your discussion: (i) (ii) (iii) Sales to customers external to the Delta Group Inter-divisional transfers to other divisions within the Delta Group at adjusted market price Labour costs or equipment rental costs that are fixed in the short term
Questions

(ii)

$m xxx xxx xxx xxx xxx xxx xxx

41

(iv) (v) (b)

Depreciation of non-current assets at Alpha Division Head office finance and legal staff costs for services provided to Alpha Division. (8 marks)

Summary financial information for the Gamma Group (which is not connected with the Delta Group) is as follows: Income statements/financial information: 20X6 $m 400 96 (29) 67 (23) 44 20X7 $m 450 117 (35) 82 (27) 55

Revenue Profit before tax Income tax expense Profit for the period Dividends Retained earnings Statements of financial position

Non-current assets Current assets Financed by: Total equity Long-term debt Other information is as follows: (1) (2) (3) (4) (5) (6) (7) (8) (9) (10)

20X6 $m 160 180 340 270 70 340

20X7 $m 180 215 395 325 70 395

Capital employed at the end of 20X5 amounted to $279m. The Gamma Group had non-capitalised leases valued at $16m in each of the years 20X5 to 20X7 which were not subject to amortisation. Amortisation of goodwill amounted to $5m per year in both 20X6 and 20X7. The amount of goodwill written off against reserves on acquisitions in years prior to 20X6 amounted to $45m. The Group's pre-tax cost of debt was estimated to be 10%. The Group's cost of equity was estimated to be 16% in 20X6 and 18% in 20X7. The target capital structure is 50% equity, 50% debt. The rate of taxation is 30% in both 20X6 and 20X7. Economic depreciation amounted to $40m in 20X6 and $45m in 20X7. These amounts were equal to the depreciation used for tax purposes and depreciation charged in the income statements. Interest payable amounted to $6m per year in both 20X6 and 20X7. Other non-cash expenses amounted to $12m per year in both 20X6 and 20X7.

Required (i) (ii) Stating clearly any assumptions that you make, estimate the Economic Value Added (EVA™) of the Gamma Group for both 20X6 and 20X7 and comment briefly on the performance of the Group. (8 marks) Briefly discuss THREE disadvantages of using EVA™ in the measurement of financial performance. (3 marks) (Total = 25 marks)

42

Questions

42 BAG (APM 12/08, Preparation question)

36 mins

The Better Agriculture Group (BAG), which has a divisional structure, produces a range of products for the farming industry. Divisions B and C are two of its divisions. Division B sells a fertiliser product (BF) to customers external to BAG. Division C produces a chemical (CC) which it could transfer to Division B for use in the manufacture of its product BF. However, Division C could also sell some of its output of chemical CC to external customers of BAG. An independent external supplier to The Better Agriculture Group has offered to supply Division B with a chemical which is equivalent to component CC. The independent supplier has a maximum spare capacity of 60,000 kilograms of the chemical which it is willing to make available (in total or in part) to Division B at a special price of $55 per kilogram. Forecast information for the forthcoming period is as follows: Division B: Production and sales of 360,000 litres of BF at a selling price of $120 per litre. Variable conversion costs of BF will amount to $15 per litre. Fixed costs are estimated at $18,000,000. Chemical (CC) is used at the rate of 1 kilogram of CC per 4 litres of product BF. Division C: Total production capacity of 100,000 kilograms of chemical CC. Variable costs will be $50 per kilogram of CC. Fixed costs are estimated at $2,000,000. Market research suggests that external customers of BAG are willing to take up sales of 40,000 kilograms of CC at a price of $105 per kilogram. The remaining 60,000 kilograms of CC could be transferred to Division B for use in product BF. Currently no other market external to BAG is available for the 60,000 kilograms of CC. Required (a) (i) State the price/prices per kilogram at which Division C should offer to transfer chemical CC to Division B in order that the maximisation of BAG profit would occur if Division B management implement rational sourcing decisions based on purely financial grounds. Note. You should explain the basis on which Division B would make its decision using the information available, incorporating details of all relevant calculations. (6 marks) (ii) Division C is considering a decision to lower its selling price to customers external to the group to $95 per kilogram. If implemented, this decision is expected to increase sales to external customers to 70,000 kilograms. Required For BOTH the current selling price of CC of $105 per kilogram and the proposed selling price of $95 per kilogram, prepare a detailed analysis of revenue, costs and net profits of BAG. Note. In addition, comment on other considerations that should be taken into account before this selling price change is implemented. (6 marks) (b) The management of Division C has identified the need to achieve cost savings in order to become more competitive. They have decided that an analysis and investigation of quality costs into four sub-categories will provide a focus for performance measurement and improvement. Required Identify the FOUR sub-categories into which quality costs can be analysed and provide examples (which must relate to Division C) of each of the four sub-categories of quality cost that can be investigated in order that overall cost savings might be achieved and hence the performance improved. (8 marks) (Total = 20 marks)

Questions

43

43 SSA (APM 12/09, amended)

45 mins

You are the management accountant of the SSA Group which manufactures an innovative range of products to provide support for injuries to various joints in the body. The group has adopted a divisional structure. Each division is encouraged to maximise its reported profit. Division A, which is based in a country called Nearland, manufactures joint-support appliances which incorporate a 'one size fits all people' feature. A different appliance is manufactured for each of knee, ankle, elbow and wrist joints. Budget information in respect of Division A for the year ended 31 December 20X0 is as follows: Support appliance Sales units (000's) Selling price per unit ($) Total variable cost of sales ($'000) Knee 20 24 200 Ankle 50 15 350 Elbow 20 18 160 Wrist 60 9 240

Each of the four support products uses the same quantity of manufacturing capacity. This gives Division A management the flexibility to alter the product mix as desired. During the year to 31 December 20X0 it is estimated that a maximum of 160,000 support products could be manufactured. The following information relates to Division B which is also part of the SSA group and is based in Distantland: 1. 2. Division B purchases products from various sources, including from other divisions in SSA group, for subsequent resale to customers. The management of Division B has requested two alternative quotations from Division A in respect of the year ended 31 December 20X0 as follows: Quotation 1 – Purchase of 10,000 ankle supports. Quotation 2 – Purchase of 18,000 ankle supports. The management of the SSA Group has decided that a minimum of 50,000 ankle supports must be reserved for customers in Nearland in order to ensure that customer demand can be satisfied and the product's competitive position is maintained in the Nearland market. The management of the SSA Group is willing, if necessary, to reduce the budgeted sales quantities of other types of joint support in order to satisfy the requirements of Division B for ankle supports. They wish, however, to minimise the loss of contribution to the Group. The management of Division B is aware of another joint support product, which is produced in Distantland, that competes with the Division A version of the ankle support and which could be purchased at a local currency price that is equivalent to $9 per support. SSA Group policy is that all divisions are allowed autonomy to set transfer prices and purchase from whatever sources they choose. The management of Division A intends to use market price less 30% as the basis for each of quotations 1 and 2. Required (a) (i) The management of the SSA Group have asked you to advise them regarding the appropriateness of the decision by the management of Division A to use an adjusted market price as the basis for the preparation of each quotation and the implications of the likely sourcing decision by the management of Division B. Your answer should cite relevant quantitative data and incorporate your recommendation of the prices that should be quoted by Division A for the ankle supports in respect of quotations 1 and 2, that will ensure that the profitability of SSA Group as a whole is not adversely affected by the decision of the management of Division B. (8 marks) (ii) (b) Advise the management of Divisions A and B regarding the basis of transfer pricing which should be employed in order to ensure that the profit of the SSA Group is maximised. (4 marks)

Discuss the problems that arise specifically when determining transfer prices when divisions are located in different countries. (5 marks)

44

Questions

(c)

After considerable internal discussion concerning Quotation 2 by the management of SSA Group, Division A is not prepared to supply 18,000 ankle supports to Division B at any price lower than 30% below market price. All profits in Distantland are subject to taxation at a rate of 20%. Division A pays tax in Nearland at a rate of 40% on all profits. Required Advise the management of SSA Group whether the management of Division B should be directed to purchase the ankle supports from Division A, or to purchase a similar product from a local supplier in Distantland. Supporting calculations should be provided. (8 marks) (Total = 25 marks)

44 Seatown

45 mins

Seatown is located on the coast. The town’s main industry is tourism with an emphasis on family holidays and consequently the cleanliness of the town’s beaches is a major factor in the town’s success. The town council, which is the local government authority, has a cleaning department that is responsible for keeping the beaches clean and tidy. Early every morning, after the tide has gone out, the beaches are swept, using equipment that is towed behind tractors. This equipment skims the top layer of sand and runs it through a filter to remove any litter, before returning the cleaned sand to the beach. Most of the litter is paper and plastic packaging which tourists have discarded, but the litter can include glass bottles and aluminium cans. To try to prevent litter being left on the beach the town council also places bins on the beaches above the high water mark. Litter bins need to be emptied regularly, otherwise holidaymakers pile their rubbish beside the bins and that leads to litter being spread by the wind or by seabirds scavenging for food scraps. The cost of cleaning the beaches is a major expense for the town council. The management team of the town council has asked the internal audit department to investigate whether the town is getting good “value for money” from this expenditure. The head of internal audit has sought clarification from the town managers on whether the audit should focus on the economy and efficiency of the cleaning operations or their effectiveness. Economy and efficiency audits generally focus on whether cost can be reduced for the same level of service and effectiveness audits ask whether better service can be achieved for the same cost. Required (a) Recommend, giving reasons, the matters that the town council’s internal audit department should study in order to evaluate the economy and efficiency of the beach cleaning activities. Your answer should include advice on how to obtain the necessary data and information. (b) (10 marks)

Recommend, giving reasons, the matters that the town council’s internal audit department should study in order to evaluate the effectiveness of the beach cleaning activities. Your answer should include advice on how to obtain the necessary data and information. (10 marks)

Following their investigation, the internal audit department advised the council to consider whether it would be beneficial to outsource the beach cleaning services rather than having an in-house cleaning department. However, the internal audit report also pointed out that if the council does outsource the cleaning services, the council will need to draw up a service level agreement with the outsource partner which it employs to provide the cleaning services. Required (c) Briefly discuss the importance of the council having a service level agreement with the outsource partner if the council decides to outsource the beach cleaning services. (5 marks) (Total = 25 marks)

Questions

45

45 LGHD (APM 6/10, amended)
It is intended that the upgrading should enhance the quality of living for the occupants of the houses.

45 mins

A local government housing department (LGHD) has funds which it is proposing to spend on the upgrading of air conditioning systems in its housing inventory.

Preferred contractors will be identified to carry out the work involved in the upgrading of the air conditioning systems, with each contractor being responsible for upgrading the systems in a proportion of the houses. Contractors will also be required to provide a maintenance and operational advice service during the first two years of operation of the upgraded systems. Prior to a decision to implement the proposal, LGHD has decided that it should carry out a value for money (VFM) audit. You have been given the task of preparing a report for LGHD, to help ensure that it can make an informed decision concerning the proposal. Required (a) (i) (ii) (iii) Prepare a detailed analysis which will form the basis for the preparation of the final report. The analysis should include a clear explanation of the meaning and relevance of each of (i) to (iii) below: Value for Money (VFM) audit (including references to the roles of principal and agent). Economy, efficiency and effectiveness as part of the VFM audit. (6 marks) (6 marks)

The extent (if any) to which each of intangibility, heterogeneity, simultaneity and perishability may be seen to relate to the decision concerning the proposal, and any problems that may occur. (8 marks)

Note: Your analysis should incorporate specific references to examples relating to the upgrading proposal. The Finance Director is keen to introduce some performance measures which can be used to judge the success of initiatives such as the air conditioning upgrade. The Finance Director has asked the management accountant to recommend some possible new performance measures which could be used but reminded him, when doing so, to remember the adage that ‘What gets measured, gets done.’ (b) Briefly discuss the importance of the quote ‘What gets measured, gets done’ for LGHD. (5 marks) (Total = 25 marks)

46 CFE coffee shops

45 mins

CFE was established in 20X1, and operates a chain of 40 coffee shops across Teeland. It is a privately owned company. The number of coffee shops in Teeland has increased rapidly over the last decade, and there are now thousands of branded coffee shops operating across the country. Their total turnover now exceeds $1 billion. Although the majority of the branded shops are run by internationally recognised multi-national companies, CFE only operates in Teeland. The range of products offered by the shops has increased over the last few years, in response to customer demand for a larger range of foods and better quality products. The branded coffee shops have been able to command higher than average prices for their products by using quality and service as differentiators. Price appears not to be a particularly sensitive factor, although CFE’s prices are largely the same as those charged by the branded shops run by the multi-national companies. In 20X1, when CFE first opened, most other coffee shops only served a selection of hot and cold drinks and a small range of snacks and cakes. However, right from the outset, CFE also sold a range of freshly made sandwiches and other food items, all made from high quality ingredients. All CFE’s shops operate from rented premises, but before opening they are fitted out to ensure they have the same high standard of shop design and fittings. Having a high quality of shop design creates a good atmosphere, and makes the coffee shops a popular place for people to meet.

46

Questions

CFE’s shops generate a high turnover. However, profitability has been lower than some of its competitors. Reasons for this include: high rental costs for some of its city centre shops; high staff costs (as high quality customer service remains a priority for CFE so it pays above the industry average); and lower than average gross margins on some products (due to the high procurement cost of the quality ingredients chosen). CFE also earns lower margins than some of its rivals on its coffee products because over 80% of its coffee beans are procured from suppliers who deal only with ‘Fair Trade’ coffee producers. Some of the regional managers have argued that their shops would be more profitable if they stopped using ‘Fair Trade’ coffee, but CFE’s directors remain adamant that the company will continue to buy coffee from Fair Trade suppliers wherever possible, because it is a socially responsible company. At a recent Board meeting, the Marketing Director said he thought CFE should introduce a loyalty card scheme, and for every six hot drinks loyalty card holders buy, they get their next one free. He argued the card scheme will help CFE’s profitability by improving customer loyalty and strengthening the brand. The Finance Director said that CFE should also consider whether it could increase the prices of its coffee products in order to increase the margins its earns on them. A summary of CFE’s trading results for the last year is shown below: ($’000) Revenue Cost of sales Gross margin Operating profit Coffee 19,517 (3,767) 15,750 Other drinks 5,541 (2,638) 2,903 Food & snacks 32,322 (13,975) 18,347 Total 57,380 (20,380) 37,000 5,606

The largest branded coffee shop in Teeland (which has 130 shops) generated revenues of $180m in the last year, with a gross margin of $124m and operating profit of $22.5m. Required (a) (b) With reference to the Marketing Director’s proposal to introduce a loyalty card scheme, evaluate the importance of brand awareness on CFE’s business performance. (12 marks) Discuss the importance of external information in relation to the Finance Director’s suggestion for CFE to increase the prices of its coffee products. (5 marks) With reference to the use of ‘Fair Trade’ suppliers, discuss the potential implications of social obligations on CFE’s business performance. (8 marks) (Total = 25 marks)

(c)

47 JIT systems (Preparation question)
(a)

36 mins

SW is a member of the SWAL Group of companies. SW manufacturers cleaning liquid using chemicals that it buys from a number of suppliers. In the past SW has used a periodic review inventory control system with maximum and re-order levels to control the purchase of the chemicals and the economic order quantity model to minimise its costs. The Managing Director of SW is considering a change by introducing a Just in Time (JIT) system and has asked for a report explaining this. Required Explain how a JIT system differs from the system presently being used and the extent to which its introduction would require a review of SW's quality control procedures. (10 marks)

(b)

The X Group is a well-established manufacturing group that operates a number of companies using similar production and inventory holding policies. All of the companies are in the same country though there are considerable distances between them. The group has traditionally operated a constant production system whereby the same volume of output is produced each week, even though the demand for the group's products is subject to seasonal fluctuations.
Questions

47

As a result there is always finished goods inventory in the group's warehouses waiting for customer orders. This inventory will include a safety inventory equal to two weeks' production. Raw material inventories are ordered from suppliers using the Economic Order Quantity (EOQ) model in conjunction with a computerised inventory control system which identifies the need to place an order when the re-order level is reached. The purchasing department is centralised for the group. On receiving a notification from the computerised inventory control system that an order is to be placed, a series of quotation enquiries are issued to prospective suppliers so that the best price and delivery terms are obtained for each order. This practice has resulted in there being a large number of suppliers to the X Group. Each supplier delivers directly to the company that requires the material. The managing director of the X Group has recently returned from a conference on World Class Manufacturing and was particularly interested in the possible use of Just in Time (JIT) within the X Group. Required Prepare a short report for the managing director explaining how the adoption of JIT might affect profitability with the X Group. (10 marks) (Total = 20 marks)

48 Tench (APM 12/11, amended)

45 mins

Tench Cars (Tench) is large national car manufacturing business. It is based in Essland, a country that has recently turned from state communism to democratic capitalism. The car industry had been heavily supported and controlled by the bureaucracy of the old regime. The government had stipulated production and employment targets for the business but had ignored profit as a performance measure. Tench is now run by a new generation of capitalist business people intent on rejuvenating the company’s fortunes. The company has a strong position within Essland, which has a population of 200 million and forms the majority of Tench’s market. However, the company has also traditionally achieved a good market share in six neighbouring countries due to historic links and shared culture between them and Essland. All of these markets are experiencing growing car ownership as political and market reforms lead to greater wealth in a large proportion of the population. Additionally, the new government in Essland is deregulating markets and opening the country to imports of foreign vehicles. Tench’s management recognises that it needs to make fundamental changes to its production approach in order to combat increased competition from foreign manufacturers. Tench’s cars are now being seen as ugly, pollutive and with poor safety features in comparison to the foreign competition. Management plans to address this by improving the quality of its cars through the use of quality management techniques. It plans to improve financial performance through the use of Kaizen costing and just-in-time purchasing and production. Tench’s existing performance reporting system uses standard costing and budgetary variance analysis in order to monitor and control production activities. The Chief Financial Officer (CFO) of Tench has commented that he is confused by the terminology associated with quality management and needs a clearer understanding of the different costs associated with quality management. The CFO also wants to know the impact of including quality costs and using the Kaizen costing approach on the traditional standard costing approach at Tench. Required In response to the CFO’s comments: (a) (b) (c) (d) Discuss the impact of the collection and use of quality costs on the current costing systems at Tench. (6 marks) Discuss and evaluate the impact of the Kaizen costing approach on the costing systems and employee management at Tench. (8 marks) Briefly evaluate the effect of moving to just-in-time purchasing and production, noting the impact on performance measures at Tench. (6 marks) Explain why the adoption of TQM is particularly important within a just-in-time (JIT) production environment. (5 marks)

(Total = 25 marks) 48
Questions

49 TAW (APM 6/08, amended)

45 mins

Telecoms At Work (TAW) manufactures and markets office communications systems. During the year ended 31 May 20X8 TAW made an operating profit of $30 million on sales of $360 million. However, the directors are concerned that products do not conform to the required level of quality and TAW is therefore not fulfilling its full potential in terms of turnover and profits achieved. The following information is available in respect of the year ended 31 May 20X8: (1) Production data: Units manufactured and sold Units requiring rework Units requiring warranty repair service Design engineering hours Process engineering hours Inspection hours (manufacturing) (2) Cost data: $ Design engineering per hour Process engineering per hour Inspection per hour (manufacturing) Rework per communication system reworked (manufacturing) Customer support per repaired unit (marketing) Transportation costs per repaired unit (distribution) Warranty repairs per repaired unit (customer service) (3) (4) Staff training costs amounted to $180,000 and additional product testing costs of $72,000. The marketing director has estimated that sales of 1,800 units were lost as a result of public knowledge of poor quality at TAW. The average contribution per communication system is estimated at $7,200. 96 70 50 4,800 240 280 4,600 18,000 2,100 2,700 48,000 54,000 288,000

Required (a) Prepare a cost analysis which shows actual prevention costs, appraisal costs, internal failure costs, and external failure costs for the year ended 31 May 20X8. Your statement should show each cost heading as a % of turnover and clearly show the total cost of quality. Comment briefly on the inclusion of opportunity costs in such an analysis. (12 marks)

A detailed analysis has revealed that the casings in which the communications systems are housed are often subject to mishandling in transit to TAW's manufacturing premises. The directors are considering two alternative solutions proposed by the design engineering team which are aimed at reducing the quality problems that are currently being experienced. These are as follows: Option 1 – Increase the number of immediate physical inspections of the casings when they are received from the supplier. This will require an additional 10,000 inspection hours. Option 2 – Redesign and strengthen the casings and the containers used to transport them to better withstand mishandling during transportation. Redesign will require an additional 2,000 hours of design engineering and an additional 5,000 hours of process engineering. Internal failure costs of rework for each reworked communication system are as follows: Variable costs (including direct materials, direct labour rework and supplies) Allocated fixed costs (equipment, space and allocated overhead) Total costs (as per note 2 on cost data) $ 1,920 2,880 4,800

The directors of TAW believe that, even if it is able to achieve improvements in quality, it will be unable to save any of the fixed costs of internal and external failure. If TAW chooses to inspect the casings more carefully, it expects to eliminate re-work on 720 communication systems whereas if it redesigns the casings it expects to eliminate rework on 960 communication systems.
Questions

49

If incoming casings are inspected more carefully, TAW estimates that 600 fewer communication systems will require warranty repair and that it will be able to sell an additional 300 communication systems. If the casing is redesigned, the directors estimate that 840 fewer communication systems will require warranty repair and that an additional 360 communication systems will be sold. External failure costs of repair for each repaired communication system are as follows: Variable costs $ 96 210 1,700 Fixed costs $ 144 70 2,900 Total costs $ 240 280 4,600

Customer support costs Transportation costs Warranty repair costs Required (b) (c)

Prepare an estimate of the financial consequences of each options and advise the directors at TAW which option should be chosen. (10 marks) Explain how Kaizen principles could be used by TAW to reduce its costs. (3 marks) (Total = 25 marks)

50 Thebe (APM 6/12, amended)

45 mins

Thebe Telecom is a large national telephone business in Fayland. Thebe provides telephone service to more than 11 million customers through its fixed line and mobile services. Thebe has three strategic business units: mobile; fixed line telephone (incorporating broadband); and corporate services (serving other businesses’ telephone needs). It has become the largest mobile operator in Fayland through a series of acquisitions of competitors and operating licences. Thebe’s CEO has won many awards for being an innovative businessman who recognises the rapid changes in technology, regulation and competitor action that occur in the sector. Thebe’s major competitor in Fayland is the original nationalised telephone company, FayTel, which was privatised 20 years ago but which retains many of the features of a monopoly supplier including a massive infrastructure. As a result, Thebe’s CEO realised long ago that competition on the basis of price and volume would not work against such a large competitor and so he has focused on customer service as the key to growing the business. In order to improve the company’s competitive position, the CEO decided that the company should consider a Six Sigma initiative to give an immediate step change improvement to the service quality at Thebe. The initiative involved a number of projects including one to improve the quality of customers’ bills. FayTel was publicly criticised by the government’s consumer advocate who pointed to occasional misallocations of call minutes to the wrong numbers and also, more frequently, the application of incorrect tariffs in calculating the costs of calls. Thebe’s CEO is aware that all telephone businesses (including Thebe) have these problems but this is an area in which Thebe can gain a competitive advantage and has taken a special interest in this project by championing it himself. The project is focused on improving the accuracy of customers’ bills and the handling of complaints. Within the billing department, the company divided activities into normal money collection, credit control on overdue payments and managing complaints. Process diagrams were created for each of these areas and then data was sourced from customer feedback at the various points of interaction with Thebe employees (such as complaint handling) and internal measurables created. The project team was formed from line managers from all three strategic business units and the billing department. The CEO’s involvement in the projects to improve service quality at Thebe made him realise that the performance summary prepared for the monthly board papers does not include any non-financial aspects of performance, and Thebe’s key performance indicators also focus solely on financial performance.

50

Questions

Required (a) (b) (c) Evaluate the benefits of Thebe’s board monitoring non-financial aspects of performance as well as financial ones. (8 marks) Explain how the general way in which Six Sigma is implemented helps improve the quality of performance, illustrating your answer with reference to Thebe. (8 marks) Explain and illustrate how the DMAIC method for the implementation of Six Sigma could be applied at Thebe. (9 marks) (Total = 25 marks)

51 T4UC (APM 6/09, amended)

45 mins

The There 4 U Company (T4UC) commenced trading on 1 January 20X6. It was founded by Ken Matthews, who is the managing director of T4UC. The initial aim of T4UC was to provide 'good quality' repairs and servicing to customers with domestic central heating systems and domestic 'white goods' (white goods are items such as washing machines, tumble dryers, dishwashers, refrigerators and freezers). T4UC provides contract services on an annual basis to individual customers who require insurance covering the repair and servicing of their central heating systems and domestic white goods. T4UC charge an annual contract fee and undertake all client repair and servicing requirements without further charge. Ken, who has a very strong background in sales and marketing, recruited engineers who came from a variety of engineering backgrounds. Initial growth was prolific with Ken being very successful in establishing a good sized customer base within the first two years of the business. Ken believes that staff utilisation is the key driver of profitability within T4UC. T4UC set up a website where clients could access product manuals and other diagnostic data as well as being able to book an appointment with a service engineer. The following data is available: Year Number of contracted clients Number of visits to contracted clients Number of clients gained via recommendation Number of telephone calls for product support received Number of telephone calls for product support answered Number of product support issues resolved by telephone 20X6 13,000 23,400 200 52,500 52,000 46,800 20X7 15,000 30,000 100 62,000 60,000 51,000 20X8 14,800 32,000 5 59,500 58,000 46,400

At the end of 20X8 Ken became anxious regarding the fact that the growth in the customer base had stopped and that a number of clients had chosen not to renew their contracts with T4UC. In view of these facts, Ken undertook an extensive survey of the customers who had entered into contracts with T4UC since it commenced trading. Ken received the following comments which were representative of all other comments that he received. 'T4UC ought to adopt a 'right first time' mentality.' 'I booked an engineer for last Monday who never arrived but two engineers turned up on Tuesday!' 'You send me a different engineer each time to inspect my central heating system. Some are here for an hour and yet others are here for the whole day and some of those even have to come back the next day.' 'Your people never seem to have the required parts with them and have to come back the next day!' 'An engineer arrived at my home to repair my washing machine but the required parts which were shipped to my home direct from the manufacturer arrived three days later! I've heard that 'Appliances R Us' is the best organisation in your service sector and that they provide a much more efficient service than T4UC and unlike T4UC is always contactable on a twenty-four hours basis during every day of the year! When I have tried to contact you on Saturdays and Sundays I have often given up out of sheer frustration!'

Questions

51

Ken also obtained the following data from the 'Centre for Inter-Firm Comparison'. Customer satisfaction rating (%) Remedial visits (%) of client visits Cost per client per visit ($) Client to staff ratio T4UC 65 8 150 250:1 Appliances R Us 92 1 75 200:1 Industry average 75 4 100 225: 1

Ken undertook further investigations which revealed remedial visits were frequently due to staff servicing appliances with which they were not completely familiar. Required (a) (b) Describe the Six Sigma methodology for the improvement of an existing process and the varying grades of qualification in Six Sigma that staff involved in the leadership of projects may possess. (11 marks) Explain how the problems at T4UC could be analysed and addressed using the Six Sigma methodology. Your answer should include suggestions regarding additional activities that should be undertaken in order to improve the performance of T4UC. (14 marks) (Total = 25 marks)

52 SSH (APM 12/08)

45 mins

The Superior Software House (SSH) commenced trading on 1 December 20X2 in the country of Bonlandia. SSH develops bespoke software packages on behalf of clients. When requested to do so, SSH also provides training to clients' staff in the use of these software packages. On 1 December 20X6, the directors of SSH established a similar semi-autonomous operation in Karendia. All software packages are produced in Bonlandia and transferred to Karendia at cost plus attributable overheads ie there is no mark-up on the software packages transferred from Bonlandia to Karendia. Karendia is a country in which the structure of industry has changed during recent years. There has been a major shift from traditional manufacturing businesses to service orientated businesses which place a far greater emphasis upon the use of business software. The operational managers in both Bonlandia and Karendia have no control over company policies in respect of acquisitions and financing. The operational manager of Bonlandia receives a bonus of 40% of his basic salary for meeting all client delivery deadlines in respect of Karendia. At a recent meeting he instructed his staff to 'install client software by the due date and we'll worry about fixing any software problems after it's been installed. After all, we always fix software problems eventually'. He also stated that 'it is of vital importance that we grow our revenues in Karendia as quickly as possible. Our clients in Karendia might complain but they have spent a lot of money on our software products and will not be able to go to any of our competitors once we have installed our software as all their businesses would suffer huge disruption'. Financial data (all stated on an actual basis) in respect of the two divisions for the two years ended 30 November 20X7 and 20X8 are shown on the next page:

52

Questions

Summary Income statements

Revenue Salaries Software & consumables Other operating costs Marketing Interest (Group) Depreciation and amortisation Total costs Profit/(loss) for the period Statements of financial position:

Bonlandia 20X8 $'000 14,600 4,340 2,040 2,880 9,260 2,392 400 2,792 12,052 2,548 Bonlandia 20X8 $'000 9,000 4,550 13,550

Karendia 20X8 $'000 2,800 1,248 486 654 2,388 600 160 760 3,148 (348) Karendia 20X8 $'000 1,600 1,000 2,600

Combined 20X8 $'000 17,400 5,588 2,526 3,534 11,648 2,992 850 560 4,402 16,050 1,350 Combined 20X8 $'000 10,600 5,550 16,150 9,150 4,000 3,000 16,150

Bonlandia 20X7 $'000 14,000 4,000 2,000 2,800 8,800 2,100 400 2,500 11,300 2,700 Bonlandia 20X7 $'000 8,000 5,000 13,000

Karendia 20X7 $'000 2,000 1,200 450 600 2,250 400 100 500 2,750 (750) Karendia 20X7 $'000 1,000 800 1,800

Combined 20X7 $'000 16,000 5,200 2,450 3,400 11,050 2,500 900 500 3,900 14,950 1,050 Combined 20X7 $'000 9,000 5,800 14,800 7,800 4,500 2,500 14,800

Assets Non-current assets Current assets Total assets Equity and liabilities Share capital and reserves Non-current liabilities Long-term borrowings (Group) Current liabilities Total equity and liabilities Required (a)

2,400

600

2,000

500

Assess the financial performance of SSH and its operations in Bonlandia and Karendia during the years ended 30 November 20X7 and 20X8. Note. You should highlight additional information that would be required in order to provide a more comprehensive assessment of the financial performance of each operation. (14 marks)

(b) (c) (d)

Discuss the statements of the operational manager of Bonlandia and assess their implications for SSH. (4 marks) Assess the likely criteria which would need to be satisfied for software to be regarded as 'quality software'. (4 marks) Suggest a set of SIX performance measures which the directors of SSH could use in order to assess the quality of service provided to its clients. (3 marks) (Total = 25 marks)

53 KPG Systems

45 mins

KPG systems was set up 10 years ago by its owner, a computer systems engineer, Andy Rowe. Andy is an entrepreneur with a high degree of technical ability and no fear of taking risks in emerging high-tech markets. KPG Systems provides network management systems to medium-sized companies. In the last 10 years the business has grown from Andy's original ideas to one turning over £12 million and employing 100 people. The approach of the business, which has appealed to potential customers, is to recognise that no two information systems are the same and to customise its products and service to meet their individual needs. The company has made a point of exploiting new technology as it became available and has been successful in several linked areas of network technology, including the use of wireless devices. As an adjunct to providing these systems, technical support has
Questions

53

become another key business element, although there have been some problems with providing a national network of service support. KPG systems is a very small player in this market and its success has been due to Andy Rowe's drive, initiative and risk taking. The business is still run on a day-to-day basis by Andy but there are now various functional departments in operation, including manufacturing; sales and marketing; research and development; and administration. Andy has thrived on this challenge, but he now finds that the business is too large for him to do everything that needs to be done. There have been some problems with product quality, time and cost overruns and recruitment. Also, turnover from larger contracts is forming a smaller proportion of the overall total. Business with smaller firms continues to expand but Andy has failed to win several large contracts against competition from larger firms. This has led him to question the continuing validity of his basic approach to the business. Andy is now concerned that the business is losing focus and he is unsure of where it is going in the future. Required (a) (b) What steps could Andy take to promote the achievement of consistently good quality in KPG's products? (10 marks) Use appropriate models to analyse the current position of KPG systems and recommend how it could develop in the future. (15 marks) (Total = 25 marks)

54 Universal Pottery Company (BA 12/07)

45 mins

The country of Europia has an extensive historical and industrial heritage. It has many tourist sites (such as castles, palaces, temples, houses and factories) which attract visitors from home and abroad. Most of these tourist sites have gift shops where visitors can buy mementos and souvenirs of their visit. These souvenirs often include cups, saucers, plates and other items which feature a printed image of the particular tourist site. The Universal Pottery Company (UPC) is the main supplier of these pottery souvenir items to the tourist trade. It produces the items in its potteries and then applies the appropriate image using specialised image printing machines. UPC also supplies other organisations that require personalised products. For example, it recently won the right to produce souvenirs for the Eurasian Games, which are being held in Europia in two years time. UPC currently ships about 250,000 items of pottery out of its factory every month. Most of these items are shipped in relatively small packages. All collections from the factory and deliveries to customers are made by a nationwide courier company. In the last two years there has been a noticeable increase in the number of complaints about the quality of these items. The complaints, from gift shop owners, concentrate on two main issues: (a) The physical condition of goods when they arrive at the gift shop. Initial evidence suggests that 'a significant number of products are now arriving broken, chipped or cracked'. These items are unusable and they have to be returned to UPC. UPC management are convinced that the increased breakages are due to packers not following the correct packing method. Incorrect alignment of the image of the tourist site on the selected item. For example, a recent batch of 100 cups for Carish Castle included 10 cups where the image of the castle sloped significantly from left to right. These were returned by the customer and destroyed by UPC.

(b)

The image problem was investigated in more depth and it was discovered that approximately 500 items were delivered every month with misaligned images. Each item costs, on average, $20 to produce. As a result of these complaints, UPC appointed a small quality inspection team who were asked to inspect one in every 20 packages for correct packaging and correct image alignment. However, although some problems have been found, a significant number of defective products have still been delivered to customers. A director of UPC used this evidence to support his assertion that the 'quality inspection team is just not working'. The payment system for packers has also been such an issue. It was established ten years ago as an attempt to boost productivity. Packers receive a bonus for packing more than a target number of packages per hour. Hence, packers are more concerned with the speed of packing rather than its quality. Finally, there is also evidence that to achieve agreed customer deadlines, certain managers have asked the quality inspection team to overlook defective items so that order deadlines could be met. 54
Questions

The company has decided to review the quality issue again. The director who claimed that the quality inspection team is not working has suggested using a Six Sigma approach to the company's quality problems. Required (a) (b) Analyse the current and potential role of quality, quality control and quality assurance at UPC. (15 marks) Examine how adopting a Six Sigma approach would help address the quality problems at UPC. (10 marks) (Total = 25 marks)

55 CCT Computer Systems (Preparation question)

22 mins

CCT Computer Systems plc specialises in the development and implementation of software for the logistics industry. After experiencing a number of years of growth and profitability the company is continuing to report growth in turnover but, for the last five quarters, it has also reported small losses. An investigation into this has revealed that costs have risen greatly in systems development and support and consequently margins have been eroded in recently completed projects. It appears that this trend is going to continue. Many people within the company attribute this worsening financial performance to a perceived reduction in software quality. Here are three testimonies received during the investigation Amelia Platt: Software Development Manager CCT Computer Systems plc 'You have to remember that the original logistics system was developed by Ilya Borisova (the founder of CCT) and three of his friends from university days. They did not build the software with expansion or maintenance in mind. Also, it is difficult to know what some of the programs actually do, so making changes is a nightmare. Programmers make changes to program code without really knowing what the knock-on effect will be.' Tony Osunda: General Manager QANDO logistics – a major customer 'We feel that the last project was most unsatisfactory. We specified our requirements very carefully but the delivered system did not work the way we wanted. We found it cumbersome to use and key areas of functionality were either wrong or missing altogether. After implementation, we asked for a number of changes so that the system would work as it should. We were originally asked to pay for these changes but we pointed out that they weren't really changes – they were things we had asked for all along. Eventually, CCT backed down and so we got the changes for free. The system works fine now, but it has been delivered late and we are still seeking compensation for this.' Carlos Theroux: One of the original programmers of the CCT logistics software solution: Now lead programmer CCT Computer Systems plc 'It is no fun here anymore. When we were smaller we could all dive in and solve the problems. When I joined we had three programmers, now we have one hundred and thirty. What do they all do? There is no work ethic. We all used to stay over until we got the problem solved. Now there is documentation, documentation and documentation. We have now adopted a formal project management method, more documentation! I am not sure this place suits me anymore.' Required A perceived reduction in software quality is blamed by many people for the decline in profitability at CCT. Discuss the importance and characteristics of software quality and explain how each of these characteristics might be measured. (12 marks)

56 Astrodome (PM 12/05, amended)

45 mins

Astrodome Sports Ltd was formed in December 20X0 by seven engineers who comprise the board of directors of the company. The seven engineers previously worked together for 'Telstar', a satellite navigation company. In conjunction with one of the three largest construction companies within their country they constructed the '365 Sports Complex' which has a roof that opens and uses revolutionary satellite technology to maintain grass surfaces within the complex. The complex facilities, which are available for use on each day of the year, include two tennis courts, a cricket pitch, an equestrian centre and six bowling greens. The tennis courts and cricket pitch are suitable for use as venues for national competitions. The equestrian centre offers horse-riding lessons to the general public

Questions

55

and is also a suitable venue for show-jumping competitions. The equestrian centre and bowling greens have increased in popularity as a consequence of regular television coverage of equestrian and bowling events. In spite of the high standard of the grass surfaces within the sports complex, the directors are concerned by reduced profit levels as a consequence of both falling revenues and increasing costs. The area in which the '365 Sports Complex' is located has high unemployment but is served by all public transport services. The directors of Astrodome Sports Ltd have different views about the course of action that should be taken to provide a strategy for the future improvement in the performance of the complex. Each director's view is based on his/her individual perception as to the interpretation of the information contained in the performance measurement system of the complex. These are as follows: Director (a) '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.' '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.' 'We should focus our attention on maximising the opening hours of our facilities. Everything else will take care of itself.' 'Recent analysis of customer feedback forms indicates that most of our customers are satisfied with the facilities. In fact, the only complaints are from three customers – the LCA University which uses the cricket pitch for matches, the National Youth Training Academy which held training sessions on the tennis courts, and a local bowling team.' '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.' 'We should hold back on our efforts to overcome the shortage of bowling equipment for hire. Recent rumours are that the National Bowling Association is 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.' 'Why change our performance management system? Our current areas of focus provide us with all the information we need to ensure that we remain a profitable and effective business.'

(b) (c) (d)

(e) (f)

(g)

As management accountant of Astrodome Sports Ltd you have recently read an article which discussed the following performance measurement problems: (i) (ii) (iii) (iv) (v) (vi) (vii) (viii) Tunnel vision Sub-optimisation Misinterpretation Myopia Measure fixation Misrepresentation Gaming Ossification

Required (a) (b) Explain the performance measurement problems mentioned in the article and identify how the views of the directors (Points a – g above) illustrate the different problems listed. (17 marks) Discuss the relevance of each of the following actions as steps in trying to remedy performance measurement problems relating to the '365 Sports Complex' and suggest examples of specific problem classifications that may be reduced or eliminated by each action: (i) (ii) (iii) (iv) Focusing on and improving the measurement of customer satisfaction Involving staff at all levels in the development and implementation of performance measures Being flexible in the extent to which formal performance measures are relied on Giving consideration to the auditing of the performance measurement system. (8 marks) (Total = 25 marks)

56

Questions

57 TRG (APM 6/08, amended)

45 mins

The Rubber Group (TRG) manufactures and sells a number of rubber-based products. Its strategic focus is channelled through profit centres which sell products transferred from production divisions that are operated as cost centres. The profit centres are the primary value-adding part of the business, where commercial profit centre managers are responsible for the generation of a contribution margin sufficient to earn the target return of TRG. The target return is calculated after allowing for the sum of the agreed budgeted cost of production at production divisions, plus the cost of marketing, selling and distribution costs and central services costs. The Bettamould Division is part of TRG and manufactures moulded products that it transfers to profit centres at an agreed cost per tonne. The agreed cost per tonne is set following discussion between management of the Bettamould Division and senior management of TRG. The following information relates to the agreed budget for the Bettamould Division for the year ending 30 June 20X9: (1) The budgeted output of moulded products to be transferred to profit centres is 100,000 tonnes. The budgeted transfer cost has been agreed on a two-part basis as follows: (i) (ii) (2) A standard variable cost of $200 per tonne of moulded products; A lump sum annual charge of $50,000,000 in respect of fixed costs, which is charged to profit centres, at $500 per tonne of moulded products.

Budgeted standard variable costs (as quoted in 1 above) have been set after incorporating each of the following: (i) A provision in respect of processing losses amounting to 15% of material inputs. Materials are sourced on a JIT basis from chosen suppliers who have been used for some years. It is felt that the 15% level of losses is necessary because the ageing of the machinery will lead to a reduction in the efficiency of output levels. A provision in respect of machine idle time amounting to 5%. This is incorporated into variable machine costs. The idle time allowance is held at the 5% level partly through elements of 'real-time' maintenance undertaken by the machine operating teams as part of their job specification.

(ii)

(3) (4) (5)

Quality checks are carried out on a daily basis on 25% of throughput tonnes of moulded products. All employees and management have contracts based on fixed annual salary agreements. In addition, a bonus of 5% of salary is payable as long as the budgeted output of 100,000 tonnes has been achieved; Additional information relating to the points in (2) above (but NOT included in the budget for the year ending 30 June 20X9) is as follows: (i) (ii) There is evidence that materials of an equivalent specification could be sourced for 40% of the annual requirement at the Bettamould Division, from another division within TRG which has spare capacity. There is evidence that a move to machine maintenance being outsourced from a specialist company could help reduce machine idle time and hence allow the possibility of annual output in excess of 100,000 tonnes of moulded products. It is thought that the current level of quality checks (25% of throughput on a daily basis) is vital, although current evidence shows that some competitor companies are able to achieve consistent acceptable quality with a quality check level of only 10% of throughput on a daily basis.

(iii)

The directors of TRG have decided to investigate claims relating to the use of budgeting within organisations which have featured in recent literature. A summary of relevant points from the literature is contained in the following statement: 'The use of budgets as part of a 'performance contract' between an organisation and its managers may be seen as a practice that causes management action which might lead to the following problems: (a) (b) (c) (d) (e) Meeting only the lowest targets Using more resources than necessary Making the bonus – whatever it takes Competing against other divisions, business units and departments Ensuring that what is in the budget is spent
Questions

57

(f) (g) (h) (a) (b) (c)

Providing inaccurate forecasts Meeting the target, but not beating it Avoiding risks.' Explain the nature of the eight problems listed above relating to the use of budgeting (15 marks)

Required Illustrate FIVE of the problems explained in (a) using the data from the Bettamould division/TRG scenario; and (5 marks) Suggest ways in which FIVE of the problems explained in (a) above may be overcome. (5 marks) (Total = 25 marks)

58 UU (APM 6/09, amended)

45 mins

The senior management of Universal University (UU) intend to develop both quantitative and qualitative measures of performance in relation to lecturing staff. As part of UU's mission to provide 'quality education' to its students, lecturers are encouraged to apply their skill and judgement in the creation, delivery and assessment aspects of the learning process. Academic staff are organised on a departmental basis. Each department is expected to achieve and improve on targets in the achievement of its role. As part of their development both personally and as departmental members, staff are encouraged to participate fully in research publication, new course design and innovation in teaching and learning methods. Academic staff have differing views on whether action on their part in pursuing aspects of such goals is compatible with their personal goals. Required (a) (i) (ii) Using the above scenario, discuss in relation to the lecturing staff within (UU) each of the following: The application of Agency Theory to staff, in their role as agents and provide examples of the observability of their role in relation to outcomes and effort; The application of Expectancy Theory with specific reference to the relationship between: – – – (b) (i) (ii) (iii) Required Describe how each of the areas (b)(i) to (iii) may be applied at UU and critically evaluate this approach to performance measurement in the context of the scenario described above. (8 marks) The financial controller has recently joined UU from a commercial retail company where managers’ performance was primarily evaluated on their ability to continually achieve short-term financial performance targets, in particular ensuring that actual costs were below budgeted costs. The financial controller has been surprised at how much less important financial performance targets appear to be at UU. In particular, he was amazed that the heads of department seem more interested in the number of research publications their departments have produced than the costs incurred by the departments. When the financial controller commented on this to one his colleagues, the colleague reminded him that the university had different priorities to the company where the financial controller had worked before. (c) Assess the different management styles used at UU and the financial controller’s previous company. (5 marks) (Total = 25 marks) 58
Questions

strength of motivation to do (X); strength of preference for outcome (Y); expectation that doing (X) will result in (Y). accounting for the numbers; ensuring the numbers are accounted for; being held accountable for events and circumstances leading to the numbers.

(12 marks)

'Hard Accountability' is deemed to apply to lecturing staff in each of three specific areas as follows:

59 Elegant Hotels (BA 6/09)

45 mins

Elegant Hotels is a chain of twenty hotels across the country. Each hotel is wholly owned by the company. Four years ago the chain was bought by a group of investors who installed a new management team. The new management team introduced a new reward scheme for the hotel managers in an attempt to motivate managers to improve the revenue and profitability of the chain. The salary package devised for each manager comprised:   A relatively low fixed salary A bonus payment based on high room occupancy rate. The occupancy rate is the percentage of usable hotel beds filled every night. Managers who achieved more than 90% occupancy rate receive a significant bonus. This target is aimed at keeping the hotel full. A smaller bonus payment based on the net profit margin achieved by the hotel. This is aimed at improving the profitability of the hotel.

However, despite these incentives the overall performance of the company is still declining. Managers are generally achieving a high occupancy rate but are largely failing to deliver higher net margins. It is also clear that some managers have achieved a high occupancy rate by declaring that some bedrooms were unfit for use or were being used as seminar rooms. Also, the pursuit of high occupancy and high net profit appears to be affecting the perceived image of the hotel chain. Once regarded as a mid-market hotel chain, the chain now seems to be perceived as a budget buy. A large percentage of bookings are received through the Internet broker lastsecondhotels.com and their view of the chain is given below, together with some visitor quotes from their web site. Comments 'Great last minute bargain … very easy to get rooms at half the advertised rate' 'Full of school children on a trip … will not be using this chain again' 'No Internet connections in the rooms or public areas, very disappointing' 'The bath was cracked and the windows were dirty. Cheap, but badly in need of a clean' 'Receptionists were very off-hand and unable to help. Did not seem to know much about the area surrounding the hotel' 'The staff were surly and uncommunicative. Much worse than last time we visited it. It used to be such a lovely hotel' 'Cheap, but don't eat there. The price for breakfast was extortionate' 'Cheap and cheerful but don't pay the full rate! Always lots of cheap beds available' 'Food was expensive and dull. The serving staff were uncommunicative, the cutlery was dirty and damaged. Staff were more interested in talking to each other than to the customers' 'Restaurant food was very expensive and of poor quality. The two nights I stayed there I was the only customer in the restaurant' Lastsecondhotels.com says: 'Value for money hotels with rooms always available. Perfect for those last minute breaks' Required (a) (b) Analyse the unanticipated consequences of the management reward scheme at Elegant Hotels. (15 marks) The DMAIC methodology of Six Sigma includes five steps: Define, Measure, Analyse, Improve and Control. Evaluate the potential benefits of using the DMAIC methodology at Elegant Hotels. (10 marks) (Total = 25 marks)

Questions

59

60 Connie Head

45 mins

Connie Head was the recently appointed HR manager in a medium sized accounting firm. Her appointment was a belated recognition by the senior partners of the firm that their ambitious corporate growth goals were linked to the performance of the individual business units and the accountants working in those units. Connie was convinced that performance management and an appraisal system were integral elements in helping the firm achieve its strategic objectives. This reflected her experience of introducing an appraisal system into the corporate finance unit for which she was responsible. The unit had consistently outperformed its growth targets and individual members of the unit were well motivated and appreciative of the appraisal process. However, the senior partner of the firm remained unconvinced about the benefits of appraisal systems. He argued that accountants, through their training, were self-motivated and should have the maximum freedom to carry out their work. His experience of appraisal systems to date had shown them to lack clarity of purpose, be extremely time consuming, involve masses of bureaucratic form filling and create little benefit for the supervisors or their subordinates. Certainly, he was resistant to having his own performance reviewed through an appraisal system. Connie, however, was convinced that a firm-wide appraisal system would be of major benefit in helping the achievement of growth goals. Required (a) (b) Evaluate the extent to which an effective appraisal system could help the accounting firm achieve its goals. (15 marks) Using models where appropriate, assess the contribution, if any, of performance management to the strategic management process. (10 marks) (Total = 25 marks)

61 Equiguard (BA, 12/08)

45 mins

Equiguard offers warranties for electrical and electronic equipment to both business and household customers. For a fixed annual fee the company will provide a free fault diagnosis and repair service for equipment covered by the warranty. A warranty lasts for one year and customers are invited to renew their warranty one month before it expires. Equiguard employs 340 full-time engineers around the country to undertake these repairs. It costs about $6,000 to train a newly recruited engineer. When equipment breaks down the customer telephones a support help line number where their problem is dealt with by a customer support clerk. This clerk has access to the work schedules of the engineers and an appointment is made for a visit from an engineer at the earliest possible time convenient to the customer. When the engineer makes the visit, faults with equipment are diagnosed and are fixed free of charge under the terms of the warranty. Equiguard is extremely concerned about the relatively high labour turnover of its engineers and has commissioned a report to investigate the situation. Some of the findings of the report are summarised in the following table (Table 1). It compares Equiguard with two of its main competitors. Table 1 Company
Equiguard Safequipe Guarantor

Labour turnover* 12% 8% 7%

Average salary ($) 24,000 23,000 22,500

Profit sharing scheme No Yes Yes

Average days holiday/year 20 23 25

Performance related pay No Yes Yes

Average training spent per year per engineer ($) 1,000 1,500 1,250

* Labour turnover is the number of engineers leaving in the last year as a percentage of the number of engineers employed at the beginning of the year An exit survey of engineers leaving the company recorded the following comments: (a) (b) ‘There is no point in doing a good job, because you get paid no more than doing an ordinary one. Average work is tolerated here.’ ‘This is the first place I have worked where learning new skills is not encouraged. There is no incentive to improve yourself. The company seems to believe that employees who gain new skills will inevitably leave, so they discourage learning.’

60

Questions

(c)

‘The real problem is that the pay structure does not differentiate between good, average and poor performers. This is really de-motivating.’

The HR director of Equiguard is anxious to address the high turnover issue and believes that quantitative measurement of employee performance is essential in a re-structured reward management scheme. He has suggested that the company should introduce two new performance related pay measures. The first is a team based bonus based on the average time it takes for the company to respond to a repair request. He proposes that this should be based on the time taken between the customer request for a repair being logged and the date of the engineer attending to fix the problem. He argues that customers value quick response times and so the shorter this time the greater the bonus should be for the whole team. In addition, he proposes an individual bonus. This will be based on the average time taken for an engineer to fix a reported fault once they have arrived. This is the average time taken for the engineer to repair the fault from the start time of the job to its completion. He argues that the company values quick repair time as this increases business efficiency and so the quicker the fix the greater the bonus should be for the individual. Required (a) Assess the deficiencies of Equiguard’s current rewards management scheme. (b) Analyse the limitations of the proposed performance measures suggested by the HR director. (15 marks) (10 marks) (Total = 25 marks)

Questions

61

PERFORMANCE EVALUATION AND CORPORATE FAILURE Questions 62 to 83 cover performance evaluation and corporate failure, the subject of Part E of the BPP Study Text for Paper P5.

62 YCT yachts

45 mins

YCT is a family-owned company employing 40 people, which builds and sells medium sized yachts. On average, YCT’s yacht normally retail for around $110,000 each. YCT operates in a very competitive market. Its yachts are usually bought by amateur sailors with high disposable incomes who value quality, reliability and performance. In 20Y1, YCT plans to sell 30 yachts. YCT's Managing Director has a vision for the company to be 'regarded as the best yacht builder for the private owner'. YCT has always emphasised the high quality of its yachts and knows that its customers are very knowledgable about yacht design and performance. Each yacht is built to a specific order and there is usually a period of at least one year between an order being placed and the yacht being delivered to the customer. YCT’s construction processes are is very traditional: most of its designs are at least 20 years old and much of the construction work on its yachts is done by hand. YCT regards its workforce as ‘craftspeople’ who have learned their skills through their work experience. YCT employs school-leavers and provides apprenticeships lasting seven years. However, most of its competitors employ university graduates who have studied yacht design and construction. YCT designs all its yachts manually which is very time consuming, although most of its competitors now use CAD/CAM* suites for their designs. YCT does not have any staff with CAD/CAM experience. YCT uses natural materials in the construction of its yachts: for example, cotton for the sails. However, recently some natural materials have become difficult to obtain and the prices of these have risen by as much as 35% in the last two years. Many of YCT’s competitors have replaced natural materials with synthetic ones as these are easier to obtain, cheaper and give enhanced performance. [*CAD/CAM: Computer-Aided Design, Computer-Aided Manufacturing] YCT uses a standard costing system for its manufacturing operations. YCT employed a consultant to design the system twenty years ago, and the company still uses this system today. The Managing Director (MD) relies on the standard costing system which is his only control system for the company. MD knows that the manufacturing cost of a yacht amounts to 60% of its total cost and believes that if he is in control of 60% he is in control of the majority of cost. However, recently MD has experienced some frustrations with the control system because it only reports financial results. MD would like a system that gives him integrated control over all aspects of the business, and has been considering the use of a Balanced Scorecard. YCT’s business comes from repeat orders and recommendations. However, it has experienced criticism in the last year because it failed to meet the promised delivery time for 25% of its orders and has lost business because the potential customers said that YCT’s yachts looked ‘old-fashioned’ and were ‘too slow’. Cash flow is particularly important for YCT, because of the long lead times for each yacht, and has been under pressure recently. YCT has had to increase its overdraft facility by $75,000 to $175,000 and this is nearly fully used. Every year since its inception YCT has reported a profit but in 20Y0 its Return on Capital Employed was 3% which MD has stated is unacceptable. He has asked senior members of staff for suggestions about how to increase YCT’s profitability. One such suggestion was that YCT should look to reduce its costs, while another was that the company should look to increase its revenues by developing and marketing a new range of yachts.

62

Questions

Required (a) (b) (c) Briefly discuss the weaknesses of YCT's current control system. (6 marks)

Advise the MD how the Balanced Scorecard could be applied and used with YCT. You should also suggest and justify ONE measure for each of the balanced scorecard’s perspectives. (10 marks) In relation to the growth and survival of YCT, evaluate the two suggestions for increasing the company’s profitability. (9 marks) (Total = 25 marks)

63 Bettaserve (APM Pilot paper)

45 mins

Bettaserve has identified and defined a market in which it wishes to operate. This will provide a ‘gold standard’ focus for an existing range of services. Bettaserve has identified a number of key competitors and intends to focus on close co-operation with its customers in providing services to meet their specific design and quality requirements. Efforts will be made to improve the effectiveness of all aspects of the cycle from service design to after-sales service to customers. This will require inputs from a number of departments in the achievement of the specific goals of the ‘gold standard’ range of services. Efforts will be made to improve productivity in conjunction with increased flexibility of methods. An analysis of financial and non-financial data relating to the ‘gold standard’ proposal for each of the years 20X7, 20X8 and 20X9 is shown below. Required (a) Prepare an analysis (both quantitative and discursive) of the ‘gold standard’ proposal for the period 20X7 to 20X9. You should use the information provided in the question, together with the data in Schedule 1 below. Your analysis should include the following: (i) (ii) (iii) A definition of corporate ‘vision or mission’ and consideration of how the proposal may be seen as identifying and illustrating a specific sub-set of this ‘vision or mission’. (5 marks) Discussion and, where possible, quantification of the proposal in both marketing and financial terms. (5 marks) Discussion of the external effectiveness of the proposal in the context of ways in which each of Quality and Delivery are expected to affect customer satisfaction and hence the marketing of the product. (5 marks) Discussion of the internal efficiency of the proposal in the context of ways in which the management of each of Cycle Time and Waste are expected to affect productivity and hence the financial aspects of the proposal. (5 marks)

(iv)

(b)

Discuss the links, both vertical and horizontal, of the performance measures investigated in (a). The discussion should include comment on the hierarchy and inter-relationships between the measures, including internal and external aspects of the expected trends in performance. (Note: a diagram may be used to illustrate the links, together with relevant discussion). (5 marks) (Total = 25 marks)

Questions

63

Schedule 1 ‘Gold Standard’ proposal – estimated statistics Total market size ($m) Bettaserve – sales ($m) Bettaserve – total costs ($m) Bettaserve – sundry statistics: Services achieving design quality standards (%) and accepted without further rectification Rectification claims from customers ($m) Cost of after sales rectification service ($m) Sales meeting planned completion dates (%) Average cycle time: (customer enquiry to service finalisation) (weeks) Service enquiries not taken up by customers (% of enquiries) Idle capacity of service personnel (%) Analysis of total cost: target cost – variable target cost – fixed internal failure costs external failure costs appraisal costs prevention costs Total cost

20X7 240 30 28.2

20X8 250 36 25.448

20X9 260 40 25.1

95 0.9 3 90 6 7.50 10 $’000 12,000 4,000 3,200 4,000 1,000 4,000 28,200

97 0.54 2.5 95 5.5 5.00 6 $’000 14,400 4,000 1,840 2,208 1,000 2,000 25,448

98 0.2 2 99 5 2.50 2 $’000 16,000 5,000 1,050 1,050 1,000 1,000 25,100

64 Cod (APM 12/11)

45 mins

Cod Electrical Motors (Cod) manufactures electrical motors for some of the 24 different European domestic appliance manufacturers. Their motors are used in appliances such as washing machines and refrigerators. Cod has been in business for over 50 years and has obtained a reputation for producing reliable, low cost motors. Cod has recently rewritten its mission statement, which now reads: ‘Cod Electrical Motors is committed to providing competitively priced, high quality products, with service exceeding customer expectations. We will add value to our business relationships by investing in product development and highly trained personnel.’ The board have recognised that their existing key performance indicators (KPIs) do not capture the features of the corporate mission. They are worried that the staff see the mission statement as a public relations exercise rather than the communication of Cod’s vision. The monthly board papers contain a simple performance summary which is used as the key performance measurement system at that level. Example of board papers for November 20X1: Cod Electrical Motors Key performance indicators for November 20X1 Profit ($m) Free cashflow ($m) Return on capital employed (%) Notes: (a) (b) (c) (d) The year end is 31 December. The comparative figure is for the same month in the previous year. ROCE is an annualised figure. YTD means year to date. This month 2·1 3·4 12·4 YTD 25·6 17·6 11·7 Comparative 1·9 1·6 11·8

64

Questions

There are additional performance indicators not available to the board that line management use for a more detailed picture. Additional performance information: Note 1 Activity No of orders No of deliveries Staff No of staff (FTE basis) No of staff training days No of vacant posts Customers No of orders with a complaint Late delivery Product quality Customer service Other Preferential supplier status Production New products begun in year to date in development at month end launched in year to date Quality internal failure costs ($'000) external failure costs ($'000) Notes: 1 2 3 4 5 Figures are year to date with comparatives from the previous year quoted on the same basis. FTE = Full-time equivalent staff numbers. Post is considered vacant if unfilled for more than four months. Complaints are logged and classified into the four categories given when received. Number of customers where Cod holds preferred supplier status. 20X1 20X0

2,560 1,588

2,449 1,660

2 3

1,229 2,286 11

1,226 1,762 17

4 26 39 21 52 14 25 31 24 43 12

5

2 4 1 3,480 872

1 3 1 2,766 693

Required (a) (b) (c) Assess whether the current key performance indicators (KPIs) meet the expected features of a modern performance measurement system. (7 marks) Explain how the performance pyramid (Lynch and Cross) can help Cod’s board to reach its goal of a coherent set of performance measures. (6 marks) Evaluate the current system using the performance pyramid and apply the performance pyramid to Cod in order to suggest additional KPIs and a set of operational performance measures for Cod. (12 marks) (Total = 25 marks)

Questions

65

65 APX Accountancy (APM 6/11, amended)

45 mins

APX Accountancy (APX) is an accountancy partnership with 12 branches covering each of the main cities of Emland. The business is well established, having organically grown over the last 40 years to become the second largest non-international practice in Emland. The accountancy market is mature and expands and contracts along with the general economic performance of Emland. APX offers accountancy, audit, tax and business advisory services. The current business environment in Emland is dominated by a recession and the associated insolvency work is covered within the business advisory area of APX. At present, the practice collects the following information for strategic performance evaluation: Audit Revenue ($m) APX Accounting industry Change in revenue on previous year APX Accounting industry Profit margin at APX Customer service score (1 to 5 with 5 being excellent) APX Tax Business Advisory 64·7 462·0 22·0% 16·0% 10·5% 4·1 Total

69·1 557·0 3·0% 2·5% 6·4% 3·4

89·2 573·0 8·0% 4·5% 7·8% 3·9

223·0 1,592·0 10·0% 6·8% 8·1%

The above figures are for the most recent financial year and illustrate the metrics used by APX. Equivalent monthly figures are produced for each of the monthly partner meetings which review practice performance. The staff are remunerated based on their grade, with non-partners obtaining a bonus of up to 10% of basic salary based on their line managers’ annual review. The partners receive a fixed salary with a share of profit which depends on their contractual responsibilities within the partnership. The managing partner of APX is dissatisfied with the existing performance management system, as she is not convinced that it is helping to achieve the long-term goal of expanding and ultimately floating the business on the national stock exchange. Therefore, she has asked you to consider the impact of applying Fitzgerald and Moon’s building block approach to performance management in the practice. In addition, the marketing manager at APX believes that the firm as a whole doesn’t pay enough attention to customer service. At the last management meeting he said that, in his opinion, the customer service score(*) was the most important figures out of the performance metrics currently used by APX, and he said he felt it was no coincidence that the area of the business with the highest customer service score had also performed best financially. [*: Customer service scores reflect ratings given by customers in relation to the level of service they feel they have received from APX.] Required (a) (b) (c) Briefly describe Fitzgerald and Moon’s building block model of performance management. (4 marks)

Evaluate the existing performance management system at APX by applying the building block model. (8 marks) Explain the main improvements the introduction of a building block approach to performance management could provide, and suggest specific improvements to the existing system of performance measures at APX in light of the introduction of the building block model. (8 marks) Briefly evaluate the marketing manager’s statement about the customer service score. (5 marks) (Total = 25 marks)

(d)

66

Questions

66 Eatwell Restaurant (PM 6/02, amended)

45 mins

The owners of The Eatwell Restaurant have diversified business interests and operate in a wide range of commercial areas. Since buying the restaurant in 20X0 they have carefully recorded the data below. 20X1 20X2 20X3 20X4 Total meals served 3,750 5,100 6,200 6,700 Regular customers attending weekly 5 11 15 26 Number of items on offer per day 4 4 7 9 Reported cases of food poisoning 4 5 7 7 Special theme evenings introduced 0 3 9 13 Annual operating hours with no customers 380 307 187 126 Proposals submitted to cater for special events 10 17 29 38 Contracts won to cater for special events 2 5 15 25 Complimentary letters from satisfied customers 0 4 3 6 Average number of customers at peak times 18 23 37 39 Average service delay at peak times (mins) 32 47 15 35 Maximum seating capacity 25 25 40 40 Weekly opening hours 36 36 40 36 Written complaints received 8 12 14 14 Idle time 570 540 465 187 New meals introduced during the year 16 8 27 11 Financial data $ Average customer spend on wine Total revenue Revenue from special events Profit Value of food wasted in preparation Total revenue of all restaurants in locality Required (a) Assess the overall performance of the business and submit your comments to the owners. They wish to compare the performance of the restaurant with their other business interests and require your comments to be grouped into the key areas of performance such as those described by Fitzgerald and Moon. (14 marks) Identify any additional information that you would consider of assistance in assessing the performance of The Eatwell Restaurant in comparison with another restaurant. Give reasons for your selection and explain how they would relate to the key performance area categories used in (a). (6 marks) Briefly discuss the factors which determine the effectiveness of performance standards used in service organisations. (5 marks) (Total = 25 marks) 3 83,000 2,000 11,600 1,700 895,000 $ 4 124,500 13,000 21,400 1,900 1,234,000 $ 4 137,000 25,000 43,700 3,600 980,000 $ 7 185,000 55,000 57,200 1,450 1,056,000

(b)

(c)

67 Amal (APM 6/12, amended)

45 mins

Amal Airline (Amal) is the national airline of Jayland. It was originally owned by the government but was listed on the local stock exchange when sold to private investors more than 20 years ago. The airline’s objective is to be the best premium global airline. Amal provides long- and short-haul services all over the world and is based at its hub at Jaycity airport. Amal has been hit by a worldwide reduction in air travel due to poor economic conditions. The most recent financial results show a loss and this has caused the board to reconsider its position and take action to address the changed environment. Amal has cut its dividend in order to conserve cash and it is trying to rebuild profitability by reducing costs by 14%. The airline is capital intensive as it requires to maintain a large fleet of modern aircraft. The two major costs for the airline are staff and fuel. In trying to renegotiate working conditions and pay, the management have angered the unionised workforce. There has already been some strike action by the unions representing the aircraft crew and
Questions

67

ground staff and more is threatened. They are upset about changes to pension provisions which will require them to make larger contributions and also, a reduction in the number of crew on each aircraft which they believe will require them to work harder and so they want a compensating pay-rise. Additionally, the board are pushing forward a large project to improve the design of the company website in order to increase the number of passengers who check-in on-line and so would not require as much assistance at the airport. The new design is also aiming to increase the number of passengers who book their tickets through the company’s website rather than other resellers’ websites or at booking agents. The project is currently two months behind schedule due to one of the main software suppliers becoming insolvent. Finally, the board has been considering taking advantage of new technology in aircraft engines by making a large investment ($450m) in new low-noise, fuel-efficient aircraft in an effort to reduce the environmental complaints surrounding air travel and also cut costs. Given all of the issues and projects affecting Amal, the CEO has tried to find a unifying view that will explain the airline’s performance. She has heard that the performance prism may provide such a framework. As further background, the CEO has supplied the data below on Amal and two of its main competitors. Kayland Air is a government owned and run airline in the neighbouring country of Kayland. It has a similar mix of business to Amal and targets a similar market. Cheapo Air is currently one of the most successful of the new privately-owned airlines that have gained significant market share over the last 15 years by offering a cheap but basic short-haul service to customers in and around Jayland. Cheapo Air subcontracts many of their activities in order to remain flexible. The CEO wants you to calculate some suitable performance measures and explain the results. Data provided by the CEO: Data for the most recent calendar year Passengers (’000s) Passenger kilometres (millions) Revenue Costs Fuel Staff Staff numbers Operating profit Number of aircraft Average aircraft size (seats) Seat kilometres (millions) Required (a) (b) Using the data provided, analyse the three airlines using appropriate performance indicators and comment on your results. (12 marks) Apply the performance prism model to Amal and suggest improvements to performance management including possible methods of performance improvement and relevant performance measures. (13 marks) (Total = 25 marks) Amal 23,649 79,618 5,430 1,480 1,560 32,501 630 182 195 100,654 Kayland Air 38,272 82,554 7,350 1,823 2,998 56,065 54 361 163 105,974 Cheapo Air 35,624 40,973 2,170 535 238 5,372 127 143 125 46,934

$m $m $m $m

Note: A seat kilometre is generated for every one kilometre flown by an available seat on the company’s aircraft.

68 B2B Deliveries

45 mins

B2B Deliveries Limited (B2B) is a large courier service operating in the UK and much of the rest of the European Union. It operates from a network of 40 sites in the UK and sites near the main airports in other EU countries. To collect and deliver a package, the site closest to the sender is responsible for collecting the package from the sender and transferring it to the site responsible for delivery. The site nearest the delivery address receives the package and is responsible for delivery to the recipient. The standard B2B service is that items collected before 16.00 hours on a working day will be delivered before 13.00 on the next working day. B2B’s newly-appointed chief executive officer (CEO) has a career background in both management accounting and operations management, and he believes that the company’s current system for measuring company performance 68
Questions

is inadequate. He thinks that there is too much focus on cutting costs and increasing productivity, and not enough focus on other aspects of performance required to meet stakeholder expectations. The CEO is particularly critical of some of the measures that are used to monitor and control the performance of the collections and deliveries. Senior managers use a variety of performance measures, which include the number and weight of packages delivered (in total and per vehicle and per driver), the percentage of packages collected on time, the percentage of packages delivered on time, the percentage of packages lost in transit, the percentage of packages delivered to the right location with no damage, and the average delivery time within the UK and within Europe. The main cost measure is the average cost per kilogram/mile delivered. The CEO believes that these performance targets and measures are not clearly linked to the objectives of the company, which include objectives in relation to employees, customers and the environment, as well as financial objectives. The CEO thinks that it would be appropriate to change B2B’s performance measurement system, using the performance prism as a structure for developing its new system. Required (a) (b) Explain briefly the features of the performance prism and how it can be used to develop a system of performance management throughout an organisation. (10 marks) Discuss how a performance measurement system based on the performance prism could be introduced at B2B. (15 marks) (Total = 25 marks)

69 Glitter Fashions

45 mins

Glitter Fashions Limited (GF Co) sells clothes through its web site. Most of its sales are fashion items, which the company either manufactures itself or buys for resale from other fashion companies. Although its sales are made entirely through the internet, GF Co has a call centre for dealing with customer complaints, which are received by telephone and e-mail. The company has grown successfully since it was established some years ago, and its chief executive officer (CEO) is continually looking for ways to improve employee motivation and to improve company performance and profits. About four years ago, the company experimented with a Balanced Scorecard approach to performance measurement. For each of the four perspectives on the Scorecard, two measures of performance were selected. These were then used as the basis for setting performance targets. In turn, managers’ and staff bonuses were dependent on the these targets being achieved. The performance measures used in the Scorecard were: Critical financial measures: Critical customer measures Critical internal measures Critical innovation and learning measures Economic value added (EVA) Cash flow Order-to-delivery cycle time On-time deliveries Batch production cycle time Design-to-production time Number of new fashion items designed Revenue per employee However, GF Co abandoned its Balanced Scorecard after two years, because it had not generated any improvement in the company’s performance, and the exercise seemed to be an unnecessary effort. GF Co has also experimented with payment of staff incentives, based on performance in specific areas of the business. For example, in the customer call centre, staff are paid a productivity bonus. However, customer satisfaction with the call centre’s service levels is low, due to the use of automated phone messages, slow response to e-mails, and unhelpful call centre staff. The CEO has recently become aware of the performance prism as a method for developing a performance management system and is interested in learning what the performance prism may offer the company that the Balanced Scorecard and other performance measures have so far failed to achieve.
Questions

69

Required (a) Discuss the similarities and differences between a balanced scorecard approach and a performance prism approach to establishing a performance measurement system, and discuss what benefits a performance prism approach might provide to an organisation. (12 marks) Identify the weaknesses in the current system used to monitor the performance of Glitter’s call centre and explain the benefits of using an approach based on the performance prism for measuring and managing the call centre’s performance. (13 marks) (Total = 25 marks)

(b)

70 TOC (APM 12/08, Preparation question)

36 mins

The Ornamental Company (TOC) makes and sells a range of ornamental products in Baseland. TOC employs experienced sculptors who have an excellent reputation for producing high-quality products. TOC has been approached by The Superior Garden Group (SGG) and asked to make two products. The two products are a water fountain known as 'The Fountain' and a large garden gnome known as 'The Goblin'. The management accountant of TOC has estimated the variable costs per unit of The Fountain and The Goblin as being $622·50 and $103·75 respectively. She based her calculations on the following information: (1) Product data Production/sales (units) Total direct material costs Total direct labour cost (2) (3) (4) (5) (6) The Fountain 2,000 $'000 450 300 The Goblin 4,000 $'000 150 100 Other products 16,000 $'000 1,200 1,200

Total variable overheads for TOC will amount to $2,400,000 of which 30% relates to the procurement, warehousing and use of direct materials. All other variable overheads are direct labour related. TOC currently absorbs variable overheads into product units using company-wide percentages on total direct material cost and total direct labour cost. SGG is willing to purchase The Fountain at $750 per unit and The Goblin at $150 per unit. TOC will not undertake any work which does not yield an estimated contribution to sales ratio of 28%. The directors of TOC are considering switching to an activity-based costing system and recently appointed a firm of management consultants to undertake a detailed review of existing operations. As part of that review, the management consultants concluded that estimated relevant cost drivers for material and labour related overhead costs attributable to The Fountain and The Goblin are as follows: The Fountain Direct material related overheads: The cost driver is the volume of raw materials held to facilitate production of each product. Material proportions per product unit: Direct labour related overheads: The cost driver is the number of labour operations performed. Labour operations per product unit: The Goblin Other products

4

7

4

6

5

4

70

Questions

Required (a) (b) (c) Calculate variable cost per unit of both products using an activity-based costing approach. (8 marks)

Using the unit cost information available and your calculations in (a), prepare a financial analysis of the decision strategy which TOC may implement with regard to the manufacture of each product. (6 marks) Critically discuss the adoption of activity-based management (ABM) in companies such as TOC. (6 marks) (Total = 20 marks)

71 SFS (APM 6/10, amended)

45 mins

The Spare for Ships Company (SFS) has a specialist machining facility which serves the shipbuilding components market. The current job-costing system has two categories of direct cost (direct materials and direct manufacturing labour) and a single indirect cost pool (manufacturing overhead which is allocated on the basis of direct labour hours). The indirect cost allocation rate of the existing job-costing system is $120 per direct manufacturing labourhour. Recently, the Visibility Consultancy Partnership (VCP) proposed the use of an activity-based approach to redefine the job-costing system of SFS. VCP made a recommendation to retain the two direct cost categories. However, VCP further recommended the replacement of the single indirect-cost pool with five indirect-cost pools. Each of the five indirect-cost pools represents an activity area at the manufacturing premises of SFS. Each activity area has its own supervisor who is responsible for his/her operating budget. Relevant data are as follows: Activity area Materials handling Lathe work Milling Grinding Inspection Cost driver used as allocation base Number of components Number of cuts Number of machine hours Number of components Number of units inspected Cost allocation rate ($) 0.50 0.70 24.00 1.50 20.00

SFS has recently invested in 'state of the art' IT systems which have the capability to automatically collate all of the data necessary for budgeting in each of the five activity areas. The management accountant of SFS calculated the manufacturing cost per unit of two representative jobs under the two costing systems as follows: $ $ Job order 973 Job order 974 Current costing system 1,172.00 620.00 Activity-based costing system 1,612.00 588.89 Required (a) Compare the cost figures per unit for Job order 973 and Job order 974 calculated by the management accountant and explain the reasons for, and potential consequences of, the differences in the job cost estimates produced under the two costing systems; (8 marks) 'The application of Activity Based Management (ABM) requires that the management of SFS focus on each of the following: (i) (ii) (iii) Operational ABM; Strategic ABM; The implicit value of an activity'.

(b)

Questions

71

Required Critically appraise the above statement and explain the risks attaching to the use of ABM. (8 marks)

SFS manufactures and sells a range of products. It is not dominant in the market in which it operates and, as a result, it has to accept the market price for each of its products. The company is keen to ensure that it continues to compete and earn satisfactory profit at each stage throughout a product’s life cycle. Required (c) Explain how SFS could use Target Costing and Kaizen Costing to improve its future performance. Your answer should include an explanation of the differences between Target Costing and Kaizen Costing. (9 marks) (Total = 25 marks)

72 LOL cards (APM 12/10, amended)

45 mins

LOL Co is a chain of shops selling cards and gifts throughout its country. It has been listed on the stock exchange for 10 years and enjoys a fairly high profile in the retail sector of the national economy. You have been asked by the chief executive officer (CEO) to advise the company on value-based management (VBM), as a different approach to performance management. The CEO has read about this method as a way of focusing on shareholder interests and in the current tough economic climate, she thinks that it may be a useful development for LOL. The company has traditionally used earnings per share (EPS) growth and share price in order to assess performance. The changes being proposed are considered significant and the CEO wants to be briefed on the implications of the new analysis and also how to convince both the board and the major investors of the benefits. Financial data for LOL 20X9 $m 50.7 4.0 35.0 160 (in $m) 99.2 104.1 97.8 20Y0 $m 43.5 7.8 26.8 160

Profit before interest and tax Interest paid Profit after interest and tax Average number of shares in issue (millions) Capital employed at the end of the year was 20X8 20X9 20Y0 LOL aims for a capital structure of 50:50 debt to equity. Cost of capital were Equity Debt (post-tax cost) Corporation tax is at the rate of 25%. Stock market information Stock market all-share index Retailing sector index LOL (average share price) ($)

20X9 12.70% 4.20%

20Y0 15.30% 3.90%

20X9 2,225.4 1,225.6 12.20

20Y0 1,448.9 907.1 10.70

The fall in profits can, in part at least, be attributed to an increase in costs. The CFO has advised that LOL needs to focus on cost reduction rather than cost containment. She proposes to achieve this through the introduction of activity based management.

72

Questions

Required (a) (b) Explain to the CEO what value-based management involves and how it can be used to focus the company on shareholder interests. (4 marks) Perform an assessment of the financial performance of LOL using Economic Value Added (EVA™) and evaluate your results compared with those of earnings per share (EPS) growth and share price performance. You should state any assumptions made. (12 marks) Evaluate VBM measures against traditional profit based measures of performance. (3 marks)

(c) (d)

Discuss how activity based management (ABM) differs from traditional cost allocation systems, and how ABM seeks to achieve cost reduction. (6 marks) (Total = 25 marks)

73 BEG (APM 6/10, amended)

45 mins

The Better Electricals Group (BEG) which commenced trading during 2002 manufactures a range of high quality electrical appliances such as kettles, toasters and steam irons for domestic use which it sells to electrical stores in Voltland. The directors consider that the existing product range could be extended to include industrial sized products such as high volume water boilers, high volume toasters and large steam irons for the hotel and catering industry. They recently commissioned a highly reputable market research organisation to undertake a market analysis which identified a number of significant competitors within the hotel and catering industry. At a recent meeting of the board of directors, the marketing director proposed that BEG should make an application to gain 'platinum status' quality certification in respect of their industrial products from the Hotel and Catering Institute of Voltland in order to gain a strong competitive position. He then stressed the need to focus on increasing the effectiveness of all operations from product design to the provision of after sales services. An analysis of financial and non-financial data relating to the application for 'platinum status' for each of the years 20Y1, 20Y2 and 20Y3 is contained in the appendix. The managing director of BEG recently returned from a seminar, the subject of which was 'The Use of Cost Targets'. She then requested the management accountant of BEG to prepare a statement of total costs for the application for platinum status for each of years 20Y1, 20Y2 and 20Y3. She further asked that the statement detailed manufacturing cost targets and the costs of quality. The management accountant produced the following statement of manufacturing cost targets and the costs of quality: 20Y1 20Y2 20Y3 Forecast Forecast Forecast $'000 $'000 $'000 Variable manufacturing costs 8,400 10,500 12,600 Fixed manufacturing costs 3,000 3,400 3,400 Prevention costs 4,200 2,100 1,320 Appraisal costs 800 700 700 Internal failure costs 2,500 1,800 1,200 External failure costs 3,100 2,000 980 Total costs 22,000 20,500 20,200 Required (a) Explain how the use of cost targets could be of assistance to BEG with regard to their application for platinum status. Your answer must include commentary on the items contained in the statement of manufacturing cost targets and the costs of quality prepared by the management accountant. (8 marks) Assess the forecasted performance of BEG for the period 20Y1 to 20Y3 with reference to the application for 'platinum status' quality certification under the following headings: (i) (ii) (iii) Financial performance and marketing; External effectiveness; and Internal efficiency.

(b)

(12 marks)
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73

(c)

Briefly explain how the performance pyramid (Lynch and Cross) could help BEG gain its ‘platinum status’ quality certification. (5 marks) (Total = 25 marks) Appendix 'Platinum status' quality certification application – Relevant statistics 20Y1 Forecast 300 24 22 20Y2 Forecast 320 30 20.5 20Y3 Forecast 340 36 20.2

Total market size ($m) BEG – sales ($m) BEG – total costs ($m) BEG – sundry statistics: % of products achieving design quality standards and accepted without further rectification Rectification claims from customers ($m) Cost of after sales rectification service ($m) % of sales meeting planned delivery dates Average cycle time: customer enquiry to product delivery (days) Product enquiries not taken up by customers (% of enquiries) Idle capacity of manufacturing staff (%)

92 0.96 1.8 88.5 49 10.5 12

95 0.75 1.05 95.5 45 6 6

99 0.1 0.8 99.5 40 3 1.5

74 ENT Entertainments (APM 6/11, amended)
(1) (2) (3) (4) Restaurants Cafes Bars Dance clubs

45 mins

ENT Entertainment Co (ENT) is a large, diversified entertainment business based in Teeland. The company’s objective is the maximisation of shareholder wealth for its family owners. It has four divisions:

Recently, ENT’s board have identified that there are problems in managing such a diversified company. They have employed consultants who have recommended that they should perform a Boston Consulting Group (BCG) analysis to understand whether they have the right mix of businesses. The chief executive officer (CEO) has questioned whether using this analysis is helpful in managing the group’s performance. A business analyst has prepared information on each division in the table below. Revenue ($m) Restaurants ENT Market sector Cafes ENT Market sector Bars ENT Market sector Dance clubs ENT Market sector Actual 20X0 54 10,752 31 3,072 349 9,984 197 1,792 Actual 20X1 56 10,860 34 3,348 342 9,784 209 1,900 Forecast 20X2 59 10,968 41 3,717 336 9,491 219 2,013 Forecast 20X3 62 10,968 47 4,051 336 9,206 241 2,195

74

Questions

In Teeland, the economy is generally growing at about 2% per annum. The restaurant, cafe and bar sectors are all highly fragmented with many small operators. Consequently, a market share of more than 3·0% is considered large as that is comparable to the share of the largest operators in each sector. There are fewer small late night dance club operators and the market leader currently holds a 15·0% market share. There have not been many new developments within the divisions except for a new wine bar format launched by the bars division which has surprised the board by its success. Each of the division’s performance is measured by economic value-added (EVA™). The divisional managers have a remuneration package that is made up in two equal parts by a salary set according to industry norms and a bonus element which is based on achieving the cost budget numbers set by the company board. The chairman of the board has been examining the consistency of the overall objective of the business, the divisional performance measure and the remuneration packages at divisional level. He has expressed the worry that these are not properly aligned and that this might lead to dysfunctional behaviour by the divisional management. Required (a) (b) (c) Perform a BCG analysis of ENT’s business and use this to evaluate the company’s performance. (7 marks) Critically evaluate this BCG analysis as a performance management system at ENT. (i) (ii) (7 marks) Evaluate the divisional managers’ remuneration packages in the light of the divisional performance systems and your BCG analysis. (6 marks) Explain the implications of the BCG analysis and divisional performance systems on the management styles which might be appropriate at ENT. (5 marks) (Total = 25 marks)

75 Vision (PM 12/06, amended)

45 mins

Vision is a reputable manufacturer of a specialist range of optical and photographic equipment. At present, marketing activities are confined to its home market in Blinkland. The directors wish to achieve a net profit per annum of $150 million by the year ending 30 November 20X9. At the latest AGM, there was a consensus among Vision’s shareholders in favour of the growth that the directors were trying to achieve, but equally there was concern about the levels of risk the directors seemed to be prepared to take in order to achieve that growth. The following information is available: Note 1 The most recent forecast covering the three year period ending 30 November 20X9, based on sales of products which were in existence at 1 December 20X6 to existing customers, is as follows: Year ending 30 November: Turnover Net Profit Note 2 Vision manufactures a range of products within its three divisions, as follows: Astronomy. This division manufactures telescopic equipment which is sold via mail order to private individuals. Medical. This division manufactures microscopes and associated equipment which are sold to hospitals and schools in Blinkland. Outdoor pursuits. This division manufactures a range of cameras and binoculars which are sold via mail order to private individuals. Note 3 The following became effective on 1 December 20X6: (i) The company created a new division called the Oceanic division which manufactures cameras suitable for underwater use. These are sold to clubs and societies that engage in scuba diving activities. Sales revenue is forecast to be $5 million in the first year of operation with an anticipated doubling of sales volume during
Questions

20X7 $m 100·0 40·0

20X8 $m 105·0 42·0

20X9 $m 110·0 44·0

75

each of the next two years of operation. Variable costs are forecast at 40% of sales revenue in the first year of operation and are expected to reduce to 35% and 30% during each of the next two years respectively. Fixed overheads are forecast at $1 million in the first year of operation and are expected to increase by 10% per annum during each of the next two years. (ii) The company purchased the 'Sound and vision' chain of camera shops comprising a total of 30 retail outlets within Blinkland. Each of the 20 'out of town' outlets is forecast to make a profit of $750,000 and each of the 10 city outlets is forecast to make a profit of $1 million during the year ending 30 November 20X7. It is anticipated that profits of 'out of town' and city outlets will increase by 8% and 4% per annum respectively during each of the next two years. The company purchased Racquets, a well-established manufacturer of tennis, badminton and squash racquets. Racquets made a profit of $15 million during the year ended 30 November 20X6 and profit is expected to increase by $1 million per annum during each of the next three years. A new camera known as the 'Birdcam-V' was launched. This camera will allow bird-watching activities to take place during the night, irrespective of prevailing noise and weather conditions. The Birdcam-V is the only camera on the market which has special 'noise and weather' filtering capabilities and has an expected life of three years. The marketing director has estimated that at a selling price of $600 per unit, a total of 85,000 units per annum would be sold during the year ending 30 November 20X7 and that each increase or decrease in the selling price of $10 will cause quantity demanded to decrease or increase by 1,000 units. The variable cost per unit is expected to remain constant at $180. Development costs amounting to $45,967,500 are to be written off evenly over the expected life of the Birdcam-V. The directors of Vision plc have agreed to adopt the combination of selling price and output that will maximise profit earned from sales of the Birdcam–V. Required (a) (b) Calculate the 'profit gap' that is forecast to exist at 30 November 20X9. (i) (ii) (c) (10 marks)

(iii)

(iv)

Explain how the use of Ansoff's product-market matrix might assist the management of Vision to reduce the profit-gap that is forecast to exist at 30 November 20X9. (3 marks) Explain how the existing product range and the actions per Note (3) would feature in Ansoff's product-market matrix. (7 marks)

With reference to Ansoff’s product-market matrix, and the profit gap, briefly evaluate the shareholders’ concerns in relation to the level of risk associated with the actions in Note (3). (5 marks) (Total = 25 marks)

76 TMC (APM 12/08, amended)

45 mins

The Motherhelp Company (TMC), which is based in Happyland, manufactures and markets disposable nappies for babies and infant children. Disposable nappies are made of super-absorbent chemicals, paper pulp and plastics. TMC has been very successful since its formation in 1996. It has established a very strong brand name and its products are sold by all leading pharmacies and supermarkets in Happyland. TMC has a strong organisational culture with high levels of employee motivation and satisfaction throughout the organisation. Available information regarding the disposable nappy market size and TMC's revenue is as follows: Actual 20X5 $m 2,726 354 Actual 20X6 $m 2,807 421 Actual 20X7 $m 2,920 526 Actual 20X8 $m 3,095 681 Forecast 20X9 $m 3,249 715 Forecast 20Y0 $m 3,347 736

Market size Revenue

The marketing director of TMC has obtained information that the birth-rate in Happyland is projected to fall after 20Y0. However, the number of years over which the projected fall might take place cannot be forecast with any degree of certainty. The directors of TMC are most concerned that in spite of the growth achieved during recent years, there remains a projected 'planning gap' at the end of 20Y2. In view of this fact the directors of TMC are considering the acquisition 76
Questions

of The Comfy Baby Company (CBC), a competitor, which had revenue of $155m during 20X8 from sales of its disposable nappies. None of the directors of TMC have any previous experience of such an acquisition. The directors of TMC have heard that CBC has experienced workplace culture based problems during recent years. The government of Happyland has recently issued a green paper, designed to encourage discussion and potentially pave the way for legislation, concerning the environment in which they stated their concerns about companies such as TMC whose entire revenues derive from sales of non-biodegradable products. Required (a) Using the above information, explain the term 'planning gap' and discuss other suitable alternative strategies to closing the planning gap which the directors of TMC might have considered prior to giving consideration to the purchase of CBC. (6 marks) Analyse THREE potential problems, based solely on the information provided above, that TMC might encounter in the acquisition of CBC. (6 marks) Explain the reasons for the concerns of the government of Happyland with companies such as TMC and advise the directors of a strategy that might be considered in order to avoid being subject to any forthcoming legislation concerning the environment. (6 marks) Evaluate the circumstances in which a government can act as an aid to business performance. (7 marks)

(b) (c)

(d)

(Total = 25 marks)

77 Joint venture

45 mins

Two years ago, LC plc established a joint venture operation with HTB. LC is a large multinational gaming company, while HTB is a smaller electronics company, which is run and managed by its founder’s family. However, HTB has recently developed a new virtual casino platform, and LC has been trying to expand its online casino side for several years now. The two companies agreed to establish the joint venture to harness HTB’s software and technological skills and LC’s existing customer base and distribution network. The initial equity investment in the joint venture was $10 million in cash, with 50% contributed by each of the joint venture partners. The partners agreed that any profits would also be split evenly between them. Since the initial investment, all additional long-term capital has been raised in the form of bank loans, secured against the assets of the joint venture operation. The management accountant of LC has produced the following financial results for the joint venture in its first two years, together with forecasts for the next two years. These are shown below. (Figures are in $millions.) Year 1 actual 14 13 1 0 1 0 (5) 55% Year 2 actual 19 17 2 0 2 0 0 45% Year 3 forecast 25 21 4 1 3 2 (7) 100% Year 4 Forecast 31 26 5 1 4 3 (4) 123%

Revenue Costs Profit before tax Tax Profit after tax Dividend Net cash flow in year Gearing

These figures have been shown to the management of HTB, who agree with most of the forecasts for the next two years, including the forecasts for sales and profits. They do not agree, however, with the dividend figures. The management of LC have argued in favour of dividend payments out of profits, as an indication to their shareholders that the joint venture is successful. The management of HTB believe that in the early years of the venture, profits should either be reinvested for faster growth or should be used to pay back debt.
Questions

77

There have also been some disagreements between the joint venture partners about transfer prices. LC makes a fixed annual charge to the joint venture for marketing support and accounting services. HTB charges the joint venture for software support by its technicians, based on an hourly rate which includes a mark-up for profit. In addition, there has been disagreement between senior management of the two joint venture partners about the measures being used to assess the venture’s performance. The management of LC expressed the view that in the early years of the joint venture, the key performance statistics were profit, sales growth and profit growth. The management of HTB argued in response that, although growth and profitability were important, it was essential to recognise the liquidity and gearing risks facing the joint venture. They contended that cash flows and gearing levels should also be monitored. Required (a) (b) (c) Evaluate the compatibility of the joint venture partners. (8 marks)

Assess the difficulties that may arise in the joint venture in relation to identifying and agreeing key performance targets, and in monitoring performance. (9 marks) Evaluate the actual and expected performance of the joint venture, from the differing perspectives of the management of LC and HTB. (8 marks) (Total: 25 marks)

78 Callisto (APM, 6/12, amended)

45 mins

Callisto Retail (Callisto) is an on-line reseller of local craft products related to the historic culture of the country of Callistan. The business started ten years ago as a hobby of two brothers, Jeff and George. The brothers produced humorous, short video clips about Callistan which were posted on their website and became highly popular. They decided to use the website to try to sell Callistan merchandise and good initial sales made them believe that they had a viable business idea. Callisto has gone from strength to strength and now boasts sales of $120m per annum, selling anything related to Callistan. Callisto is still very much the brothers’ family business. They have gathered around themselves a number of strategic partners into what Jeff describes as a virtual company. Callisto has the core functions of video clip production, finance and supplier relationship management. The rest of the functions of the organisation (warehousing, delivery and website development) are outsourced to strategic partners. The brothers work from their family home in the rural North of Callistan while other Callisto employees work from their homes in the surrounding villages and towns. These employees are involved in video editing, system maintenance, handling customer complaints and communication with suppliers and outsourcers regarding inventory. The employees log in to Callisto’s systems via the national internet infrastructure. The outsourced functions are handled by multinational companies of good reputation who are based around the world. The brothers have always been fascinated by information technology and so they depend on email and electronic data interchange to communicate with their product suppliers and outsourcing partners. Recently, there have been emails from regular customers of the Callisto website complaining about slow or non-delivery of orders that they have placed. George has commented that this represents a major threat to Callisto as the company operates on small profit margins, relying on volume to drive the business. He believes that sales growth will drive the profitability of the business due to its cost structure. Jeff handles the management of outsourcing and has been reviewing the contracts that exist between Callisto and its strategic partner for warehousing and delivery, RLR Logistics. The current contract for warehousing and delivery is due for renewal in two months and currently, has the following service level agreements (SLAs): 1. 2. 3. 4. RLR agree to receive and hold inventory from Callisto’s product suppliers. RLR agree to hold 14 days inventory of Callisto’s products. RLR agree to despatch from their warehouse any order passed from Callisto within three working days, inventory allowing. RLR agree to deliver to customers anywhere in Callistan within two days of despatch.

Breaches in these SLAs incur financial penalties on a sliding scale depending on the number and severity of the problems. Each party to the contract collects their own data on performance and this has led to disagreements in 78
Questions

the past over whether service levels have been achieved although no penalties have been triggered to date. The most common disagreement arises over inventory levels held by RLR with RLR claiming that it cannot be expected to deliver products that are late in arriving to inventory due to the product suppliers’ production and delivery issues. Required (a) Assess the difficulties of performance measurement and performance management in complex business structures such as Callisto, especially in respect of the performance of their employees and strategic partners. (17 marks)

George has also been increasingly concerned about the length of time it is taking for customer complaints to be addressed, and the damage which delays in replying to customer complaints could have on Callisto’s reputation. In this respect, he is also worried that Callisto’s employees are not working as productively as they could be. Consequently, he has designed a daily report which lists all the employees in alphabetical order, and then shows four columns of data for each employee: 1. 2. 3. 4. How long they have been logged on to Callisto’s system How many videos they have edited How many complaints they have handled How many suppliers or outsourcers they have contacted

Required: (b) Evaluate the usefulness of George’s proposed report, and suggest ways the output report could be improved. (8 marks) (Total = 25 marks)

79 CHN Retail chain

45 mins

CHN is a major retail chain based in European country. The company’s competitive strategy is based around emphasising the quality of its products and its customer service, even if this means its products are sometimes more expensive than those sold by other supermarkets. CHN has recently introduced a vendor managed inventory (VMI) relationship with 15 of its main suppliers. Under the VMI relationship, CHN’s suppliers replenish products automatically without CHN raising purchase orders for them. The suppliers have access to CHN’s sales quantities and inventory data (via an Electronic Data Interchange (EDI)) and use this to work out when replenishment is needed. The data available via the EDI is updated on a real-time basis, by the sales data recorded on the electronic point of sale (EPoS) systems in all of CHN’s stores. The suppliers also have access to CHN’s sales forecasts to allow them to adjust replenishment quantities according to demand predictions. When the system VMI system was introduced, CHN’s Operations’ Director argued that it should allow CHN to reduce inventory levels yet still improve availability, because the suppliers can plan their production and deliveries more efficiently than us in order to supply products as they are needed. The Operations’ Director pointed out that suppliers typically only deal with a relatively small number of stock lines, whereas CHN’s buying department deals with thousands of product lines overall. At the time the Marketing Director remained critical of the system. He said it would only work if CHN’s suppliers are agile and adaptable. He said he felt it was a risk shifting responsibility for the quantity and timing of product deliveries to the suppliers, particularly in the absence of any service level agreements with the suppliers. In addition, he added, ‘Only about half of our main suppliers actually deliver what we want, every week. Others continually fail.’ However, initial performance reports suggest that CHN’s VMI system is working well, and the company is now looking to add additional suppliers into the relationship. The procurement manager is currently evaluating two existing suppliers who supply similar goods, but he only wants to add one of them onto the list of preferred suppliers under the VMI relationship. He has rated them on a number of characteristics (below) on a scale from 1 – 10; where 1 is ‘very poor’, and 10 is ‘excellent’.
Questions

79

Supplier BY Cost performance Quality record Reliability (orders fulfilled correctly) Dependability of supply (on time deliveries) Volume flexibility Range of products provided Scope to develop new products Ease of doing business with Required (a) (b) 10 8 9 7 8 9 7 8

Supplier KA 8 9 10 9 9 8 10 8

Evaluate the extent to which the VMI system adds value for CHN’s customers.

(6 marks)

Assess the importance of CHN establishing service level agreements with the suppliers using the VMI system, and identify TWO measures of supplier performance which CHN should include in a service level agreement. (8 marks) Recommend, with reasons, which of the two suppliers CHN should select as its preferred supplier. (6 marks) Briefly discuss the impact which CHN’s competitive strategy will have on the performance information which the directors should monitor. (5 marks) (Total = 25 marks)

(c) (d)

80 BPC (APM 12/07, amended)

45 mins

The directors of Blaina Packaging Co (BPC), a well-established manufacturer of cardboard boxes, are currently considering whether to enter the cardboard tube market. Cardboard tubes are purchased by customers whose products are wound around tubes of various sizes ranging from large tubes on which carpets are wound, to small tubes around which films and paper products are wound. The cardboard tubes are usually purchased in very large quantities by customers. On average, the cardboard tubes comprise between 1% and 2% of the total cost of the customers' finished product. The directors have gathered the following information: (1) The cardboard tubes are manufactured on machines which vary in size and speed. The lowest cost machine is priced at $30,000 and requires only one operative for its operation. A one-day training course is required in order that an unskilled person can then operate such a machine in an efficient and effective manner. The cardboard tubes are made from specially formulated paper which, at times during recent years, has been in short supply. At present, four major manufacturers of cardboard tubes have an aggregate market share of 80%. The current market leader has a 26% market share. The market shares of the other three major manufacturers, one of which is JOL Co, are equal in size. The product ranges offered by the four major manufacturers are similar in terms of size and quality. The market has grown by 2% per annum during recent years. A recent report on the activities of a foreign-based multinational company revealed that consideration was being given to expanding operations in their packaging division overseas. The division possesses large-scale automated machinery for the manufacture of cardboard tubes of any size. Another company, Plastic Tubes Co (PTC) produces a narrow, but increasing, range of plastic tubes which are capable of housing small products such as film and paper-based products. At present, these tubes are on average 30% more expensive than the equivalent sized cardboard tubes sold in the marketplace.

(2) (3)

(4)

(5)

80

Questions

Required (a) (b) Using Porter's five forces model, assess the attractiveness of the option to enter the market for cardboard tubes as a performance improvement strategy for BPC. (10 marks) Discuss the limitations of Porter’s five forces model as a technique for assessing how attractive an industry is to enter. (5 marks)

JOL Co was the market leader with a share of 30% three years ago. The managing director of JOL Co stated at a recent meeting of the board of directors that: 'our loss of market share during the last three years might lead to the end of JOL Co as an organisation and therefore we must address this issue immediately'. Required (c) Discuss the statement of the managing director of JOL Co and discuss six performance indicators, other than decreasing market share, which might indicate that JOL Co might fail as a corporate entity. (10 marks) (Total = 25 marks)

81 RM Batteries (APM 12/10, amended)

45 mins

RM Batteries Co (RMB) is a manufacturer of battery packs. It has expanded rapidly in the last few years under the leadership of its autocratic chairman and chief executive officer, John Smith. Smith is relentlessly optimistic. He likes to get his own way and demands absolute loyalty from all his colleagues. The company has developed a major new product over the last three years which has necessitated a large investment in new equipment. Smith has stated that this more efficient battery is critical to the future of the business as the company operates in a sector where customers expect constant innovation from their suppliers. However, the recent share price performance has caused concern at board level and there has been comment in the financial press about the increased gearing and the strain that this expansion is putting on the company. The average share price has been $1·56 (20X8), $1·67 (20X9) and $1·34 (20Y0). There are 450 million shares in issue. A relevant Z-score model for the industry sector is: Z = 1·2X1 + 1·4X2 + 3·3X3 + 0·6X4 + X5 Where X1 is working capital/total assets (WC/TA); X2 is retained earnings reserve/total assets (RE/TA); X3 is Profit before interest and tax/total assets (PBIT/TA); X4 is market value of equity/total long-term debt (MVE/total long-term debt); and X5 is Revenue/total assets (Revenue/TA). A score of more than 3 is considered safe and at below 1·8, the company is at risk of failure in the next two years. The company’s recent financial performance is summarised below: Summary Income Statements 20X8 $m 1,460 1,153 307 35 272 87 185 20X9 $m 1,560 1,279 281 74 207 66 141 20Y0 $m 1,915 1,724 191 95 96 31 65

Revenue Operating costs Operating profit Interest Profit before tax Tax Profit for the period

Questions

81

Statements of financial position 20X8 $m Assets Non-current assets Current assets Total assets Equity and liabilities Share capital Retained earnings reserve Long-term borrowings Current liabilities Total equity and liabilities 1,120 235 1,355 230 204 465 456 1,355 20X9 $m 1,778 285 2,063 230 344 991 498 2,063 20Y0 $m 2,115 341 2,456 230 410 1,261 555 2,456

A junior analyst in the company has correctly prepared a spreadsheet calculating the Z-scores as follows: Share price ($) No of shares (millions) Market value of equity ($M) X1 X2 X3 X4 X5 WC/TA RE/TA PBIT/TA MVE/Total long-term debt Revenue/TA Z 20X8 1.56 450 702 –0.163 0.151 0.227 1.510 1.077 2.746 107% 20X9 1.67 450 752 –0.103 0.167 0.136 0.758 0.756 1.770 173% 20Y0 1.34 450 603 –0.087 0.167 0.078 0.478 0.780 1.452 197%

Gearing [debt/equity] Required (a) (b) (c) (d)

Discuss the strengths and weaknesses of quantitative and qualitative models for predicting corporate failure. (6 marks) Comment on the results in the junior analyst’s spreadsheet. (5 marks)

Identify the qualitative problems that are apparent in the company’s structure and performance and explain why these are relevant to possible failure. (5 marks) Critically assess the results of your analysis in parts (b) and (c) alongside details of RMB’s recent financial performance and suggest additional data that should be acquired and how it could be used to assess RMB’s financial health. (4 marks)

RMB used a market skimming pricing strategy for its new product at the introduction stage in its lifecyle. However, John Smith now believes that the new product has moved into its growth phase, and he is concerned about how long it will be until the product becomes mature. (e) Explain the changes that are likely to occur at the maturity and decline stages of the product’s life cycle in relation to its selling price and production costs. (5 marks) (25 marks)

82

Questions

82 NW Clothes

45 mins

NW Clothes Co (NWC) is a well-established clothes retailer in Nordland, with a number of shops across the country. In recent years, NWC, like many of the other clothes retailers in Nordland, has offered customers the opportunity to buy clothes online as well as by visiting its shops. Tough economic conditions in Nordland in recent years have placed consumers’ disposable income under increasing pressure, and value for money is becoming increasingly important in their purchasing decisions. At the same time, increases in commodity prices (particularly cotton prices) have led to an increase in NWC’s costs. An extract of some key figures from NWC’s financial statements is given below: Revenue Operating profit Net cash flow from operations Total debt 20X7 ($m) 230.0 40.0 25.5 42.5 20X9 ($m) 232.0 36.0 26.7 49.5

The latest market research figures that the value of total clothing sales increased by 4.5% between 20X7 – 20X9, with low cost stores and online sales being the major contributors to this growth. Internet sales increased by nearly 20% over the two years. In 20X8 NWC had refurbished all of its stores because the Chief Executive felt that their dated look and feel was adversely affecting NWC’s sales. The other directors felt the company should be focusing on increasing its online sales, but they Chief Executive dismissed their arguments claiming that the high street stores remained the core area of NWC’s business. There have been adverse comments in the financial press about the cost of the refurbishment programme, and the effect that it has had on NWC’s gearing and interest payments. NWC drew down an additional $10 million loan in 20X8 to cover the cost of the programme, which has been budgeted to cost $9 million. It ended up costing just under $11 million. The Directors are also concerned that about the downward trend in NWC’s share price over the last three years. The average share price has been: $1.76 (20X7), $1.65 (20X8) and $1.42 (20X9). At the latest annual general meeting, a number of shareholders expressed serious concerns about NWC’s performance and some even questioned its future as an independent entity. The Chief Executive, however, said he remained bullish about the company’s prospects, and highlighted that a new inventory management system had allowed NWC to reduce inventory holdings to less than 3% of revenue, and by switching some of its suppliers it would be able to reduce costs in the future. The day after the general meeting, one of the national newspapers in Nordland published an article about the dramatic increase in the number of customer complaints about the poor quality of NWC garments they have bought recently. Another newspaper published a leaked report which suggested NWC is considering closing some of its shops, and it will not be renewing the leases for those shops when they become due for renewal next year. Required (a) (b) With reference to NWC, discuss the importance of evaluating external factors as well as internal ones when predicting corporate failure. (8 marks) Identify the problems that are apparent in NWC’s structure and performance, and explain how they are relevant to possible failure. (12 marks)

Following the concerns the shareholders raised at the annual general meeting about NWC’s performance, the management accountant calculated the company’s Z-score based on figures from the 20X9 financial statements. His calculations showed that NWC had a Z-score of 2.7. Required (c) Briefly discuss the implications of the accountant’s calculations for NWC. (5 marks) (Total = 25 marks)

Questions

83

83 Action Buttons

45 mins

Action Buttons Co (AB Co) manufactures a range of electronic action toys for children. It was established eight years ago by two friends from university, Chris Booker and Sally Thomas, who still manage the company jointly. For the first five years, the company enjoyed rapid growth in sales and profits, which encouraged Chris and Sally to expand their product range. The growth was financed by a medium-term bank loan. In the last two or three years, business has not been as good though. Sales have continued to rise in spite of competition from imported goods from China and, more recently, Eastern Europe. However, profits have fallen because the company has been unable to increase its selling prices despite operating costs rising. In addition, the company has incurred interest costs on its borrowings. Chris and Sally recently received an offer from a venture capitalist firm that specialises in buying and turning round failing businesses, which wanted to buy AB Co. Chris and Sally were surprised to learn that AB Co was considered a failing business, but the venture capital representative informed them that AB Co had a mixed portfolio of products (some successful and others not), an excessive level of debt, and an apparent lack of strategic direction. Chris and Sally recognise that they have only limited information about the profitability of each of their products. AB Co employs a head accountant who prepares an annual budget and monthly budgetary control reports comparing budget and actual revenue and expenditure, but they have little additional information about company or product performance. They do not employ a finance director because Sally manages the company’s finances and relationship with the bank. Chris and Sally agreed that they were fully in control of their business, but decided to call in a firm of consultants to give them advice about their business prospects. The consultants recommended a review of the company with a view to preparing a corporate failure prediction score, and the consultants suggested that this should be based on Argenti’s ‘A score’ model, rather than a ‘Z score’ approach. This was agreed, although Chris and Sally did not know exactly what to expect from the review. The consultants carried out the review and reported that the corporate failure prediction ‘A score’ for AB Co was 30, which put it in the category of companies that were at risk of corporate failure. Chris and Sally were shocked when they heard this. Chris asked how the consultants could be so confident when the scoring system seemed to be based on judgement and not on any hard evidence. Sally agreed, and commented that predictions and forecasts are often wrong. Even so, Chris and Sally were doubtful what they should do in view of the consultants’ report. Required (a) (b) (c) (d) Identify the different types of reason why business fail. (5 marks)

Explain the purpose and nature of Argenti’s A score for corporate failure prediction and its advantages over a Z score approach. (6 marks) Discuss Chris and Sally’s criticisms that the A score is based on the judgement of the consultants, and that the corporate failure prediction could be wrong. (6 marks) On the basis of the information available, advise Chris and Sally what measures they could take to deal with the possible problems revealed by AB Co’s corporate failure prediction ‘A score’. (8 marks) (Total = 25 marks)

84

Questions

CURRENT DEVELOPMENTS AND EMERGING ISSUES IN PERFORMANCE MANAGEMENT Questions 84 to 88 cover current developments and emerging issues in performance management, the subject of Part F of the BPP Study Text for Paper P5.

84 Environmental management accounting (Preparation 36 mins question)
'Businesses have become increasingly aware of the environmental implications of their operations, products and services. Environmental risks cannot be ignored, they are now as much part of running a successful business as product design, marketing and sound financial management. Poor environmental behaviour may have a real adverse impact on the business and its finances.' Required (a) (b) (c) Discuss ways in which an increasing general concern for the environment can impact on organisations' performance. (5 marks) Discuss how environmental management accounting can be used to overcome the shortcomings of traditional management accounting in dealing with environmental costs. (10 marks) Z is a publicly quoted company. Its products are based on raw materials grown in tropical countries and processed either in these countries or in the eventual sales markets. Processing is undertaken partly by Z and partly by sub-contractors. The products are branded and sold to consumers through a very large number of outlets worldwide

Required Describe the information required at board level, as well as the information that should be published, if the company were required by law to report on its environmental and social policies to shareholders. (5 marks) (Total = 20 marks)

85 Management accounting relevance (Preparation question)
36 mins
Required (a) Identify and discuss the circumstances that have brought about the proposition that traditional management accounting control systems have lost their 'relevance' to today's manufacturing and organisational environment. (5 marks) Evaluate strategic cost management initiatives which may be used in order to restore the 'relevance' of management accounting control systems in today's manufacturing and organisational environment. (15 marks) (Total = 20 marks)

(b)

86 School League Tables

45 mins

Each year, the government of Erewhon publishes league tables ranking the performance of the schools in the country. All the schools in Erewhon are funded by the state, and are all ultimately accountable to the government’s Education Department. The Education Department argues that the league tables help identify those schools whose performance is appreciably greater or lower than expected, and to show the level of variation in performance between schools. However, the Education Department also argues it is important to identify why there are large and unexplained variations, and then work to bring about an early improvement in those schools which have performed worse than expected.
Questions

85

Critics have argued that the league tables only look at selected aspects of performance, and the indicators have been selected on the basis of what data is available rather than that which is valued by parents and pupils. Another criticism is that they have a negative impact on public confidence and professional morale. An extract from the most recent schools league table (based on exam grades) showed the following: % of pupils passing at least 5 final exams with Grade A - C 85 62 54 Value added score (Par = 100) 103 94 115

Rank 1 52 103

School CAD School HI School SPO School

[The ‘Value added’ score indicates how well students performed in their final exams compared to their performance in intermediate exams.] HI School and SPO School are neighbouring schools. In the last three years, SPO has been over-subscribed, while HI has a pupil roll that is below capacity. The three schools (CAD, HI and SPO) have also recently had their routine inspections by the Education Inspector. CAD received a rating of ‘Good’; HI received a rating of ‘Satisfactory’; but SPO received a rating of ‘Excellent.’ Here are some extracts from the Education Inspector’s reports: [CAD School]: ‘Although the standard of teaching was very high, there seemed to be a concentration of resources on those students who were on the threshold of getting a Grade C in their exams.’ [SPO School]: ‘There seemed to be a real sense of community and togetherness at this school. The number of after school clubs and study support clubs was particularly impressive, as was the pastoral care afforded to the pupils.’ Required (a) (i) (i) (b) Explain THREE possible problems accompanying the use of performance measures. (6 marks)

Evaluate the appropriateness of the league table for monitoring schools’ performance in Erewhon. (8 marks)

Recommend, with reasons, TWO additional indicators (apart from those included in the league tables) which schools in Erewhon could use for evaluating their performance. (6 marks)

Following the publication of the most recent Inspector’s reports, the Governors of HI School have called for a review of the way performance is measured in the school. Required (c) Briefly discuss THREE factors which will influence the effectiveness of any performance standards selected for the school’s new performance measurement system. (5 marks) (Total = 25 marks)

86

Questions

87 BPL Leisure

45 mins

BPL is a medium-sized hotel and leisure company based in a European country. The hotel and leisure market in BPL’s country is very competitive, and in recent years the company has noticed a significant drop in revenue and profits as a result of falling customer numbers. However, the performance of the hotels division has been worse than that of the other divisions in the company, and the Divisional Managing Director has scheduled a meeting of his senior management team to discuss the division’s performance and future strategy. The Managing Director has asked the divisional Management Accountant to prepare a summary of the division’s performance for the meeting. The Accountant’s figures included the following information: Prior Year ($m) BPL Hotels - Revenue Operating profit 145 7.5 Current Year Forecast (Next year) ($m) 135 6.5 ($m) 120 5.3

Market sector – Revenue IC Hotels (market leader) – Revenue

14,000 1,580

14,300 1,620

14,550 n/a

Despite preparing the performance information, the Accountant has not been invited to the meeting . The Marketing Director, who has recently joined BPL from the IC Hotels Group has expressed his concern that the Accountant would not be attending the meeting, and suggested to the Managing Director that he felt it was very important that the Accountant should be involved in any discussions about the division’s future performance and strategy. However, the Operations Director argued strongly against this. He told the Marketing Director, “The Management Accountant’s role is to provide us with the information we need about the division’s financial performance to date, which can then help us make informed decisions about its future strategy. But the Accountant has no part to play in the managerial decision-making process itself.” In an angry exchange, the Marketing Director countered that if such an out-dated approach is indicative of the quality of management across the division, this may help to explain why it has performed so poorly in recent years. This prompted a wider discussion about what the role of a Management Accountant should be. Among the observations made were the following:  The HR Director reported the results of a recent international study which ranked the five most important aspects of management accountants’ work within their organisations as: 1. 2. 3. 4. 5.  Preparation and interpretation of management accounting information Developing and implementing accounting systems and financial controls Cost analysis and control Identifying profit improvements Strategic financial planning

BPL’s IT Director noted that the company had recently introduced a new IT software system, and one of the benefits given to support the business was that it would enable operational staff to produce and monitor some performance information themselves. Another benefit given was that the software would reduce the amount of time the accounting team would need to spend processing information.

Questions

87

Required (a) (b) (c) Compare and contrast the Marketing Director and the Operations Director’s views on the role of management accountants and management accounting in an organisation. (7 marks)

Evaluate the extent to which the results of the study cited by the HR director support the idea that the traditional role of the management accountant has been replaced by a role as a business partner. (7 marks) Assess how technology and the competitive environment could change the Management Accountant’s role in the hotel division at BPL. (6 marks)

BPL’s main Board of Directors are also concerned about the hotel division’s performance, and are considering a proposal to sell the division. (d) With reference to the BCG matrix, briefly evaluate the proposal to sell BPL’s hotel division. (5 marks)

(Total = 25 marks)

88 Mentons

45 mins

Mentons Co is a large private company that produces confectionery and chocolate products at four sites in the UK. The company has been in existence for nearly one hundred years. In the past few years, competition from other European producers has intensified, but Mentons has responded successfully and now exports a large proportion of its products to markets across Europe. Until ten years ago, the company produced a limited range of confectionery and chocolate products, but in response to the increasing competition, it now produces a much wider product range, and is continually trying to innovate. Its recent designs of chocolates for special occasions, such as birthdays and weddings, have been a notable success. The company now has an integrated IT system that links the four production centres with head office. Authority over operational decisions has largely been delegated to local management, subject to guidance from head office on matters of strategy and risk. Each production centre prepares its own operational and cost data, which is then consolidated at head office for the purpose of reporting to senior management. At a senior management meeting, the CEO has raised the subject of economising on costs. One suggestion he proposed was to eliminate the role of management accountants within the company. At the moment there is a management accountant at each production centre and two at head office. The CEO doubts how much useful information the management accountants produce which operations management could not extract themselves from the company’s computer system, and he is aware that many traditional management accounting techniques, such as standard costing, are no longer required or appropriate. “We have a modern lean manufacturing system based on just-in-time production methods. We need operations managers, not management accountants” the CEO said. Required (a) (b) (c) Explain the reasons why many of the traditional management accounting methods and techniques have lost their relevance in a modern manufacturing environment. (7 marks) With reference to the developments at Mentons, discuss the reasons suggested by Burns and Scapens as to why the role of the management accountant has changed over time. (9 marks) Assess the contribution that the management accountant, or a similarly professionally-qualified accountant, can make in a commercial organisation such as Mentons. (9 marks) (Total = 25 marks)

88

Questions

SECTION A QUESTIONS Questions 89 to 104 are 50 mark questions which, like the Section A questions in the P5 exam, cover a range of topic areas.

89 Cognet
(a) (b) (c) (d)

90 mins

The activity matrix below shows the budget for the sales order department of Cognet. Relevant information with regard to the operation of the sales order department is as follows. A team of staff deals with existing customers in respect of problems with orders or with prospective customers enquiring about potential orders. The processing of orders requires communication with the production and despatch functions of the company. The nature of the business is such that there is some despatching of part orders to customers which helps reduce inventory holding costs and helps customers in their work flow management. Sales literature is sent out to existing and prospective customers by means of a monthly mailshot.

Cognet plc has decided to acquire additional computer software in order to improve the effectiveness of the sales order department. The cost to the company of this initiative is estimated at $230,000 pa. It is estimated that there will be the following cost and volume changes to activities in the sales order department. (a) (b) (c) (d) Reduction in overall salaries by 10% per annum, applied to the existing salary apportionments. Reduction of 60% in the stores/supplies cost in the sales literature activity only. $20,000 of the computer software cost will be allocated to the sales literature activity. The balance will be shared by the other activities in proportion to their existing share of IT costs. Sundry costs for customer negotiation, processing of orders and implementing despatches will vary in proportion to the number of units of each activity. Sundry costs for sales literature and general administration will be unchanged. Amended volume of activity will be: total customers 2,600; customer negotiations 6,000; home orders 5,500; export orders 2,000; despatches to customers 18,750.

(e)

Recent industry average statistics for sales order department activities in businesses of similar size, customer mix and product mix are as follows. Cost per customer per year Cost per home order processed Cost per export order processed Cost per despatch Sales literature cost per customer Average number of orders per customer per year Average number of despatches per order Activity cost matrix – sales order department
Cost element Salaries Stores/ supplies IT Sundry costs Total Volume of Activity Total cost $'000 500 90 70 80 740 2,000 customers Customer negotiations $'000 80 Processing of orders Home Export $'000 $'000 160 100 16 6 30 10 216 5,000 orders 20 6 132 1,200 orders Implementing despatches $'000 90 8 10 20 128 11,500 despatches Sales literature $'000 20 60 General Administration $'000 50

$300 $50 $60 $8 $35 4.1 3.3

10 8 98 3,000 negotiations

10 90

26 76

Questions

89

Required (a) (b) Prepare a summary of the amended activity cost matrix for the sales order department after implementing the proposed changes. (8 marks) Assuming the managers are already aware of the figures you have calculated in part (a), and referring to them as necessary, prepare a report for the management of Cognet which examines and analyses the implications of the IT initiative. The report should include the following: (i) A benchmarking exercise on the effectiveness of the sales order department against both its current position and the industry standards provided. You should incorporate comment on additional information likely to improve the relevance of the exercise. (14 marks) (ii) An investigation of the customer negotiation activity where an analysis of the number of negotiations is as follows. Existing customer New customers No further problems solved obtained customers obtained Original budget 300 1,800 900 Post-IT budget 900 3,500 1,600 (7 marks) Detail of four strategic planning objectives of the company which may be aided through implementing the IT initiative and suggestions why the IT initiative may help in each case. (8 marks) (4 marks)

(iii)

Professional marks will be awarded for the format, style and clarity of the report. (c) (d)

Explain how benchmarking can be useful in helping an organisation assess its current strategic position and its generic competitive strategy. (4 marks) Briefly describe the possible dangers of implementing a benchmarking programme. (5 marks) (Total = 50 marks)

90 Armstrong Stores (Sample question, amended)

90 mins

Armstrong Stores (Armstrong) is a listed business with a chain of 126 general department stores in South Postland. The company is known for the high quality of its products, mainly food and clothing. The majority of its goods are sourced from trusted manufacturers and branded under the company’s own ‘Strongarm’ label. Currently, Armstrong faces a tough competitive environment with all the major players in its market trying to secure their positions. Poor economic conditions worldwide have significantly affected South Postland. Consumer spending is falling throughout the economy and there is no immediate likelihood of a resumption of growth. Armstrong’s chief executive officer (CEO) has recently conducted a strategic review of the business in the context of the current economic recession. He has identified the following strategy as critical for Armstrong’s success:      Focus on key customers – those who are occasional shoppers but not currently loyal to the business. Ensure Armstrong’s offering addresses their needs. Cut out costs that do not address these customers’ priorities. Amend current processes to meet this new focus. Build for the future with a programme of sustainable development.

The company now needs to address the impact of this new strategy on its performance measurement systems. Armstrong uses a balanced scorecard to assess its strategic performance and the scorecard is used to connect the business strategy with its more detailed performance measures. The CEO has asked you to consider the implications of the new strategy for the performance measures used by the business. Currently, Armstrong uses Economic Value Added (EVA), earnings per share (EPS) growth and share price performance to monitor its financial performance. The company has supplied data in appendix 1, which the CEO wishes to see used to assess the financial performance from the shareholders’ perspective. She has asked that you

90

Questions

explain the problems of capturing performance with these particular metrics, and also, how they may affect management’s behaviour. Finally, in order to aid refocusing the company, the CEO has requested a report to the board comprehensively benchmarking the current performance of Armstrong. The board needs to have benchmarking exercise explained and then the results described. Appendix 2 contains data analysing Armstrong, its two main competitors and statistics provided by the government of South Postland. A junior analyst has already correctly completed the preliminary calculation work for benchmarking in appendix 3. The CEO has requested a critical assessment of these different sources as well as the comments on the results of the analysis. APPENDIX 1 Financial data for Armstrong Stores 20X8 $m 505.7 40.2 465.5 353.8 1,600.0 20X8 $306m 20X9 $m 435.1 77.6 357.5 271.7 1,600.0 20X9 $110m

Operating profit Interest Profit before tax Profit for the year Average number of shares in issue

Economic value added (EVA) Stock market information

South Postland market index Retailing sector index Armstrong Stores (average share price) APPENDIX 2 (a) Comparative data BS stores 20X8 Revenue: – Food – Clothing Total Profit for the year No. of stores No. of suppliers No. of warehouses (b) $m $m $m $m 1,542 1,234 2,776 142 81 3,400 6 20X9 1,538 1,222 2,760 127 83 3,100 6 20X8 2,100 2,723 4,823 294 167 4,200 8

20X8 1,115.2 2,450.7 $2.45

20X9 724.9 1,911.5 $2.08

CS Stores 20X9 1,978 2,610 4,588 193 186 4,200 9

20X8 1,985 2,450 4,435 354 119 4,122 7

Armstrong 20X9 2,025 2,475 4,500 272 126 4,468 7

Government statistics Market totals - revenue 20X8 $m 12,403 25,792 20X9 $m 12,656 22,500

– Food Retail – Clothing Retail

Questions

91

(c)

Armstrong data for 20X9 Region by region (South Postland is split into three large regions) Acelon Revenue: – Food – Clothing Total Profit for the year No of stores No of warehouses $m $m $m $m 648 792 1,440 87 37 2 Baselon 810 1,114 1,924 111 51 3 Caselon 567 569 1,136 73 38 2

APPENDIX 3 Junior analyst’s working papers (a) Comparative data BS stores Revenue: – Food – Clothing Total Profit for the year No of stores No of suppliers No of warehouses -0.3% -1.0% -0.63% -10.3% 2.5% -8.8% 0.0% BS stores 20X8 20X9 Market share – Food – Clothing 12.4% 4.8% 12.2% 5.4% CS Stores -5.8% -4.1% -4.9% -34.5% 11.4% 0.0% 12.5% Armstrong 2.0% 1.0% 1.5% -23.2% 5.9% 8.4% 0.0% Armstrong 20X8 20X9 16.0% 9.5% 16.0% 11.0%

CS Stores 20X8 20X9 16.9% 10.6% 15.6% 11.6%

Revenue per shop (b)

$m

BS stores 34.27 33.25 Acelon 38.92 6.0%

CS Stores 28.88 24.67 Baselon 37.72 5.8%

Armstrong 37.27 35.71 Caselon 29.90 6.5% Total 35.71 6.0%

Regional data for Armstrong Revenue per shop Profit margin $m

Required (a) Describe the four perspectives of the balanced scorecard showing how the new strategy of the business as outlined by the CEO links to the different perspectives. Illustrate your answer by suggesting appropriate performance measures for Armstrong for each of the detailed points within the strategy. (8 marks) (i) (ii) (c) Assess the financial performance of the company using the three shareholder performance indicators. (5 marks) Critically evaluate the use of these performance metrics and how they may affect management’s behaviour. (6 marks)

(b)

Prepare a report to the board on a benchmarking exercise using the information given in the appendix: (i) (ii) Evaluate the benefits and difficulties of benchmarking in this situation (4 marks)

Evaluate the performance of Armstrong using the data given in the question. Indicate what further information would be useful and conclude as to the performance of the company. (8 marks) (4 marks)

Professional marks for appropriateness of format, style and structure of the report. 92
Questions

Following the CEO’s strategic review of the business, the directors have been debating whether Armstrong should develop an online store in addition to its existing chain of stores. The CEO is in favour of the new development, and has pointed out that Armstrong’s shareholders are keen to see the business grow. In 20X7, Armstrong published a five year plan which set a target profit of $400.0 million by 20Y2. However, the latest forecast figures show that it Armstrong continues with its current strategy, its profit in 20Y2 will be $265.0 million. Despite this, the Operations Director is not in favour of the expansion online. He has argued that, given the current economic situation in South Postland, it is more important to focus on survival rather than trying to achieve growth. Required (d) (e) With reference to Armstrong, discuss the potential conflict between survival and growth, and the implications they have for performance management. (8 marks) Explain the term ‘planning gap’ and discuss its usefulness when debating the proposal to develop Armstrong’s online store. (7 marks) (Total = 50 marks)

91 Robust Laptops (APM 12/10, amended)

90 mins

Robust Laptops Co (RL) makes laptop computers for use in dangerous environments. The company’s main customers are organisations like oil companies and the military that require a laptop that can survive rough handling in transport to a site and can be made to their unique requirements. The company started as a basic laptop manufacturer but its competitors grew much larger and RL had to find a niche market where its small size would not hinder its ability to compete. It is now considered one of the best quality producers in this sector. RL had the same finance director for many years who preferred to develop its systems organically. However, due to fall in profitability, a new chief executive officer (CEO) and a new chief financial office (CFO) have been appointed. The CEO wishes to review RL’s financial control systems in order to get better information with which to tackle the profit issue. The CEO wants to begin by thinking about the pricing of the laptops to ensure that selling expensive products at the wrong price is not compromising profit margins. The laptops are individually specified by customers for each order and pricing has been on a production cost plus basis with a mark-up of 45%. The company uses an absorption costing system based on labour hours in order to calculate the production cost per unit. The main control system used within the company is the annual budget. It is set before the start of the financial year and variances are monitored and acted upon by line managers. The CEO has been reading about major companies that have stopped using budgets and wants to know how such a radical move works and why a company might take such a step. He has been worried by moves by competitors into RL’s market with impressive new products. This has created unrest among the staff at RL with two experienced managers leaving the company. The CEO is also concerned about the management information which is currently produced at Robust. His view is that performance information throughout the company seems to focus on cost control to the detriment of measuring any other aspects of performance. The CEO has also been critical of the performance summary which is currently provided in the monthly board papers. The board papers contain a high level summary of financial information, comparing performance against budget for revenue, costs and profit. They also report Robust’s KPIs which are: profit, profit margin, free cashflow and return on capital employed. In addition to his other concerns, the CEO has also indicated that he feels Robust’s KPIs do not adequately meet the needs of a modern performance measurement system. He feels that Robust needs to identify what its critical success factors are, and then link its KPIs to them.

Questions

93

Financial and other information for Robust Laptops Data for the year ended 30 September 20Y0 Volume (units) 23,800 Total $,000 Direct variable costs Material Labour Packaging and transport Subtotal Overhead costs Customer service Purchasing and receiving Inventory management Administration of production Subtotal Total Labour time per unit Data collected for the year No of minutes on call to customer No of purchase orders raised No of components used in production Order 11784 Units ordered Direct costs for this order: Material Labour Packaging and transport Other activities relating to this order: No of minutes on call to customer No of purchase orders raised No of components used in production Administration of production (absorbed as general overhead) Required Write a report to the CEO to include: (a) An evaluation of the current method of costing against an Activity Based Costing (ABC) system. You should provide illustrative calculations using the information provided on the costs for 20Y0 and for Order 11784. Briefly state what action management might take in the light of your results with respect to this order. (15 marks) An explanation of the operation of a beyond budgeting approach and an evaluation of the potential of such a change at RL. (10 marks) (4 marks) 3 hours 899,600 21,400 618,800 16 $ 27,328 2,608 1,424 1,104 64 512 3 Labour hours per unit 40,650 3,879 2,118 46,647

7,735 2,451 1,467 2,537 14,190 60,837

(b)

Professional marks will be awarded for the format, style and structure of the report.

The CEO is also concerned about the management information which is currently produced at Robust. His view is that performance information throughout the company seems to focus on cost control to the detriment of measuring any other aspects of performance. The CEO has also been critical of the performance summary which is currently provided in the monthly board papers. The board papers contain a high level summary of financial information, comparing performance against budget for revenue, costs and profit. They also report Robust’s KPIs which are: profit, profit margin, free cashflow and return on capital employed. 94
Questions

In addition to his other concerns, the CEO has also indicated that he feels Robust’s KPIs do not adequately meet the needs of a modern performance measurement system. He feels that Robust needs to identify what its objectives and critical success factors are, and then link its KPIs to them. Required (c) (d) (e) Evaluate the CEO’s concerns that the focus on cost control throughout Robust’s management reports is a problem for the company. (8 marks) Assess whether Robust’s current key performance indicators (KPIs) meet the expected features of a modern performance measurement system. (7 marks) With reference to Robust, explain the link between objectives, critical success factors and KPIs. (6 marks) (Total = 50 marks)

92 RRR (APM 12/09, amended)

90 mins

The RRR Group (RRR) provides roof repair, refurbishment and renewal services to individual customers on a nationwide basis. RRR operates a large number of regional divisions, each of which offers a similar range of services. RRR expects divisional management to prepare its own annual budget by focusing on the achievement of a net profit figure set at group level. This budget is currently used for planning and reporting. Table A (below) hows actual results for Alpha division for the years ending 30 November 20X8 and 30 November 20X9, together with data representing an average of a number of similar competitor company divisions. RRR has given Alpha division a budgeted profit requirement of $20m for the year to 30 November 20Y0. The management of Alpha division has prepared the strategy shown in Table B as the framework for the achievement of the budget profit requirement for the year to 30 November 20Y0. RRR plc has, however, decided that in line with current 'beyond budgeting' philosophy, each division should follow a number of adaptive processes including the following: (1) (2) (3) Setting 'stretch goals' aimed at relative improvement and avoiding dysfunctional decision-making. Evaluation and rewards at each division based on relative improvement contracts (with hindsight). Action planning that focuses on a strategy to achieve continuous value creation for the group.

As an incentive to the overall achievement of goals and the creation of 'value', a set of KPIs (key performance indicators) will be introduced in 20Y0 and used on the basis of the data in Table C. Divisional staff will be paid a bonus as a percentage of salary based on the overall weighted percentage score deduced from the analysis as per table C. The finance director recently stated that ‘If we implement a reward scheme, it is bound to be beneficial for RRR.’ Required Prepare a report for the divisional management team at RRR which: (a) (b) Evaluates the extent to which the budget of Alpha division for the year ending 30 November 20Y0 is achievable and consistent with the 'beyond budgeting' philosophy detailed above. (14 marks) (i) Applies the KPI performance appraisal process shown and explained in Table C, using actual data for 20X8 and 20X9 in order to show the bonus (as a % of salary) that would have been achieved by Alpha division for the year ending 30 November 20X9; (12 marks) Discusses the potential benefits that may be derived from applying the KPI appraisal approach, both for Alpha division and throughout the RRR Group. (3 marks) (4 marks) (6 marks)

(ii)

Professional marks will be awarded for the format, style and structure of the report. (c) (i) (ii) Explain the potential benefits to be gained from the implementation of a reward scheme.

Discuss the factors which should be considered in the design of a reward scheme for RRR, and evaluate the finance director’s statement about implementing a reward scheme. (11 marks) (Total = 50 marks)
Questions

95

Table A Summary of financial and other operating information Alpha division Alpha division 20X9 20X8 $m $m 90.0 80.0 60.0 8.5 4.0 0.8 1.5 0.2 75.0 15.0 15,000 10,000 300 100 50.0 8.0 4.0 0.5 1.4 0.1 64.0 16.0 16,000 8,800 440 132 Competitor divisions 20X9 $m 85.0

Sales revenue Less Costs: Cost of sales (note 1) Marketing Staff training Remedial work on orders (note 2) Customer enquiry costs (note 3) Customer complaint related costs (note 4) Total costs Net profit Number of Customer enquiries Customer orders placed Orders placed requiring remedial work Customer complaints

69.5 15.5

Note 1: includes materials, wages/salaries, vehicle and machine costs, etc Note 2: following inspection by surveyors after work implemented Note 3: initial survey and site analysis Note 4: investigation & action on complaints. Table B Proposed strategy for Alpha division for year to 30 November 20Y0 It is estimated that the budgeted profit requirement of $20m will be achieved as a consequence of the following: – – – – – – – The number of orders received and processed will be 11,000 (with average price levels remaining as per 20X9 actual price levels) from an initial total of 15,500 customer enquiries The marketing cost allowance would be reduced to $7.2m The training cost allowance would be reduced to $3m Cost of sales ($) will rise by 10% from the 20X9 actual total to allow for the combined effect of volume and price changes Remedial work on orders will total $1m for material, labour and overhead costs Initial survey and analysis costs on customer enquiries will remain at the 20X9 average cost per enquiry Customer complaint related costs are expected to rise to $0.25m.

96

Questions

Table C Staff bonus calculation for the year ended 30 November 20X9 using Key Performance Indicators (KPI's) based on relative contract factors Weighting Factor KPI Total Score % KPI (A) (B)* (see below for basis) Revenue 20X9 versus previous year 0.15 Revenue 20X9 versus competitor 0.20 Profit 20X9 versus previous year 0.15 Profit 20X9 versus competitor 0.20 Quality items 20X9 versus previous year: No. of orders requiring remedial work No. of complaints investigated % of enquiries converted into orders Total 0.075 0.075 0.15 1.000 Bonus (%) = ? Weighted Score % (A) × (B)

(B)* – each KPI score value is positive (+) where the 20X9 value shows an improvement over the previous year OR negative (–) where the 20X9 value shows poorer performance than in the previous year. Each KPI score value is the % increase (+) or decrease (–) in 20X9 as appropriate.

93 BWY houses

90 mins

BWY Co is a listed company, based in Erewhon, which builds private houses and apartments. These range from one bedroom apartments to five bedroom houses. The housing market in Erewhon has experienced substantial volatility in the past 20 years, both in terms of the number of houses being sold, and the prices at which comparable houses are sold. In the early 1990s there was a price slump with house, during which prices declined significantly. However, by the late 1990s price had stabilised, and then between 2000 – 2006 there was a sustained and substantial increase in prices. During this time, the average price of houses in Erewhon more than doubled, although there were significant regional variations across the country. However, in 2007 the market began to slow down again, and the number of sales transactions began to fall. The average price of houses peaked in early 2007, and then began to fall as well. The credit crunch and global economic slowdown have meant that the volume of transactions and house prices have remained depressed since 2008. The supply of private properties in Erewhon, like most other countries, can be split into two sectors. The first is the ‘new build’ sector consisting of new houses and apartments which are sold to customers by building companies such as BWY. The second sector comprises private individuals selling existing properties to other individuals, often using an intermediary (an estate agent or realtor) to advertise and administer the sale process. In addition to the private property markets in Erewhon, there is also a supply of social housing, owned by local authorities and housing associations and rented out to tenants at subsidised rates. In the private property market, most buyers borrow a large proportion of the money they need to purchase their houses, in the form of a mortgage. A consequence of the recent credit crunch has been a reduction in mortgage availability as lenders have withdrawn some of their mortgage products. However, mortgage interest rates still remain relatively low, reflecting the low base rate of interest in Erewhon at present. The number of ‘new build’ properties for sale in Erewhon has maintained a long term annual average of about 160,000, although in the boom period between 2000-2006 this figure exceeded 200,000 per year. The total number of property transactions (including ‘new builds’ and re-sale) can vary quite significantly each year, but in recent years it has been around 1 million. BWY has attempted to establish a reputation for building good quality houses with quality fittings that are not provided by many competitors. BWY has also held itself out as being an environmentally friendly company by using recyclable materials and refusing to build on land where there is significant environmental cost. BWY charges a price premium of about 5% over most other builders for similar size houses.
Questions

97

Over the last decade, BWY has acquired a large number of plots of land (a 'landbank') which it holds prior to developing. However, before BWY can building on this land it requires planning approval from the relevant local authorities. Historically, BWY has made some major gains on the land it has held. These gains have ultimately been reflected in high profits on the sale of houses as BWY’s costs have risen considerably more slowly than its selling prices. BWY’s results, and those for PMN, the market leader in Erewhon, for the year ended 31 December 2010 show the following: BWY PMN Houses and apartments sold Revenue ($ million) Profit before tax ($ million) 7,450 1,428 174 14,850 2,613 427

The housing industry in Erewhon faces a lot of uncertainty in the next few years. Some analysts have predicted house price decreases of around 25%, while other analysts have predicted a small increase in prices. There is also uncertainty about the expected volume of house sales, although most analysts expect this to remain relatively low. The board of BWY is seeking to develop a new strategy to address the issue of future uncertainty in the housing market in Erewhon. One suggestion put forward at a recent board meeting is to expand into the countries around Erewhon by building houses in them. To date, BWY has only built houses in Erewhon. New housing development A local authority in one of the neighbouring countries to Erewhon has recently announced proposals for a major new housing development. BWY has been invited to tender for the contract to build the development, and it is currently considering whether or not to tender. The local authority has indicated that it is initially looking to build 500 new houses, but there is a possibility that the total homes may increase to 750 or 1,000 in future depending on demand. The local authority has indicated that it demand increases to 750 or 1,000 the contract to build the extra houses would be offered in the first instance to the developer building the initial 500. In the invitation to tender document, the local authority has stated it will pay a fixed sum of $20m for the initial 500 houses, rising to $30m for 750 houses or $40m for 1,000 houses. The local authority already owns the land being used for the development. BWY is currently considering its bid for the tender. Its architects and draftsmen have prepared two proposals: a very basic design, and a higher specification design. The higher specification designs have higher costs, but it is believed the higher specification designs will increase BWY’s chances of winning the contract. BWY can only include one of the specifications in its final submission to the local authority. BWY’s costing team has estimated that the cost of building the basic design house is $25,000, rising to $30,000 for the higher specification design. The business development manager has recently joined BWY from a rival house builder with extensive experience of local authority projects. He believes BWY has a greater chance of winning the tender if it submits the higher specification design, and has assessed the probability of winning future orders as follows: Demand 500 750 1,000 Probability Type 1 Type 2 50% 80% 25% 40% 10% 16%

98

Questions

Required (a) Using the PEST model, discuss the impact of external factors on BWY, and explain the potential effects of each factor on the company’s future profitability. Note: Do not discuss any strategies for expansion in this part of the question. (b) Evaluate the position and performance of BWY compared to PMN. Note: Your evaluation should apply, and critically appraise, the Boston Consulting Group (BCG) Matrix, but should not be restricted only to this model. (10 marks) (c) (d) Assess the role that risk and uncertainty could play in deciding whether or not BWY should expand into the countries around Erewhon. (8 marks) Write a report to BWY’s Board which: (i) Briefly discusses the issues which BWY should consider before deciding on their approach to the tender, highlighting any further information which would be useful in order to recommend an appropriate choice of method for assessing the tender. Evaluates the tender, using methods for decision-making under risk and uncertainty, and assesses the suitability of the different methods used. Note: Ignore any potential issues relating to the cost of capital or the time value of money. (18 marks) Professional marks will be awarded for the appropriateness of style and structure of the report. (4 marks) (Total = 50 marks) (10 marks)

(ii)

94 Film Productions Co (APM 12/10, amended)

90 mins

Film Productions Co (FP) is a small international company producing films for cinema release and also for sale on DVD or to television companies. FP deals with all areas of the production from casting, directing and managing the artists to negotiating distribution deals with cinema chains and TV channels. The industry is driven by the tastes of its films’ audience, which when accurately predicted can lead to high levels of profitability on a successful film. FP was founded by three people 20 years ago. At that time, the company used a new technology which had been developed by one of the founders which improved the quality of computer generated imagery and 3-dimensional graphics in its films. The third person is Mr Z, who is the current CEO, who has a strong, dynamic, personality. Mr Z has been the driving force behind the development and growth of the business to its present size of 350 employees. In the early years, with a charismatic leadership style, Mr Z was very proud of the fact that he knew all employees by their first names and considered everyone to be part of one big team. Everyone understood exactly what the company stood for and how things should be done. As the company has grown, Mr Z feels he is not in touch with newer members of staff and that they do not understand his, and the company’s, values. In addition, the technology used by FP is no longer considered innovative and there are a number of other competitors operating in exactly the same way. The company produces films which it hopes will have mass appeal. The company makes around $200 million of sales each year equally split between a share of cinema takings, DVD sales and TV rights. FP has released 32 films in the past five years. Each film costs an average of $18 million and takes 12 months to produce from initial commissioning through to the final version. Production control is important in order to hit certain key holiday periods for releasing films at the cinema or on DVD. The company’s films have been moderately successful in winning industry awards although FP has never won any major award. Its aims have been primarily commercial with artistic considerations secondary. Recently, FP has been approached by two companies with requests to make promotional videos (for use as television adverts) for them, but FP turned the requests down because it did not have sufficient resources available to make the videos in the timescale required. However, Mr Z feels that making these promotional videos could be a useful way to supplement FP’s income in future.

Questions

99

The company uses a top-down approach to strategy development with objectives leading to critical success factors (CSFs) which must then be measured using performance indicators. Currently, the company has identified a number of critical success factors. The two most important of these are viewed as: (i) (ii) improve audience satisfaction strengthen profitability in operations

At the request of the board, the chief executive officer (CEO) has been reviewing this system in particular the role of CSFs. Generally, the CEO is worried that the ones chosen so far fail to capture all the factors affecting the business and wants to understand all possible sources for CSFs and what it means to categorise them into monitoring and building factors. These CSFs will need to be measured and there must be systems in place to perform that role. The existing information system of the company is based on a fairly basic accounting package. However, the CEO has been considering greater investment in these systems and making more use of the company’s website in both driving forward the business’ links to its audience and in collecting data on them. The CEO is planning a report to the board of Film Productions and has asked you to help by drafting certain sections of this report. Required You are required to draft the sections of the CEO’s report answering the following questions: (a) (b) (c) Explain the difference between the following two types of CSF: monitoring and building, using examples appropriate to FP. (4 marks) Identify information that FP could use to set its CSFs and explain how it could be used giving two examples that would be appropriate to FP. (6 marks) For each of the two critical success factors given in the question, identify two performance indicators (PIs) that could support measurement of their achievement and explain why each PI is relevant to the CSF. (10 marks) Discuss the implications of your chosen PIs for the design and use of the company’s website, its management information system and its executive information system. (11 marks) Professional marks will be awarded for the style and structure of your sections of the report. (4 marks)

(d)

Despite having a clear set of strategic objectives the company does not have a mission statement. The CEO feels that this should be remedied as a matter of urgency. (e) (f) Discuss the issues which FP should consider when creating an appropriate mission statement. (11 marks) Discuss where the proposal to make promotional videos for television advertising would feature in Ansoff’s product-market matrix. (4 marks) (Total = 50 marks)

95 Metis (APM 6/12, amended)

90 mins

Metis is a restaurant business in the city of Urbanton. Metis was started three years ago by three friends who met at university while doing courses in business and catering management. Initially, their aim was simply to ‘make money’ although they had talked about building a chain of restaurants if the first site was successful. The three friends pooled their own capital and took out a loan from the Grand Bank in order to fit out a rented site in the city. They designed the restaurant to be light and open with a menu that reflected the most popular dishes in Urbanton regardless of any particular culinary style. The dishes were designed to be priced in the middle of the range that was common for restaurants in the city. The choice of food and drinks to offer to customers is still a group decision amongst the owners. Other elements of the business were allocated according to each owner’s qualifications and preferences. Bert Fish takes charge of all aspects of the kitchen operations while another, Sheila Plate, manages the activities in the public area such as taking reservations, serving tables and maintaining the appearance of the restaurant. The third founder, John Sum, deals with the overall business issues such as procurement, accounting and legal matters. 100
Questions

Competition in the restaurant business is fierce as it is easy to open a restaurant in Urbanton and there are many competitors in the city both small, single-site operations and large national chains. The current national economic environment is one of steady but unspectacular growth. The restaurant has been running for three years and the founders have reached the point where the business seems to be profitable and self-sustaining. The restaurant is now in need of refurbishment in order to maintain its atmosphere and this has prompted the founders to consider the future of their business. John Sum has come to you as their accountant looking for advice on aspects of performance management in the business. He has supplied you with figures outlining the recent performance of the business and the forecasts for the next year (see the performance report below). This table represents the quantitative data that is available to the founders when they meet each quarter to plan any short-term projects or initiatives and also, to consider the longer-term future. Bert and Sheila have often indicated to John that they find the information daunting and difficult to understand fully. John Sum has come to you to advise him on the performance reporting at Metis and how it could be improved. He feels that the current report is, in some ways, too complex and, in other ways, too simple. He wants to look at different methods of measuring and presenting performance to the ownership group. As a starting point, he has suggested to you that you consider measures such as NPV, EVA™, MIRR as well as the more common profit measures. John is naïve and wants the NPV and MIRR to be appraised as if the business was a three-year project up to 2012 so he knows the performance of the business to date. He has requested that other calculations in your performance review should be annual based on the 2012 figures although he is aware that this may be omitting in his words ‘some important detail’. At recent meetings, Sheila has been complaining that her waiters and waitresses are not responding well to her attempts to encourage them to smile at customers although her recent drive to save electricity by getting staff to turn off unnecessary lights seems to be working. Bert stated that he was not convinced by either of Sheila’s initiatives and he wants her to make sure that food is collected from the kitchen swiftly and so delivered at the right temperature to the customer’s table. Also, Bert has said that he feels that too much food is becoming rotten and having to be thrown out. However, he is not sure what to do about it except make the kitchen staff go through lengthy inventory checks where they review the food held in store. John is worried about these complaints as there is now an air of tension in the owners’ meetings. He has been reading various books about performance management and has come across the quote, ‘What gets measured, gets done.’ He believes this is true but wants to know how it might apply in the case of his business. John is also concerned at the potential impact the tension between his co-owners could have on strategic decisions at Metis. At the last meeting, Bert expressed his concern at the impact the proposed building upgrade was forecast to have on the figures for 2013, and he suggested that Metis should reconsider whether it needs to undertake the upgrade in the next year. However, Sheila retorted that this was a very short-term view, and if Metis didn’t upgrade its restaurant, customers were likely to stop eating there. John explained that he could appreciate both Bert and Sheila’s perspectives, because it was important that Metis considers its long-term future as well as its short-term position. You should assume it is now June 2012.

Questions

101

Metis Performance Report Metis Restaurant

Year to 31 March

Actual 2010 $ Revenue Food Wine Spirits Beer Other beverages Outside catering Total Cost of sales Food Wine Spirits Beer Other beverages Outside catering Total Gross profit Staff costs Other operating costs Marketing Rent/mortgage Local property tax Insurance Utilities Waste removal Equipment repairs Depreciation Building upgrades Total Manager salary Net profit/loss before interest and corporate taxes Net margin Additional notes: 1. 617,198 127,358 83,273 117,562 24,492 9,797 979,680 200,589 58,585 21,651 44,673 3,674 3,135 332,307 647,373 220,428 25,000 150,800 37,500 5,345 12,600 6,000 3,500 120,000 150,000 360,745 35,000 31,200

Actual 2011 $ 878,220 181,220 118,490 167,280 34,850 13,940 1,394,000 285,422 83,361 30,807 63,566 5,228 4,461 472,845 921,155 313,650 10,000 175,800 37,500 5,585 12,978 6,180 3,658 120,000 371,701 36,225 199,579

Actual 2012 $ 974,610 201,110 131,495 185,640 38,675 15,470 1,547,000 316,748 92,511 34,189 70,543 5,801 4,950 524,742 1,022,258 348,075 12,000 175,800 37,500 5,837 13,043 6,365 3,822 120,000 374,367 37,494 262,322

Forecast 2013 $ 1,062,180 219,180 143,310 202,320 42,150 16,860 1,686,000 345,209 100,821 37,261 76,882 6,323 5,395 941 571,891 1,114,109 379,350 20,000 193,400 37,500 6,100 13,173 6,556 3,994 120,000 550,723 38,806 145,230

Latest quarter to 31 March 2012 (Q4 2012) $ 185,176 38,211 24,984 35,272 7,348 2,939 293,930 60,182 17,577 6,496 13,403 1,102 1,634 99,701 194,229 66,134 3,000 43,950 9,375 1,459 3,261 1,591 956 956 30,000 93,592 9,373 25,130

Previous quarter

(Q3 2012) $ 321,621 66,366 43,394 61,261 12,763 5,105 510,510 104,527 30,528 11,283 23,279 1,914 173,165 337,345 114,865 3,000 43,950 9,375 1,459 3,261 1,591 30,000 93,592 9,373 119,515

3·2%

14·3%

17·0%

8·6%

8·5%

23·4%

The business was founded with $600,000 which comprised $250,000 of equity from the founders and the remainder in a loan from Grand Bank. Under the terms of the loan, all principal is repayable in 10 years’ time and interest is charged at a fixed rate of 8·4% per year. John has estimated the overall cost of capital to be 12·5%. The company earns 4·5% on any returns in its deposit account. John wishes you to use the $600,000 original investment as the capital employed figure for analysis purposes as no new capital has been input and the owners have taken out all residual earnings so far as dividends. The corporation tax rate for Metis is 30%, paid in the same year as profits are generated. Accounting depreciation is a tax allowable cost. Marketing spending is for the short-term promotion of offers only.

2. 3. 4.

5. 6.

102

Questions

Required Prepare a report to Mr John Sum addressing the following issues: (a) (b) Critically assess the existing performance report and suggest improvements to its content and presentation. (12 marks) Calculate and briefly evaluate: (i) (ii) (c) The use of John’s suggested performance measures, and Other profit-based measures, using the most recent year’s actual figures where appropriate as examples. (14 marks) (10 marks) (4 marks)

Assess how the quote ‘What gets measured, gets done’ could apply to Metis. Professional marks will be awarded for the format, style, structure and clarity of your report.

(d)

With reference to the issues arising at the last owners’ meeting, discuss the importance of managing both short-term and long-term performance at Metis. (10 marks) (Total = 50 marks)

96 GWCC (PM 6/06, amended)

90 mins

The Great Western Cake Company (GWCC) is a well-established manufacturer of specialist flour confectionery products, including cakes. GWCC sells its products to national supermarket chains. The company's success during recent years is largely attributable to its ability to develop innovative products which appeal to the food selectors within national supermarket chains. The marketing department of Superstores plc, a national supermarket chain has asked GWCC to manufacture a cake known as the 'Mighty Ben'. Mighty Ben is a character who has recently appeared in a film which was broadcast around the world. The cake is expected to have a minimum market life of one year although the marketing department consider that this might extend to eighteen months. The management accountant of GWCC has collated the following estimated information in respect of the Mighty Ben cake: (1) Superstores plc has decided on a launch price of $20·25 for the Mighty Ben cake and it is expected that this price will be maintained for the duration of the product's life. Superstores plc will apply a 35% mark-up on the purchase price of each cake from GWCC. Sales of the Mighty Ben cake are expected to be 100,000 units per month during the first twelve months. Thereafter sales of the Mighty Ben cake are expected to decrease by 10,000 units in each subsequent month. Due to the relatively short shelf-life of the Mighty Ben cake, management has decided to manufacture the cakes on a 'just-in-time' basis for delivery in accordance with agreed schedules. The cakes will be manufactured in batches of 1,000. Direct materials input into the baking process will cost $7,000 per batch for each of the first three months' production. The material cost of the next three months' production is expected to be 95% of the cost of the first three months' production. All batches manufactured thereafter will cost 90% of the cost of the second three months' production. Packaging costs will amount to $0·75 per cake. The original costs of the artwork and design of the packaging will amount to $24,000. Superstores plc will reimburse GWCC $8,000 in the event that the product is withdrawn from sale after twelve months. The design of the Mighty Ben cake is such that it is required to be hand-finished. A 75% learning curve will apply to the total labour time requirement until the end of month five. Thereafter a steady state will apply with labour time required per batch stabilising at that of the final batch in month five. The labour requirement for the first batch of Mighty Ben cakes to be manufactured is expected to be 6,000 hours at $10 per hour. A royalty of 5% of sales revenue (subject to a maximum royalty of $1·1 million) will be payable by GWCC to the owners of the Mighty Ben copyright. Variable overheads are estimated at $3·50 per direct labour hour. The manufacture of the Mighty Ben cake will increase fixed overheads by $75,000 per month. In order to provide a production facility dedicated to the Mighty Ben cake, an investment of $1,900,000 will be required and this will be fully depreciated over twelve months.
Questions

(2) (3)

(4)

(5)

(6) (7) (8) (9)

103

(10) (11)

The directors of GWCC require an average annual return of 35% on their investment over 12 months and 18 months. Ignore taxation and the present value of cash flows.

Note. Learning curve formula: y = axb where y = average cost per batch a = the cost of the initial batch x = the total number of batches b = learning index (= –0·415 for 75% learning rate) Required Prepare a report for the directors of GWCC which: (a) (b) Advises them whether the manufacture of Mighty Ben cakes will provide the required rate of return for GWCC over periods of twelve months and eighteen months. (20 marks) (i) (ii) (c) Advises them about specific actions which may be considered in order to improve the estimated return on their investment of $1,900,000. (8 marks) Briefly discusses TWO factors which could reduce the rate of return earned by the investment as per the results in part (a). (4 marks)

Explains the term 'target costing' and how it may be applied by GWCC, and briefly discusses any potential limitations in its application. (8 marks) Professional marks will be awarded for the structure and presentation of your report. (4 marks)

In recent months – and in response to feedback they have received from their customers - the supermarkets have raised a number of complaints about the quality of the cakes GWCC has supplied for them. The majority of these complaints have been about the texture and flavour of the cakes, with many saying that the cakes seemed overcooked. GWCC has recently started using a new type of flour mixture in its cakes which cooks more quickly than the mixture it used previously. TSM supermarket has reduced the number of cakes it orders from GWCC, and two other supermarkets have said they will do likewise if the level of complaints persists. A fourth supermarket has asked for the last batch of cakes it ordered to be replaced by GWCC. The Operations manager has highlighted that while, in his opinion, GWCC has always recognised the need to produce high quality cakes for the supermarkets, it does not have a formalised quality management programme. However, he said the current issue illustrates the need to recognise and classify quality costs. Required (d) With reference to quality cost classifications, explain the potential quality costs at GWCC. (6 marks) (Total = 50 marks)

97 JHK Coffee Machines (APM 6/11, amended)

90 mins

JHK Coffee Machines Co (JHK) manufactures coffee makers for use in bars and cafes. It has been successful over the last five years and has built and maintained a loyal customer base by making a high quality machine backed by a three-year warranty. The warranty states that JHK will recover and repair any machine that breaks down in the warranty period at no cost. Additionally, JHK always maintains sufficient spare parts to be able to quote for a repair of any of its machines made within the previous 10 years. JHK is structured into two divisions: manufacturing/sales (M/S) and service. The board are now considering ways to improve coordination of the activities of the divisions for the benefit of the company as a whole. The company’s mission is to maximise shareholder wealth. Currently, the board use total shareholder return (TSR) as an overall corporate measure of performance and return on investment (ROI) as their main relative measure of performance between the two divisions. The board’s main concern is that the divisional managers’ performance is not being properly assessed by the divisional performance measure used. They now want to consider other measures of divisional performance. Residual income (RI) and economic value added (EVA™) have been suggested. 104
Questions

A colleague has collected the following data which will allow calculation of ROI, RI and EVA™. Manufacturing/sales $m 880 494 386 85 301 1,294 9% pa 5·5% 30% Service $m 17·0 11·0 6·0 1·0 5·0 38·0

Revenue Operating costs Operating profit Apportioned head office costs Profit before tax Capital employed The notional cost of capital used is The current cost of debt is The tax rate is Operating costs include:

Depreciation Other non-cash expenses All operating costs are tax deductible.

Manufacturing/sales $m 88 4

Service $m 2·7 0·3

In addition to the divisional performance measures, the board want to consider the position of the service division. The standard costs within the service division are as follows: Labour (per hour) Variable divisional overhead (per hour) Fixed divisional overhead (per hour) overheads are allocated by labour hours Currently, the service division does two types of work. There are repairs that are covered by JHK’s warranty and there are repairs done outside warranty at the customer’s request. The service division is paid by the customer for the out-of-warranty repairs while the repairs under warranty generate an annual fee of $10m, which is a recharge from the M/S division. The company sells 440,000 units per year and in the past, 9% of these have needed a repair within the three-year warranty. Parts are charged by the M/S division to the service division at cost and average $75 per repair. A repair takes two hours, on average, to complete. The board are considering amending this existing $10m internal recharge agreement between M/S and service. There has been some discussion of tailoring one of the two transfer-pricing approaches (market price or cost plus) to meet the company’s objectives. Although the service division has the capacity to cover all of the existing work available, it could outsource the warranty service work, as it is usually straightforward. It would retain the out-of-warranty service work as this is a higher margin business. It would then begin looking for other opportunities to earn revenue using its engineering experience. A local engineering firm has quoted a flat price of $200 per warranty service repair provided that they obtain a contract for all of the warranty repairs from JHK. The board are also considering a change to the information systems at JHK. The existing systems are based in the individual functions (purchasing, production, sales, service, finance and human resources). The board are considering the implementation of a new system based on an integrated, single database that would be accessible at any of the company’s five sites. The company network would be upgraded to allow real-time input and update of the database. The database would support a detailed management information system and a high-level executive information system. Finally, at present, the management team at JHK are uncertain whether the purchasing function is maximising its potential in terms of purchasing efficiency and effectiveness. The management team are currently considering the introduction of a system of benchmarking to measure the performance of the purchasing department. 105 $ 18 12 25

Questions

Required Write a report to the finance director to: (a) (b) Evaluate the divisional performance at JHK and critically discuss the proposed measures of divisional performance. (12 marks) Outline the criteria for designing a transfer pricing system and evaluate the two methods discussed of calculating the transfer price between the service and M/S divisions. (Perform appropriate calculations) (12 marks) Evaluate the potential impact of the introduction of the new executive information system at JHK on performance management. (5 marks) Professional marks will be awarded for the format, style and structure of the discussion of your report. (4 marks) (d) (e) (f) Explain the concept of 'benchmarking' and briefly discuss the potential benefits that can be obtained as a result of undertaking a successful programme of benchmarking. (5 marks) Describe how a system of benchmarking could be introduced to measure the performance of the purchasing department at JHK. (8 marks) Discuss the problems that the management of JHK might encounter in implementing a system of benchmarking. (4 marks) (Total = 50 marks)

(c)

98 TSC (APM 12/08, amended)

90 mins

The Sentinel Company (TSC) offers a range of door-to-door express delivery services. The company operates using a network of depots and distribution centres throughout the country of Nickland. The following information is available: (1) (2) (3) Each depot is solely responsible for all customers within a specified area. It collects goods from customers within its own area for delivery both within the specific area covered by the depot and elsewhere in Nickland. Collections made by a depot for delivery outside its own area are forwarded to the depots from which the deliveries will be made to the customers. Each depot must therefore integrate its deliveries to customers to include: (i) Goods that it has collected within its own area; and (ii) Goods that are transferred to it from depots within other areas for delivery to customers in its area. Each depot earns revenue based on the invoiced value of all consignments collected from customers in its area, regardless of the location of the ultimate distribution depot. Depot costs comprise all of its own operating costs plus an allocated share of all company costs including centralised administration services and distribution centre costs. Bonuses for the management team and all employees at each depot are payable quarterly. The bonus is based on the achievement of a series of target values by each depot. Internal benchmarking is used at TSC in order to provide sets of absolute standards that all depots are expected to attain. (a) The Appendix shows the target values and the actual values achieved for each of a sample group of four depots situated in Donatellotown (D), Leonardotown (L), Michaelangelotown (M), and Raphaeltown (R). The target values focus on three areas: (i) Depot revenue and profitability; (ii) Customer care and service delivery; and (iii) Credit control and administrative efficiency. The bonus is based on a points system, which is also used as a guide to the operational effectiveness at each depot. One point is allocated where the target value for each item in the Appendix is either achieved or exceeded, and a zero score where the target is not achieved.

(4) (5) (6) (7) (8)

(b)

(c)

106

Questions

Appendix Target and actual value statistics for Donatellotown (D), Leonardotown (L), Michaelangelotown (M), and Raphaeltown (R) for the year ended 31 October 20X8 Revenue and Profit Statistics: Revenue (1) Target Actual $m $m 200 240 16 14 12 18 15 18 14 22 Profit (2) Target $m 30 2·4 2·1 1·8 2·7 Actual $m 32 2·3 2·4 2·2 2·8

Company overall Selected depots: D L M R

Note. For the purpose of calculation of each depot's points it is essential that actual profit as a percentage of actual revenue must exceed the target profit (%). Customer Care & Service Delivery Statistics: Target Selected Depots: % Measure (% of total): (3) Late collection of consignments (4) Misdirected consignments (5) Delayed response to complaints (6) Delays due to vehicle breakdown Measure (% of revenue): (7) Lost items (8) Damaged items 2·0 4·0 1·0 1·0 1·0 2·0 D % 1·9 4·2 0·7 1·1 0·6 1·5 L % 2·1 3·9 0·9 1·4 0·9 2·4 Actual M % 1·8 3·3 0·8 0·3 0·8 1·5 R % 2·4 5·1 1·2 2·0 1·9 1·8

Credit Control & Administration Efficiency Statistics: (9) Average receivable weeks (10) Receivables in excess of 60 days (% of total) (11) Invoice queries (% of total) (12) Credit notes as a % of revenue Other information: Aged Debtor (receivables) analysis (extract): Less than 30 days 31–60 days Value of credit notes raised during the period ($000) Note: TSC operates all year round. D $000 1,300 321 45 L $000 1,500 133 36 M $000 1,180 153 28 R $000 2,000 552 132 Target 5·5 5% 5% 0·5% D 5·8 ? 1·1% ? L 4·9 ? 1·4% ? M 5·1 ? 0·8% ? R 6·2 ? 2·7% ?

Questions

107

Required (a) Prepare a report for the directors of TSC which: (i) Presents a summary table which shows the points gained (or forfeited) by each depot. The points table should facilitate the ranking of each depot against the others for each of the 12 measures provided in the Appendix. (9 marks) Evaluates the relative performance of the four depots as indicated by the analysis in the summary table prepared in (i); (5 marks) Assesses TSC in terms of financial performance, competitiveness, service quality, resource utilisation, flexibility and innovation and discusses the interrelationships between these terms, incorporating examples from within TSC; and (10 marks) Critiques the performance measurement system at TSC. (6 marks) (4 marks)

(ii) (iii)

(iv)

Professional marks will be awarded for the format, style and structure of the discussion of your report.

A central feature of the performance measurement system at TSC is the widespread use of league tables that display each depot's performance relative to one another. Historically, these league tables were prepared manually by the management accountant, but TSC has now introduced a new IT software system which produces them automatically. The new software system also enables operational managers to view key performance information themselves, something again was something they historically relied on the management accountant to provide them with. When the new software was introduced, the management accountant asked the financial director how the software would affect her job, because she was considered that there would no longer be a role for her at TSC. However, the finance director reassured the management accountant there she still had an important role to play at TSC, although her new role would be more akin to that of a business partner for the operations than that of a traditional management accountant. In addition, the finance director highlighted the need for TSC to monitor developments in the industry and the performance of its competitors more closely that it had done previously. He said that he felt TSC’s management information has historically been too inward looking, and hoped the management accountant would be able to help his address this issue. Required (b) (c) Evaluate the potential benefits and problems associated with the use of 'league tables' as a means of measuring performance. (6 marks) With reference to the developments at TSC, discuss the reasons suggested by Burns and Scapens as to why the role of the management accountant has changed over time, and assess the on-going contribution that the management accountant can make at TSC. (10 marks) (Total = 50 marks)

99 BEC (APM 12/09, amended)

90 mins

The Benjamin Education College (BEC), which is partially government funded, is a well-established provider of professional courses for students of accounting, law and marketing in the country of Brightland. Its mission statement states that the college 'is committed to providing high quality education to all students'. BEC provides education to private fee-paying students as well as to students who are funded by the government. The Jackson Business Centre (JBC) which commenced trading during 20X4 is also a provider of professional courses for students of accounting, law and marketing in the country of Brightland. It is a privately owned college and all its students are responsible for the payment of their own fees. Relevant operating data for BEC and JBC for the year ended 30 November 20X9 are as follows:

108

Questions

(1) (2)

Both BEC and JBC offer a range of courses in accounting, law and marketing on a twice per annum basis. Fees (budget and actual) payable to BEC and JBC in respect of each student who enrolled for a course BEC Privately funded students $ 1,200 1,000 800 BEC Government funded students $ 900 750 600 JBC Privately funded students $ 1,000 1,200 1,200

Course type: Accounting Law Marketing (3)

Salary costs per staff member were payable as follows: BEC Budget $ 50,000 20,000 BEC Actual $ 52,000 20,800 JBC Actual $ 55,000 22,000

Lecturer Administrative (4)

Budgeted costs for the year based on 8,000 students per annum for BEC were as follows: Tuition materials Catering Cleaning Other operating costs Depreciation $ 720,000 100,000 40,000 600,000 40,000 Variable cost (%) 100 80 25 20 – Fixed cost (%) – 20 75 80 100

Variable costs vary according to the number of students attending courses at BEC. (5) Actual costs (other than salary costs) incurred during the year: BEC $ 741,600 95,680 40,950 646,800 40,000 JBC $ 730,000 110,000 40,000 645,000 60,000

Tuition materials Catering Cleaning Other operating costs (including costs of freelance staff) Depreciation (6) (7) (8)

The management of JBC is considering introducing on-line tuition support by its lecturing staff. Both BEC and JBC operated a policy which aimed to employ 60 lecturers throughout the year. The appendix below shows budget and actual statistics for BEC and actual statistics for JBC.

Questions

109

Appendix Sundry statistics for the year ended 30 November 20X9 BEC Budget Number of students: Accounting Law Marketing Student mix (%) for each course type: Privately funded Government funded Number of enquiries received: Accounting Law Marketing Number of lecturers employed throughout the year: Number of lecturers recruited during the year: Accounting Law Marketing Number of administrative staff employed throughout the year Number of administrative staff recruited during the year Number of times freelance lecturing staff were used Number of new courses under development Required (a) The senior management team of BEC has asked you, as management accountant, to prepare a report providing them with the following: (i) A statement which shows actual and budgeted income statements of BEC and an actual income statement for JBC in respect of the year ended 30 November 20X9 on a comparable basis; (10 marks) An assessment of the performance of BEC and JBC using both financial and non-financial measures based on the information contained in the question. You should identify other measures of performance which you consider relevant to BEC; (10 marks) A discussion of the issues that might restrict the extent to which a performance measurement system is accepted and supported by management and employees; (6 marks) 3,600 1,500 1,800 80 20 4,800 2,000 2,400 60 2 1 1 10 2 – – BEC Actual 3,800 1,400 2,000 70 30 4,750 2,800 2,500 60 6 3 3 10 8 – – JBC Actual 4,000 1,560 2,000 100

5,000 2,000 2,400 60 1 – – 8 – 20 4

(ii)

(iii)

Professional marks will be awarded in this question for appropriateness of format, style and structure of the report. (4 marks)

'Total reward package' JBC experiences difficulty in recruiting staff even though it pays comparable salaries to rival colleges in Brightland. Senior managers do not feel that there are problems with either staff morale or the external image of the company. The Director of Strategy explains that although JBC offers a number of benefits to its employees beyond basic pay, this is not made explicit enough either internally or externally. The Director has so far identified a good pension scheme, flexible working hours, personal insurance cover at reduced rates, and a subsidised canteen. The Director has also found that employees feel that the ‘work-life balance’ (between professional and personal life) is a distinguishing feature of being an JBC employee. It is the Director's view that all the benefits which are available to staff should be examined and a 'total reward package' approach should be introduced. This would draw together all the financial and non-financial benefits (including working 110
Questions

practices, and development opportunities) into an integrated package, and employees would then be able to select which benefits they want to receive from the package. The Director has proposed that the ‘total reward’ scheme should be open to all employees. Performance appraisal system JBC has operated a formal performance appraisal system, supported by standardised procedures and paperwork, for a number of years. The scheme has clear organisational objectives, which are based on staff development and improved performance, rather than being a basis for pay reviews or paying individual annual bonuses. However, the scheme is not well regarded by either managers or staff and its objectives are not being met. Senior managers complain about the amount of time that is taken up holding appraisal interviews and then completing the necessary paperwork afterwards. Exit interviews are conducted whenever someone leaves JBC, and a review of a sample of recorded comments indicates staff feelings on the scheme very clearly: 'appraisal is just a paper exercise', 'a joke', 'a waste of time and effort'. Required (b) (i) (ii) Discuss the potential advantages and disadvantages for JBC of developing a ‘total reward package’ approach. (10 marks) Discuss the possible reasons why the objectives of the formal appraisal system are not being met. (10 marks) (Total = 50 marks)

100 HFG (APM 6/08, amended)

90 mins

The Health and Fitness Group (HFG), which is privately owned, operates three centres in the country of Mayland. Each centre offers dietary plans and fitness programmes to clients under the supervision of dieticians and fitness trainers. Residential accommodation is also available at each centre. The centres are located in the towns of Ayetown, Beetown and Ceetown. The following information is available: (1) Summary financial data for HFG in respect of the year ended 31 May 20X8. Ayetown $000 Revenue: Fees received Variable costs Contribution Fixed costs Operating profit Interest costs on long-term debt at 10% Profit before tax Income tax expense Profit for the year 1,800 (468) 1,332 (936) 396 Beetown $000 2,100 (567) 1,533 (1,092) 441 Ceetown $000 4,500 (1,395) 3,105 (2,402) 703 Total $000 8,400 (2,430) 5,970 (4,430) 1,540 (180) 1,360 (408) 952

Questions

111

Average book values for 20X8: Assets Non-current assets Current assets Total assets Equity and liabilities: Share capital Retained earnings Total equity Non-current liabilities Long-term borrowings Total non-current liabilities Current liabilities Total current liabilities Total liabilities Total equity and liabilities (2) (3) (4) (5) (6) (7) (8) (9)

1,000 800 1,800

2,500 900 3,400

3,300 1,000 4,300

6,800 2,700 9,500 2,500 4,400 6,900 1,800 1,800 800 800 2,600 9,500

80 80

240 240

480 480

HFG defines Residual Income (RI) for each centre as operating profit minus a required rate of return of 12% of the total assets of each centre. At present HFG does not allocate the long-term borrowings of the group to the three separate centres. Each centre faces similar risks. Tax is payable at a rate of 30%. The market value of the equity capital of HFG is $9 million. The cost of equity of HFG is 15%. The market value of the long-term borrowings of HFG is equal to the book value. The directors are concerned about the return on investment (ROI) generated by the Beetown centre and they are considering using sensitivity analysis in order to show how a target ROI of 20% might be achieved. The marketing director stated at a recent board meeting that 'The Group's success depends on the quality of service provided to our clients. In my opinion, we need only to concern ourselves with the number of complaints received from clients during each period as this is the most important performance measure for our business. The number of complaints received from clients is a perfect performance measure. As long as the number of complaints received from clients is not increasing from period to period, then we can be confident about our future prospects'.

Required (a) The directors of HFG have asked you, as management accountant, to prepare a report providing them with explanations as to the following: (i) Which of the three centres is the most 'successful'? Your report should include a commentary on return on investment (ROI), residual income (RI), and economic value added (EVA) as measures of financial performance. Detailed calculations regarding each of these three measures must be included as part of your report; (14 marks)

Note: a maximum of seven marks is available for detailed calculations. (ii)

The percentage change in revenue, total costs and net assets during the year ended 31 May 20X8 that would have been required in order to have achieved a target ROI of 20% by the Beetown centre. Your answer should consider each of these three variables in isolation. State any assumptions that you make. (6 marks) Whether or not you agree with the statement of the marketing director in note (9) above. (5 marks) (4 marks)

(iii)

Professional marks for appropriateness of format, style and structure of the report.

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(b)

The Superior Fitness Co (SFC), which is well established in Mayland, operates nine centres. Each of SFC's centres is similar in size to those of HFG. SFC also provides dietary plans and fitness programmes to its clients. The directors of HFG have decided that they wish to benchmark the performance of HFG with that of SFC.

Required Discuss the problems that the directors of HFG might experience in their wish to benchmark the performance of HFG with the performance of SFC, and recommend how such problems might be successfully addressed. (7 marks) The managers of each of HFG’s three centres are paid a basic salary which is broadly in line with the industry average, but they are also eligible for an annual bonus of up to 15% of their salary. The level of bonus awarded depends on the manager’s performance against a range of financial and non-financial objectives. However, in order for the manager to qualify for a bonus in any year, the operating profit for their centre has to at least achieve its budgeted level. The manager of the Ceetown centre has only recently been appointed, but he is unhappy about the bonus scheme. In particular, he believes the budget for 20X9 is unachievable. Because there was only an interim manager at the Ceetown centre during the budgeting process, the budget was set by the senior management team, without any discussion with the interim manager or the staff at Ceetown. The 20X9 budget set a target for fees received of $5.0 million, and a contribution of $1.575 million. However, not only is Mayland currently in a recession, but a competitor has recently opened a new fitness centre in Ceetown and has been offering promotional discounts. The manager pointed out that because HFG’s policy does not allow him any discretion over the price of memberships or fitness programmes, he has seen a decrease in client numbers since the rival centre opened, even though he has not received any complaints about the quality of service or the programmes available at his centre. The manager has suggested that he thinks he should be entitled to a bonus according to how well he has performed against his personal objectives, regardless of whether or not his centre achieves its budgeted profit. Required (c) (d) Assess the appropriateness of HFG’s current bonus scheme in relation to the manager at Ceetown. (6 marks) Evaluate the manager’s suggestion that he should be entitled to a bonus, and suggest alternative improvements to the reward system and HFG. (8 marks) (Total = 50 marks)

101 SBC (APM 6/10, amended)

90 mins

The Superior Business Consultancy (SBC) which is based in Jayland provides clients with consultancy services in Advertising, Recruitment and IT Support. SBC commenced trading on 1 July 20X3 and has grown steadily since then. The following information, together with that contained in the Appendix at the end of the question, is available: (1) Three types of consultants are employed by SBC on a full-time basis. These are: Advertising consultants who provide advice regarding advertising and promotional activities Recruitment consultants who provide advice regarding recruitment and selection of staff, and IT consultants who provide advice regarding the selection of business software and technical support. (2) (3) During the year ended 31 May 20Y0, each full-time consultant was budgeted to work on 200 days. All consultations undertaken by consultants of SBC had a duration of one day. During their 200 working days per annum, full-time consultants undertake some consultations on a 'no-fee' basis. Such consultations are regarded as Business Development Activity (BDA) by the management of SBC. 113

Questions

(4)

SBC also engages the services of subcontract consultants who provide clients with consultancy services in the categories of Advertising, Recruitment and IT Support. All of the subcontract consultants have worked for SBC for at least three years. During recent years the directors of SBC have become increasingly concerned that SBC's systems are inadequate for the measurement of performance. This concern was further increased after they each read a book entitled 'How to improve business performance measurement'.

(5)

Required (a) Prepare a report for the directors of SBC which: (i) Discusses the importance of non-financial performance indicators (NFPIs) and evaluates, giving examples, how a 'balanced scorecard' approach may be used to improve performance within SBC; (13 marks) Contains a calculation of the actual average cost per chargeable consultation for both full-time consultants and separately for subcontract consultants in respect of each of the three categories of consultancy services during the year ended 31 May 20Y0; (7 marks) Suggests reasons for the trends shown by the figures contained in the appendix; (5 marks)

(ii)

(iii) (iv)

Discusses the potential benefits and potential problems which might arise as a consequence of employing subcontract consultants within SBC. (6 marks) Professional marks will be awarded for appropriateness of format, style and structure of the report. (4 marks)

After receiving your report, one of the directors expressed concern that SBC’s information systems will not be able to provide the range of non-financial information which would be needed for a balanced scorecard. The director suggested that it would be better for SBC for focus on those areas of performance it can measure easily rather than incurring additional costs to include data about additional areas of performance in its information systems. Required (b) Briefly evaluate the director’s statement about which areas of performance SBC should measure. (5 marks)

Currently SBC pays all its consultants a fixed salary. However, some of the IT consultants are unhappy that their salaries are lower than those earned by the other types of consultant. Recently four of SBC’s longest-serving IT consultants resigned to go and work for rival consultancies. All of them said that the reward packages available had played a significant part in their decisions. The directors are worried about the prospect of more consultants leaving SBC and joining rival consultancies. As a result, the directors are reviewing SBC’s reward packages. The directors are aware that all the major software providers in Jayland pay a commission to consultancy firms if the firm recommends their software to a client. Currently, this commission is payable to SBC as a whole, but the directors are considering whether it should be paid to individual consultants. They are also considering a proposal under which the IT consultants would receive a lower basic salary, but would then be entitled to receive any commissions earned from the software providers. Required (c) Evaluate the directors’ proposal to revise the way in which SBC’s IT consultants are paid. (10 marks) (Total = 50 marks)

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Appendix SBC – Relevant actual and forecast statistics 20Y0 Actual Number of full-time consultants by category: Advertising Recruitment IT Support Salaries per full-time consultant ($): Advertising Recruitment IT Support Number of chargeable consultations (total demand): Advertising Recruitment IT Support Per cent of chargeable days spent on Business Development Activity (%): Advertising Recruitment IT Support Cost per consultation undertaken by subcontract consultants ($): Advertising Recruitment IT Support Other operating costs ($000): Full-time consultants 20 30 50 40,000 35,000 30,000 4,200 6,250 10,250 7 22 12 300 220 200 1,075 1,050 1,270 20Y1 Forecast 20 25 50 40,800 35,700 30,600 4,100 5,750 10,500 8 22 13 20Y2 Forecast 20 20 50 40,800 35,700 30,600 4,000 5,000 10,000 10 25 14

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102 Glasburgh (APM 6/09, amended)

90 mins

The Royal Laurel Hospital (RLH) and The King Hardy Hospital (KHH) are government-funded institutions which are managed by the Glasburgh Trust. The following information is available for the year ended 31 May 20X9. RLH Actual 37,000 3,330 740 44,000 4,400 1,320 220 70 300 4 96 1,620 1,539 600 2 80 80 8·4 80 138,750 ? 80% 29,008 54·2 22·3 5·5 (1·0) 31 RLH Budget 36,500 365 0 43,800 2,190 438 0 98 400 0 98 803 803 730 6 100 60 7·4 60 146,000 ? 80% ? 55·2 22·2 5·5 0·0 30 KHH Actual 40,000 320 0 44,000 352 220 0 100 300 0 100 420 416 800 0 20 20 9·2 20 134,320 ? 80% 31,840 60·2 19·6 4·0 4·0 35

Total inpatients Number of inpatients waiting >5 weeks for admission Number of inpatients waiting >11 weeks for admission Total outpatients Number of outpatients waiting >5 weeks for treatment Number of outpatients waiting >11 weeks for treatment Number of outpatients waiting >13 weeks for treatment Achievement (%) of target maximum waiting time of 2 weeks for admission to Rapid Access Chest Pains Clinic Number of emergency admissions Number of 12 hour 'trolley' waits for emergency admissions Achievement (%) of target of 4 hours or less time spent in accident and Emergency ward Number of complaints received Number of complaints responded to within 25 days Number of deaths (all inpatients) Infection control – number of instances of infections reported Number of drug administration errors Number of staff shortages Staff productivity measure (number of patient days per staff member) Number of times of Government or agency staff usage Bed occupancy (number of inpatient bed days) Theatre utilisation (%) % of inpatients requiring a single operation Number of operations performed Revenue from clinical and non-clinical activities ($m) Medical staff costs ($m) Other staff costs ($m) Income and expenditure surplus margin Number of days cash in hand Additional information: (1) (2) (3) (4) (5) (6) Both hospitals were in operation for 365 days during the year Each hospital has 42 wards, each of which accommodates 10 beds

RLH budgeted that each inpatient would require a stay of four days and nights in hospital. Each hospital has ten operating theatres in each of which an average of nine operations per day were undertaken. No outpatient required an operation during the year. The management of the trust uses a 'balanced scorecard' approach in order to assess the performance of each hospital. Their balanced scorecard has four dimensions which are as follows: (i) (ii) (iii) (iv) Access to services Clinical Efficiency Financial management.

In recent years, there has been growing pressure to reduce the financial resources allocated to government-funded organisations across the country in which Glasburgh is located. Increasingly, these organisations are being 116
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required to provide an effective service while making more efficient use of scarce resources. Comparative performance indicators are being applied by the providers of resources to organisations which operate within the same sector, such as health-care provision. These performance indicators provide statistics on expenditure and service delivery and frequently attempt to portray levels of efficiency by producing league tables which rank the organisations being compared. Required (a) Discuss the limitations of assessing performance by using comparative data drawn from organisations operating in the same government-funded service sector. (10 marks)

Prepare a report to the management of the Glasburgh Trust which: (b) Critically assesses, on the basis of the above information, the performance of both hospitals for the year ended 31 May 20X9. You should use the four dimensions to perform your assessment as per note (6) above; (20 marks) Evaluates the balanced scorecard used by the Glasburgh Trust and provides recommendations which would improve its usefulness as a performance measurement tool. (11 marks)

(c)

Professional marks will be awarded for the appropriateness of the format and presentation of the report and the quality of its content. (4 marks) Performance reports, containing detailed performance information similar to that at the beginning of this question, are provided for the hospital Trustees’ management meetings which take place every three months. One of the Trustees has commented that he feels the reports are too detailed, and he finds it difficult to identify the key performance issues which need to be managed. He has asked the management accountant to consider whether any improvements could be made to the content or presentation of the report. (d) Recommend, with reasons, THREE improvements which could be made to the content and/or presentation of the current quarterly management report. (5 marks) (Total = 50 marks)

103 AAA Management Consultancy
AAA is a small management consultancy practice, based in the capital city of its country.

90 mins

Over the last 5 years, AAA has grown significantly. In 20X8 AAA earned a fee income of $2.8 million (20X3: $1.6 million), and profit after tax of $0.6 million (20X3: $0.4 million). AAA now employs a total of 14 consultants (including the partners) and 11 support staff. The support staff mainly work in administration, finance, research and marketing roles. AAA’s accounts for 20X8 showed net assets of $1.1 million (20X3: $1.0 million). AAA’s business AAA has a number of clients in financial services, manufacturing, construction, retail and logistics. Most of AAA’s clients can still be regarded as Small and Medium Enterprises (SMEs), but a few of them have now grown to become large and successful organisations. Indeed, AAA now has three clients in the ‘top ten’ of the country, ranked by turnover. In all projects, AAA ensures that the staff of the client organisation are fully involved in the consultancy process. Client staff are normally included as members of the project team, thus ensuring that the project has greater acceptance from the client organisation. As a result of this approach, AAA has a reputation for successful projects and has achieved some client referral and repeat business.

Questions

117

Staff retention Until 20X7, AAA had never ‘lost’ a key employee. The partnership was, and still is, viewed as a caring and loyal employer, at least matching the market rate in terms of salaries and benefits. The partners were confident that staff loyalty would continue, as AAA was still growing and provided both interesting and challenging projects and opportunities for career progression. The partners were shocked when, in 20X7, two consultants resigned to join rival consultancy firms. In 20X8, another consultant left, this time to join a client organisation as director of finance. So far this year, a consultant resigned to set up his own business, and another chose not to return to the partnership at the end of an interim management assignment with a client. Although AAA has recruited suitably qualified replacements for the staff who have left, the cumulative effect of all these losses is that about a third of all AAA consultants have now been with the firm for less than five years. Knowledge management Mr Amit is the partner of AAA responsible for administration, marketing and IT within AAA He believes that AAA could be able to offer knowledge management consultancy services to its clients in the future. However, in the first instance he is keen to run a ‘pilot scheme’ within AAA to improve the way knowledge is managed within the firm. He is concerned that communication and knowledge sharing within AAA is nowhere near as effective as it could be. Project resourcing When AAA begins a new consultancy project, the designated project manager ‘recruits’ the consultancy team from those consultants who are not engaged in another project. Staff are allocated to projects on a ‘first come, first served’ basis, so it is common for project managers to find that some of the consultants with the greatest experience in the required specialist areas are already engaged on another project and are thus unavailable. XXX Consultants Ltd One of the partners of AAA is a friend of the owner of XXX Consultants. XXX was formed 10 years ago by Mr Bell, a former university lecturer in business and IT, and specialises in the provision of information systems and knowledge management solutions to SME clients. As AAA and XXX are currently not direct rivals, they decided to exchange information for the purposes of benchmarking. Mr Bell has since provided the following information about XXX to the partners of AAA. XXX Consultants – key information Total employees 8 (including 6 consultants) (20X8 – $ million) 1.5 0.4 0.6 (20X4 – $ million) 1.1 0.2 0.5

Total fee income Profit after tax Net assets (closing balance)

Ms Adam, who left AAA in 20X7, joined XXX as a senior manager. Feedback from Ms Adam is that she prefers XXX’s approach to serving client needs. XXX is so small that the whole organisation can be dedicated to each and every client project. She also likes XXX’s emphasis on continuing professional development (CPD), which is not something that AAA feels to be important. Since its formation, no staff have left XXX. XXX has also received two awards for outstanding customer service levels from the local Chamber of Commerce. Required Write a report for the partners at AAA which: (a) Includes a benchmarking analysis comparing the performance of AAA with that of XXX, and uses the Balanced Scorecard as a framework for the analysis. Note: There are 12 marks available for calculations in this requirement. (b) (28 marks)

Advises the partners of AAA how they might best protect the strategic position of AAA, using Porter’s ‘five forces’ model as a structure for your advice. (12 marks) (4 marks)

Professional marks will be awarded for the structure and content of your report.

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The senior partner at AAA is keen to boost revenue and profits at the partnership. At a recent partners’ meeting that ‘every consultant should aim to ensure that 95% of the total hours he or she works are billed to clients. This will ensure that we remain both profitable and competitive.’ (c) Discuss the senior partner’s statement, drawing attention to any concerns you may have about it. (6 marks) (Total = 50 marks)

104 Zed Leisure
(a) (b)

90 mins

Describe the main elements in corporate failure models and discuss the main limitations of these models. (8 marks) Zed Leisure published its annual report for the year to 31 December 20X9 recently. An extract from the Chairman's report follows. Financial analyses are in the Appendices at the end of the question. Chairman's report 'The group's financial position has never been stronger. Revenue has risen 209% and the share price has almost doubled during the last four years. Since the end of the financial year the company has acquired Beddall Hotels for $100 million, financed at 9% per year by a euro floating rate loan which has little risk. Our objective is to become the largest hotel group in the United Kingdom within five years.' Required In his report the chairman stated that 'the group's financial position has never been stronger'. From the viewpoint of an external consultant, prepare a report for Zed’s Board of Directors analysing whether you agree with the chairman. Your report should incorporate the following: (i) (ii) An evaluation of the group's financing policies and strategic objective, with suggestions as to how these might be altered. (17 marks) An analysis of the organisation (with and without the investment business) and of its sectors. (15 marks) (4 marks)

Professional marks will be awarded for the structure and content of your report.

One of the reasons Zed wanted to acquire Beddall Hotels was that Beddall’s hotels operate in a different sector of the market to any of Zed’s current hotels. Beddall’s hotels offer high quality, luxury accommodation, and pride themselves on the quality of service they give to their guests. Zed uses a standard set of performance measures across all its hotels, but the group accountant has been having problems with the figures for Beddall. Not only does it use a different management information system to Zed, but also some of the performance measures which Beddall currently monitors are different to those which Zed monitors. Required (c) With reference to a suitable business integration model, briefly discuss the implications of applying Zed’s standard performance measures to Beddall. (6 marks) (Total = 50 marks)

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APPENDIX A
EXTRACTS FROM THE ANNUAL REPORT AND ACCOUNTS INCOME STATEMENT SUMMARIES FOR THE YEARS ENDING 31 DECEMBER

Revenue Operating profit Investment income Interest payable Profit before tax Income tax expense Profit attributable to shareholders Dividends Retained earnings

20X6 $m 325 49 18 67 14 53 23 30 12 18

20X7 $m 370 60 10 70 16 54 19 35 12 23

20X8 $m 490 75 3 78 24 54 19 35 12 23

20X9 $m 680 92 1 93 36 57 16 41 12 29

STATEMENT OF FINANCIAL POSITION SUMMARIES AS AT 31 DECEMBER 20X6 $m ASSETS Non-current assets Tangible assets Investments Current assets Inventory Receivables Cash TOTAL EQUITY AND LIABILITIES Equity Ordinary shares (10 cents nominal value) Share premium Revaluation reserve Revenue reserves Shareholders' funds Non-current liabilities Bank loans 13% debenture 20Y6-8 Current liabilities Trade payables Income tax expense Overdraft Other 20X7 $m 20X8 $m 20X9 $m

165 120 285 40 56 2 98 383

260 68 328 45 52 3 100 428

424 20 444 70 75 4 149 593

696 4 700 110 94 5 209 909

50 22 – 74 146 42 80 82 18 – 15 115 383

50 22 – 97 169 42 80 94 19 – 24 137 428

50 22 – 120 192 102 80 130 19 42 28 219 593

50 22 100 149 321 102 180 176 20 68 42 306 909

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APPENDIX B Analysis by type of activity 20X6 Revenue Profit1 $m $m 196 36 15 (3) 24 6 43 7 5 (1) 10 1 32 3 325 49
2The

Hotels Theme park Bus company Car hire Zoo2 Waxworks Publications
1Operating

20X7 Revenue $m 227 18 28 45 6 11 35 370

Profit $m 41 (2) 8 8 (1) 3 3 60

20X8 Revenue Profit $m $m 314 37 24 3 38 14 52 12 9 0 13 4 40 5 490 75

20X9 Revenue $m 471 34 46 62 10 14 43 680

Profit $m 45 5 18 15 (1) 5 5 92

profit before taxation.

zoo was sold during 20X9. 20X6 82 1,500 178 10:1 20X7 104 1,750 246 12:1 20X8 120 1,800 344 19:1 20X9 159 2,300 394 25:1

Zed Leisure average share price (cents) FT 100 Share Index Leisure industry share index Leisure industry P/E ratio

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124

1 Diverse holdings
Text reference. Strategic planning and SWOT analysis are discussed in Chapter 1 of the Study Text. Top tips. Part (a) is general and doesn't really need to be related to the scenario. However, in part (b), you must apply your comments to the company. Importantly, though, the focus here is not on SWOT as a strategic planning tool, but how SWOT can be used to help manage performance. So, for example, once Diverse has identified any strengths or weaknesses, how can it use them to help improve performance within the organisation? In part (c) you need to consider growth and market share. This is effectively applying the BCG matrix to the company's subsidiaries. However, you won't get extra marks for naming the matrix so show your understanding in applying it instead. We have identified more than four advantages for completeness but you must only write on four. Likewise we have listed four rather than three strategies to give you an idea of the range of possible strategies you can write about. Easy marks. The advantages required in part (a) are listed in the BPP Study Text for Paper P5 – you don't even need to apply the detail of the scenario to score marks but you will get better marks if you do so. (a) Advantages of a formal system of strategic planning (i) (ii) (iii) (iv) (v) It helps identify risks. It forces managers to think and can encourage creativity and initiative. It forces management to takes decisions, highlighting the need to change and adapt, not just 'stand still' and survive. Management control can be better exercised if targets are explicit. It enforces consistency at all levels. Long-, medium- and short-term objectives, plans and controls can be made consistent with one another. Otherwise strategies can be rendered ineffective by budgeting systems and performance measures which have no strategic content.

Additional possible answers (vi) It enables the long-term plan for the business to become public knowledge, thereby enabling decision making by a range of staff. (vii) It provides long-term plans. (viii) It ensures the activities of different business functions are coordinated and directed towards a common goal. (ix) Objectives are clarified, management being forced to define what they want to achieve. (x) It ensures responsibility is allocated by providing a plan which shows how people fit in. (b) How SWOT analysis may assist the performance management process SWOT analysis will help the management identify the company’s strengths and weaknesses, and the external opportunities and threats affecting it. Strengths and weaknesses analysis at Diverse Holdings plc will require the management to look at the strengths and weaknesses of the divisions and the products/service range. As the group is diverse there would be a range of SWOT analyses, for each subsidiary. This analysis should identify both shortcomings in the skills and resources of the various divisions, for example (so that management can then take action to overcome them), and strengths of the different divisions that should be exploited to produce profit-making opportunities. Management should also consider the strengths and weaknesses of the group as a whole – for example, whether the range of different markets it is involved in represent a strength or a weakness.

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Opportunities and threats analysis should encourage management to look at possible profit-making opportunities in the business environment, but also to identify environmental threats (such as the entry of new competitors) which management need to respond to. For example, opportunities include the growth markets for OFL and OPL; threats include the competition facing KAL. By identifying and analysing strengths, weaknesses, opportunities and threats, the management of Diverse Holdings plc should be in a position to strengthen the group. A SWOT analysis will help in strategic decision making. For instance it will highlight where there is a shortage of funds in the group allowing management opportunity to arrange financing. In this respect, SWOT analysis can play an important role in the performance management process. Performance management can be any activity designed to improve an organisation’s performance and ensure that its goals are being met. By identifying opportunities and threats, and helping to identify the strategic choices to pursue, SWOT analysis plays an important part in the planning activity designed to improve an organisation’s performance. For example, identifying weaknesses or limiting factors which need to be addressed should then help the management team at Diverse address them. Identifying critical success factors - SWOT analysis could also help the management team identify the critical success factors for each of the subsidiaries, and for the group as a whole. In turn, this could allow them to create and monitor key performance indicators, designed to show how well the business is performing in relation to these critical success factors. Determining information needs – Once Diverse has established its KPIs, management will then need to assess what information they need to monitor performance against these indicators, and whether their current information systems can provide them with this information. Setting targets. Although Diverse has prepared forecasts for each of its subsidiaries, it is not clear what their goals or targets are. Carrying out a SWOT analysis could also encourage the management team to consider what targets should be set for the subsidiaries to allow them to build on their strengths and/or take advantage of opportunities, as well as minimising their weaknesses and the threats they face. For example, OFL appears to be the market leader in the food production market, so one of its targets could be to maintain its market leadership in order to take advantage of the growing market. Equally, however, a consideration of an organisation’s strengths and weaknesses, and the opportunities and threats it faces, will the management team to assess whether any targets which have already been suggested are realistic and achievable. (c) (i) Organic Foods Ltd (OFL) is achieving strong growth in a rapidly-growing market, and is forecast to increase market share from 5% in 20X3 to 8% in 20X7. Operating profits appear to be healthy (at or above 20%) and therefore OFL is a 'strength' of Diverse Holdings Plc. Its financial performance is matched by its strong reputation. Haul-Trans Ltd was acquired on 1 December 20X5 and has a record of recent profitability. This is forecast to increase by 40% ($1.6m) during its first two full years of ownership. Although the market share of Kitchen Appliances Ltd (KAL) in 20X5 was very close to that of the market leader, it is forecast to have a relatively low market share in a declining market. Given the fall in operating profit that has occurred and is forecast, it may have a high level of fixed costs. It is forecast to make a loss in 20X7. It has suffered from squeezed margins as a consequence of competition from low cost imports. Paper Supplies Ltd (PSL) has a relatively low market share (only two customers!) in a growing market. The market leader enjoys 35% of the market, whilst PSL appears to be struggling to achieve any growth in revenue or profit. This might be explained by the fact that it sells a narrow range of products. The products of Office Products Ltd (OPL) are highly regarded by health and safety experts. This should confer a competitive advantage on OPL, which may help to maintain its trend of increased profitability. The company is operating in a high-growth market but seems unable to achieve a reasonable market share in spite of the fact that its products are highly regarded by health and

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safety experts. The market leader has 25% market share, while OPL only has 6.9% at 30 November 20X5. More effort should be directed towards promoting this feature. (ii) From the above analysis, it is clear that KAL and OPL require the immediate attention of management. (1) The position of KAL is not sustainable. Competitors within low growth markets will invariably offer high levels of resistance to any attempts to reduce their share. Divestment of KAL might be worth considering. As far as PSL is concerned, management should endeavour to find new markets for its products. Also, management should consider extending the narrow product range currently on offer. In the case of OPL, management needs to devise an appropriate growth strategy, as currently it is in a high-growth market but without a healthy market share. More effective advertising of the endorsement of the product range by health and safety experts would help to promote its quality to new customers.

(2)

(3)

Additional answer (4) A strategy which further integrates the divisions and enables them to both benefit from each other and take advantage of any synergy offered by the acquisition of HTL should be developed as a matter of urgency. Management need to ensure that sufficient funds are made available for the promotion of strong subsidiaries such as OFL. Divestment of KAL could provide some funding whilst allowing the directors of Diverse Holdings Plc to concentrate on more profitable subsidiaries.

(5)

2 ST University
Text reference. The contrast between strategic and operational levels in an organisation is discussed in Chapter 1 of the Study Text. Top tips. One of the important distinctions between ‘strategic’ and ‘operational’ issues is often the degree to which they relate to ‘planning’ rather than ‘control’. Strategic issues often relate more to planning and the longer-term, whereas operational issues often relate more to control and the shorter term. However, it is important to remember (as in Anthony’s hierarchy) that there is a middle layer between the strategic and the operational: the managerial (or tactical) layer. In effect, the majority of the criticisms fit into this middle category. Nonetheless, the link between control and operational issues could be useful for answering part (b). The control measures you suggest need to be practical ones which the University could implement to improve its daily operations. Note that although the audit report identified eight criticisms, the questions requirement specifically asks for you to concentrate on two criticisms only. For tutorial purposes, we have included all eight areas to show potential controls you could have suggested to improve them. However, you should only have addressed TWO of the criticisms in your answer. However, there is no instruction to say that you can only recommend one control to help improve each area of criticism. So, if you can think of, say, two controls for an area, you should include both of them. However, note you are asked to ‘Recommend, with reasons…’ so it is vital you discuss the reasons why you have recommended a particular control. Simply describing the control is not sufficient to score the marks available here. In the answer below we have started with the operational issues, and then worked through the management issues, and finally addressed the strategic issue. Note that the operational issues lend themselves most easily to new controls, and so should be the quickest for STU to resolve. Management issues are more complex than operational ones, and so are less likely to be solved by a quick solution. In turn, strategic issues are more complex again, and cannot be solved through any single actions or controls. They are likely to require a change in the overall approach and strategy of the organisation.

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127

In part (c) it is important to think how information systems could be useful to STU in relation to each of the different levels: operational, management and strategic. In order to implement the strategic plan successfully, STU will need to have appropriate controls in place at operational and management level, and information systems can play an important role in helping to achieve this. (a) Strategic criticisms – The criticisms are strategic if they relate to aspects of STU which are fundamental to the University and its objectives as a whole, and to its long-term ability to achieve those objectives. The criticism that the overall quality of education is ‘Poor’ appears to be a strategic criticism, given that one of STU’s main purposes will be to provide the highest quality of education that it can to its students. Operational criticisms – By contrast, operational criticisms will relate to weaknesses or problems in the specific, day-to-day activities which STU carries out in order to achieve its financial or operating objectives. In this respect, the fact that STU could not produce a head-count of the number of students enrolled, and the fact that there were discrepancies in cash counts both seem to be operational criticisms. Managerial criticisms – However, a number of the criticisms seem to relate to issues between these two extremes, meaning they are best viewed as management or tactical issues. In other words, they relate to the way that resources are obtained or used to try to achieve STU’s objectives as effectively and efficiently as possible. For example, the high numbers of students dropping out of their courses, or complaining, suggests that STU is not achieving its educational objectives as well as it could be. Equally, the fact that it is operating at a deficit, and it is not managing its debtors effectively suggests it is unlikely to be performing as well as it could be financially. Computing facilities – The reference to computing facilities, and the management team’s response to this also gives an indication of the importance of strategic objectives being linked to the tactical and operational level. It is not clear whether STU’s intention has simply been to provide more computing facilities or whether it has intended to use computer technologies to enable particular types of learning. However, if there was a particular educational strategy, it seems this has not been communicated clearly to those responsible for implementing it throughout the university (in the different academic departments, or the libraries for example) so consequently STU is not making the best use of the computing facilities it now has. (b) The strategic plan needs to address the criticisms highlighted in the audits, and suggest ways in which STU’s resources can be used more efficiently and effectively to improve STU’s performance in the nine areas identified. Monitoring performance – Control measures will provide a framework for monitoring performance in these areas. The measures will force managers to assess STU’s actual performance compared to plan, and identify areas where further improvement is still needed. Aligning goals and objectives - The control measures should be designed to ensure that day-to-day (operational) activities are aligned with STU’s strategic goals, and thereby help it to achieve its strategic goals. In this respect, the control measures could be presented as critical success factors (CSFs) supported by key performance indicators (KPIs). If STU monitors its performance against its KPIs – and takes corrective action if performance slips below the target level – this should help it achieve the goals set out in the strategic plan. For example, providing a high quality of education should help address the high drop-out and failure rates, and reduce the number of student complaints, so this could be established as a CSF. STU’s academic staff could be given targets of ‘x% of students grading their lectures as ‘Excellent’ such that quality becomes integral to staff performance.

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Answers

Controls to improve performance 1 Absence of an accurate head count of students enrolled If the university doesn’t know how many students are enrolled, this will cause problems for resource planning (for example, allocating students to tutors) and also for obtaining government funding (because funding levels are likely to relate to student numbers). Student database – All students should be registered on a central database which is continuously up-dated as new students join or existing students leave. Identity cards – Based on the information in the database, each student should be given an identity card and a student number. STU should ensure that students who do not have a valid identity card will not be able to use university facilities such as the library, student union or the sports centre (thereby also giving the students an incentive to make sure they are properly registered). 2 Defective internal control of cash receipts, leading to discrepancies There will be a number of cash transactions every day – for example, in the student union (canteen / bar) or the library. If cash controls are weak, there is a danger of theft and the shortfall of income against expenditure will be increased. Pre-paid charge cards – STU should try to minimise the number of cash transactions as far as possible. For example, students could all be given pre-pay (top up) cards which they use to pay for certain items (eg canteen lunches, library fees) by swiping through a card reader. Cash handling procedures – STU should also make sure that, as far as possible, there is a segregation of duties between staff who handle cash and those who account for cash. Cash should be banked frequently to ensure that large cash balances on not held on the university campus for any length of time. Possible improvements for the other areas of criticism in the report: Operating deficit (Expenditure exceeds income) A situation in which expenditure exceeds income is clearly not sustainable in the long run because it would lead to STU becoming insolvent. The operational improvement suggested in the two recommendations (above) could help this situation (for example, having accurate information on student numbers should allow STU to claim the correct funding) but it is unlikely that operational improvement alone will make good the deficit. Expenditure review – STU’s management should review all the expenditure across the university as a whole and assess where savings can be made. For example, does it need 350 academic staff and 420 other staff for a student population of 8,000? Income targets – As well as cutting costs, STU should also consider ways it could increase its revenue. For example, could it increase student numbers above 8,000? Or could it increase its fees and prices for auxiliary services (such as meals) without seeing a disproportionate fall in demand? Overall, STU’s management needs to control expenditure and income so that the university at least breaks even rather than operating at a deficit. High student drop-out and failure rates (in excess of the national average) High drop-out rates indicate students are either unhappy with their courses or with life as STU as a whole. High failure rates may also indicate problems with the courses, or with the standard of tuition students receive. Both of these issues are potentially damaging for STU’s reputation, and so could adversely affect student numbers (and therefore income). Understanding reasons for leaving – STU needs to understand the reasons why students drop out so that it deal with the causes of the problem. (For example, are drop-outs caused by poor tuition, poor facilities, or students finding they simply didn’t like the subject they’d enrolled for?) If STU conducted exit interviews, or had a questionnaire equivalent, for students who drop-out this should help gather the relevant information.

Answers

129

Analysis of failure rates – It is not clear if failure rates are universally poor across all departments or whether some departments and lecturers have worse rates than others. This should be analysed. If some departments are performing particularly poorly, the course programmes and the quality of the teaching should be subject to a detailed academic inspection. High (and increasing) level of student complaints As with the high drop-out rates, a high and increasing level of student complaints indicates that students are not satisfied, for example, either with the teaching or with their overall experience at STU. Analyse causes for complaint – It is not clear if there are any specific aspects of their courses or of the university in general which are prompting students to complain. STU needs to analyse the complaints they receive, and then address the issues which are leading to the most frequent complaints. High numbers of debtors and lack of action to collect debts The fact that a number of the debtors are ex-students may be linked to STU’s inability to produce a head count. If STU never registered someone as a student, then it may well also have no record of them as a debtor. If STU is letting debtors go uncollected, this will be damaging to its cashflow. Link to student database – If a debtors ledger account is set up for every student when they enrol (through a link to the student database) then student debtors should no longer go unrecorded. If it doesn’t already have it, STU should also consider instigating a policy that students cannot graduate until all their debts to the university have been cleared. Debt numbers – STU should set some key performance indicators (KPIs) around the number and value of debtors outstanding, and the credit control department (or whoever is responsible for debtor management) should be monitored as to whether they achieve these KPIs. High staff turnover A high level of staff turnover (particularly among academic staff) may be contributing to the high failure rates and student dissatisfaction, especially if the better lecturers are leaving and being replaced with less good ones. STU will also incur costs in relation to advertising for, and recruiting, new staff. Exit interviews – When staff leave, they should have an exit interview at which the reasons for their departure are discussed, along with any issues they have with working at STU. This should highlight if there are any particular factors which are causing staff to leave; and, in turn, management should then focus on dealing with those issues. Staff surveys – STU should conduct surveys of all its staff (both academic and non-academic) to find out which aspects of their jobs they like and which they are less satisfied with. Management should then consider if there are any ways the main issues causing dissatisfaction can be addressed. Poor quality of education This criticism may be connected to a number of the others: high drop-out and failure rates; increasing student complaints; and high staff turnover. Moreover, if this rating is published externally it could damage STU’s reputation and may deter potential new students from applying. This will make it harder for STU to increase income and to help reduce its operating deficit. However, perhaps the most important implication of this criticism is that STU’s key aim in the period 2011-6 must be to improve the overall quality of its education. This improvement will need to be central to the new Strategic Plan. Quality control - In order to assess whether the required quality improvements are being made, STU should establish a quality control department, which carries out periodic quality audits on all departments and processes in the university. The quality control department could also benchmark performance in key areas between departments. And if it identifies practices or processes one department is using which work particularly well, it could get these shared with other departments.

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Performance targets – STU can make quality integral to staff performance by including quality targets in the staff’s performance management objectives. For example, academic staff could have a target of ‘x% of students grading lectures as “Excellent”.’ (c) Information systems (IS) can support the implementation of the strategic plan at each of the three levels of the control hierarchy: operational, management and strategic. Operational STU’s information systems need to provide up-to-date (real time) information about key areas of operational performance. For example, the IS should be able to show how many students are enrolled at any time. STU should also be able to use IS to review cash and debtors balances at any time. In all of these cases, it is important that data is ‘real time’ so that management can make decisions based on current figures. In this respect, the IS will need data capture mechanisms to ensure figures are continuously updated – for example, so that if a student joins or leaves this is picked up in the head count records. Management Performance measures and reporting – it is likely that one of the key steps in achieving the goals of the new strategic plan will be hitting revised performance targets for some of the areas criticised in the audit. IS could be used to provide reports showing performance against targets and KPIs which support the University’s CSFs. For example, performance reports could indicate drop-out rates, complaint levels, and debtor numbers /values. These reports will enable management to see if any further corrective action still needs to be taken (in the areas where actual performance continues to fall below the target level.) Strategic Performance reporting – In the same way that IS were used to support the analysis of performance against KPIs at management level, so they can allow STU to assess performance against its CSFs at strategic level. On-line classrooms – It is not clear to what extent, if any, STU uses IS in its teaching. However, IS could play an important role here: for example if STU introduced webcasts or online tutorials, students could use these to supplement their existing classroom lectures. In this way, IS could be a source of competitive advantage to STU, as well as being a means of enabling performance measurement.

3 HEG
Text reference. This question covers brought forward knowledge as well as drawing on topics found in Chapter 1 and Chapters 3 and 16. Top tips. Part (a) is actually asking for an income statement. So draw one up and then calculate the sales margin which you can compare to the target margin of 32%. You will also need to work out the maximum increase in the price of ingredients and the percentage increase or sensitivity that this represents. Part (b) draws on your knowledge of strategic planning and using CSFs. Part (c) is a separate requirement which tests your knowledge of MIS and recent changes in the role of the management accountant. You don't need to refer to the scenario here as the question tests your general knowledge of ERPS. We have included a separate note which analyses the examiner's answer contrasting it with a student answer. The analysis explains why the examiner's answer earns more marks. Read through this note and use it to audit your own answer once you have attempted part (c ). Easy marks. The table in part (a) should be easy enough to calculate. Examiner's comments. Part (a) was answered well by most candidates as was part (b). However many candidates answered part (c) badly by adopting a 'scattergun' approach and writing all that they knew.

Answers

131

Marking scheme
Marks

(a)

Profit Profit/sales % Materials – price sensitivity

6 × 0.5

3 1 2 3 10 3 3

Maximum

6

(b)

Explanation of CSFs – 1 mark per relevant point – Up to 3 Critical success factors 5×2

Maximum 13

(c)

Explanation of how ERPS changes the nature of work Explanation of the impact ERPS has in changing the role of the management accountant

Maximum 6 Total = 25

(a)

Expected sales margin and increase in the price of ingredients Revenue (W1) Costs Ingredients (W2) Packaging and labelling (W3) Fixed overheads (W4) Distribution costs (W5) Total costs Net profit Margin to sales %(W6) Target margin % (Note 8) Comments

$'000 45,000 17,500 3,750 5,401 3,600 30,251 14,749 32.78 32.00

The sales director reached his conclusion using the data in the table to show that HSC can achieve a margin of slightly more than 32%. However ingredients are a major cost and an increase in the price of ingredients of just 2% would mean the target was not achieved. This is worked out as follows: Target margin of (32%  revenue of $45m) = $14.4m Actual margin = $14.749m Therefore the margin can decrease by $0.349m or material costs increase by $0.349m, to $17.849m, which is an increase of 1.99% or 2%, before the target is not achieved. This shows the target margin is very sensitive to an increase in the price of ingredients purchased by HEG. However, these come from suppliers chosen by SFG and so HEG has no control over material costs. Workings for the table 1. 625m  0.04  $2.40  ¾ = $45m. Notes 2,3 The 2. $0.70  625m  0.04 = $17.5m. Notes 2,4 3. $0.15  625m  0.04 = $3.75m. Notes 2,5 4. From the question 5. $45m  0.08 = $3.6m. Note 7 6. Sales margin = (14,749/45,000)  100%
3 4

is the inverse of the mark-up of 33

1

3

or

4

3

to

SFG on the sandwiches.

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(b)

Critical success factors Critical success factors (CSFs) are the aspects of an organisation’s activity which are crucial to its future competitive success. Once an organisation has established its objectives, it needs to identifying the key factors and processes which will enable it to achieve those objectives. These key factors and processes are its CSFs. Importantly, when identifying its CSFs, an organisation should focus on the aspects of a product or service which are particularly valued by customers. In order to out-perform its competitors, an organisation needs to excel in those aspects of performance which customers value. In turn, once an organisation has identified its CSFs it needs to know how well it achieving them. This can be done by using key performance indicators (KPIs), which measure how well it is performing against its CSFs. Five CSFs that HSC must focus on to achieve success in its marketplace (i) Profitability. The cost of ingredients is the largest single cost of the sandwiches. The latitude for an increase in cost of 2% only before the target margin is eroded also means that this cost needs to be carefully monitored. However as HSC cannot influence the price directly it may have to do so by negotiation with SFG. The quality of the sandwiches. A fast food product has an immediate impact on the customer who will not repeat a purchase if it is not up to standard. Therefore HSC must ensure the highest quality all of the time. It may have some problems as it has no control over the ingredients in its sandwiches and its workforce is largely inexperienced in food manufacture. Compliance with food safety regulations. HSC needs to ensure that complies with the strict food safety regulations in the manufacture and storage of the sandwiches. If there are any concerns that HSC is not complying with the necessary regulations, it is likely that SFG will stop buying its sandwiches from HSC. The supply chain and freshness of the sandwiches. HSC must ensure that its sandwiches are delivered well before 2pm to make the maximum sales. No sandwiches are sold after the day of delivery so speed of making and delivering the sandwiches is paramount. Product range. The market for sandwiches ranges from traditional favourites to new tastes and sandwich makers compete to produce new flavours whilst maintaining sales of cheese and mayonnaise classics. HSC will have to produce new ranges that SFG will accept to sell in its supermarkets, monitoring success and withdrawing slow selling lines.

(ii)

(iii)

(iv)

(v)

(c)

How the introduction of an ERPS could impact on the role of management accountants An ERPS is designed to integrate all the different applications included in a management information system (MIS) thereby allowing a single point of access to all data. As such it should reduce the workload of management accountants. Management accountants traditionally gather data from across the organisation using a variety of sources and synthesise this data to produce reports to management. They are held responsible for many of the systems they use such as the inventory control system. An ERPS allows managers to run reports themselves from the MIS thereby cutting out the need to ask the management accountant to produce these reports. IT specialists who make sure the system is installed and running properly oversee the ERPS. However the management accountant is instrumental in the specification for the ERPS as a major user and overseer for audit purposes. The management accountant can also advise managers using the ERPS who may need guidance when producing budgeting and monitoring statements. The management accountant may also use the ERPS in a more strategic role for reporting to the board on high level data.

Answers

133

4 CTC
Text reference. This covers brought forward knowledge and the use of strategies from Chapters 1 and 7. Top tips. The question is quite typical of questions set at this level. The examiner will test your knowledge often by calculations, but will also assess your understanding by asking you to apply strategies and models which analyse your calculations, in this case to explore the contrast between short term and long term performance measures. Part (a) is asking for calculations of profit for each product [product profitability] for the two years. You will need to aggregate these to get the profit or loss of CTC. There are only four marks for this so don't spend a lot of time on it. To save time, use a table like the one we have prepared below and state your numbers in $'000. You should then be able to comment on the numbers. You don't need to add notes and workings as we have done here. This is only to help you understand where figures have come from. Part (b) has multiple requirements. Part (i) is a standard NPV calculation with the data you need contained in the notes. Once again this is for four marks so draw up a table and slot in revenue cash flows and capital costs. We have included workings and references to notes in the question to show you where figures come from. You may not have time to do this and it is not necessary. You should also work in $'000 unless asked to do otherwise as this will also save you time when writing out numbers. Part (ii) needs you to work backwards from your calculations in part (i) in a sensitivity calculation which is effectively asking for the target C/S ratio at which NPV is zero. Finally, in part (iii) you need to think about an alternative strategy that will help address CTC’s performance issues. Our answer below looks at operational strategy in relation to pricing and value analysis. However, you could also have considered strategy in the context of market development or product development (as in Ansoff’s matrix.) Examiner's comments. Part (a) was generally well answered. However part (b) (ii) was not attempted at all by a large number of candidates or they failed to pick up as the need to use NPV analysis.

Marking scheme
Marks

(a) (i) Sales revenue Variable costs Contribution Product margin by product Company fixed costs/net profit (ii) Comments (on merit) (b) (i) Initial investment Working capital Contribution Fixed overheads NPV/Decision (ii) Approach to problem Correct answer (iii) Comments (on merit): Up to 4 4×1

1 1 1 1 1 4 0.5 1.5 1 1 1 3 1 4

Maximum 4 4

Maximum 4 4 4 Total = 20

134

Answers

(a)

(i)

Statement of product profitability
20X8 Bruno $'000 7,200 5,040 (3,800) 1,240 Kong $'000 7,500 4,875 (2,400) 2,475 Leo $'000 3,600 2,160 (2,040) 120 CTC $'000 18,300 12,075 (8,240) 3,835 (1,650) 2,185 Bruno $'000 4,800 3,360 (2,400) 960 Kong $'000 2,400 1,560 (1,340) 220 20X9 Leo $'000 4,320 2,592 (2,100) 492 CTC $'000 11,520 7,512 (5,840) 1,672 (1,650) 22

Sales (W1) Contribution (W2) Fixed costs (W3)
Product profitability

Other fixed costs Net profit

Workings 1 2 3 (ii) Sales is sales price  forecast sales units. So taking Bruno 20X8: 180,000 units  $40/unit = $7,200,000. C/S ratio is stated in Note 1 in the question (sales  C/S ratio = contribution). Using Bruno 20X8: $7,200  0.70 = $5,040. Note 2 in the question.

Commentary on products and profitability. (All figures stated in $'000) 1 Bruno and Kong will see a significant decline in their forecast profitability in absolute and (in one case) percentage (margin). Thus Bruno will decrease by $280,000 or 23% on 20X8 but its margin will slightly improve to 20% from a 17% net margin. Kong's profitability will fall by $2,255,000 or 90% on 20X8 and its margin will drop to 9% from 33%. C/S ratios are constant over the period so the declining performance will be due to other factors. In each product, sales will fall due to sales volumes and not price as this will remain constant. The total production capacity of CTC is 400,000 units. In 20X8, 390,000 units are planned which is 97½% of capacity. However, this is forecast to fall to 240,000 units in 20X9 or 60% of total capacity. Bruno's sales forecast a drop of 33% and Kong's 68%. However, fixed costs are expected not to decrease by the same percentages so Bruno's share of fixed overheads will fall by 32% and Kong's by 44%. In Kong's case, margins will be eroded. 2 3 Leo is forecast rising sales volumes during the two years from 60,000 units to 72,000 units. This is not enough to offset the decline in sales from the other two products. CTC will see a dramatic fall in its profit by $2,163,000 to $22,000, giving a profit to sales ratio of just 0.19%. P/E 1.6.20X8 $'000 Annual cash flow (W1) Capital costs Outflows (W2) Working capital (W3) Discount factor Discounted cash flows NPV Y/e 31.5.20X9 $'000 400 (200) 200 0.893 179 Y/e 31.5.20Y0 $'000 3,060 – 3,060 0.797 2,439 Y/e 31.5.20Y1 $'000 1,204 700 1,904 0.712 1,356

(b)

(i)

Product viability on financial grounds

(3,900) (500) (4,400) 1.000 (4,400) (426)

The product has a negative NPV at the organisation's cost of capital of 12%. Therefore, it is not financially viable and should not be invested in.

Answers

135

Workings 1 Annual cash flows Y/e 31.5.20X9 20X9 $'000 4,000 2,000 1,600 400 Y/e 31.5.20Y0 20Y0 $'000 9,000 4,500 1,440 3,060 Y/e 31.5.20Y1 20Y1 $'000 5,000 2,500 1,296 1,204

Sales @$50/unit (Note 1 in the question) Contribution given C/S at 50% (Note 2 in the question) Fixed costs (Note 3 in the question) Cash flow 2 3 (ii) Note 4 in the question. Note 5 in the question.

The product is currently financially unviable, because NPV is -$426,000. In order for the product to become financially viable, an increase in the contribtion to sales ratio % (C/S %) is required. The minimum target C/S ratio at which Nellie the Elephant becomes financially viable will be that at which NPV is zero. The resulting change in C/S ratio (%) required can be calculated as follows: (Assume ‘X’ is the change in contribution to sales ratio %). Additional contribution from year 1 + Additional contribution from year 2 + Additional contribution from year 3 = 426,000 (4,000 × X × 0.893) + (9,000 × X × 0.797) + (5,000 × X × 0.712) = 426 3,572 X + 7,173 X + 3,560 X = 426 14,305 X = 426 Therefore X =0.0298 Current contribution to sales ratio = 50%. Therefore, C/S ratio (%) required for Nellie to become financially viable = 50 + 2.98 = 52.98%

(iii)

Multi product packages - If no new products are available, then CTC must look to boost revenues obtained from its existing product portolio whilst seeking to reduce product specific fixed overheads and the company’s other fixed overheads. In order to do this, CTC should focus its attention on the marketing activities it undertakes. CTC should consider selling all of its products in ‘multi product’ packages as it might well be the case that the increased contribution, achieved from increased sales volumes, would outweigh the diminution in contribution arising from reductions in the selling price per unit of each product. Focus on value-added - CTC could also apply target costing principles in order to reduce costs and thereby increase the margins on each of its products. Value analysis should be undertaken in order to evaluate the value-added features of each product. For example, the use of non-combustible materials in manufacture would be a valued added feature of such products whereas the use of pins and metal fastenings which are potentially harmful to children would obviously not comprise value added features. CTC should focus on delivering ‘value’ to the customer and in attempting to do so should seek to identify all non-value activities in order that they may be eliminated and hence margins improved.

136

Answers

5 AB Electronics
Text reference. Strategic management accounting is discussed in Chapter 1 of the Study Text. Attitudes to risk are discussed in Chapter 4. Top tips: For part (a), think about the features of strategic management accounting which distinguish it from ‘traditional’ management accounting: for example, a focus on external factors, and on non-financial information as well as on internally generated financial information. How could these features be useful to AB for managing the performance of the trading company? Part (b): Although there are likely to be financial implications of withdrawing from Asia (eg the liability to the local entrepreneur) you should not have focused solely on this in your answer. There are also likely to be non-financial implications: for example, what will be the impact on AB’s reputation? Moreover, if AB withdraws from Asia, are there any alternative markets it can move into to generate replacement sales and growth? Remember, the shareholders want increased growth and profitability, and the company has declared a strategic aim to expand internationally. In this respect, it is important for AB to consider both the short-term cost implications and the longer-term organisational issues, and the discussion in your answer should reflect this. Part (c): The scenario highlights that the Board take a relatively cautious approach to risk, while the institutional shareholders appear to be less risk averse. How might this affect the way the two parties respond to different opportunities? Strategic management accounting – Unlike ‘traditional’ management accounting which looks primarily at internally generated financial information, strategic management accounting looks at information which relates to external factors, and it looks at non-financial as well as financial information. Competitors’ costs - For example, as well as looking at the trading company’s own operating costs and margins, strategic management accounting would also encourage AB to look at competitors’ costs. This will help focus attention on the need to control the trading company’s costs if it is going to compete successfully with its competitors. For example, why are the trading company’s wage costs proportionally so much higher than its competitors’ costs? Given the nature of IEC’s product (standardised electrical components) cost efficiency is likely to be an important factor in the trading company’s competitiveness. There is likely to be little scope for differentiation as a competitive strategy. Market growth – Strategic management accounting will also encourage AB to look at market size and growth, and the trading company’s share of the market. The scenario highlights that the downturn in economic conditions has slowed the growth demand for electronic components as a whole, which could intensify competition in the market. Instead of market growth being a source of increased sales, the trading company will now have to increase its market share in order to increase its sales. Although the scenario mentions the presence of competitors, it does not give any indication of the number of competitors or their size relative to the trading company. However, these factors could both affect the trading company’s ability to compete successfully in the market. In this respect, strategic management accounting’s external focus is very important: AB needs to understand the market environment in Asia in order to analyse the trading company’s current performance, and then to evaluate future strategies for the company. Analysis of current performance – Strategic management accounting can contribute to the trading company’s success by monitoring its performance and results compared to its competitors, and then assessing whether its current strategy appears to be working successfully or not. For example, the trading company’s revised forecast suggests that its profit for 20X1 is now expected to be 20% lower than had originally been expected. Some of this shortfall may be due to an over-optimistic budget, since the trading company is still a relatively new entrant to the Asian market. However, it could also be an indication that the trading company has not been able to sustain its initial success and break into the 137

Answers

market as successfully as it had hoped. Therefore it will be useful to compare the company’s performance against its competitors, for example to see the extent to which their revenues and profits are growing or falling. If it appears the trading company is performing relatively worse than its competitors, then AB should consider how it could revise its strategy to help improve the company’s performance. Forecasting – Strategic management accounting can also be used to help forecast performance. AB’s forecasts should not look solely at the trading company’s own performance but should also look at competitors’ performance and market trends in general. For example, how realistic is the level of forecast sales growth in the context of a slowdown in the market? Equally, economic intelligence suggests that wage inflation is going to continue increasing over the next two years. However, the reason the trading company’s wage costs are currently much higher than its competitors’ may be that it is paying above the market rates. In which case, it may be able to offer lower annual wage increases than many of its competitors who are currently paying lower wage rates. If not, the trading company will need to review its staffing model and its labour productivity, and try to reduce its wage costs relative to its competitors. (b) Sales potential – Despite the trading company not seeming to be as profitable as had hoped, it is still generating a profit for AB (with it’s 50% share of the company’s profit expected to be around $800,000 in 20Y1). It is not clear how much AB has invested in the company is, or what its target rate of return is on any investments. Although the local entrepreneur has invested $500,000, it is likely that AB has invested more, given the level of profit the company is generating. Therefore, before deciding whether to withdraw, AB needs to consider how profitable it expects the trading company to be in the future, and equally whether it feels it could invest its capital more profitably elsewhere. Impact of environmental factors – The trading company’s performance appears to have been adversely affected by economic factors (economic slowdown) and political factors (protectionism) in the external environment. However, it is not clear the respective impact that these two factors have had on the trading company’s performance, nor the impact that other factors have had on its performance. Long term or short term impact – Although economic conditions have worsened at the moment, they should improve again in the future, at which point AB might expect demand to increase again. Therefore the protectionist policies introduced by some of the Asian countries may be a more significant factor, if they are expected to remain in place for the longer term. Alternative business structures - Although AB is considering withdrawing from the trading company this need not mean it withdraws from Asia completely. Although the trading company does not seem to have been as profitable as it had hoped, AB should consider whether it stops selling its products in Asia altogether or whether it needs to find an alternative channel. For example, if there is still a market for IEC’s products in Asia, it could consider using Asian sales agents to act on its behalf. Strength of competition – However, AB should also consider the strength of competitive rivalry within the Asian markets, because this will affect its profitability, both in the short term and the longer term. Alongside this, AB could also consider factors such as the threat of new entrants, and the bargaining power of customers which could also affect its profitability. Exit barriers – AB and the local entrepreneur both have 50% shares in the trading company. If AB withdraws, the local entrepreneur will have to decide whether he wants to acquire AB’s share and try to maintain the trading company himself, or whether the company should cease trading. If the company ceases trading, AB will be liable to pay the entrepreneur C$500,000. This exit payment could affect AB’s decision of whether to withdraw or not. Wider implications – The trading company seems to have been AB’s first significant venture into Asia. If AB withdraws from the venture within about three years of establishing it, this could be damaging for its reputation. This could be problematic either if AB wants to continue selling its products through sales agents, or if, in future, it wants to re-establish a joint venture company.

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(As we have noted earlier, although market conditions have worsened at the moment, they should improve again in future at which point AB might look to expand into Asia again. But if AB has a poor reputation in Asia, local businesses will be reluctant to become venture partners with it. ) Business portfolio - Moreover, before withdrawing from the Asian company, AB should critically assess the growth prospects of its current European and American markets. If there are limited growth opportunities in these market (for example, because they are more mature than the overseas markets), the Board might be advised to persevere with looking at expansion into new overseas markets. Fit with strategic aims – AB has stated in its annual report that it wants to develop its international presence by expanding into overseas markets. Establishing the trading company in Asia is a way of helping to achieve this aim. By contrast, withdrawing from the Asian market would seem contradictory to this aim, and to the shareholders’ wishes for increased growth and profitability. (c) AB’s board has traditionally taken a ‘relatively cautious approach’ to providing strategic direction for the company which suggests that they are likely to be relatively averse to taking risks and cautious when dealing with uncertainty. By contrast, if the institutional shareholders are looking for the company to achieve increased growth and profitability, they may be prepared for it to take higher risks in order to achieve this. This difference in the amount of risk which the different groups are prepared to accept could influence the way they look at possible new opportunities. Risk averse - For example, if the Board are essentially risk averse they could make decisions based on the worst outcome that could occur , and will try to minimise the effect that this could have on AB. This suggests that they might adopt a ‘maximin’ approach to decisions they take in the context of strategic planning. Risk seekers - By contrast, the institutional shareholders might prefer the directors to evaluate strategic options in terms of the best outcome which could occur, and seek the one which maximises the benefit for AB, regardless of how small the chance that this outcome will actually occur. This would entail the the directors adopting a ‘maximax’ approach to decisions in strategic planning instead of a ‘maximin’ approach. In this respect, the Board and the shareholders could come to different conclusions about what course of action to take in relation to strategic options (for example, around how AB should grow or expand). Risk and return – When looking at potential new opportunities, AB should also set a target return which compensates for risk. Again, the difference in attitude to risk between the Board and the shareholders could mean that the Board will want higher level of return to compensate for the perceived risk involved than the shareholders would want. This might, therefore, lead to the directors rejecting possible opportunities which the shareholders would have been keen for them to accept.

6 Megasnack
Text reference. The scope for potential conflict between strategic business plans and localised decisions is covered in Chapter 1 of the BPP Study Text. Top tips. Part (a): A key issue here is whether the KPIs are aligned with Megasnack’s targets and strategy (both financial and corporate) and can therefore help the company achieve its strategy, or whether the KPIs could also be encouraging any of the ‘incidents’ outlined in the scenario. In answering part (b), explain the problem fully and clearly, making reference to the details given in the scenario. Do not assume that some of the points are so obvious that there is no need to describe them. There is a risk of failing to state the obvious and so losing marks that could be fairly easily earned.

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Nevertheless, make sure that you ‘use’ the details given in the scenario (for example, by explaining how they illustrate the reasons for conflict) rather than simply copying out the problems and incidents described in the scenario. Part (c) calls for judgement about the measures that might be taken to reduce the scope for conflict and the risk that incidents will occur. Consequently, your view may differ from the solution that is suggested here, and your points could be equally valid. However, you should avoid the temptation to give an answer that is over-simplistic – such as suggesting that ‘management should do their jobs better’ or that head office should ‘tell’ the outlet managers what to do. Part (a) Revenue per store – An important element of Megasnack’s financial strategy is achieving sales growth. In this respect, measuring revenue is important, so revenue per outlet seems a sensible performance indicator to use; although it may be more useful to measure ‘revenue growth’ over time rather than a simple ‘revenue per outlet’ figure. However, managers’ actions leading to incident 1 (offering special discounts and deals) could possibly be an unintended consequence of a KPI based on revenue per outlet. For example, if revenue figures are running below budget for certain outlets, the managers of those outlets may decide to offer special discounts and deals in order to try to boost revenues. In this respect, if Megasnack does not already do so, it may also need to measure gross profit margin (%) per outlet as well as a simple revenue figure – because offering special discounts and deals is likely to reduce the gross profit margin an outlet will earn. Perhaps more importantly, though, managers’ behaviour in offering special discounts and deals is not consistent with Megasnack’s overall strategy based on conformity. Again, therefore it will be important for Megasnack to have additional controls which ensure conformity, in addition to the revenue KPI. Staff costs – Staff costs are likely to be a significant cost at Megasnack so it is important to monitor them. Equally, the numbers and quality of staff employed in Megasnack’s outlets could play an important part in determining if Megasnack meets customer needs and expectations better than its rivals. For example, Megasnack needs to ensure if has enough staff on duty at any time to ensure that customers do not have to wait a long time for their meals. Equally, however, it will be inefficient for Megasnack to be over-staffed, particularly during less busy times of the day. Crucially, the measure Megasnack uses is a relative one. It does not simply measure ‘staff costs per outlet’ but measures staff costs as a proportion of revenue. Therefore, outlets could improve their performance against the indicator by increasing revenue as well as by reducing staff costs. In this way, the measure appears designed to strike a balance between revenue and staffing levels. However, incident 2 could still be seen as an unintended consequence of the KPI. If managers are looking to reduce wage costs in their outlet they could cut training or take on untrained staff as a means of doing so. Such actions are likely to reduce customer service levels and so are not congruent with Megasnack’s strategy. Again, however, if revenue falls as a result of falling customer service levels, this will be picked up by the KPI, by virtue of it being a relative measure (staff costs as a percentage of revenue.) Part (b) Conflict of interest - A conflict between the strategic aims of an organisation and local decision-making can be explained largely by a conflict of interests. The strategic aims of a company are often decided by senior management but responsibility for operations is delegated to local management. (i) Strategic objectives are usually long-term in nature, but at the same time local managers are given short-term performance targets, and may be rewarded with incentive bonuses for achieving or exceeding those targets. Even if there is no bonus payments system, local managers may be put under pressure by head office to achieve their budget targets. The short-term targets may not be fully consistent with strategic aims, but will nevertheless be given priority by local managers wanting to earn a bonus.

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(ii)

Head office strategy is concerned with the objectives of the organisation as a whole. Local managers may have a much more narrow view, and shown concern for the performance of their local operation. For example, if a rival fast food outlet is taking business by offering discounts or other incentives to customers, it is natural to expect local managers in Megasnack’s outlets to want to respond with counter-initiatives of their own – regardless of head office policy. Local managers may also want to exercise their own authority to make decisions, even if this sometimes means ignoring head office guidance or instructions. The difference between head office strategy and local decision-making is evident in some of the incidents at Megasnack. Local managers have taken their own initiative to improve the performance of their outlet, for example by offering price discounts as a means of increasing sales. At a local level price discounts or similar measures may ‘work’, but they are not consistent with the broader policy of standardisation of products and service, and consistency in meeting customer expectations. If different outlets offer different discounts customers will no longer know what price they should expect to pay for their meals when they visit different outlets. Short term focus - In many organisations, management have traditionally been expected to focus on financial performance, and this had led to them focussing on measures to cut costs, improve productivity or increase sales and profit margins. A typical response by local management to shortterm cost pressures is to cut discretionary costs, such as the cost of training staff, without considering the consequences for performance standards of inadequate training. Local focus - The focus of local managers on the concerns of their own area of operations can sometimes result in a misguided belief that what seems best for the local operation must also be best for the organisation as a whole. This may be the reason why some food pre-preparation centres were reluctant to the demand for more output. The centre managers may have considered product quality to be the overriding concern for the company, when the concern should have been on finding ways of meeting the higher demand without compromising on quality – which is a different perception of the problem. The suggestions provided so far about the reasons for a conflict between corporate and local decision-making have assumed that the problem lies mainly with the local managers. In some respects, however, the problem may originate at the corporate centre (head office).

(iii)

(iv)

Head office may set long-term strategic performance targets and short-term ‘budget’ targets that are not consistent with each other. For example, if the long term strategic plans are aimed at business growth, it would be inconsistent not to also expect some costs to increase in order to facilitate revenue growth. If targets are inconsistent, the incentive for local managers to take short-term decisions (in this example, by cutting costs) may actually be encouraged by head office. Head office may not communicate all of its policies sufficiently well. The manager at the outlet which disposed of food in a way which contravened Megasnack’s health and environmental policies may not have deliberately breached company policy. It is possible that he or she didn’t understand the policy properly (although this doesn’t excuse the local manager for disposing of food in a which was contrary to health and safety laws.) To some extent there may also be lack of clarity in the company’s policy on delegation of decisionmaking. It is surprising that the outlets in one country should have sold additional products, given the importance Megasnack places on the standardisation of its menu. This should raise a question about why the outlet managers considered that they had the authority to take this initiative, and whether head office had not made it clear to them that the menu should remain fixed.

(v)

(vi)

Part (c) Problem recognition - The first essential step has been taken to deal with the problem, namely that senior managers have now recognised that a problem exists. They should try to establish the reasons for conflicts between strategy and local short-term decision-making in order to identify suitable measures to take. Strategy review - Senior management should review the company’s strategies, and re-assess whether these are appropriate for and consistent with its long-term objectives. The current strategy is to provide a consistent standard product and service that meets customer expectations no matter which outlet they visit.

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This strategy has been used by other fast food chains, and may well be appropriate. However, Megasnack’s management may wish to consider the implications of current strategy for flexibility and innovation. Some local decision-making by outlet managers may have been prompted by the lack of flexibility in the company’s strategy. Range of performance targets - It is appropriate for head office management to establish shorter-term targets for local managers, but these should be consistent with the strategic objectives of the company. Instead of rewarding local managers for achieving financial targets, a balanced scorecard approach may be introduced, in which non-financial and strategy-related performance is also rewarded. Key performance indicators for strategic objectives should be established and reported regularly to local management. For example, if outlet managers are rewarded for providing training to staff, this will given them an incentive to provide the training rather than to cut training costs in order to meet financial performance targets. Improved communication - Head office should also communicate its strategies, and what they are intended to achieve, throughout the management structure of the company. At Megasnack, this would mean communicating not only the company’s strategies for consistency of products and service, but also (possibly in a corporate code of ethics) company policy on employee relations, health and safety, and environmental protection. The benefits of standardisation and consistency should also be stressed, in terms of meeting customer expectations, brand or corporate image, and the effectiveness of global advertising. Business monitoring - Finally, head office should establish procedures for monitoring compliance with strategic business plans. This may require the establishment of an internal audit team or team of inspectors to carry out checks on local outlets, (for example, health and safety checks, or price checks). These teams should report apparent inconsistencies between local operations and corporate policy, and Megasnack also needs to establish policies and procedures for following up on these reports. Although it may be impossible to eliminate a conflict of interest between long-term strategy and short-term opportunism entirely, a recognition of the problem and a willingness to look for solutions, by both head office and local managers, would go some way to keeping the problem under control.

7 Ganymede
Text reference. Benchmarking is discussed in Chapter 1 of the BPP Study Text. Public Sector League Tables are discussed in Chapter 16. Top tips. Part (a). A useful approach to this requirement would be to think through, in order, the stages involved in a benchmarking process. This should help you identify which stages Ganymede has already undertaken and which it still needs to undertake. To answer this question well you need to know the stages involved in a benchmarking process, but don’t simply list the stages in general terms. Make sure you consider specifically which stages Ganymede has undertaken, and which are still required. Part (b). Note that the focus of your evaluation here should be Ganymede’s position, not on benchmarking’s usefulness for assessing Ganymede’s position. However, the fact that the question requirement says ‘as far as possible’ should serve as an indicator that some details which would help you evaluate Ganymede’s position may be missing from the information provided. In this case, you should highlight the additional information which would help you evaluate Ganymede’s position more fully. Part (c). You are asked to evaluate the usefulness of the league tables from the students perspective. So, you should consider how they might be useful to students in making a decision about where to study; but, perhaps more importantly, you should also consider the drawbacks or limitations in the league tables, or why they may not be helpful to students in making their decisions about where to study. Examiner’s comments. Part (b) ought to have been a relatively straightforward analysis of the data given in the scenario. However, candidates displayed a disappointing lack of judgement over what constitutes useful advice in this scenario and failed to use the drivers highlighted in the scenario to calculate suitable relative measures.

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Marking scheme
Marks

(a)

For each relevant point on the progress of the benchmarking exercise – 1 mark Note: Only 2 marks in total are available for identifying the stages of the benchmarking process in general terms Total for part (a) – Up to 7 marks Calculation of performance indicators using appropriate drivers – 1 mark each Commenting on the results – 1 mark per relevant point Total for part (b) – Up to 10 marks

7

(b)

Up to 6 Up to 6 10 Up to 3 Up to 7 8

(c)

Potential benefits of proposed league tables – 1 mark each Limitations of proposed league tables – 1 mark each Total for part (b) – Up to 8 marks

Total = 25

(a)

Benchmarking exercises can be described using seven stages, and we will use these stages to assess the progress of GU’s current benchmarking exercise. Actions that have been undertaken (i) Set objectives and determine the area to benchmark The underlying objective of the exercise is to improve efficiency, and the area being benchmarked has been identified as the administrative costs incurred in relation to teaching and research. (ii) Identify key performance drivers and indicators It is important that the benchmarking exercise focuses on performance areas which are crucial to Ganymede’s success. Three key drivers of costs have revenues have been identified (research contract values supported; student numbers; and staff numbers). Key performance indicators can be derived from these; for example, costs per student. However, although the drivers have already been set, the driver ‘staff numbers’ could be improved by distinguishing between teaching staff and administrative staff. (iii) Select organisations to study and benchmark against The chancellor has asked the administrator to benchmark Ganymede’s performance against the other two large universities in Teeland (AU and BU), and the government has endorsed this proposal. However, the exercise as it stands will not compare GU’s performance against any of the five smaller universities in Teeland, nor against any foreign universities. This could be a weakness in the proposed exercise, because the universities which are excluded could provide examples of best practice which GU could lead from if they had been included.

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(iv)

Measure performance for own organisation and the other organisations involved in the exercise Information about GU, AU and BU’s administrative costs for the most recent academic year has been collected. The step has been made easier by the government insisting that all three universities co-operate and supply information to each other. Actions still required

(v)

Compare performance This is the stage that the exercise has currently reached. The results of the performance comparison are given in part (b).

(vi)

Design and implement improvement programme The results of the performance comparison should help identify which areas GU needs to improve. For those aspects of performance where GU is lagging behind one (or both) of the other universities it should send a member of staff to the university which is performing best to identify what that university is doing differently to GU which is leading to the difference in performance levels. In turn, that staff member should devise a programme to introduce improvements at GU and implementing the best practices which have been identified at the other universities.

(vii)

Monitor improvement Whilst implementing the improvement programme should help GU improve its performance, there is no guarantee how successful it will be and how much improvement it will actually deliver. Therefore, management should monitor GU’s performance once the programme has been implemented to see if it achieves its goals or if further improvements will still be necessary. At the end of the programme, GU’s management should also consider a post-project review, to consider any lessons which have been learned from the project and which could be useful for any subsequent projects.

(b)

Results from the benchmarking exercise: GU ($) Research (Cost per $000 of contract value supported) Contract management Laboratory Teaching facilities management (Cost per student) Student support services (Cost per student) 78 226 87 257 97 281 AU (S) BU ($)

951

1,197

920

71

89

73

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GU ($) Other support services (Cost per staff member) Teachers' support services Accounting Human resources IT management General services 506 204 156 817 2,153

AU (S)

BU ($)

532 204 156 803 2,088

544 197 191 737 2,286

Research categories GU has the lowest costs relative to the value of the research contracts supported, and it has also earned the highest value contracts. This may suggest that the government monitors factors such as cost control when deciding where to allocate its costs, in which case it is important that GU continues to maintain its good practice in this area, particularly if the other universities will be looking to improve their performance to bring its closer to GU’s performance. Teaching facilities management & Student support services AU spends significantly more per student on its teaching facilities and student support than the other two universities. AU also has significantly fewer students than the other two universities. We might expect that AU’s higher spending on teaching facilities and student support would make it more attractive to students than the other two universities, leading to higher student numbers. At face value, the benchmarked figures would suggest that student enrolment is not significantly influenced by these factors though. However, the lower student numbers at AU may also reflect that it can accommodate fewer students than the other two universities; or even that it only wants to accommodate a smaller number of students and therefore sets harder entry requirements than the other two. Therefore, it might also be useful to compare the number of applications each university receives relative to the number of places it has available. Equally, it might also be useful to compare factors such as student drop out rates, pass rates, and students’ success rates in gaining employment after they graduate, to assess whether there is a correlation between these and the more expensive teaching environment at AU. However, these quality measures are not currently reflected in the benchmarking exercise. Other support services Human Resources – BU’s human resource costs per staff member are 22% higher than the other two universities, despite BU having the highest number of staff to spread its HR costs. In this respect, it appears that BU may have more HR staff, or more-highly-paid HR staff than it needs, whereas GU’s model appears more efficient. Teachers’ support services – BU also appears to provide more support services for its staff than the other two universities. The difference between BU and AU is not significant, but GU’s costs are around 7% lower per staff member than BU’s. However, it is not clear exactly what costs are included in this category so it is difficult to determine whether the figures suggest that GU is more efficient in the provision of these services, or whether it offers less support services to its teachers than BU. IT management – By contrast to their respective positions for HR and Teachers’ support services, GU spends considerably more (around 11%) on IT management than BU. However, this may be due to the subjects being taught. For example, if GU is more oriented to science and technology-based subjects this is likely to mean it will need greater computing resources than if it was more oriented to arts and humanities. However, if the difference in IT management costs cannot be explained by variations in the subjects taught, then GU (and to a slightly lesser extent, AU) need to consider how BU appears to have been able to control 145

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its IT costs more effectively than them. For example, has BU outsourced any of its IT services rather than managing them all in house? Accounting services – All three universities cost control appears broadly the same here. BU has achieved a small advantage (3.5%) over the other two, but there is nothing significant here. General services – Again, there appears to be relatively little variation between the three universities here, although AU appears to have slightly lower costs than GU, which, in turn, is has slightly lower costs than BU. General point Although we have identified some variations between GU’s performance and that of the other two universities, it is important to exercise a degree of caution when looking at these comparisons. We have no information about the mix of the subjects being taught or researched at the different universities, but this mix could have an impact on their performance statistics. Equally, we do not have any information about the relative locations of the three universities. For example, if one of the universities is a region which is economically more prosperous than the other two, then that university’s staff costs are automatically likely to be higher than the other two’s, as a result of the geographical variation in salary weightings rather than any internal factors. (c) The league tables will provide students with some additional information which could help them compare different universities before deciding which ones to apply to. Academic and non-academic criteria – The measures chosen seem to recognise the importance of nonacademic factors as well as academic ones. For example, if students are strongly dissatisfied with the university facilities this may lead to them not completing their courses, as would the fact that the course content is not what they had hoped it would be. Equally, the prospects of finding work after graduating is likely to be something which is important to students, so the inclusion of this measure in the league tables could be valuable to them. However, some of the other measures included in the table may be less important to students when choosing where to study: Research or tuition – The value of research funding secured by each university may give some indication of the quality of the academic staff it employs, and how highly the university is regarded in the academic and research community. However, a potential student may be more interested in the quality of tuition they will receive than the amount of research the university carries out. If a university prioritises research above teaching, this would improve its ranking in this element of the league table, but may actually be disadvantageous to the student; if the tutors are more concerned with their research than their students. Choice of measures – In addition, there are a number of other possible measures which the tables do not include, yet which would be valuable for students. For example, information about spending on academic services, and the ratio of students to academic staff might be more useful to students than information about research funding. Equally, information about entry requirements is also likely to be useful to prospective students. Aggregate measures – However, perhaps the biggest weakness in the league tables is that they look at aggregate figures, rather than figures for particular departments for example. However, the quality of the particular course they want to study is likely to be a very important factor for a student when choosing where to study. A university which performs relatively poorly overall in the league tables may be a centre of excellence in a particular subject; while conversely a university which performs well overall might have poor departments for certain subjects. By only considering overall figures, there is a danger that the league tables will obscure variation within them.

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Importantly, also, the league tables do not give any indication of the numbers of students taking different courses, but this could also affect the results. For example, if there is a shortage of engineering graduates in Teeland, and a University has a large engineering department, this might lead to the proportion of its graduates in employment being higher than a University with only a small engineering department. Trends – It is not clear from the scenario how frequently the ministry envisages the league tables should be produced. However, when looking at any figures in the tables, students should consider whether the figures for a single period are representative, or whether the need to look at an average or a trend over a longer period of time. For example, the numbers of students gaining first class or 2:1 degrees could vary from one year to the next, so looking at one year in isolation may not give an accurate picture of the university’s overall performance in this respect. Unintended consequences – Another potential disadvantage of introducing league tables focusing on only a small number of measures is that they will encourage the universities to focus on their performance in those areas potentially at the detriment of other areas. For example, if there is a focus on ensuring that the proportion of students achieving first class and 2:1 degrees is as high as possible, there could be a danger that a university makes its entry requirements more demanding, with the result that less students overall come to the university. The league tables do not show entry requirements, which could be a useful measure for students to consider when choosing which universities to apply to. Equally, there could be a danger that universities could inflate results (for example, by uplifting marks so that students obtain 2:1 degrees instead of 2:2 degress) to improve the university’s place in the league tables.

8 Budgeting
Text references. Read Chapter 2 to help you answer this question. Top tips. Part (a) draws on previous studies of budgeting but wants you to write a critical discussion of budgeting and its place in the performance cycle. Critical means analysing and evaluating rather then making just negative judgements. The marking scheme awards two marks for each of the four uses stated so state one advantage and one disadvantage for each. Part (b) wants you to compare activity based budgeting (ABB) with incremental budgeting so here you should be writing about the advantages of ABB. The marking scheme gives two marks for each comment. We have listed more than three points for completeness but you need only put down three in your answer. Then part (c ) tests your understanding of 'Beyond Budgeting' and there are 1 ½ marks for each valid comment made. Once again we list more than the four reasons required. Read the article by Shane Johnson about ‘Beyond Budgeting’, which is on the ACCA website; this sets out the arguments as the examiner gives them in his official answer. Easy marks. If you are clear on the key features of 'Beyond Budgeting' then there should be some easy marks available here. (a) Budgeting and the performance cycle A budgetary planning and control system is essentially a system for ensuring communication, coordination and control within an organisation. Communication, coordination and control are general objectives: more information is provided by an inspection of the specific objectives of a budgetary planning and control system.

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147

(i)

(ii)

(iii)

(iv)

Planning This is probably the most important feature of a budgetary planning and control system. Planning forces management to look ahead, to set out detailed plans for achieving the targets for each department, operation and (ideally) each manager and to anticipate problems. It thus prevents management from relying on ad hoc or uncoordinated planning which may be detrimental to the performance of the organisation. However some factors may be difficult to quantify in terms of a budget for customer satisfaction, for example. Co-ordination The activities of different departments or sub-units of the organisation need to be coordinated to ensure maximum integration of effort towards common goals. This concept of coordination implies, for example, that the purchasing department should base its budget on production requirements and that the production budget should in turn be based on sales expectations. Although straightforward in concept, coordination is remarkably difficult to achieve, and there is often 'sub-optimality' and conflict between departmental plans in the budget so that the efforts of each department are not fully integrated into a combined plan to achieve the company's best targets. Control A budget is a yardstick against which actual performance is measured and assessed. Control over actual performance is provided by the comparisons of actual results against the budget plan. Motivation The interest and commitment of employees can be retained via a system of feedback of actual results, which lets them know how well or badly they are performing. The identification of controllable reasons for departures from budget with managers responsible provides an incentive for improving future performance. Nonetheless, budgets can be imposed and perceived as a pressure device for managers who have not agreed to them.

(b)

Advantages of using activity based budgeting (ABB) compared to incremental budgeting (i) ABB ensures that the organisation's overall strategy and any changes to that strategy will be taken into account. Incremental budgeting does not refer to strategy as it just updates existing data and focuses on resources. So ABB attempts to manage a business as the sum of its interrelated parts. ABB identifies critical success factors, which are activities that a business must perform well if it is to succeed. Once again incremental budgeting does not analyse the activities or drivers of performance as it focuses on inputs and resources. Incremental budgeting does not look for improvements in performance or encourage new activities. ABB concentrates on the whole activity so that there is more likelihood of getting it right first time. For example, the production department ensuring that goods are produced on time and that the despatch manager has sufficient resources to deliver them.

(ii)

(iii)

Additional answer (iv) ABB can increase the commitment of management to the budget process as management have to analyse and focus on each activity. However ABB can also be time consuming and complicated to prepare. Therefore it is less suited to a steady-state organisation with few complexities. (c) Beyond Budgeting Some reasons why advocates of 'Beyond Budgeting' may see budget preparation as a waste of resources are listed below. Broadly, as modern organisations have to adapt to dynamic and turbulent business conditions, the traditional budget has become too rigid and prescriptive hampering management ability to respond to change. (i) (ii) Adhering to the budget is not seen as compatible with a drive towards continuous improvement. There is an essential conflict between the use of budgeting for communicating corporate goals such as setting objectives, continuous improvement etc and the original purpose of budgeting as a financial control mechanism.

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(iii) (iv)

Where management relies too much on the 'agreed' budget, this can affect management behaviour, which can become dysfunctional and so affect the objectives of the organisation as a whole. Budgets are often based on protracted internal negotiations rather than on a rational, causal model of resource consumption.

Additional answer (v) (vi) Budgets prepared using traditional methods add little value and take up too much valuable management time. This time would be better spent elsewhere. Traditional budgeting processes can be insufficiently focused on external factors.

9 Business process re-engineering
Text reference. Business process re-engineering is covered in Chapter 3 of the Study Text. Top tips. Part (a): Hammer identified seven key principles of BPR, and these provide the answer to part (a). There is no requirement to link part (a) to the scenario; this is a test of knowledge only. However, parts (b) and (c) should be linked to the scenario, with part (b) looking at the potential advantages of implementing BPR, while part (c) is looking at one of the perceived criticisms on BPR programmes. The scenario has identified a number of issues with the way that FCI currently operates: for example, increasing errors, falling customer satisfaction, and inefficiencies resulting from the reliance on paper-based transactions. Therefore, it is likely that the directors will hope that the BPR exercise will improve FCI’s performance in relation to a number of fundamental areas: cost, quality, service and speed. Notice that the requirement for part (b) (ii) is to recommend performance targets. The scenario highlights, for example, that the number of complaints from customers is increasing, which should indicate the importance of monitoring the level of customer complaints. However, the question isn’t simply asking you what FCI should measure, but rather to recommend suitable targets for those areas of performance it is measuring. Part (c): The BPR exercise is also likely to reduce the number of paper-based transactions the staff have to deal with. How if this likely to affect staff morale and motivation? Will staff be pleased by the ways technology could help them in their work and reduce the amount of paperwork they have to do, or will they be concerned that the BPR programme will ultimately lead to job cuts? (a) Business process re-engineering Business process re-engineering (BPR) is the fundamental redesign of business processes to achieve dramatic improvements in key measures of performance such as cost, quality, service and speed. There are seven principles of BPR: (i) Focus on customer-focused outcomes – Processes should be designed to achieve a desired customer-focused outcome (for example, quality, service or speed) rather than being organised around existing tasks. People who use the output from a process should perform that process – If the staff who use the output of a process are involved in the operation of that process, the risk of errors should be reduced and so should time delays in the process. Information processing should be included in the work which produces the information. In other words, there shouldn’t be a distinction between information processing and information gathering. The development of online databases can be crucial here, allowing users to have access to real time information, thus minimising delays in response to queries. Geographically-dispersed resources should be treated as if they are centralised – For example, there should be a centralised database of suppliers which all departments use, so that they benefit from the economies of scale achieved by the central negotiation of supply contracts.

(ii)

(iii)

(iv)

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149

(v)

Parallel activities should be linked rather than integrated – As far as possible, activities should be processed in parallel rather than sequentially. If tasks are performed sequentially, bottlenecks and delays might arise while waiting for the output of a previous process. People should be self-managing and exercise greater autonomy over their work – The traditional distinction between workers and managers should be abolished. BPR aims to allow decisions to be made as quickly as possible and as near to the end customer as possible. This allows increased responsiveness, and also empowers the individuals who make the decisions. Information should be captured once, and at source – If information is transferred from one data source to another there is a risk of human error. If information is only input into a system once, and is input as early as possible, the risk of error is reduced, and consistent replies can be obtained in response for any queries about the information. Expected improvements More rapid information processing and error reduction – It appears that the processes at FCI haven’t been updated to take advantage of the IT / IS systems that are widely available today. In particular, relying on a predominantly paper-based system makes FCI’s processes much slower than they need to be, and it also increases the opportunity for error as information is manually recorded and then transferred between systems. A new database-led system would prevent the need for rekeying and transferring information, and so should reduce the scope for errors in the system. This system will also mean that FCI has reliable, up-to-date information about its customers. Any details the sales staff or telephone operators obtain about a customer can be entered into the central database on a real time basis, and the system can then be continually updated for other staff to use. Moreover, no paper-based transfers of information from one part of the organisation to another will be necessary. Again, this reduces delays and reduces the risk of errors occurring. Improved database system - If FCI develops an electronic database which stores all customer data, this should enable staff to respond to telephone enquiries more quickly. For example, if a phone operator receives a call, they can access the database and gather the relevant information to help them deal with the customer enquiry straight away. This faster response time should lead to improved customer satisfaction. Better support for sales staff - Having an electronic (or online) database and improved technology should also help the sales staff when they visit potential customers. If the sales staff can access the database remotely (from laptops) they can get details of policies and premiums while they are with the customer, and so could potentially make a decision about a policy application straight away without having to return to the office to check details or process paperwork. Customers have complained about the slowness of FCI’s current process, so speeding up the process should directly address these complaints. Increased staff motivation – Not only have customers complained about the current sales process, but FCI’s sales staff have also complained about them. Staff motivation and job satisfaction are likely to suffer if the staff feel they are having to work with out-dated processes and technology. Therefore, providing the sales staff with more up-to-date technology will not only allow them to do their job more effectively but it should also improve their motivation to do so. Moreover, customers are likely to have a more favourable impression of the sales staff if they provide a quick and efficient service. If this, in turn, leads to the sales staff making more sales it is likely to increase their motivation still further. Organisation structure - BPR’s principle of working back from a desired ‘customer-focused outcome’ will help FCI to find the most efficient and effective way of delivering that outcome. This is likely to lead to a change in FCI’s organisation structure or the tasks that individual people do, to reduce the level of internal communication required in response to telephone enquiries.

(vi)

(vii)

(b)

(i)

150

Answers

The degree of communication required internally to respond to telephone enquiries suggest that FCI’s organisation structure is quite inflexible, and everyone has quite narrowly defined areas of responsibility. The increased focus on the customer may lead to a greater flexibility, as FCI’s business will be organised around outcomes rather than tasks. Greater process flexibility and speed – The paper-based nature of FCI’s current system means that tasks have to be done sequentially. However, one of the principles of BPR is that linked activities should be conducted in parallel rather than sequentially. In this case, if FCI improves its IT/IS systems, and stores customer details electronically, staff may be able to deal with different aspects of a customer transaction in parallel, thereby speeding up the transaction process. (ii) Key business objectives – It seems that reducing the time taken to process transactions and improving the quality of the paperwork issued are key business issues within FCI and so it is likely that it will have business objectives relating to these areas. Consequently, FCI should also have performance measures looking at these areas, in order to assess how well the re-engineered processes have helped to improve performance in relation to them. Performance targets % of transaction completed within a given time – The slow speed of the current process is a major source of complaints, therefore FCI should want to speed up the process. It may not be practical to measure (or monitor) how long FCI takes to complete each individual transaction, and some, more complex, policies may take longer to process than others. Therefore, a more useful target could be to ensure that a certain proportion of transactions that a completed within a given time. Number of complaints about errors in paperwork reduced by x% - One of the key aims behind the BPR exercise is to help FCI reduce the number of errors in the paperwork which customers receives. Setting a target to reduce the number of complaints about errors should focus people’s attention on addressing this issue. (c) Perception of BPR programmes – Although the main aim of BPR programmes is to increase business efficiency, there is often a perception that they end up simply being cost-cutting exercises. It is likely that this is a major reason behind the staff’s concerns about the programme, with them being concerned that it could lead to redundancies, or could threaten their jobs and prospects within a company. Change and uncertainty – Even if the programme doesn’t lead to redundancy, the fact that it will result in the fundamental redesign of business processes is still likely to lead to significant changes which affect staff. For example, if may lead to new patterns of work, changes in people’s roles or changes in the composition of work groups. In this respect, people’s uncertainty about how the programme could affect them is likely to make them concerned about it and may lead them to resist it. Resistance may be exacerbated because the out-of-date processes are likely to have been in place for some time and have therefore become ingrained in the staff.

10 GMB Co
Text reference. Chapter 3 covers ABM which is the management application of ABC. This question covers material from Paper F5 on ABC but asks for a higher level discussion than that syllabus. Top tips. The requirements of part (a) are clear. Just remember to multiply the list in the question by the number of units for unit based costs. Part (b) is a bit more difficult as there are multiple requirements and four verbs or actions needed. We have identified and discussed seven cost drivers used in part(a). Then we suggested likely causes and benefits for three of these and commented on possible benefits. The cost drivers are actually given in the question but you will need to flesh out the brief descriptions from the table. We have answered both parts together as they flow on but you can keep them separate. In part(c), there is no specific requirement to link your answer to the scenario or any particular problems related to implementing an ABC system at GMB.

Answers

151

Examiner's comments. Many candidates provided a correct solution to part (a) and achieved maximum marks. However, some candidates ignored the information on batches which made their answers wrong. Parts (b) and (c) were generally answered well.

Marking scheme
Marks

(a)

Unit level costs Batch related costs Product sustaining costs Business sustaining costs Identification and appropriateness of cost driver levels 1 to 4 expenses Causes of the cost drivers 1–3 Possible benefits Practical problems identified and discussed - 1 mark per relevant point up to a maximum of 7

1.5 2 1.5 1 6 3 3 7

66

(b)

Maximum 12 7 Total = 25

(c)

(a)

Statement of total cost for Order 377 Level Unit-based Direct material (W1) Direct labour (W1) Power (W1) Batch-related Administration (W2) Production scheduling (W2) Selling (W2) Machine set-up (W2) Design (W2) Distribution (W2) Product sustaining Marketing (W3) Production line maintenance (W3) Engineering design and support (W3) Total costs before business/facility costs Business/facility (W4) Total cost of order Workings 1 2 3 4 For unit level costs, take the unit cost driver rate and multiply by the number of units in the batch. For instance, direct materials will be $180  5,000 units = $900,000. For batch-related costs, take the cost driver rate and multiply by the number of batches. Taking administration as an example, this will be $24,000  5 = 120,000. For product-sustaining costs, the cost allocated to order number 377 is shown in the question. Business/facility level costs are based on a 30% share of the total of the other cost levels and so is 30%  $5,000,000 = $1,500,000. $'000 900 750 600 2,250 120 300 300 170 150 60 1,100 200 1,100 350 1,650 5,000 _____ 6,500 $'000

1,500

152

Answers

(b)

Cost drivers – Cost drivers influence the level of costs. They denote the factor that links activity resource consumption to product outputs. The cost drivers identified in the question and discussed here should tell management what activities drive the costs incurred. In turn this should enable managers to work out the cost of the resources consumed by an order more accurately. In addition, management can also take appropriate action to monitor and control the costs by investigating the activities (ie the cost drivers) that underlie them. Management’s investigations may highlight that GMB instances where it can reduce the cost per unit of cost driver. (i) Cost drivers at the unit level Labour costs - The cost drivers for labour costs are the rate per hour and the hours taken in manufacture. Pay is determined by the pay rates of the employees directly involved in the manufacture of order number 377. The time taken depends on the specification for manufacture and proficiency of the employees doing the task. A likely cause or influence on this cost driver is the ability of the employees involved in the manufacturing process so experienced employees will take less time than others and make fewer mistakes. They are also likely to be paid more and so labour rates will go up. A benefit in identifying this cost driver is that a suitable level of skilled employee can be assigned to manufacture thereby saving unnecessary costs. Direct material costs – Direct material costs are driven by the quantity, range, quality and price of materials required per product unit, according to the specification of the order. This highlights that the costs will vary directly according to the specification of the order. Fore example, the costs could be reduced by using material of a lower quality, but there is a danger that the quality of product Zeta may suffer as a result. However, this costs driver also highlights how GMB’s costs are also likely to be affected by external factors. For example, if the price of raw material inputs increase, the direct material costs of producing a unit of output will increase as a result. Equally, however, an investigation into material prices may highlight that they are higher than necessary due to inefficient sourcing of materials. This inefficiency may be overcome by reviewing the sourcing policy, or introducing new training and guidelines for staff who are responsible for procurement of materials. (ii) Cost drivers at the batch level The cost driver for design work is the design hours per batch. The number of design hours per batch is likely to reflect the complexity of product Zeta and whether it is a new or a radically different product. A benefit in identifying this cost driver is that decisions can be made about how much time should be spent on design and whether the design should be streamlined accordingly to make the manufacture of the product more efficient. Machine set –ups – The number of machine set-ups per batch is the cost driver for machine set ups. There would appear to be a clear correlation here between the number of machine set-ups required and the cost of producing a batch of output. In this case, the number of machine set-ups per batch may indicate a lack of planning in relation to batch sizes. GMB needs to produce 5,000 units, and currently produces 5 batches of 1,000 each. However, it may be possible to increase the batch sizes to 1,250 each in which case only four batches would be required to fulfil the order. This should reduce the costs of fulfilling the order.

Answers

153

(iii)

Cost drivers at the product sustaining level The cost driver for engineering design and support is engineering design and support hours per order. The cost of design and support will be determined by the time spent by the relevant support department on order 377. The cost driver for production line maintenance is production line maintenance hours per order. Again the cost allocated to order 377 for this support work is based on the time spent by the relevant function. A likely cause of this cost driver is the level of maintenance carried out to a suitable standard. Do skilled engineers undertake this satisfactorily or are faults made requiring repeat visits. A benefit from identifying this cost driver would be identifying training needs for engineers thereby saving unnecessary costs on down time and reducing repeat remedial visits whilst ensuring the production line runs to capacity. The amount of time which the engineers need to spend supporting the system could also be determined by the level of skill they have. In addition to considering whether it needs to provide additional training to its engineering staff (which should enable them to carry out maintenance more quickly and therefore more cheaply), GMB could even consider whether the production line maintenance could be done more efficiently by out-sourcing it to a specialist provider, or whether it should be retained in house.

(iv)

Cost driver at the business sustaining level The cost driver for business sustaining costs based on the perceived share of the cost/activity of the overall production process that order 377 consumes. This is necessarily arbitrary as the costs are difficult to trace to units, batch or order so a rate of 30% of total costs before business sustaining costs has been chosen. However, wherever possible efforts should be made to identify aspects of this residual cost that could be added to the unit, batch or product related analysis, to minimise level of costs which have to be allocated arbitrarily.

(c)

Although an organisation could benefit from introducing an activity-based system as the basis for product cost and profit estimation, the benefits from introducing it may not be straightforward to achieve. A number of problems may be identified. Time and expense - There is considerable work and expense involved in setting up an activity-based system and identifying the sources of data. Organisations need to consider whether the additional time and expense is worth the information generated. Data collection - An organisation could also experience difficulties in collecting the necessary data to enable accurate cost driver rates to be calculated. It may need to require an extensive data collection and analysis system to provide all the data it needs. Selecting cost drivers - Deciding upon the cost drivers can be tricky as some activities may have multiple cost drivers or lie within several functions. Arbitrary cost drivers - It may be difficult to identify a cost driver for some activities (such as the business/facility sustaining cost at GMB) and so they may end up being costed in an arbitrary way. Distinguishing between fixed and variable costs - Equally, in some case it may be difficult to distinguish between fixed and variable costs. For example, the design cost for a batch may be fixed. However, its impact could be reduced if the batch size could be reduced without a proportionate increase in costs. Impact on behaviour - The system can encourage dysfunctional behaviour. Thus employees may be measured on cost per set up and decide to split production runs thereby having more set ups. This reduces the cost per set up but increases workload. Managers may also feel that the activity based approach includes too many assumptions about activities and cost drivers. This may in turn lead management to have doubts about the degree of increased accuracy

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Answers

which an ABC system will provide. If they have doubts such as these, management may not be committed to changing their existing costing system; and if management are not commitment to a new system, it is unlikely to be implemented successfully in an organisation.

11 Sports Shop
Text reference. The Value Chain is discussed in Chapter 3 of your BPP Study Text. Top tips. The scenario should provide you with plenty of examples of the way that SPS adds value. The trick is to analyse these examples in terms of the value chain model. However, the value chain is actually most applicable to manufacturing businesses so it can be more difficult to apply it to a service business such as a retailer. In addition, SPS’s value activities could be classified in more than one way, 'according to interpretation' so there isn’t a single ‘right’ answer to this question. The message here, therefore, is this: be bold in your analysis and do not worry too much about the nuances. You must avoid obvious error, such as calling an HRM activity a logistics one for example, but if you can establish a link of some kind between an activity and an aspect of the value chain, you can base your analysis on it, even if another interpretation is possible (eg the allocation of recruitment both to HRM and to procurement). (a) Value chain activities Value chain activities, using Porter's model, can be depicted as follows. (i) Firm infrastructure The location, design and layout of SPS's shops enhance customer convenience and satisfaction and are therefore important sources of value. Firm infrastructure, as described by Porter, includes such continuing administrative activities as planning and accounting, while buildings and furnishings are assets rather than activities. However, the decision-making processes that resulted in the current benefit derived by SPS from its fixed assets certainly qualify as important value activities. (ii) Human resource management SPS's staff are enthusiastic and knowledgeable; they are helpful and provide excellent customer service. As is heavily emphasised by the extended marketing mix, the degree of success achieved by a service business such as SPS is heavily dependent on the people it employs. SPS has both recruited and trained its employees with great care and the company's shops are now staffed by people who make a major contribution to the value it creates through the way that they do their work. (iii) Procurement SPS's range of goods in stock is far wider than those of its competitors, which provides its customers with a greater degree of choice and an improved likelihood that they will be able to purchase items suited to their needs and wants. These factors are likely to have a positive effect on both footfall (the rate at which potential customers visit the premises) and on actual sales. SPS is in this position as a result of developing close relationships with major manufacturers, which is an important procurement activity. The potential downside to this is that SPS's stock holding costs are likely to be higher than those of its rivals. (iv) Technology development and inbound logistics The company has developed a sophisticated stock control system that can be used to locate any desired item that is in stock in SPS's shops or warehouse; it can also be used to check the availability of stock with the manufacturer. This system is likely to provide significant enhancement to customer satisfaction and thus to sales. The potential downside to this advantage is the cost of developing the system.

Answers

155

(v)

Marketing The managers of SPS's shops have recently carried out a customer survey. This is an important aspect of customer communications and a proper customer focus: it is important to know what customers think of the company's market offering.

(b) Top tips. In effect, part (a) of this question required you to look at SPS’s current value chain, while part (b) requires you to think about how it may change in the future. So, for part (b) you needed to identify, from the activities discussed in part (a), those which may be affected by the e-retail investment. Then you need to ‘explain' the effects of the e-retail investment in terms of whether the value added would increase or decrease. It is obvious that any e-commerce operation dealing with physical goods needs an appropriate system to deliver the items ordered online. This is known as fulfilment, and would be analysed in value chain terms as outbound logistics, an activity that does not appear to exist in SPS as described in the narrative. (i) Firm infrastructure The location, design and layout of SPS's shops will remain an important source of value, although this may be reduced as physical stores give way to ‘virtual' on-line displays and sales. In essence, SPS would move from having a purely physical infrastructure to having a mixed physical and on-line infrastructure. Sales revenue through the stores will decrease as some existing customers choose top shop on-line, but the associated costs of operating the stores will substantially remain. However, it is likely that SPS's overall turnover will increase as a result of starting its on-line store. Although there will be some cannibalisation of the existing shop sales, it should expect the on-line store to also generate some new, incremental business. The e-retail avenue may increase the added value of pointof-sale infrastructure, by enhancing the perceived offering to customers (in terms of convenience, empowerment and potentially an entertaining on-line experience), generating additional sales revenue at lower administrative cost. (ii) Human resource management Given that customers continuing to use the retail stores will be doing so primarily because of the human service element, the capacity of SPS's staff to add value within the off-line retail segment should be increased. This will, however, be diluted in overall terms by the shift in sales to e-retail, where customer value is not significantly added by human intervention. The focus of HR added value may shift to skills in the design and implementation of the e-retail system: the ability of IT staff to deliver a quality service at lower administrative/maintenance cost to the firm. (iii) Procurement The e-retail system should increase the added value of SPS's supply strategies and inventory control systems. It will enable the full range of goods stocked to be visible to all customers, regardless of location, maximising the value of an attribute highly valued by customers. The e-retail system should also support better-quality information-sharing with suppliers, enabling better demand forecasting and delivery performance throughout the supply chain. This may enable SPS to add further value through just-in-time supply strategies, thereby reducing the amount of working capital tied up in inventories. Meanwhile, procurement has potential to add new value through the procurement of IT infrastructure, equipment and services – perhaps through managing an outsourced IT support. There may be a further role in managing outsourced fulfilment activities: many e-retail organisations outsource their warehousing and distribution systems to specialists who can cope with the greater-volume of small transactions.

156

Answers

(iv)

Technology development and inbound logistics Integration of the e-retail system with the existing stock control system should increase its potential to add value. It will empower customers to access stock availability information, generate orders and track orders at lower cost than via sales staff intervention. The system should also allow real-time updating of stock figures – and triggering of stock replenishment – in response to on-line purchases: this increases the potential for reduced costs through fully automated and integrated e-procurement.

(v)

Marketing The addition of an e-retailing capacity has the potential to add considerable value to the firm's marketing activities. It presents highly flexible, controllable and cost-efficient opportunities for information, advertising, purchase incentives (eg on-line loyalty schemes and sales promotions), public relations (eg posted media releases), relationship marketing (eg gathering customer data, encouraging registration, site personalisation, e-mail permission marketing) and so on. It particularly enhances market/customer research, by replacing customer survey data with data about actual customer browsing and purchase patterns and preferences.

(vi)

Additional value-adding activities It should also be noted that e-retail will create potential for new value-adding activity in the area of outbound logistics, which currently operates within the internal supply chain only, (warehouse-tooutlets) and represents cost without generating revenue. This is a ‘waste' activity, which can be reduced by supplying direct from the warehouse to the customer. Prompt, reliable and trackable delivery is a major contributor to customer satisfaction, so outbound logistics has the potential to create significant value – although the greater frequency and smaller value of deliveries will also create new costs. In value chain terms, service means after sales service. This is likely to be minimal at the moment and consists largely of dealing with returned faulty goods. With e-retailing, it will be necessary to offer a more comprehensive reverse-logistics service – which again both adds value and incurs cost.

12 Scott
Text reference. Management information systems are discussed in Chapter 5 of the BPP Study Text. Top tips. This is quite a long and complicated scenario. You'll improve your chances of writing a good answer by adopting reading the scenario carefully and then planning your answer. We suggest that you start by making notes as a rough sketch for your answer. Spend around ten minutes doing this. Then elaborate your notes into your answer, using headings and paragraphs, and picking out the main points from the question. So, for example, head up a paragraph 'open systems' and write a paragraph on open systems. This makes it much clearer to mark and uses the key phrases the examiner is looking for in a good answer. Part (b) of this question illustrates the importance of being able to apply theory to the scenario. You may not be able to give any examples of closed systems as these rarely occur. Just make sure you put down an explanation so that you get credit for knowing what a closed system is. We have put our answer to Part (c) in a table though you could also use headings and paragraphs to answer the question. (a) Issues in upgrading the existing information system The issues involved an upgrade of the existing information system include achieving the potential advantages at minimum cost and anticipating and managing necessary changes. (i) Advantages of upgrade A networked system would allow the transmission of information both to and from the business units and head office at Scott. As such it is likely that performance indicators, financial statistics and similar information could be rapidly gathered, processed and disseminated. Improved communication between units and head office should improve, leading to rapid reaction to changes both within the organisation and outside it. This should result in a responsive, evolving organisation
Answers

157

capable of meeting the challenges of the market place. It would also get rid of the problems currently experienced where some countries do not have the most up-to-date information on products and prices. (ii) Costs The costs of providing a fully networked computer system, changeover costs and the costs of future maintenance and training must be evaluated and budgeted for. The development and implementation of security measures to prevent the misuse of corporate data, and to prevent fraud by unauthorised users (who may be employees or external to the organisation) have to be considered and costed. In addition, there may be a possible need to recruit specialised staff to implement the changes to the existing information system. All of these costs are foreseeable and can be planned. (iii) Changes Upgrading corporate information systems usually result in many unforeseen changes to the culture of the organisation and to the working practices of staff at all levels. For example, would greater efficiency be achieved by allowing staff to have more flexible hours of attendance? Can costs be reduced by allowing some staff to telecommute on a regular basis, thus allowing hot-desking to take place? Is it likely that morale will be adversely affected by staff who may be concerned about using new technology or staff who fear that they may lose their jobs through the changes? The proposed changes are unlikely to change the role and remit of management in relation to the directing of staff, although it is likely that there will be some impact upon organising staff tasks as new needs arise. Strategic and tactical planning are likely to change in response to the improved, and more rapid, flow of information that the information system will provide. Operational decisions can be taken at lower levels of the corporate hierarchy as information becomes available more rapidly and in an appropriate format. As well as providing a swift response to changes in the business environment, it is possible that the organisation will, in time, evolve into one with a flatter hierarchy. This would particularly suit the autonomous business unit structure in Scott which already operates with devolved decision making. However, there is always the danger of 'information overload' which can reduce efficiency and morale within the organisation. (b) Closed systems and open systems Closed system A closed system is one that does not react to external stimuli or allow communication from internal processes to interact with the outside environment. They are seldom, if ever, found in naturally occurring situations. A typical example of a closed system would be a chemical reaction that takes place under controlled conditions within a laboratory. Closed systems can be created to eliminate external factors and then used to investigate the relationship between known variables in an experiment. Open system An open system is one that interacts fully with its environment. It accepts inputs from its surroundings, processes the inputs in some manner and then produces an output. The input parameters can be foreseen or be unpredictable. Similarly, outputs can either be predicted or unforeseen. For example, predictable inputs of a metal smelting works would include items like the raw materials and coal while the predictable outputs would be ash, smoke and the smelted metal. If the raw material to be smelted became contaminated in some way, it is likely that an undesirable product would be produced. These are examples of unforeseen inputs and outputs. Examples in the question Turning to the question, we can see that Scott is clearly an open system. It reacts, albeit imperfectly, to inputs from its environment and produces outputs. Sales figures are collated and analysed and predictions are made based upon this information. Hence the organisation responds to external stimuli and reacts appropriately.

158

Answers

The question also provides instances of sub-systems within the organisation that are themselves open systems. For example, the information system, the corporate management team, the business units and retail outlets are examples of sub-systems within the business that are all open. (c) Three types of MIS and how they would be used in an organisation Type of MIS Decision support systems (DSS) Detail Used by management to help make decisions on poorly defined problems (with high levels of uncertainty). They provide access to information with a wide range of information gathering and analytical tools. Decision support systems allow the manager to scan the environment, consider a number of alternatives and evaluate them under a variety of potential conditions. There is a major emphasis upon flexibility and userfriendliness. Give executives a straightforward means of access to key internal and external data. They provide summary-level data, captured from the organisation's main systems (which might involve integrating the executive's desk top PC with the organisation's mainframe), data manipulation facilities (such as comparison with budget or prior year data and trend analysis) and user-friendly presentation of data. Draw on a computerised knowledge base (such as details of the workings of tax legislation) and can give factual answers to specific queries, as well as indicating to the user what a decision ought to be in a particular situation.

Executive information systems (EIS)

Expert systems

(d)

Establishing costs Design and testing - The costs of establishing a system for measuring and reporting customer profitability are difficult to estimate. The costs of establishing the system can be estimated as the costs of the time of managers (including the management accountant) in designing and testing the system. There may be external software development costs that would be directly attributable to the system design. Operating costs - The costs of operating the system would also be very difficult to measure, since the data records would be originated by different individuals. If a cost or management accountant is employed to collect and input data, and produce profitability reports, the cost of his or her time would be directly attributable. Expected benefits The benefits of the information system will depend on whether the customer profitability reports would be likely to affect decision-making by management. Specifically, would it affect which groups of customers Scott sells to, or any variations in price which it offers to different groups of customers. The system’s potential value comes from identifying which groups of customers are most profitable to Scott, so that it can focus on maximising sales to these customers. Again, however, it could be difficult to quantity the value of having this information. Equally, Scott will not be able to analyse the benefits of the system with any certainty until after it has been introduced.

Answers

159

13 MKO Clothing
Text reference. The impact of IT on strategic management accounting is covered in Chapter 3. Top tips. For part (a)(i), you should think about the potential benefits of a company-wide IT system, in terms of the quality of information and how the information can be used to improve performance. Think particularly about the context in which MKO operates, and how it can increase the value it provides for its customers. Part (a)(ii) does not ask you to refer specifically to MKO, but is a more general discussion. However, note that you are not being asked to explain the benefits of introducing an ERP system itself, but rather how introducing one could affect the role of a management accountant within an organisation. Part (b) calls for a brief definition of strategic management accounting and then about how IT can contribute to one particular aspect of strategic management accounting, competitor analysis. However, note that there are two elements to the requirement: (i) the information that might be required for competitor analysis; and (ii) whether an IT system for competitor analysis will help to improve decision-making in MKO. (a) (i) An ERP system integrates the information required by all functions within an organisation into a single system, so that everyone uses the same data and information. A properly-designed system will also provide for continual updating, so that the information it contains is both current and accurate. An ERP system should also enable employees who are away from the company’s premises to have immediate access to the system, both to input data and to obtain information. It appears that a large proportion of the company’s employees are out of the office for much of the time, speaking with potential customers and visiting their premises, so it will be important for them to be able to easily access up-to-date information about MKO’s performance. MKO also needs to be flexible and responsive to its customer’s demands. Its retail customers are not particularly loyal to their suppliers; instead they are looking for quick delivery and low prices, as well as items of clothing that will sell well. By integrating its manufacturing and inventory systems, the ERPS should help MKO increase the flexibility and efficiency of its production, which are characteristics the retailers value. An ERP system should enable MKO to respond to customer requests promptly. The sales representative can access the inventory files to check whether inventory is available for immediate delivery. If there is insufficient inventory, the system should be able to provide an estimate of when the items can be produced and delivered. The system should also hold information about the current state of work in progress, so that information about delivery dates for these items can also be given to retailers. The customer can therefore be given reliable information about availability and delivery. If a retailer asks for a special batch of an item, the MKO representative should be able to quickly obtain a price quotation from the accounts data on the IT system. Orders from retailers can be fed into the system prompting automatic decisions about producing new items. The system may also provide information for predicting future orders so that items can be produced in anticipation of orders – allowing the company to deliver orders more quickly when they are eventually obtained. Data on production and delivery costs should be recorded immediately, so that up-to-date product costs can be measured and reported. Sales prices can be adjusted as appropriate in response to changing costs. MKO has some retail outlets of its own. The checkout function in each of these outlets can be linked to the ERP system, providing immediate information about sales in each retail outlet. The sales information can be used to predict future order quantities for each of the outlets, and the managers of each outlet should also be able to input orders to the central system. By linking checkout to order and delivery systems, the retail outlets should be kept better stocked to meet customer demand. In summary, an ERP system should provide an integrated IT system that allows for input from different locations, including remote input from representatives, and for the provision of up-to-date information about inventory, work-in-progress, sales demand for different products, sales orders and costs. In a competitive environment, this should help MKO to respond immediately to customer

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requests and queries, and so provide a better service to the customer and (hopefully) secure a higher volume of sales. By integrating the IT system for the company as a whole, the ERP will provide access for many employees to data that was previously unattainable that they can use to perform their jobs more effectively. (a) (ii) ERP systems could have a significant impact on the work of management accountants within an organisation. Information gathering – Introducing an ERP system should significantly reduce the time spent gathering and processing routine information. In particular, because ERP systems are integrated systems, management accountants should be able to gather information from a single source rather than having to gather information from a number of different sources (for example, an inventory management system, a sales system or even an HR system). User access – Another benefit of ERP systems is that they allow managers across an organisation to have access to information. In this way, if managers can access information themselves, they no longer need management accountants to provide it for them. Analysis - As a result, if management accountants have to spend less time gathering or processing information, they can spend more time analysing or interpreting the performance information which is available. Therefore, rather than simply producing information, management accountants may find themselves providing support and analysis for managers across an organisation. Timeliness of reporting – One of the benefits of ERP systems is that sales and production forecasts are updated immediately to reflect customer orders, along with cash forecasts. Having instant access to data allows organisations to monitor their performance much more rapidly than they have traditionally been able to. As a result, this may mean that managers are less reliant on month-end accounts (or similar reports) to know how the business is performing, because they can monitor performance almost on a realtime basis. However, again, this means that the focus of a management accountant’s role may shift from producing reports (for example, month-end accounts) into a more analytical role – analysing trends or variances which are emerging, and helping managers update targets or forecasts as new information becomes available. (b) Strategic management accounting involves the provision of information to management for strategic decision-making purposes. Strategic decision-making is concerned with achieving strategic objectives over the long term. It is therefore largely forward-looking in nature, involving targets and forecasts of what will happen. The information required for strategic decisions comes from both external and internal sources, and is not derived from a traditional cost accounting system. Competitor analysis is one method or technique that comes within the definition of strategic management accounting. MKO operates in a competitive environment, and to remain successful it needs to establish a competitive position in the market and offer its products to customers in a way that competitors cannot match. To do this it needs to understand the strengths and weaknesses of major competitors, and monitor their strategies alongside its own. An IT system to support competitor analysis can help management to monitor competitors more closely and respond to their initiatives more quickly. It should be able to provide information about competition in various markets, for example, that managers can use to drill down for more detailed information about specific competitors, sales regions or products. The CEO may be correct in stating that an IT system will help to improve decision-making, but the value of the IT system will depend on various factors. The quality of the IT system will only be as good as the information that it provides. The information requirements of management need to be established, so that the system is capable of providing them with the information they need.

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The information should also be reasonably easy to obtain, whether from published financial accounts, press releases, advertising and sales promotion materials, word-of-mouth or other sources. It should be stored on file in a form that makes it easy to access. The information should also be valuable, in the sense that management should be able to use it in a way that helps them to make better strategic decisions to improve the competitive position of MKO. An information system for strategic decision-making will take time to establish. Therefore, before an IT system is designed, the actual strategic information needs of management must be established. However, there remain aspects of MKO’s strategic decision-making which the IT system will not be able to influence. For example, the Board will need to identify the risk appetites of different stakeholder groups such that any strategic options chosen will be acceptable to the key stakeholders.

14 BV Entertainments
Text reference. The impact of IT on strategic management accounting is covered in Chapter 3. The characteristics of service organisations are also covered in Chapter 3. Top tips. Part (a): Although the requirement asks you to make reference to BVE in your answer, this should still be a relatively simple test of knowledge. If anything, the references to BVE should help you explain the characteristics identified by the requirement. Part (b) deals with a specific item in the syllabus: assessing the changing needs of modern service-orientated businesses compared with the needs of traditional manufacturing systems. In this context, it is important to think how the nature of a ‘service’ differs from manufacturing production, and therefore how this affects the nature of performance management and control in each. The key issues in part (c) are the quality and availability of information. The nature of the representatives’ meetings with clients mean that they need to be able to find accurate, up-to-date information which they can use in their negotiations with the clients. If the representatives don’t have this information, how can they agree any prices or deals with the clients? (a) Intangibility Whereas the outputs from a manufacturing organisation are tangible, individual products which can easily be quantified or measured, the outputs of a service organisation are not tangible. For example, if one of BVE’s clients visits a sporting event, they don’t have anything tangible at the end of it in the way they would, for example, if they had bought a new piece of kitchen equipment. In BVE, for example, not only is the service provided intangible, the performance of the service comprises many other intangible factors (such as the speed which customers are dealt with and the helpfulness of the staff) which will undoubtedly influence customers' perception of the service they have received. Heterogeneity Each 'service' provided by BVE is likely to be slightly different from all those that have already been provided or those that will be provided in the future, The exact ‘service’ that a customer receives each time they visit a theatre show or an opera, for example, will vary according to how well the performers perform on the night, the atmosphere created by the audience members, or how busy the venue is. By contrast, if a customer buys a manufactured product, they could expect that product to be the same every time they buy it. Simultaneity The production and consumption of a service occur at the same time, and therefore a service cannot be inspected for quality in advance and neither can it be returned if it was not what was required. For example, if one of BVE’s clients books a package for a sporting event, they cannot guarantee in advance the quality of the sporting action they will see. The concept of simultaneity also highlights the important of the interaction between the producer and the consumer in a service transaction. For example, a restaurant can produce a dinner, but for the dinner ‘event’ to take place it also needs diners to eat the meal. And this interaction with the consumer can play an important part in the outcome of a service transaction. For example, if two of BVE’s clients order the same item from a restaurant menu, one might like it a lot, but another may not like it.

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Perishability Services are inherently perishable and cannot be stored for later use. For example, a given sporting event takes place at a given time and date. Therefore, unlike a piece of kitchen equipment which can be used repeatedly, a sports event can only ever be ‘used’ once; because after that it no longer exists. (b) Production costs - In a traditional manufacturing company, the main focus of management accounting information is often on production costs. There will be a cost accounting system that records costs of production and provides a valuation for inventory. Annual plans are produced in the form of budgets, and where standard products are manufactured, there may be a standard costing system. Manufacturing conditions are often relatively stable, which means that budget forecasts can often be produced by using the previous year’s performance as a basis for planning the future. Control information for management is likely to be provided in the form of monthly variance reporting. Basis of costing – However, while such information will be useful for DAS, it will be less useful for a service organisation like BVE. Although cost information is required about the services provided, there should be little if any requirement for inventory costs. This means that costing is more likely to be based on marginal costing than absorption costing. Individual packages – Even more importantly, BVE does not provide standard services, and clients negotiate entertainment packages. Because services are non-standard and BVE needs to be flexible in its operations, BVE’s accounting system must be able to monitor the profitability of individual contracts with clients. Historical cost information may be of limited value for BVE, because services are non-standard. It is much more important for the IT system to provide information about current costs and expected costs. This will allow representatives to calculate the cost of packages that clients are requesting, quote prices and, where necessary, negotiate on the details. Timeliness of information - In a traditional management accounting system, it may be sufficient to obtain control information about costs on a monthly basis. In BVE it is much more important to provide immediate access to information for all the company’s representatives, as well as management. The IT system must be accessible and responsive. Feed-forward control - Cash flow is important for BVE because it often has to make payments (for tickets or venue hire) well in advance of receiving payment from clients. BVE’s information system must therefore be capable of providing feed-forward control information about cash flow, so that management can anticipate any future cash shortage and take measures to deal with the problem, for example by deferring some payments, asking some clients for deposits, or arranging for a sufficient overdraft facility with the company’s bank. Non-financial information – Given the nature of the services BVE offers, financial performance information should be supplemented by critical non-financial information, such as customer satisfaction and the quality or dependability of service delivery. BVE’s accounting information system should therefore include nonfinancial elements. BVE operates in a changeable and flexible business environment. A company such as DAS manufactures high-volume consumer products and operates in a more stable and predictable environment. The accounting systems in each company will differ substantially because of the different information needs of management in each business. (c) An IT system that provides instant access to data about costs, prices and entertainment venues and resources should improve the effectiveness of the company’s selling operations, which in turn should result in higher sales revenue and profits. Timeliness of information - The most important quality of the information provided by the system is probably timeliness. There are two aspects to this: The first is that information can be made available to sales representatives in meetings with the client, which will often be at a time that the client may be able to make a decision and agree to buy an entertainment package.

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The second and more important aspect of timeliness is the speed with which the information is made available. Representatives will have immediate access to information about cost/prices and ticket available to make an instant price quotation for any type of package that the customer may want. Whenever some costs change, the new cost can be fed into the system and made immediately available for re-pricing of services and packages. The representative’s sales message can be reinforced if the system also delivers visual information about possible venues and entertainment facilities. The immediacy of the information provision should therefore encourage prompt decision-making by the customer, which should in turn result in more sales. Costs and ticket availability - The IT system should also contribute to the longer-term performance of the company by giving representatives reliable information about costs/prices and ticket availability. The information should be more reliable than if it is provided by a manual information system or by a separate sales system, because it should be more up-to-date. Up-to-date reliable information should enable representatives to quote realistic prices and confirm the availability of tickets. Over time the company should develop a reputation for efficiency and reliability in this way. Managing supply and demand - The system will also allow management to monitor the state of the business, for example by checking customer demand patters and by ensuring that quoted prices are sufficient to cover costs. It should also be possible to anticipate sporting events where the company will have too many tickets or too few tickets. By anticipating surpluses or shortages, measures can be taken to deal with the problem – reducing the price of entertainment packages to sell more tickets, or trying to acquire more tickets. In summary, the IT system will become an integral part of the selling and management systems, and by improving the quality of information, it should improve the performance of the company.

15 EEE Chemical company
Text reference. Stakeholder analysis is covered in Chapter 3 of your BPP Study Manual. Top tips. This question is obviously built around Mendelow's work, but you need to be clear in your mind exactly what it is asking for. There is no part of any of the requirements that asks you to explain in detail what stakeholder analysis is, or what Mendelow's matrix is. This question requires the application of knowledge to the scenario described. Part (a) Top tips. Although you are not asked what 'stakeholder analysis' is, thinking about this would have helped you focus on what is relevant here and what is not. However, note you were not required to identify or discuss any individual stakeholders in the part of the question. That was the requirement for (b), and should have been kept separate from this part of the question. EEE's stakeholders are persons or groups with a legitimate interest in what EEE does. Stakeholder analysis establishes who the organisation's stakeholders are and the various discrete categories which they fall into. These categories are determined by a combination of the nature and extent of their interest in the organisation, and the extent of their power to influence the organisation's behaviour. Advantages of stakeholder analysis (a) (b) Identify potential backers of the proposal to develop the new extraction process. This will help the Board to approach them and gain their support. Identify potential opponents who might try to block the proposal. The Board could then try to take action to reduce the resistance of opponents. However, if the Board feel that the opposition to the proposal is too strong they could decide to modify or abandon the proposal before money is wasted on it.

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(c)

Demonstrate good corporate governance. As part of their commitments to corporate social responsibility, managers are increasingly being asked to consider the interests of a range of stakeholders groups and not just shareholders in their decision making. By considering the interests of a different stakeholder groups in its decision-making process, EEE can demonstrate it is taking its corporate social responsibility seriously.

If EEE does decide to proceed with the proposal, it will then also have to manage the reactions of the various groups, given that some will support the project while others will oppose it. Again though, it will be useful for EEE to have identified the levels of interest and power of the different stakeholder groups, because these factors will help to shape the way it manages different groups. Part (b) Top tips. To answer part (b) well you have to apply your knowledge of stakeholder mapping to the specific context of the organisational decision. Note that you are not simply asked to analyse the principal stakeholders of EEE as an organisation, but specifically in relation to the proposed investment in the new process. The information provided in the scenario should have pointed you towards the principal stakeholders, and you should then have analysed them using the concepts of 'power' and 'interest' (from Mendelow's matrix). Note also the examiner's comment below about potential overlaps between groups. This again illustrates the importance about thinking about the practical context of the scenario. Easy Marks. If you knew the form of Mendelow's matrix, and related the stakeholders identified in the scenario to it, you should have been able to make a number of relevant points. Several of the stakeholder groups should have been both easy to identify from the scenario and easy to allocate to the matrix – for example, employees, and local government. An analysis of EEE's stakeholder groups using Mendelow's criteria of power and influence is shown below. Key players (high degree of both interest and influence) (a) The founding family forms a majority of the board and holds 30% of the share capital; it therefore, collectively controls the company. Its members are likely to give strong support to adoption the new process since it will confer a definite competitive advantage. If local government operates as in the UK, it will have extensive power to regulate industrial processes and developments. It will be very interested in EEE because it is a major element in the local economy and in the new process because of the complaints of the local residents. The council will therefore have mixed feelings about the new process. EEE's employees depend on the company for their livelihood and make a major contribution to its success. They also control or influence 20% of the shares in the company. Their interest lies in the successful introduction of the new process, since the competitive advantage its gives should also be to their benefit in terms of job security and, possibly, pay.

(b)

(c)

Note. The trade union representative who is also a local councillor falls into two of these categories: like the council itself, he may have mixed motivations, to the extent that he suffers from a conflict of interest that he should formally declare to his fellow councillors. Keep satisfied (low degree of interest, high degree of power) The institutional shareholders control 20% of the share capital; the extent of their activity in relation to the running of the company is unknown, but is likely to be minor. They will probably be content if EEE continues to operate reasonably successfully. However, they have the capacity to become interested if a major and costly problem arises. Keep informed (high degree of interest, low degree of power) Local residents fall into two sub-categories. Both will be directly interested in the new process, but any influence they can bring to bear on the company will be mediated through intermediaries. (a) The affluent residents that have complained can only have significant effect through the local council and, possibly, by a media campaign. The effectiveness of either route will depend on how well EEE manages its press and public relations. In addition, the ambivalence of the council already commented on will limit this

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group's power. However, this group could seek to cause problems for EEE in the future if they are antagonised and so EEE should treat them with respect. (b) Other local residents may also be concerned about unpleasant odours, but many of them are likely to be connected to the company through the employment of a family member; this group is more likely to be sympathetic to the new process.

Minimal effort (low degree of interest and influence) Although the remaining shareholders own 30% of the shares in total, they are unlikely to be particularly interested in the new process or, perhaps more importantly, to act as a single group. Part (c) Top tips. You should not have simply repeated suggestions made in (b) in this part of the question. Instead you should have used your analysis to recommend how EEE should proceed. As ever, your recommendations should be practical rather than theoretical: to go ahead with the decision or not; and how to manage with the public relations message arising from the decision. The economic advantages of the new process are such that all of the key players are likely to agree that it is very desirable for EEE to adopt it on a large scale. However, the company cannot afford to ignore the feelings of those local residents that object on grounds of amenity. People can be very resistant to changes affecting their home life, and a campaign against the company could, eventually, be very damaging. The company should therefore adopt the process but should also take two important steps to safeguard its position. First, it should be prepared to make a reasonable investment in developing the technology in a way that will minimise the objectionable odours. This might involve further chemical processing or filtering or merely something as simple as only using the process on days when the wind is in an appropriate direction. This will both reduce the potential for actual dispute and provide a basis for the second step, which is careful PR management. EEE should ensure that its operations are presented in the best possible light, stressing the economic benefits to the area, and the company's efforts to be a good neighbour. This will assist the local council to take a positive view of the company and will discourage the formation of a single-issue pressure group by the objecting affluent residents. EEE could also consider some more pro-active PR events such as sponsoring local events or facilities, to build up its image as a good neighbour.

16 GSC groceries
Text reference: Stakeholder analysis is covered in Chapter 3 of the BPP Study text. Top Tips: Part (a): Although the requirement refers to shareholders, the reference to Mendelow’s matrix, and to levels of power and interest should have indicated very clearly that this question was about stakeholder analysis – with the stakeholders you had to analyse bring the different groups of shareholders identified in the scenario. However, it is important that you realise that the relative power of different shareholder groups is not determined solely by the size of their shareholding. The group which is probably the most powerful (the Directors) actually has the lowest shareholding. For part (b), note that you were only asked to advise the Board of THREE other stakeholder groups who would be interested in the decision to sell alcohol and tobacco. However, there are a number of possible groups to choose from here. In addition to the three groups we have suggested in our answer, you could have suggested: GSC’s local competitors, or potential investors (interested in the impact of the 25% increase in profits). Provided you identified a relevant group, and supported your advice with a logical argument, you would have scored the marks available here.

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Part (c): The key point here is that RCB ‘seeks short-term profits’ whereas the pension fund seeks long-term security for its pensioners. So, in effect, the question is looking at the potential for conflict between short-term and long-term goals. (a) High power; high interest GSC directors – Although the directors collectively have the lowest holding of the eight groups of shareholders (2%), they have the highest power over the decision because it is they who have decided to implement the new retailing strategy. Similarly, it is they who have the power to modify the new retailing strategy – either, for example, if it does not prove to be as profitable as had been hoped, or else in response to pressure from other stakeholder groups. Again, the fact that they have taken the decision to implement the new strategy identifies the directors as having a high level of interest in the strategy, and the Managing Director’s statement to the Stock Exchange reinforces this. RCB: private equity fund – RCB has the highest individual shareholding in HWS, with 25% of the share capital. Although it still only hold’s a minority of GSC’s total equity, the size of RCB’s holding still puts it in a relatively powerful position. Moreover, RCB’s focus on the short-term profitability of its investments will also increase its interest in the decision, given the Managing Director’s statement that the strategy should increase GSC’s annual profits by at least 25% [£10m/£40m] by the end of the next year. Additional point: It is not clear from the scenario whether RCB’s holding has changed in recent years, or how it has changed if it has. However, if its holding is increasing this could soon increase RCB’s power further. London Stock Exchange regulations mean that any shareholder (or group of shareholders acting together ‘in concert’) which holds 30% or more of the equity in a company has to make an offer to acquire that company. In this case, if RCB’s holding increases the 5 percentage points from 25% to 30% this would then mean RCB has to make an offer to acquire GSC. The scenario does not indicate whether or not RCB wants to reach this position, but if it does make a successful offer for GSC in due course – and subsequently acquires the company – then its power over GSC’s strategic decisions will increase further. UK Clearing Bank – The Bank’s power comes partly from the fact that it is the second-largest shareholder (holding 20% of GSC’s share capital) but also from the fact that GSC is one of its clients. As with RCB, the Bank’s holding is still only a minority holding, although it is a sizeable minority, but in conjunction with having GSC as a client this will give the Bank a high level of power over GSC’s decisions. Similarly, the Bank will be interested in the commercial success of the new strategy, because of the potential impact this could have on GSC’s gearing and future cash flows (and its potential ability to pay back any capital or interest owing to the bank). High power; low interest Pension funds; investment trusts – Together, the pension funds and investment trusts hold 30% of GSC’s share capital, and so collectively they could have a high degree of power. Individually, each of the funds or trusts would hold less power, though. Collectively, the funds’ and trusts’ shareholdings are worth £135m at current market value [30% × £450m] which may suggest the investors have a high degree of interest in GSC’s on-going success. However, there is no indication what proportion of their respective portfolios these GSC shares constitute, and it is likely that the proportion could actually be quite small. This will reduce the investors’ interest in the decision. Moreover, as institutional investors, it is likely that they are more interested in GSC’s overall results and performance rather than the individual decisions the company takes. And, although the decision to increase the product portfolio may be significant for GSC, in effect, it is only bringing GSC’s product portfolio more in line with other newsagents and grocers stores.
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Low power; high interest GSC Charitable trust – Unlike the Directors, the GSC Trust is not directly responsible for any of the decisions taken by the company. Moreover, the Trust’s shareholding (10%) is not large to give it any significant power over the company’s decisions. However, the Trust has a very high level of interest in the decision, as indicated by the strongly worded statement it issued. Given its role in working to improve the health of the population, the Trust will be particularly critical of GSC’s decision to sell alcohol and tobacco, given the potentially adverse impacts both can have on people’s health. GSC employees – Again, in contrast to the Directors, the employees have little power to shape any of the GSC’s decisions. However, because the security of their jobs is likely to depend on the company’s ongoing success they will have a high level of interest in how the decision affect’s future profits. Moreover, because on average the employees hold shares worth about £9,000 each [(10% × £450m)/5,080] they will have high level of interest in how the stock market reacts to the announcement and how it affects GSC’s share price. Low power; low interest Private investors – 15,000 investors collectively only hold 3% of GSC’s share capital, which means that individually each investor only holds a very small percentage of the share capital. Consequently, these investors (either individually or collectively) have very low power to influence any decisions GSC may make. Moreover, given that on average each investor’s holding is worth about £900 [(3% × £450m)/15,000] it is unlikely that many of these private investors will take a keen interest in GSC’s business decisions. (b) Customers – The reason why GSC has decided to sell alcohol and tobacco is in response to customer demand, particularly from customers using its shops between 2am and 6am. In this respect, these customers probably have the highest level of interest of any stakeholder group in the new strategy. However, other customers may also be interested in the decision, but may not be in favour of it. For example, they may feel that alcohol and tobacco are damaging to health and so the number of outlets selling them should be restricted not increased. Local communities – The main demand for alcohol and tobacco products appears to be from customers using the shops between 2am and 6am. Local residents living near GSC shops may be concerned that the decision to sell alcohol and tobacco will lead to an increase in noise and litter, because the residents may (rightly or wrongly) feel that people shopping for alcohol and tobacco late at night could be drunk and boisterous. Local healthcare workers – Local health care workers may be concerned that increasing the opportunities for people to buy tobacco and alcohol may lead to increased consumption of them, with the potential adverse impact this could have on the health of GSC’s customers buying them. Perhaps equally importantly, health workers and doctors are likely to be concerned about the costs of treating alcohol and tobacco related illnesses. (c) Short-term profits – RCB’s motive for investing in GSC is to earn short term profits – presumably through GSC’s share price rising in the short term so that it can sell its share at a higher price than it paid for them. Therefore, RCB’s attitude towards the decision is likely to be determined by the impact it is likely to have on GSC’s performance in the short term. For example, if RCB thinks the decision (an any associated increase in GSC’s profits) will boost the company’s share price in the short term, it is likely that RCB will support the decision. Long-term security – By contrast, the pension funds have a much longer term perspective for their investment, with a view to trying to ensure long-term security for their pensioners. Consequently, the pension funds are likely to be concerned about the potential effects of the decision on GSC’s long-term performance. For example, if GSC’s ethical positioning is an important factor which helps to differentiates it from its competitors, if GSC loses this bases for differentiation its longer term performance could be adversely affected. In turn, if the pension funds are concerned that this may be case, they are likely to oppose the decision (or may sell their shares in GSC as a result of the decision.)

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17 GTR panels
Text reference. External influences on organisational performance, including the impact of risk and uncertainty, covered in Chapter 4. Rolling budgets and beyond budgeting are covered in Chapter 2. Top tips. Part (a) – In effect there are two elements to part (a): (i) how might the level of risk and uncertainty in the industry affect GTR’s strategic planning and decision-making; and (ii) how might the risk appetites of shareholders and lenders affect strategic planning and decision-making? The scenario has identified that there is a considerable amount of uncertainty in GTR’s operating environment. Does this mean strategic planning is no longer valuable or useful? The scenario has also indicated that GTR’s shareholders and lenders may be more risk averse than the directors. How will this affect the strategic choices which may be acceptable to them compared to those which the directors might be prepared to accept? Part (b): Government can be an important external influence on an organisation’s performance, and the scenario has highlighted the importance of the cash grants the government offers in stimulating demand for GTR’s products. However, you should also try to consider ways a government could aid performance – for example, in relation to international competition. Part (c) picks up from the first part of requirement (a), and asks how GTR’s management might be able to look at the impact risk and uncertainty could have on its performance. We have suggested two techniques they could use, but these are not the only ones possible. For example, you might have also suggested scenario planning which could be useful to them here. In part (d), it is important to note that you are being asked to recommend potential alternatives to fixed annual budgets, not necessarily to abandon budgeting itself. Given the degree of uncertainty GTR is facing, would it more appropriate to use monthly rolling budgets, for example, rather than trying to prepare an annual budget each year? (a) Shorter planning horizons - Risk and uncertainty in the industry has made the board of GTR end its rolling five-year business plans because the board believes the benefit does not justify the time and effort spent in planning. However, although the level of risk of uncertainty in the industry suggests that GTR should shorten the length of its planning horizon, it is not necessarily a good idea for GTR to abandon strategic planning altogether. One of the benefits of planning is that it will the board to monitor the difference between actual outcomes and the plan. This can provide useful information for deciding what to do next. Risk vs uncertainty - A distinction can be made between risk and uncertainty. Business risk is inherent in the nature of a business, and some businesses are more risky than others. For example oil exploration is inherently more risky than food retailing, and investors in risky businesses should expect a higher return to compensate them for the risk. A risk in the solar panelling business, which is a fairly new industry, is the speed and extent of take-up of the new product by customers. Solar energy is currently more expensive than other forms of energy, and this is likely to deter many customers from switching to it. The financial return for manufacturers of solar panelling may not be sufficient unless and until demand for the product picks up in the future. Risk appetite - This risk may already have affected the future performance of GTR. Although the directors would be prepared to invest in the new machine technology for solar panelling, other stakeholders – the shareholders and lenders to the company – appear to have a lower appetite for risk. If the company needs more capital in order to invest in the new technology, the reluctance of capital providers to accept the additional risk will presumably prevent the company from making the investment. This could have a significant effect on GTR’s future. Future uncertainty - Uncertainty arises when it is difficult to predict what will happen in the future, often due to an absence of reliable information. For GTR, there is uncertainty about whether grants will be reduced or ended for the installation of solar panelling in homes. There is also uncertainty about the costs of other forms of energy, and about whether manufacturers in China and the USA may try to flood the market with cheaper solar panels because of over-capacity in the industry.
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When there is uncertainty about what will happen in the future, planning is difficult. Strategic decisions may therefore become more conservative. As indicated earlier, GTR may be reluctant to invest more in the business because it is not certain whether sufficient demand for the product will exist. The limit of GTR’s strategic ambition may be to remain profitable and grow the business prudently and organically. However, the board of directors should prepare plans that recognise the risk and uncertainty facing the company, so that the company is able to respond to adverse developments in the business. The board should not stop planning; it should incorporate risk and uncertainty into its plans. (b) Boosting demand – Governments can directly increase demand for products by offering grants or other incentives to consumers to buy them. This has been the case at GTR: the high value of grants has made solar energy more competitive in relation to other sources and so has increased the number of domestic customers who have bought GTR’s solar panels. However, this kind of boost to demand may be temporary. GTR are concerned that the government is soon going to cut grants to domestic buyers of solar panels, which may mean that demand for them falls again. Alternatively, if or when the government officially announces its intention to cut grants, GTR may experience a short term increase in demand as customers who want solar panels act to have them installed before the grants are lowered. Managing aggregate demand – As well as assisting the performance of particular businesses or industries (for example, through grants), a national government can also increase aggregate demand for goods and services by increasing governments spending and/or reducing taxation so that people have more disposable income to spend. However, it appears unlikely that the government in GTR’s country will be able to aid performance in the short term, because it wants to cut spending and reduce its budget deficit. Quotas and tariffs – Government policy via the use of quotas and import tariffs could make it more difficult for foreign firms to compete in domestic markets. GTR is likely to be concerned about the increased competition from (cheap) imports from China and USA, given the surplus capacity in those countries. So, for example, the government could impose quotas to prevent China and USA flooding the market in GTR’s country with cheap imports to help them use up their spare capacity. Environmental policy – Government policy can also regulate the activities of firms which do not act in the best interests of the environment. In this way, government policy may encourage firms to be more efficient with their energy usage, and to reduce the level of waste they produce. However, government policy may also encourage firms to use more environmentally-friendly energy sources, such as solar energy. (c) Worst case scenarios - GTR could assess the risks that it potentially faces by considering a ‘worst possible’ scenario and whether the company could survive a severe downturn in business conditions, by conducting one or more stress tests. For GTR, a severe stress test may be to assess the company’s likely performance a business environment where the government ends grants for domestic solar panelling, and there is no increase in the cost of other sources of energy, so that solar energy remains more expensive. Another condition may be that cheap solar panels are imported from the USA or China and that these prevent any price rises for GTR’s solar panels. Assumptions about sales volumes, revenues and costs under these conditions should enable the company to assess whether it could remain profitable, or what it might need to do to avoid insolvency. Sensitivity analysis - Stress testing considers extreme business conditions. An alternative approach to assessing risk and uncertainty would be sensitivity analysis applied to a budget or business forecast. ‘What if’ questions could be applied to a spreadsheet model of the budget or forecast. For example, it would be possible to assess the financial effect of a 20% fall in sales volume, or to calculate the amount by which sales could fall short of the budget without the company making a loss. Sensitivity analysis could be applied to costs and sales prices, as well as sales volumes, and a picture of possible future outcomes could be built up. The board of GR could then make decisions for the future with some awareness of the situation that the company might have to face.

170

Answers

(d)

GTR is faced with the problem of how to plan in conditions of uncertainty and possible change. The board has already abandoned five-year planning. The main disadvantage of annual budgeting is that it is generally a fixed annual plan that may get out of date when business conditions change rapidly. A fixed plan in changeable business conditions can be too rigid and may discourage management from reacting more proactively to change. Rolling budgets - The board of GTR may consider two alternatives if it is dissatisfied with annual fixed budgets. One of these would be to revise budgets much more frequently, every three months or possibly even every month, and to produce rolling budgets. Rolling budgets are a way of responding to current conditions, and can be a way of anticipating change and dealing with problems and developments as they arise. Beyond budgeting - A second alternative would be to abandon budgets entirely and adopt a ‘beyond budgeting’ approach to decision-making. However to implement this approach, it is necessary to delegate decision-making to operational management and make them responsible for performance management. The management information system would also have to be altered so that appropriate information flow to operational managers or is accessible to them.

18 GHG
Text reference. This question covers some knowledge which should be brought forward from the strategy paper P3. Strategic management accounting is discussed in Chapter 1 of the Study Text. Top tips. Part (a) is asking for a discussion which means to examine in detail by using arguments for and against. There isn't much of a scenario to comment on but use your knowledge from Chapter 5 and your brought forward knowledge from P3 (Business Analysis) and then link this to points in the brief sketch given. We suggest that you deal with the two classes of factor separately so maybe start with four strategic factors and then four economic ones. You could draw on a model such as Ansoff to lead onto strategies combining new markets and products or services. We have listed additional factors that are valid for information only. These are in a separate box, you may think of others too. Part (b) draws on your knowledge of cultural factors affecting the organisation in the local workforce. You only need to explain two ways but will need to make three clear points for each as there are six marks in total. For part (c), think about the features of strategic management accounting which distinguish it from ‘traditional’ management accounting: for example, a focus on external factors, and on non-financial information as well as on internally generated financial information. How could these features be useful to GHG? (a) (i) Strategic factors to consider The nature and extent of competition will need to be considered. If there is likely to be a lot of competition from other multinational hotel chains this will affect performance. Clearly if the hotel has less competition then this will make the prospect more attractive. As the hotel will be some distance from other group hotels, it will have to be more self-sufficient and will require delegated management. The extent to which local management is employed depends on the expertise of local staff. It may be that initially the hotel uses seconded management until local managers are up to the required standard. Local legislation is likely to affect the operation of the hotel. If Tomorrowland has strict pollution control laws or employment protection regulations these will affect how the hotel operates. There may be laws in place that require some local ownership or control in a foreign business and this may make the decision unattractive. Political stability will be a significant factor in the group's decision to site a hotel in Tomorrowland. If Tomorrowland has a stable government the group could consider a long-term investment. However if there is instability and the possibility of civil war, the group should defer the decision.

Answers

171

(ii)

Economic factors to consider The stability of the local economy is important when deciding to invest in Tomorrowland. This is a developing country and if its economy grows very fast the hotel could benefit from this. If the economy is founded on tourism, it is highly dependant on the state of the economies in the home countries of tourists. Any recession in these countries could see the tourist industry suffer in Tomorrowland. Taxation and fiscal policies will also affect the decision to set up in Tomorrowland. Clearly low corporate taxation or incentives such as reliefs for investors will make the decision to locate the hotel there more attractive. Exchange rates will affect the cost of anything brought into the country and the cost of holidays taken by foreign tourists. If there is a cheap, skilled local labour force this will make the decision to invest more attractive.

Other factors you might have raised (i) Strategic factors (1) Social and cultural constraints GHG needs to consider the local attitude toward international brands in Tomorrowland where it may not be seen favourably as an 'outsider'. There is also the local attitude toward work and outside management to take into account. GHG will have to understand what these are and consider how to work within or despite existing attitudes.

(2)

Communication Language barriers are likely to exist and these must be addressed as early as possible to minimise any risks to GHG. (ii) Economic factors (1) (2) The availability of resources, especially suitable building materials and local labour need to be planned for early on in the building programme. Local and international legislation will affect the planned hotel. For instance, local planning and licensing laws in alcohol impact on the siting of the hotel and how it operates.

(b)

Cultural differences and their impact on the performance of a local workforce (i) Religious views. If members of the workforce belong to a religion which forbids alcohol and certain foods, they may object to working in an environment that encourages alcohol and a wide range of foods. They may also regard the dress of tourists on holiday as immodest and see their behaviour as Attitude to authority. It is possible that custom in Tomorrowland encourages long lunch breaks if the climate is hot during the height of the sun. This may conflict with construction timetables and hinder timely completion. When the hotel is open for operation this may remain an issue. Local workers may also regard management as having more authority and worthy of more respect than a 'western' employee would. This could help managers in issuing orders but may not encourage employees to be independent and think for themselves.

(ii)

(c)

Strategic management accounting – Unlike ‘traditional’ management accounting which looks primarily at internally generated financial information, strategic management accounting looks at information which relates to external factors, and it looks at non-financial as well as financial information. Market growth – Strategic management accounting will encourage GHG to look at market size and growth, and the company’s share of the market in Tomorrowland. Strategic management accounting’s external focus is very important: GHG needs to understand the market environment in Tommorowland in order to analyse the trading company’s current performance, and then to evaluate future strategies for the company.

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Answers

External factors – Developing an understanding of the market conditions and the external environment will be particularly important for GHG since Tomorrowland is 3,000 kilometres away from GHG’s next hotel. Therefore, GHG will need to build up its understanding of the local market in Tomorrowland. For example, if economic conditions in Tomorrowland are more favourable than in other countries, GHG might also be justified in expecting the hotel in Tomorrowland to perform better than hotels in other countries. Analysis of current performance – Strategic management accounting can also contribute to GHG’s success by monitoring the hotel’s performance and results and benchmarking them against its competitors. GHG can then assess whether its current strategy appears to be working successfully or not. For example, GHG could consider its room occupancy rates or its revenue per available room compared to its competitors. If it appears the company is performing relatively worse than its competitors, then GHG should consider how it could revise its strategy to help improve the company’s performance.

19 F4U
Text reference. Chapters 1, 8 and 10. Top tips. Part (a). Read the requirements carefully. The cost of capital is a 'money' rate so you need to adjust it to be able to use it in the calculations. Be careful with the timings of cash flows, remember to account for tax and note when the tax is due to be paid. We have used a proforma introduced in your earlier studies in Paper F9 to set out the calculations. You could also treat the annual cash flows as an annuity and discount them using the appropriate rate from the annuity table rather than the PV table. This would save you some time. The discount tables will be provided in the exam so you won't need to derive the discount factors. Ensure you make a recommendation on whether to go ahead with the franchise otherwise you lose a mark. Part (b). This is quite difficult as P5 doesn't cover intellectual capital in the syllabus, although it is a topic you should have covered earlier in your studies (eg P2). You will need to draw on that prior knowledge to understand what is needed here. As ever there is an element of how narrow performance measures can't satisfy modern performance measurement. So confine your answer to a brief definition and then discuss the issues as requested. What the examiner wants you to explain is why you think intellectual capital would be difficult to measure but why intellectual capital is included in financial statements nevertheless. Would the development of new franchises draw on any existing intellectual capital in F4U or would expertise need to be brought in? In part (c) the examiner touches on a theme which recurs throughout P5: that financial performance measures aren't sufficient to measure performance fully. Do non-financial measures help give a more rounded picture of performance? The examiner makes five main points and then expands on them which works out at one to two marks per point made. You can find ideas in Chapter 18. The question is unclear on whether you should relate your answer to F4U but we suggest you do so as the examiner always looks for evidence of application to the scenario in good answers. Part (d) tests attitude to risk which is covered in Chapter 1 and Paper F5. We have used the method in Chapter 1 to work out the three decision rules. You can pick out the data on demand, fee (price) and NPV from the table in the question. Examiner comments. Some candidates did very well but there were significant weaknesses that should be highlighted. These include being unable to calculate the correct discount rate in part(a) and guessing the meaning of intellectual capital in part (b). However there were many good answers to parts (c) and (d). Candidates either knew or didn't remember the decision rules. In the latter case they often made no attempt to answer this part thereby forfeiting seven marks.

Answers

173

Marking scheme
Marks

(a) Margin after tax Discount rate NPV Decision (b) Elements Issues (c) Comments (on merit) (d) Maximax Maximin Minimax regret criterion

2 2 1 1 4 4

6

Maximum 6 6

2 2 3 Total =

7 25

(a)

NPV of the Dance and Drama franchise proposal Year 0 $'000 (6,000) (6,000) 1.000 (6,000) 3,119 Year 1 $'000 3,600 (1,080) 2,520 2,520 0.901 2,271 Year 2 $'000 3,600 (1,080) 2,520 (1,000) 1,520 0.812 1,234 Year 3 $'000 3,600 (1,080) 2,520 (1,000) 1,520 0.731 1,111 Year 4 $'000 3,600 (1,080) 2,520 2,520 0.659 1,661 Year 5 $'000 3,600 (1,080) 2,520 2,520 0.593 1,494 Year 6 $'000 3,600 (1,080) 2,520 2,520 0.535 1,348

Net cash flows (W1) Taxation at 30% Net cash flow Initial investment/capital costs Net cash flow Discount factors (W2) Present value Net present value ('000)

The NPV of the franchise proposal is positive so the proposal should go ahead on this basis. Workings 1. Annual cash flows Revenues Variable costs Fixed costs Net cash flow 2. $ 300 × $20,000 300 × $6,000 $'000 6,000 (1,800) (600) 3,600

The relationship between the nominal or money rate of interest and the real rate is expressed as follows: (1 + i) = (1 + r)(1 + h) Where h r i = = = rate of inflation real rate of interest nominal (money) rate of interest

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Using the data in the question: (1+ 0.1544) = (1+ r) (1+0.4) 1.1544/1.04 = (1+r) 1.11 = (1+r) therefore r = 11%. This is the discount rate you should use in the NPV calculation. You can also treat the annual costs as an annuity and discount one-off costs at PV. All cash flows are stated in $'000: Net cash flow = $2,520 with an annuity rate for 11% over 6 years of 4.231 from the table. NPV = ($2,520 × 4.231) - $1,000 × 0.812 - $1,000 × 0.731 – $6,000 = $3,119.12 (b) Intellectual capital Intellectual assets, or 'intellectual capital' as they are sometimes called can be divided into three main types. (i) (ii) (iii) External assets. These include the reputation of brands and franchises and the strength of customer relationships. Internal assets. These include patents, trademarks and information held in customer databases. Competencies. These reflect the capabilities and skills of individuals.

'Intellectual assets' thus includes 'human assets'. In F4U, intellectual capital refers to assets including know-how and skills in franchising. It is intangible and therefore cannot be measured using traditional financial performance measures. Alternative measures would have to be used to measure competence. These could include number of new ideas or the skills of staff for instance their qualifications to do their role. F4U would need to think about the existing employee knowledge and expertise from franchising and whether any new expertise needs to be brought in to setup and market the franchises. There will be costs associated with this being recruitment and retention. (c) How reliance solely on financial performance measures can weaken performance management effectiveness (i) When managers concentrate on financial performance measures they ignore other important variables that cannot be stated in monetary terms. For instance, quality of service is a vital competitive activity in business but it can't be stated in money terms. In knowledge industries intangible factors such as innovation and learning need to be measured. Franchising involves innovation and know-how which are intangible. The balanced scorecard measures innovation and learning as one of its four perspectives. Some financial performance measures can lead to short-termism where managers focus on achieving annual returns at the expense of long-term investment. The use of ROCE is an example of this. By keeping old assets which have been written down, the measure of ROCE is improved but the business may be retaining assets past their most productive period. Concentrating on cutting costs is an example of looking solely at a financial measure of performance. When staff are laid off this may see a short-term cost reduction but motivation may suffer and good, experienced staff may be lost forever. Financial measures look backward at what has happened rather than trying to plan for the future. Managers cannot rely on past performance solely to guide them going forward.

(ii)

(iii)

(iv)

(v)

F4U should consider a range of performance measures for its franchising operation to overcome the issues listed above. Innovation is essential in the business but needs to be rewarded so a performance measurement system should capture data to enable this. Intelligence on competitors and on the market for franchises is essential. Outward looking measures then need to be used to capture the appropriate data. Using NPV to assess the dance and drama franchise looks at the financial consequences of undertaking the franchise into the future. This is a good measure of certain aspects of performance but fails to look at other aspects such as maintaining quality in franchisees. The project appraisal using NPV also only looks at a limited range of variables including one possible discount rate and one inflation rate. The business needs

Answers

175

to consider future demand using a range of variables, financial and non-financial. F4U could model possible outcomes using a range of inflation rates, cash flows and take up of franchises. (d) Franchise fee pricing strategy Maximax We need to maximise the maximum NPV. Demand/price 270/$22,000 300/$20,000 355/$18,000 Maximum NPV $4,274,183 $4,007,630 $4,348,226

Set a price of $18,000. This is a risk seeking approach, because if variable costs are higher than $5,000 then the NVP will be lower than if the other fee alternatives had been chosen. Maximin We need to maximise the minimum NPV. This is a risk averse strategy where managers play safe and strive to minimise their losses/costs. Demand/price Minimum NPV 270/$22,000 $2,674,865 300/$20,000 $2,230,610 355/$18,000 $2,245,419 Set a price of $22,000. Minimax regret We need to minimise the maximum regret (lost contribution) of making the wrong decision. Variable cost $'000 5 6 7 Maximum regret $18 0 (W) 177,702 429,446 429,446 Price ($'000) $20 340,596 355,404 444,255 444,255 $22 74,043 0 0 74,043

Minimax regret strategy is that which minimises the maximum regret ($74,043). A fee of $22 should therefore be selected. Workings The values in the table are calculated using the highest NPV for a level of variable cost less the actual NPV. So for example, at a variable cost of $5,000 the highest NPV is $4,348,226 and so the lost contribution if a price of $20 is selected rather than the $18 (optimum at that cost level) is $(4,348,226 – 4,007,630).

20 CAP
Text reference. Chapters 1 and 8. Top tips. Part (a) asks you to evaluate financial performance. You need to comment on the performance of CAP and come to a conclusion on this performance based on the figures you have calculated. You will only earn minimal marks for just calculating measures. We have included a table in our answer to keep our workings neat and you can refer to the table in your answer. Just select a few measures, four or five will do. The majority of the marks will be awarded for showing you can understand and comment on the measures. The information in the question guides you toward what measures to use and hints at a year on year comparison. Look at activity measures such as the revenue or profit per park. These tell you about what the business is doing as well as how well it is doing.

176

Answers

What does the P/E ratio tell you about the future prospects of CAP perceived by the market? How liquid is the company? Is it in a good position to cover its liabilities? Don't just write 'yes' or 'no' answers. At this level you must be willing to argue and come to a conclusion using the data you have calculated to support your points. The examiner awards half of the marks here, for evaluation, to measures of margin and the remainder for dividend, liquidity and PE measures. We suggest up to half a page to answer this part including a table for the calculations of year on year measures. Part (b) asks for a discussion on the proposed expansion using the environmental considerations. Use information in the scenario, and answer each of the three requirements separately. Part (c): You should have realised from the scenario that the expansion into Robland would be the first time CAP has operated outside Lizland. So, in effect, the question is asking you to discuss the potential issues with performance management in a multinational organisation; for example, practical issues such as how Jody Cundy can control operations in a country 3,200 kilometres away, or how variations in the ‘Rob’ could affect the performance which gets reported. Examiner comments. Most candidates used the scenario satisfactorily. Part (a) saw maximum marks for many candidates with very good evaluations of the financial performance, rather than simply providing calculations or ratio analysis. Part (b) was mainly acceptable but a significant number of candidates assumed retained earnings were available to finance the redemption of the preference shares or the expansion planned.

Marking scheme
Marks

(a)

Financial performance: Margin Dividend cover Liquidity Price earnings ratio Issues: Financial Economic Social Maximum 14 For each difficulty discussed, and related to the scenario: Up to 2 marks each Maximum 5

Up to 3 1 1 1

6

(b)

Up to 5 Up to 5 Up to 5 14

(c)

Up to 5 5 Total = 25

(a)

Jody Cundy (JC) has correctly perceived a difficulty in maintaining profitability in the Lizland parks. Workings are given in the table below.     Turnover has been falling since 20X7, in the latest year by 9.1% from 20X8. It is now $4.52m per park from $5.89m per park in 20X6. Profits have fallen from $60m in 20X6 to $40m in 20X6, or by 1/3 over three years. The average profit per park fell to $0.65m ($40m/62) in 20x9 from $1.07m ($60/56) in 20X6, a drop of 40%. Operating costs have also fallen, however, from $270m in 20X6 to $240m in 20X9, or by 11%. Despite this, net margins have suffered, falling from 18% in 20X6 to 14% in 20X9.

Answers

177

Before making a decision to move into Robland, JC should consider alternative options.   He could review revenue sources in Lizland, from both existing sites and new ones, rather than expanding overseas at a huge cost of $120m. He may be able to squeeze more cost savings out of existing operations given operating costs have increased from 81. 8% of turnover to 85.7% from 20X6 to 20X9. This does depend on the level of variable cost against fixed costs, as fixed costs are more difficult to cut in the short term. The split between variable and fixed costs is unknown. 20X6 60/330 = 18% 330/56 = 5.89 60/56 = 1.07 ((330-325)/325) × 100% = 1.5% (270/330) × 100% = 81.8% 20X7 56/320 = 17.5% 320/58 = 5.52 56/58 = 0.97 ((320-330)/330) × 100% = (3.0)% ((270 – 264)/270) × 100% = (2.2)% (264/320) × 100%= 82.5% 20X8 52/308 = 16.9% 308/60 = 5.13 52/60 = 0.87 ((308 – 320)/320) × 100% = (3.8)% ((264 – 256)/264) × 100%= (3.0)% (256/308) × 100% = 83.1% 20X9 40/280 = 14.3% 280/62 = 4.52 40/62 = 0.65 ((280 – 308)/308) × 100% = (9.1)% ((256 – 240)/256) × 100%= (6.25)% (240/280) × 100% = 85.7%

Workings Net profit margin % Turnover per park ($m) Net profit per park ($m) % fall()/rise in turnover % fall()/rise in operating costs Operating costs as % of turnover

Dividend cover of 1.5 ($(30m PAT - $9m pref shares div)/$14m dividend) for 20X9 is low and it may be difficult to keep up this level of dividend in future years if profits continue to fall. Liquidity is also a concern as the bank balance of $10m at 30 November 20X9 is insufficient to meet trade and other payables due at that date of $15m. The low PE ratio compared with industry average suggests the market has concerns over future prospects for CAP. The repayment of the redeemable preference shares may have caused this in part: CAP must find $110m in the next year but has only $120m in reserves at the latest year end. (b) Financial considerations JC will need to guarantee finance of $120m to fund the new parks, starting December 20X9. He also needs to fund the redemption of the preference shares, due in 20Y0, for $110m. Thus up to $230m needs to be found in the next year, though it is unlikely all of the parks will be built in 20X9. If construction costs can be staggered over several years then the immediate need for funds will be less, but inflation may mean final costs are more than $120m. There is only $122m of retained profits at 30 November 20X9. JC will need to raise funds by loan or share issue if he is going to fund all of these obligations.  He is reluctant to lose control, however, which he may do if he issues more shares. He must also consider how existing shareholders will see the expansion and if they will expect their level of dividend to be maintained. The company is already priced at a discount based on its PE ratio so shareholders regard the company as underperforming. If he agrees a loan then he may have to fulfil covenants relating to performance and will have to repay the loan and interest. Present trends in profitability may see lenders reluctant to lend unless the downward path ceases. However gearing is low and there is adequate security from net current assets ($30m) and non current assets ($220m). A third possibility is for CAP to obtain some funding from the government in Robland given that he will be investing in the company, bringing in revenue and probably jobs and tourism.

Economic considerations The market research indicated reasonable future prospects but gave no more detail on the economy of Robland. For instance, data on the size of the market, existing competition and structure of the economy would have been useful. JC should obtain more information on these factors as a minimum before he decides to invest in Robland. Government policy may favour industry investment rather than investment in pleasure parks. On the other hand, Robland may favour tourism and incentives could be available for inward investment including low tax

178

Answers

rates. Given the size of the investment, CAP should be clear on how the government of Robland views the investment and what incentives are available for a major investment in their economy. Finally, CAP needs to plan for exchange rate fluctuations if it is going to remit funds. There may be problems with remitting profits if these are made in an unstable currency or one which may devalue against CAP's own currency leading to significant losses on exchange. CAP should therefore decide whether to hedge for any fluctuations between the Rob and CAP's own currency ($). Social considerations The market research indicated reasonable future prospects for investment in Robland. If Robland is a developing country, it may have little infrastructure and industry and these may take time to develop and the standard of living to rise. There will be few local consumers of pleasure activities if the consumers cannot afford entry. If Robland is a mature economy, with a high standard of living and ample leisure time, then the parks could do very well. The research didn't comment on how the investment would be seen locally. For instance setting up parks in a country with strong religious laws may see locals reluctant to work in construction or be employed by the parks at certain times. Some countries have traditions of afternoon rest which would not suit an all-day amusement park. There may be local customs governing how people in authority are respected and the role of women and minorities. This affects the operation of the parks. JC needs to seek local professional advice on these issues and others, including rates of pay and legal responsibilities in employment. (c) Impact of becoming an interantional company Currently, CAP operates entirely within Lizland, so the expansion into Robland means that it will become an international company for the first time. Performance measurement and performance management in an international company will bring different challenges compared to managing a company in a single country. Performance comparisons - When assessing the performance of the forty Aqua Parks in Robland, CAP will need to allow for any differences in economic conditions between Robland and Lizland; for example, the potential impact of different inflation rates on revenue and cost figures, or the wider impacts of there being different economic growth rates in the two countries. If economic conditions in Lizland are different than in Robland, it may be unrealistic for CAP to compare the financial performance of the parks in the two countries on a like-for-like basis. Any such differences in the economic conditions between Robland and Lizland could also make it harder to set reliable budgets for the Robland business, particularly in the early years of its operation, because there will be little (if any) comparative performance information to base budgets and performance targets on. Moreover, the distance between Robland and Lizland means that CAP may have imperfect knowledge and the market conditions in Robland. Local management – It is not clear from the scenario who will be managing the new parks in Robland; for example, whether expatriate managers from Lizland will be used, or whether local managers from Robland will be used. In choosing which approach to take, CAP will need to consider practical issues such as any language or cultural differences between the two countries (which may mean it is preferable to use local managers). On the other hand, CAP may prefer to use experienced managers from Lizland to ensure that its new operations in a similar way, and with similar standards of quality and customer service, than its existing operations. Although Jody’s statement that he always wants to control the business relates to its share capital, it may reflect a wider desire to keep tight controls over the business. In which case, Jody may prefer to use experienced managers to manage the new parks.

Answers

179

Geographical distance - Nonetheless, the distance between Robland and Lizland could make it harder for Jody to manage the new parks than it would be to manage the existing parks. In particular, it will be more time-consuming for Jody to visit the parks in person to see how they are operating. Management accounting information – In this respect, it is likely that Jody will want the management information produced by the new parks to be in a similar format to the existing parks, to assist comparison between them and to see how CAP group as a whole is performing. However, there may be differences in the accounting policies used in Robland compared to Lizland, which could mean that the results are not necessarily comparable. For example, if assets are valued differently in Robland compared to Lizland this could lead to difficulties in comparing performance using ROI or RI as performance measures.

21 EMA
Chapter references. Chapter 4. Top tips. Part (a) is not complicated but you need to take a bit of care especially when working out the number of lessons available at the riding school. Part (b)(i) draws on prior knowledge from F5. Ensure you draw up your table as requested so you need to show net profit or loss, combined probabilities and the expected value of net profit or loss. Part (b)(ii) also tests your prior knowledge. In F5 you looked at risk attitudes and this is what this part is referring to. Part (b)(iii) wants you to think more broadly. What does the government promote? Is the new venture likely to be profitable given what you know about demand. Easy marks. The marking scheme for part (a) gives lots of little marks for small calculations so you can get a few easy marks here. Examiner comments. Candidates' answers varied significantly with most producing excellent answers in part (a) but many struggled in part (b) where they were asked to find an expected value. Part (b) (iii) was generally wellanswered but some candidates didn't read the question and supplied six reasons rather than the three asked for. (a) Statement of net profit or loss Budget College $'000 Fee income Surgery (30%) Dentistry (25%) Business management (45%) 1,200  0.30  $12,000 1,200  0.25  $10,000 1,200  0.45  $6,000  1.05 Budgeted fee income Costs $6,500 x 1.04 11,088 (6,760) 4,328 4,320 3,000 3,240 10,560 Beginner (50%) Competent (25%) Advanced (25%) School $'000 245,760 (W)  0.50  $15 245,760  0.25  $30 x 1.10 245,760  0.25  $50 x 1.10 1,843.20 2,027.52 3,379.20

7,249.92

$5,750 x 1.06

Total budgeted profit of EMA (W): Total number of lessons: 320 days  4  240  80% = 245,760

(6,095.00) 1,154.92 4,328.00 5,482.92

180

Answers

(b)

(i)

Expected value table for EMA
% change in fee income No change Equine college prob (p1) 0.20 0.20 0.20 0.60 0.60 0.60 0.20 0.20 0.20 Riding school prob (p2) 0.10 0.60 0.30 0.10 0.60 0.30 0.10 0.60 0.30 Combined prob College revenue $ 11,088,000 11,088,000 11,088,000 9,979,200 9,979,200 9,979,200 8,870,400 8,870,400 8,870,400 Riding school revenue $ 8,156,160 7,249,920 6,343,680 8,156,160 7,249,920 6,343,680 8,156,160 7,249,920 6,343,680 Total revenue $ 19,244,160 18,337,920 17,431,680 18,135,360 17,229,120 16,322,880 17,026,560 16,120,320 15,214,080 Total costs $ 12,855,000 12,855,000 12,855,000 12,855,000 12,855,000 12,855,000 12,855,000 Net profit or loss $ 6,389,160 5,482,920 4,576,680 5,280,360 4,374,120 3,467,880 4,171,560 $ = Total $ x p1xp2 127,783.20 657,950.40 274,600.80 316,821.60 1,574,683.20 624,218.40 83,431.20 391,838.40 141,544.80 4,192,872.00

0.02 0.12 0.06 0.06 0.36 0.18 0.02 0.12 0.06 1.00

Decrease by 10%

Decrease by 20%

12,855,000 3,265,320 12,855,000 2,359,080 Expected value of net profit

(ii)

The use of expected values Expected values attempt to model outcomes based on a range of likely probabilities. The choice of probabilities depends on the risk profile of the manager doing the modelling. A risk-averse manager would focus on the likelihood of the worst outcome occurring. However, the risk neutral manager will focus on the most likely outcome or the expected value here, rather than probabilities, as here, which suggests the management of EMA have a risk-neutral attitude.

(iii)

Three reasons why the government of Hartland might decide to open an academy with an equine college and riding school The government of Hartland promotes environmental initiatives which would preserve the environment of Hartland. A new riding school and college would further encourage the use of horses as transport and for leisure. This may also lead to the need for more veterinary surgeons as more horses will be used. The government may also have in mind competition for the existing establishment or regulation of the industry or even offering cheaper or free opportunities for students as part of state provision. Hartland may also see plenty of revenue opportunities as the current college operated at full capacity in 20Y0 suggesting the demand for courses is more than current availability.

22 FGH Telecom
Text reference. Chapters 4 (for environmental factors) and 16 (for issues around environmental management accounting). Top tips. Part (a) asks you to evaluate how well the environmental strategy is aligned to stakeholder interests. So it is important that you link the stakeholders’ interests directly to the strategy, and don’t just talk about stakeholders in generic terms. Also note that part (a) is only worth 5 marks, so don’t spend too long on this part of the question. Part (b) asks for an environmental assessment. You could use PEST/PESTEL as these provide a structured analysis. However, you then need to suggest suitable performance indicators for each factor. Remember, performance indicators need to be measurable. To score well, the performance indicators you suggest need to be well explained. So, for example, a vague reference to competitor reviews for instance is not sufficient, and would score few marks. Part (c) asks for an evaluation of the data in the table. What categories could be used to summarise the data? Remember to refer to the company’s stated goal and how it is a long term goal. The company is part-way though the period covered by the goal so do you think it is on target for reaching a 60% reduction by 20Y7? At this level you need to take an overall view of performance measurement so think about overall performance not just the detail. In part (d) think of what factors affect the data – miles travelled for instance using each form of transport.

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181

Marking scheme
Marks

(a)

Up to 2 marks for the interests of each stakeholder group evaluated in relation to the environmental strategy. Maximum of 5. 1 mark per factor identified as relevant for each section of the broad sections of the analysis (PEST or PESTEL sections are appropriate and competition could be an additional area considered). Up to 1 mark for each performance indicator relevant to the factors identified. Maximum of 8. Up to 4 marks for analysis of basic data, commenting on overall picture and achievement of target. Up to 2 marks for simplifying data into broad categories and commenting Up to 4 marks for analysis of mix of methods of travel and commenting (Another acceptable categorisation could be related to fuel type: petrol, diesel and aviation – rail is problematic as it is a mix of diesel and electricity but reasonable assumptions will be acceptable) Maximum of 9 marks. 1 mark per point reasonably made up to 3 marks.

5

(a)

8

(b)

9 3 Total = 25

(c)

(a)

Shareholders –The tough economic environment, in conjunction with the competitive nature of the telecommunications sector, are likely to mean shareholders will be particularly concerned about the level of profits which FGH can maintain. The environmental strategy could be particularly useful for two reasons in this respect:  It can save costs and increase efficiency through reducing resource usage  It could lead to increased sales as a result of improved reputation amongst customers Government – Government has been calling for change from the business community in relation to environmental issues, and FGH have taken action which are designed to bring about these changes. If organisations (such as FGH) reduce their environmental footprints voluntarily, this will reduce the need for government to impose regulation and legislation in order to encourage better performance. Public – Like government, sections of the public have been calling for change from the business community in relation to environmental issues. If it can demonstrate that it has responded to these calls, FGH should be able to benefit from an improved reputation amongst customers and potential customers. Employees – Although it is not clear from the scenario whether FGH’s employees prefer working at home to commuting into an office, it is likely that a number of them will. In which case, they will be pleased with the impact of the strategy on their day-to-day life, regardless of the environmental benefits of the strategy. If other employers prefer working in the office rather than working at home, they are likely to resent the new initiative. By contrast, the content of some employees’ work may mean that they cannot work from home, in which case the homeworking initiative is unlikely to affect them, so they may have little interest in it at all. Similarly, it is not clear whether the employees prefer teleconferences to the travel required to attend regular meetings, but again, it is likely that at least some will be pleased with the reduced amount of travelling they have to do.

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Answers

(b)

Regulation and legislation - FGH’s environmental strategy will be directly affected by increased regulation and legislation from government. These would include recycling targets for materials, and limits on emissions such as pollution and waste levels. Carbon levies may be an additional tax. Performance indicators which FGH could use to monitor its progress include the cost of additional recycling, fines for failing to meet regulations and targets, and the cost of a carbon levy. Economic factors – Economic factors which could affect FGH’s strategy include the difficulty in obtain capital (through the debt or equity markets) as well as general factors such as inflation, interest rates and exchange rates. The difficulties in raising capital through the debt or equity markets could be monitored through FGH’s cost of capital. This could be particularly important if any environmental initiatives is considering would require significant capital expenditure in order to implement. The touch economic environment is also likely to mean that firms will find it difficult to maintain their profits, so any cost savings from reductions in energy use could be useful to help offset any fall in profits. Social factors - The general public has an impact on FGH’s environmental strategy as they use its products and are calling for reductions in emissions. So, for example, if FGH is known to be more environmentally friendly than other telecommunications providers, this may improve its brand image and may prompt consumers to switch to FGH in preference to other providers. A suitable performance indicator could be to measure the perceived image of FGH by means of a customer survey. Technological factors - Finally technological change will affect FGH’s environmental strategy as it can adopt new technologies such as electric and hybrid cars, and new technologies for storing and capturing energy such as recharging solar cells which could be used in production. Performance indicators would require the measurement of how new technologies affect existing emissions data.

(c)

Progress to date- The company has set itself a target of reducing emissions by 60% of their 20X1 value by 20Y7 (16 years). In total it has been able to cut emissions by 38% in nine years from 20X1 to 20Y0 (106.6/172.6). In just the last year (20X9 to 20Y0) it has cut emissions by 16% (106.6/127.5). However, this optimistic rate may not necessarily continue as emissions become increasingly hard to cut when the easier targets have been met in the early years of the programme. Modes of transport - The data used can be usefully summarised into road, rail and air and the individual measures included under each. Detail of the data is included in Appendix 1 below. In summary, rail travel has seen a decrease of 63%, the largest across the categories, then road travel which as seen a reduction of 38% and the least in air travel which saw a decrease of only 16% over the nine years. Both the first two categories are decreasing at a rate well within the target of 60% as the falls already achieved are at least 38% with seven years to go. The problem with air transport may reflect increasing globalisation and the need to travel to meet clients and have meetings. If the composition of the three types of transport are analysed in the base year of 20X1 and compared with 20Y0 it is clear that air travel has increased slightly from 6% to 8% of total travel whilst rail travel has fallen by the same amount which may explain part of its success in reducing emissions. However, the reason for this may be a change in the emissions technology relating to each category travelled rather than the number of miles travelled by each method. Looking in detail at each category, the largest trend is a move from commercial petrol vehicles to commercial diesel vehicles whereby there are nil emissions in 20Y0 from petrol vehicles. This reduction is easier to achieve with the commercial fleet than the other types of car as there may be an element of choice exercised by employees in the other categories for instance company cars.

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183

(d)

Total distances travelled - One key area that could be measured is the number of miles total distances travelled by employees so that the impact of the changes on employee behaviour can be monitored. This would allow the assessment of the home working scheme to see how far employees commute and the effect on this of working from home. It would also allow FGH to measure how much travel is done by air and the effect of moving from travelling to meetings by air and alternatives such as teleconferencing. The data could also be used to calculate the effect of switching transport by calculating average emissions per kilometre travelled. Appendix 1 Measured in millions of kgs Commercial Fleet Diesel Commercial Fleet Petrol Company Car Diesel Company Petrol Other road travel (Diesel) Other road travel (Petrol) Rail travel Air Travel (short haul) Air Travel (long haul) Hire Cars (Diesel) Hire Cars (Petrol) Total Index 20X1 Base year 105.4 11.6 15.1 10.3 0.5 3.1 9.2 5.0 5.1 0.6 6.7 172.6 100% Year on year change 20X9 77.7 0.4 14.5 3.8 1.6 0.5 9.6 4.4 7.1 1.8 6.1 127.5 74% –16% 20Y0 70.1 0.0 12.0 2.2 1.1 0.3 3.4 3.1 5.4 2.9 6.1 106.6 62% Change on base year –33% –100% –21% –79% 120% –90% –63% –38% 6% 383% –9%

Simplifying categories 20X1 Base year 153.3 10.1 9.2 172.6 20X9 106.4 11.5 9.6 127.5 20Y0 94.7 8.5 3.4 106.6 Change on base year –38% –16% –63% –38%

Road travel Air travel Rail travel Total Mix of travel methods in each year

Road travel Air travel Rail travel

20X1 Base year 89% 6% 5%

20X9 83% 9% 8%

20Y0 89% 8% 3%

184

Answers

23 SQR Sports racquets
Text reference: PESTEL analysis and Porter’s Five Forces are covered in Chapter 4 of the BPP Study text. You should be familiar with the concept of product life cycles from P3, but they are revisited in Chapter 15 of the P5 Study Text. Top Tips: Part (a). Although the requirement invites you to select ‘appropriate models’ the references to the external environment in which SQR is operating should have indicated that PESTEL analysis and Porter’s Five Forces model should be appropriate models to use here. (Opportunities and Threats from SWOT analysis would also be appropriate, but Strengths and Weaknesses would not be). The key issue which is concerning the directors about the budget is the expected decline in profit margins. So when you are applying the models to the scenario, think how they could be useful to help the directors understand whether the lower profit margins look reasonable. For example, if the majority of the forces identified by Porter’s Five Forces model are strengthening this would suggest that it is harder to sustain a profit in the industry as a whole, and so by implication it may also be harder for SQR to sustain its profit levels. Part (b). The scenario highlights, amongst other things, that the industry has become increasingly competitive and that SQR has had to reinvest much more money into research and development to remain competitive. However, SQR has remained in a relatively strong financial position, although margins have now started to fall. Think about how sales and profit levels are expected in the different stages of the product life cycle, and how the levels of competition vary. What impacts would you expect these factors to have on SQR’s performance? Note: In our suggested solution below we have treated the product life cycle as the life cycle for sports racquets as a whole. You could also have considered the product life cycle for individual makes of racquet – in which case, the life cycle is much shorter, and is likely to become even shorter as the competition in the market increases. (a) SQR’s most recent budget showed an expected fall in profit margins, which concerned the directors. However, it is important that the directors understand the logic behind these lower margins, and there are a number of factors in the macro-environment and the industry environment which can help them gain the necessary understanding. Although SQR has historically performed well, it is important that the directors’ expectations for the future are not over-optimistic. Considering the external environment will help to identify threats which could have an impact on SQR’s performance in the future. Equally, however, environmental analysis should also help SQR identify possibly opportunities which could generate additional revenues and profits in future. Macro-environment – PESTEL analysis Technical influences The improvements to raquet design and construction are a major factor here. SQR needs to continue to respond to changes in this area by continuing to invest substantially in racquet development, utilising the latest materials and designs. In this respect, SQR needs to provide sufficient investment to allow it to remain competitive in the long run, even if this investment may reduce measures of profitability in the short term. There are also implications for staffing here: SQR may need to recruit (and then retain) suitable design consultants to ensure its racquets remain leading edge. Production techniques – SQR needs to ensure that it is using the latest techniques and production methods so that it is able to produce the latest designs and shapes to meet consumer demand. However, SQR also needs the flexibility to respond quickly to changes in consumer tastes and preferences. The scenario identifies that SQR has had to make significant changes to its production techniques and its traditional methods of production. However, it is not clear what impact this is having SQR’s costs. For example, SQR to what degree are the racquets still hand-made by craftsmen, and how far is the production process now automated?

Answers

185

Obsolescence – Frequent technological changes and changes in consumer demand can also make existing product ranges obsolete more quickly. Again, this could have a direct effect on SQR’s profits if it has to sell stock at a discount or write it off. Economic influences Tough economic conditions – Because SQR sells all of its racquets through a UK-based shop its sales are likely to be affected by economic conditions in the UK. The UK economy has been bordering on recession in recent years, but SQR managed to retain a relatively strong financial position. If the UK economy remains depressed, disposable income will remain relatively low, and this will have an adverse effect on the demand for discretionary expenditure on items such as sports racquets. However, the scenario does not make clear whether the economic conditions for the coming year are forecast to be worse than the current year. The reduction in profit margins might suggest that they are, but there must be a degree of uncertainty about any such prediction. Exchange rates – SQR appears to be facing increasing competition from France, Germany and the Far Eastern countries. However, variations in exchange rates could affect the price UK consumers have to pay for these imported racquets, and thereby affect their desirability relative to SQR’s racquets. For example, if the UK pound weakens against the Euro, ultimately the price of goods imported from France and Germany will become more expensive in the UK. (In a similar manner, SQR should consider the levels of inflation in the UK relative to the other countries, because this will affect production costs, and therefore either prices or margins.) However, a related question for the directors to consider is whether consumers choose which racquet to buy on grounds of price, or whether, for example they are loyal to a particular brand. Social Leisure demand - In general terms the public is becoming more and more health and fitness conscious, and racquet sports such as tennis and badminton are still very popular. This should help sustain demand for SQR’s racquets. In this context, social factors (sustaining demand) appear to be working in the opposite direction to economic factors, so it is important for SQR to assess which set of factors its thinks will have a greater impact on its business in the coming year. Porter's Five Forces Bargaining power of customers It appears that, in effect, SQR is dependent on a single customer (the nationwide sports chain) for its revenue. This dependence could be a major risk for the long term viability of the company. SQR is operating in a rapidly changing environment and new competitors are emerging all the time, both nationally and internationally. If the sports chain decided to stop selling SQR’s products (in favour of one of these competitors’ products) SQR’s revenue would decline disastrously - unless it could persuade another retailer to stock its racquets. The apparent imbalance of power in the relationship between the SQR and the retailer, are likely to depress the margins SQR earns on its products. One way SQR could look to address this issue is by developing its own website so that it can increase the number of racquets it sells directly to the public. Having a website would also mean that SQR could sell racquets outside the UK, whereas at the moment it is limited to a single geographical market.

186

Answers

Threat from new entrants The threat of new entrants is another major threat SQR faces. SQR currently has the advantage of existing capacity, an established customer, and an established reputation/brand name, and the other producers will be in a similar position. These characteristics (particularly brand names) may serve to act as a barrier to entry to some extent, but a number of new racquet producers have emerged in recent years, suggesting that the barriers to entry are not very strong. SQR’s strategy appears to be based more on quality and craftsmanship, rather than low cost and mass production, so although it may benefit from economies of scale, these are unlikely to act as a barrier to entry for potential new entrants. However, the availability of skilled craftsmen and racquet designers may be restricted, so this may hinder new entrants trying to join the industry. Competitive rivalry The emergence of new producers (in France, Germany and the Far East) has led to the market becoming increasingly competitive. This could be a major factor in profit margins becoming lower. Market growth - The speed at which the markets for sports racquets are growing overall could also be important here. The squash market enjoyed rapid growth in the early 1990s, but growth rates seem to have slowed subsequently. Again, competition is likely to become more intense as the growth rate in markets fall, and this is also likely to lead to a fall in profit margins. Marketing expenditure - If competition is intensifying, SQR may also need to increase its marketing expenditure to encourage consumers to remain loyal to the SQR brand rather than buying a rival product. As a result, part of the fall in profit margins may come from an increase in marketing expenditure. (The scenario does not give any detail about the budgeted figures, or what contributed to the reduced margin). Importance of strategy - One of the main factors behind SQR’s growth and success has been the quality of its racquets. This suggests SQR will enjoy a substantial mark-up on each racquet, but the new entrants may be prepared to sacrifice profit mark-up (particularly in the short term) and compete by price cutting in order to penetrate the market. If this is the case, then the directors need to ensure that SQR has an appropriate strategy in place to ensure that it can compete effectively. It seems that the most likely strategy will be one based on quality and product differentiation. However, it is important that the assumptions used in the budget reflect this approach: for example, sufficient resources are allocated to quality control and quality assurance. Conclusion The threats from substitutes and from the bargaining power of suppliers are likely to be lower than those from the other three of the Five Forces. Nevertheless, the strength of the three forces we have looked at in more detail suggests that it may be increasingly difficult for SQR to sustain profit margins at the level the directors might like. Moreover, SQR appears to be operating in an industry which is experiencing significant changes to its environment. SQR has to be aware of these changes and adapt its design, production and marketing strategies to take account of them. However, the decline in profit margins should also prompt the directors to look internally at SQR’s value chain as well as looking externally at environment influences. For example, it may be beneficial for SQR to set up a website to sell racquets directly to consumers. (b) Growth rates – In the few years at the end of the 1990s and at the beginning of the 20th century, SQR’s revenue and earnings grew impressively as a result of the growth in the tennis and badminton markets. However, although SQR has remained in a relatively strong financial position, it seems that the rate of sales growth from the end of the 1990s has not been maintained. This suggests that the market for these racquets as a whole has reached the mature stage of its life cycle. However, although profit levels may start to decline during the mature phase, they should remain good. This suggests that SQR should be able to remain profitable, despite the tougher economic climate.

Answers

187

However, SQR may find it harder to increase sales, as many purchases will come from existing customers replacing raquets, rather than new customers buying a raquet for the first time. Therefore, customer retention could be a key success factor for SQR. Competitive market – The market has become increasingly competitive as rival firms have joined, and have incorporated new technology and new materials into their products. The entry of new competitors into the market, and the increasing complexity of products, could both be seen as characteristics of the growth stage of a product life cycle. Product features - However, in the growth stage, products need to have additional features to differentiate them from their competitors as buyers become more sophisticated. This appears to be the case for SQR as players want raquets that are made using the latest materials and technologies. This highlights the importance of SQR investing significant amounts of money into research and development in order to remain competitive. Equally, however, if racquets as a generic product are now in the mature phase of their life cycles, this also means it is important for SQR to control its costs, so that it can continue to be profitable as customers become increasingly price sensitive. Price sensitivity is a characteristic of the mature phase of the product life cycle.

24 Handra
Text reference. The difference between strategic and operational information is covered in Chapter 1 of the BPP study text. Performance management information systems are covered in Chapter 5. Top tips. Part (a) may seem relatively straightforward, although you need to provide sensible examples of the different types of information that may apply to Handra. Part (b) should also be relatively straightforward. The scenario has highlighted that the quality, reliability and functional features of Handra’s equipment are important to customers, so it is important for Handra to monitor how well it is performing in these areas. But cost control and profitability are also important, so it cannot afford to overlook them. Part (c) may need some careful thought. One sensible approach might be to consider what the objectives of management accounting (and management accounting information) are, and then consider whether the current management accounting system at Handra provides the appropriate information. Part (a) could be a useful link here, by encouraging you to think whether the current system provides information which is suitable for the different levels of the hierarchy (strategic; tactical and operational). Part (d) also picks up on this idea. If more responsibility is being delegated to the employees, they will need operational information to be able to assess their performance. But does Handra’s current system provide any (operational) information which would be useful to the employees working on the factory floor? (a) Strategic, tactical and management information are classifications of information that distinguish the purposes for which that information is used. The classifications can also be used to distinguish the type of information that is used at different levels in an organisation with a hierarchical management structure. Strategic information - Strategic information is used for strategic decision-making. It often relates to longterm objectives and performance, and to matters that are external to the organisation. For Handra, relevant strategic information would include information about competitors in the market. It appears that a competitor may be in financial difficulty; it may be useful for Handra to know more about this and the reasons why the competitor may be in difficulty. It would also be useful to have information about how rival organisations may respond to any competitive initiative by Handra. The management of Handra would also benefit from strategic information about technological developments in the industry, the possibility of rising water and energy prices, or even the possibility of government action to discourage excessive energy use by business organisations. Tactical information - Tactical information is generally associated with planning and control activities within the framework of annual budgets or plans. It is information to help management make decisions for

188

Answers

planning, or for monitoring actual performance against the budget expectation, and also to manage spending and efficiency within the organisation. Tactical information can include both non-financial and financial information. Examples of tactical information include budgets, variance reports for control purposes, efficiency and capacity ratios, and summary information about quality failures (re-working of faulty items and items returned under warranty) and on-time deliveries. Operational information - Operational information is information provided to management, supervisors and other employees at a day-to-day operational level. It is usually detailed information and much of it is nonfinancial in nature. It is needed to help individuals to do their day-to-day work. Examples of operational information include detailed information about throughput times, machine failures and downtime, bottlenecks, complaints, quantities of rejected items and so on. Information systems should provide sufficient relevant information for decision-making at all levels and for all management an operational purposes within the organisation. When information is not sufficient, there is a much greater risk of inappropriate decision-making by management. (b) Importance of non-financial measures – The quality and reliability of the equipment that Handra produces could both potentially be critical success factors for Handra because they are likely to be important in customers’ buying decisions. By performing well in these areas, Handra should be better placed to sustain its financial performance than if it performs badly in them. For example, if it provides its customers with high quality, reliable equipment, this should ensure a high level of customer retention, which should in turn help it maintain its revenues. In this way, there would seem to be a strong link between non-financial performance and financial performance. Importance of financial measures – However, it is also important that Handra continues to monitor its financial performance, because there is no guarantee that favourable non-financial performance will necessarily translate into favourable financial performance. For example, although Handra’s equipment may be very reliable, if it is significantly more expensive than competitors’, customers may choose to buy the competitors’ equipment instead. Also, the directors have already highlighted the importance of reducing costs in order to improve profitability. This identifies the importance of monitoring financial performance, in order to assess how successfully Handra is reducing its costs and improving profitability. Combination of measures – Handra’s profit margins are known to be low, as a result of the intense competition in the market. This reinforces the need to monitor aspects of its financial performance (such as costs and margins). However, it is equally important to monitor whether sales and market share are increasing or decreasing in this competitive market, and how Handra is performing in relation to the other critical success factors which will affect customers buying decisions. Efficiency measures – Handra’s costs and margins are also likely to be affected, at least to some extent, by operational efficiency. Measures of efficiency (such as machine utilisation or capacity utilisation usage, for example) could be seen as non-financial performance measures, but they are also closely related to financial performance. (c) Focus on tactical information - The cost and management accounting system of Hydra appears to provide information about product costs, including standard costs, and also monthly variance analysis reports. This should help management to prepare budgets and then control performance at a tactical level by providing comparisons between actual and standard or budgeted costs. The system presumably also produces estimates of cash flows for the purposes of DCF analysis, because a decision was taken not to invest because the rate of return was insufficient. Lack of strategic information - Management accounting should provide information to assist and support decision-making by management. Information is needed at a strategic as well as a tactical level. Much strategic information is forward-looking and long-term in nature, whereas budgetary control variance reports are historical and most budgets do not plan beyond the next financial year.

Answers

189

Strategic management accounting information should also include non-financial as well as financial information, such as information about customer needs and customer satisfaction, competitive advantage and product differentiation. It seems that Handra does not have a management accounting system that provides strategic information, and the current system is therefore incompatible with the purposes of management accounting. Focus on cost - The current management accounting information system appears to focus exclusively on cost. Competition is strong and profit margins are low; therefore it is appropriate to consider costs and cost control. However, customer buying decisions are influenced by quality and product design considerations and it is therefore appropriate to provide management information about these aspects of performance as well as cost. A lack of information about these matters indicates a weakness in the information system. Investment decisions - The decision against investing in the new machines may also indicate a weakness in the current management accounting system. The decision was presumably based on estimates of net present value or IRR, but the possible future rises in water and energy costs may have been omitted from the assessment. In retrospect, if the costs of water and energy increase significantly, the decision not to invest in the machinery may turn out to be a bad one. At the very least, the board should have considered this issue when it made the decision about the investment. If it failed to do so, this would suggest a weakness in the current management accounting information. The management accountant of Handra is unwise to be satisfied with the current management accounting system. By failing to provide non-financial information and strategic information, it is not fulfilling the purpose of management accounting, to support well-considered decision-making. (d) If employees in the manufacturing units are empowered, and given some authority to take decisions affecting production operations, they will need information to help them to make decisions and to provide them with feedback about the effects of their decisions. Much more information will have to be made available to them, although much of this information will probably be operational (and so non-financial) in nature. Budgetary control information is unlikely to be of much value, unless the employees are involved in setting standards and budgets, because they will not accept responsibility for plans and targets with which they have not been involved. It may also be necessary to provide an information system in which information can be exchanged between employees in different areas of manufacturing operations, with horizontal rather than vertical information flows.

25 FDS Irrigation systems
Text reference. Sources of management information are covered in Chapter 6. Top tips. Internal sources of information and the cost and value of accounting information or performance reporting systems should be a fairly straightforward topic, but the challenge with this question is to apply general principles to a particular scenario and company. This is specifically the case with part (a) of this question. You are not asked to discuss information requirements or sources of data in general terms, but specifically in relation to FDS. Part (b) - The main benefit of the new system should be that it allows FDS’s management to have better information about the profitability of different types of contract. This is the key point behind part (b). How will FDS’s management be able to use this information to improve the company’s performance? In effect part (c) is picking up the point raised by the CEO about the costs and benefits of the system. What costs will be involved in obtaining and producing the information? But perhaps even more importantly, how can FDS measure the benefit of the system to work out whether it is worth introducing?

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Answers

(a)

A customer profitability reporting system for FDS will presumably categorise customers into four types: farmers, local government bodies, sports centres and building contractors. It would be possible to have a project costing system, whereby costs and revenues are attributed to individual projects, and the profitability of each category of customers would then be calculated as the total profits of all the projects for that customer type. Sources of information The revenue for each project can be found from the contract agreed with the customer or from the invoices raised for the work done. Direct costs The related cost information for the costs directly associated with project should also be obtainable from internal sources. (i) The costs of materials for each project would be recorded from the documents for requisitioning materials to the project, and materials would be priced either from inventory records or from purchase invoices from suppliers. The costs of labour working on site for each project should be obtained from time sheets and payroll records. The cost of plant hire from each project should be obtained from invoices from plant hire companies. If FDS owns its own plant, records should be kept of the use of plant on each project and a charge for depreciation can be made to a project on the basis of the time that the plant is on the project site.

(ii) (iii)

Overhead costs To establish a customer profitability reporting system, it will probably be necessary for FDS to record some costs that in the past may have been accounted for as general overheads. (i) The cost of the sales effort to win contracts should be recorded and charged to contracts. For customer profitability reporting, the cost of salesmen’s time and expenses should include the cost of unsuccessful sales effort as well as successfully negotiated contracts. A system of recording time spent selling, and related expenses, will be required. Time sheets can be used to record time, and expense claims should indicate which expenses were incurred o particular projects or types of customer. Irrigation systems presumably have to be planned, and some contracts are more complex than others. The time spent by planners on the design of the system for each contract should be recorded on time sheets. Costs of delivering inventory to the customer’s site should be recorded. The costs will include the time of drivers and their assistants, together with fuel costs. It is possible that an average cost per tonne-kilometre carried may be used as a standard delivery cost. This could be estimated from delivery records in the transport department. If external delivery firms are used to deliver inventory, invoices can be attributed directly to individual projects. The cost of holding inventory may be considered a significant cost. If so, a cost of holding inventory can be calculated for each project from the cost of the inventory on site, the time from purchase of the inventory to payment by the customer, and an appropriate cost of interest or capital for FDS. If some maintenance costs are included within the price of a contract (for example if maintenance is provided free for a time after installation), maintenance times for engineers and any direct expenses should be recorded and charged to each contract. If there are miscellaneous directly attributable costs to projects, a system may be required to capture this cost data and attribute it to individual projects or customer types.

(ii)

(iii)

(iv)

(v)

(vi)

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(b)

Highlight differences in profitability - The purpose of a customer profitability reporting system should be to provide information that will help management to monitor and control the profitability of contracts for each type of customer. However, this information will only have value if costs differ significantly between different types of customer. It appears that farmers often negotiate lower prices than some other groups, which might initially suggest that the profitability of farming contracts will be lower than for other contracts. However, negotiations with local government bodies may be lengthy and the contracts may be complex, suggesting that selling and planning times and costs may be high for this type of customer. Equally for sports centres, there is often difficulty with delivering materials to the customer’s site which means that delivery costs of materials to site and costs of completing projects may be more than for other types of customer. Therefore, there is a degree of uncertainty about how profitable each type of contract actually is, if all the relevant costs are included. However, as the management accountant has suggested, it is important the FDS understands the profitability of different types of contract; either so that it can focus its attention on the most profitable contracts, or so that it can increase the profitability of other types of contract (for example, by reducing the level of discounts it is prepared to give to farmers). Decision making – The potential differences in the profitability of different types of contract become even more important as FDS gets closer to full capacity. FDS needs to ensure that it accepts the contracts which will generate the highest contributions to profit. Of the three installations FDS has recently been asked to undertake, the ‘Farm’ installation generates a significantly lower contribution to profit than the ‘Sports Centre’ or the one for the ‘Building Contractor.’ This would suggest that FDS should not accept the ‘Farm’ contract. Sports centre Discounted price ($) Installation team costs Additional delivery costs Contribution to profit ($) 192,000 (84,000) Farm 190,000 (75,000) (25,000) 90,000 Building contractor 194,000 (67,500)

108,000

126,500

Improved pricing - Better information about each type of customer may help FDS to price its contracts differently, or to resist demands for lower prices from farmers if profit margins on their contracts seem too low. There is a shortage of skilled engineers for installation and maintenance; therefore another possible use of customer profitability analysis is to make decisions about which type of contract should be preferred. FDS might even introduce some kind of limiting factor analysis which looks at contract revenues and profitability in relation to engineer hours, so that preference (and more selling effort) can be given to the type of contract or customer which generates the highest profit per engineer hour. (c) Establishing costs The costs of establishing a system for measuring and reporting customer profitability are difficult to estimate. The costs of establishing the system can be estimated as the costs of the time of managers (including the management accountant) in designing and testing the system. There may be external software development costs that would be directly attributable to the system design. The costs of operating the system would also be very difficult to measure, since the data records would be originated by different individuals. If a cost or management accountant is employed to collect and input data, and produce profitability reports, the cost of his or her time would be directly attributable. Most of the costs of the information system would probably be ‘lost’ in general overheads, however, and the benefits of monitoring the costs are doubtful. The only significant decision affecting the cost of the system is whether the cost of developing and introducing the system is justified by the expected benefits.

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Expected benefits The benefits of the information system will depend on whether the profitability reports would be likely to affect decision-making by management. Specifically, would it affect decision-making about the pricing of contracts, or would it affect decisions about which projects to undertake when there is insufficient skilled engineers’ time to meet all the current demand? If the potential benefits are considered significant, the performance measurement system should be introduced. Unfortunately, it will not be possible to estimate the benefits with certainty until after the system has been introduced.

26 TREN engine components
Text reference. Lean manufacturing and lean information systems are covered in Chapter 5. Top tips. This question focuses on one specific part of the P5 syllabus: “Evaluate whether the management information systems are lean and the value of the information that they provide.” To answer the question, it is necessary to identify the requirements of a lean information system (part (a)) and then to discuss why the existing ‘traditional’ management accounting system at TREN may fail to do this (part (b)). Having established the difference between the two types of system, you then need (part (c)) to identify the changes which are needed to convert TREN’s ‘traditional’ systems into ‘lean’ systems. Note that there is no requirement to link your answer to part (a) directly to the scenario. However, your answers to parts (b) and (c) do need to be linked directly to the scenario. (a) A lean information system should provide value to the users of the system. Key principles are the elimination of waste, speed of information flow, and clarity. Elimination of waste - A lean system seeks to eliminate all waste. In an information system, waste is created by errors in the information, which means that incorrect information is used and wrong decisions may be taken. Alternatively the information has to be corrected when the error is identified, and this results in a cost of correction. Correcting errors does not add value, because the error should not have occurred, and correcting errors is wasted effort. Efficiency in the flow of information - A lean manufacturing system is one in which there is an efficient flow of items though the manufacturing process. In a lean information system, there should be an efficient flow of information. Information should be available to individuals when they need it, and there should not be unnecessary delays in providing it or making it available. While efficiency in the flow of information means that information should be available when it is needed, it should not be provided before it is needed. Information should be available ‘just in time’. This is the concept of pulling items through the system rather than pushing them through. If information is provided before individuals are ready to use it, it does not have value. Clarity is also an element of lean information. Information must be clear to the people who use it and should therefore be presented in a form that they can understand and use. If information is presented in a form that is difficult to understand, it will be difficult to use. Unless it is used for its intended purposes, information has no value. Together, the elimination of waste, efficiency of information flow, and clarity of information are qualities of an information system that give value to the information that the system produces. Reasons why lean principles may not lead to improvements in productivity and profitability. In many situations, an organisation supposedly using lean principles has not experienced the improvements in productivity and profitability expected. It is difficult to know whether this is due to shortcomings in the lean philosophy or whether the techniques involved are being interpreted and applied correctly. Change in approach - To be successful, lean techniques should be seen and treated as outward signs of a more fundamental approach to operations and quality. However, many organisations seem to treat the techniques as the end itself – they have a mistaken belief that simply putting structures and mechanisms (eg

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quality circles) in place will improve efficiency and quality. Sustainable differences require a change in thinking and in culture – which are difficult to achieve. Cost-cutting exercise - Lean production is often viewed as a simple cost-cutting exercise rather than a fundamental commitment to eliminating waste and adding value. Many companies use lean manufacturing to improve quality and reduce costs. But the benefits most businesses realise are only a fraction of what could be achieved if these strategies were applied in conjunction with the aim of creating a workplace with real organisation and order, and with an engaged workforce who take pride in their work. (b) There are several reasons why TREN’s current management accounting system does not fulfil the requirements of a lean information system. Errors - There are many errors in data capture for the cost accounting system. Errors represent waste in the system, by providing incorrect information about costs, or requiring correction when the errors are found. Errors also reduce the confidence of users in the information that the system provides. ‘Push’ system - Monthly variance reports are provided but not until two months after the end of the month. There are two weaknesses in this reporting system. The first is the delay in making information available if required. The information about performance is being held by accountants and is not made available to the managers who can use it. The second problem is that the information is pushed out to management in the form of monthly variance reports, when it would be more appropriate to make the information available when management want to use it for monitoring and control purposes. The information system is dictating how and when the information should be used, whereas management should be doing this. Not encouraging lean manufacturing - More fundamentally, it can be argued that traditional cost and management accounting methods provide managers with inappropriate information that encourages the wrong sorts of management for an organisation that uses lean manufacturing methods. A key feature of lean manufacturing is the elimination of inventory, because holding inventory is wasteful. Absorption costing, however, encourages manufacturing at full capacity, even if this means manufacturing items that are not yet needed by customers, so that inventory will build up. This is because high volumes of production reduce the unit costs of manufacture by spreading overhead costs over a larger volume of output. Variance reporting of efficiency also encourages greater volumes of output, because greater efficiency means faster production. When the work force is paid a fixed wage or salary, attempts to improve efficiency will result in greater production quantities, and a build-up of inventory. The current reporting systems therefore encourage managers to control operations in a way that is inconsistent with lean manufacturing. (c) Error reduction - To create a lean management accounting system, waste must be eliminated and information flow improved. The causes of the data errors in data capture are not known. The problem may be the use of manual documentation for recording costs, or errors in input by inadequately trained staff. Methods of recording costs should be investigated, and the target should be to eliminate input errors entirely. Flows of information - The flow of information must be improved, so that up-to-date information is available to management when they want it. The speed of entering data into the accounting system should be reviewed, and the aim should be to minimise the delay between recording data and inputting it into the accounting system. Automated methods of monitoring inventory movement or recording labour times may be considered. User access to information - The accounting system should also allow managers on-line access to information about costs, so that they can obtain and use the information they need at a time that they need it. This should apply to senior management as well as to management at the operational level. Cost allocation - The information provided by the accounting system should be reviewed, and absorption costing should be abandoned. There may be some value in using activity-based management to monitor and control overhead costs, but the most important requirement should be to value inventory at direct materials cost. This means that there will be no incentive to produce at high capacity volumes or operate at unnecessary levels of efficiency. Favourable capacity and efficiency variances will not affect inventory costs and so will not improve management performance. 194
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Performance measures - Different items of information should be provided for performance measurement purposes. Traditional performance measurement methods for materials – price and usage variances – should be used to control materials costs. For labour, however, non-financial measures of performance may be appropriate, such as production cycle times of throughput times and the ratio of idle time to active time for the work force. The company is considering JIT purchasing for its main suppliers: if so, a suitable measure of performance may be the order-to-delivery cycle time for purchase orders. In a lean information system, information should have a practical use and support the aims of management. The management accounting system should be changed so that it provides value – a practical purpose, with no waste, rapid information flow and clarity of meaning.

27 KLP divisions
Text reference: Performance measurement information systems are covered in Chapter 5. Accountability and control are discussed in Chapter 12. Top tips. The current reporting system does not contain any responsibility accounting features. The new performance reporting system has to provide information that will enable responsibility accounting to be applied. A key issue is controllability, and the need for accounting reports to indicate the performance that each divisional manager should be in a position to control. The new system should also recognise the way in which the divisional managers will respond to performance reports. The managers will focus on the performance that is measured and for which they will be rewarded. An issue to consider is whether a reporting system based entirely on financial performance is appropriate for the long-term interests of the company. The references to capital investment decisions, transfer prices at cost plus and to a learning curve in the question should suggest that points can be made about these issues too. Part (c) looks at a specific aspect of accountability and control – the different types of control mechanism which companies can use to ensure organisational control. The three broad categories of control mechanism which you should have discussed here are: action control, personnel control and results (or output) control. (a) Responsibility accounting is accounting in way that makes managers responsible and accountable for performance that they are in a position to control. In the case of investment centres, a responsibility accounting system should make divisional managers responsible and accountable for sales revenues, costs, profit and return on investment, for aspects of performance within their area of control. Controllable and non-controllable costs For the new performance reporting system at KLP, divisional managers should be made accountable for the costs within their control, but they should not be made accountable for apportioned head office overhead costs. An appropriate reporting system may therefore distinguish between controllable and non-controllable (apportioned) fixed costs, as follows: Divisional performance Sales Variable costs Contribution Directly attributable divisional fixed costs Controllable profit Apportioned general overheads Net profit $ X (X) X (X) X (X) X

The profit performance of divisional managers should be based on the controllable profit. Manufacturing costs last year were 53% of sales revenue, but sales and distribution costs (17% of sales revenue) were also quite high. The responsibility accounting system should ensure that sales and distribution costs for which each division is directly responsible are included within the variable costs or directly attributable fixed costs of each division.

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In the same way, the assets that are accounted for as divisional assets should be assets over which the divisional managers have some control. This may be difficult in practice, especially when a division occupies a building that is shared with staff from other divisions or head office staff. Learning curve The design of a responsibility accounting system should also recognise the implications of the learning curve in one division, and its potential impact on transfer pricing arrangements. The existence of a learning curve in one division means that expected average production times will get shorter as new products are produced in (cumulatively) larger quantities. The division should therefore benefit from improving efficiency but these improvements will come ‘naturally’ and should not be attributed to effective management. The reporting system should therefore be capable of including the expected learning curve effect when setting performance targets for the division and comparing actual costs and production times with expectation. The divisional manager should not be credited with the efficiency improvements that come from the learning curve. Transfer prices When investment centres transfer goods or services between each other, the transfers add to the revenue and profits of the transferring division and add to the costs of the receiving division. This creates potential for disagreements about what the transfer prices should be. Since there is no external market for most transferred items, transfer prices for these items at cost plus would seem to be appropriate. However, the transfer prices should be fixed periodically at a negotiated price based on expected cost plus a profit margin. Actual cost plus should not be used for transfer pricing, because inefficiencies and overspending in the transferring division would be passed on and charged to the receiving division in the transfer price. This would be inconsistent with the principle of responsibility accounting. (b) It should be assumed that if divisional managers are rewarded on the basis of the performance of their division, they will be motivated to optimise the performance by which they are rewarded. They will be much less concerned about aspects of performance that do not affect their reward. Short vs long term performance The board currently believes that divisional managers should be rewarded on the basis of financial performance only – profitability and return on investment. It is likely that rewards would also be based on annual financial performance rather than longer-term financial performance. This would be inappropriate, because long-term performance is an important consideration, and non-financial aspects of performance as well as short-term financial measures will affect longer-term performance. The new performance reporting system should be designed in a way that motivates divisional managers to recognise the longer-term aspects of performance. Financial and non-financial performance An appropriate performance reporting system may therefore be one based on a balanced scorecard of performance targets, with annual bonuses based on the achievement of non-financial as well as financial targets. A balanced scorecard would include performance measures from customer, internal efficiency and innovation and learning perspectives. Goal congruence - Performance measures could still include short-term performance measures. For investment centres, an important aspect of performance is financial return on investment. The performance measurement system should encourage managers to make capital investment decisions that are in the best interests of the company. Ignoring issues such as risk, investment decisions should be taken if they will be expected to achieve a positive net present value. However, if divisional performance is based on accounting return on investment, there will be a possibility that divisional managers will choose not to make new investments because, in the early years of the investment, the effect will be to reduce the division’s ROI. The performance reporting system should therefore be designed in a way that encourages desirable capital investment. The use of residual income, or even economic value added (EVA™), should therefore be considered as alternatives to ROI as measures of short-term financial performance.

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(c)

There are three broad categories of control mechanism which KLP might use to cope with the problem of organisational control: action control; personnel control; and results control. Action control The aim of action controls is to ensure that only those actions which are desirable occur, and actions which are undesirable do not occur. Action accountability involves defining actions that are acceptable or unacceptable, observing the actions and then rewarding acceptable (or punishing unacceptable) actions. In this way, action accountability sets limits on employee behaviour. For example, setting budgets for different categories of expenditure in each division makes the divisional managers accountable if they exceed the budget limit, such that they have to explain or justify their actions. Personnel control The aim of personnel controls is to help employees do a good job, by ensuring they have the capabilities and the resources needed to do that job. This is through appropriate recruitment and selection (finding the right people to do a specified job); training and job design (where job design includes making sure that jobs are not too complex, onerous or badly designed so that employees do not know what is expected of them); and providing the necessary resources for people to do their jobs. Cultural control – These represent a set of values or social norms that are shared by members of an organisation and influence their actions. The Board of KLP could introduce codes of conduct, or group based rewards schemes, such as annual bonuses based on how well staff perform against objectives (rather than simply based on profitability and return on investment). Results control The focus of results control is on collecting and reporting information about the outcomes of work effort. The key value of results controls for KLP would be to identify deviations from desired performance measures (e.g. variances to budget) and then allow corrective actions to be taken to try to improve performance.

28 Racer deliveries
Text reference. Recording and processing methods, including the recoding of qualitative information, is covered in Chapter 6 of the BPP study text. Issues around interpreting qualitative data are covered in Chapter 10b. Top tips. Performance measurement systems need to provide information of a qualitative nature to management, although quantitative measures should be used even for qualitative issues, where this is achievable. Qualitative aspects of performance can be particularly useful in service businesses, and this appears to be the case here. However, the question is whether these qualitative factors do actually contribute to RACER’s competitive advantage, or whether the directors have just assumed they have. In part (a) you need to identify what aspects of performance are perceived to contribute to RACER’s competitive advantage, and then think how qualitative information could help assess the impact they are actually having on the company’s performance. In part (b) you then need to think about the practical problems associated with trying to capture qualitative information. It is often subjective, so how can it be measured? Part (c) picks up on this point. The surveys which the management accountant will could enable RACER to quantity qualitative data, but are there any potential issues with such a process? For example, will all customers give the same level of service the same score? (a) The board of directors of RACER believes that its competitive advantage is based on reputation, brand recognition, reliability, experience and personalised service by its call centre staff. This belief appears to have made the directors decide that RACER should not copy its rivals and introduce an automated ordering system, even though this may be less expensive to operate.

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Information for decision-making - The directors would probably benefit from information about these aspects of the company’s service, because their views currently seem to be based on opinion rather than firm evidence. In this respect, it seems probable that the board is basing decisions about the company’s future strategy on its views of RACER’s competitive advantage, rather than any firm evidence. If the directors believe that these qualitative aspects of performance are the reason why RACER is successful in the market, they will probably base the company’s future strategy on preserving the factors that create this advantage. Therefore it would be valuable to obtain information about whether these qualitative aspects of performance really do create value for RACER; for example, by establishing whether they affect customer’s choice of which delivery service to use. Competitive advantage – If qualitative aspects of performance are strategically significant, then it is also important that Information about them is reported regularly so that the board can monitor any change in circumstances that might create a threat to competitive advantage. The most significant qualitative aspects of performance that appear to be significant for RACER may be those that have been identified by the board. (i) Brand recognition - The board believe that RACER has a good reputation for service and that it benefits from strong brand recognition. Information about the strength of the company’s reputation and brand recognition by customers would help the company to develop its marketing strategies. For example an advertising campaign might promote the brand name and image. Service reliability - The board believes that the company’s reputation is based largely on its service reliability. Reliability probably means on-time collections and deliveries, or possibly speed of delivery. Information about on-time services and speed of services would help management to monitor this aspect of performance, and try to ensure that the service standard is maintained. Customer service - The board also believes that customers value the experience and personal service of its call centre operators. As a result, it has taken the important decision to retain a personal calls system for customer orders, when rival companies have chosen to cut costs and use automated voice recognition ordering systems. Information about the value of this service to customers would enable the board to confirm their view – or prove it wrong. Customer needs - Information about the quality of the telephone ordering service and reliability of service are important only if they are significant to customers. RACER does not seem to have obtained reliable information about customer needs and whether RACER’s services are meeting them sufficiently well. Information about how much extra customers would be willing to pay for additional features in the service would also be of value.

(ii)

(iii)

(iv)

(b)

One of the distinctions between qualitative and quantitative information is that it can be harder to measure qualitative information and qualitative aspects of performance. For quantifiable aspects of performance, it is possible to set specific targets for achievement; whereas often qualitative aspects targets can only be expressed in more general terms. When targets are not measurable and performance is not measured, it can be difficult to assess whether the targets are being achieved. There is a risk that monitoring qualitative aspects of performance can become self-delusional. Management may decide that actual performance is what they would like it to be, not necessarily what it actually is. Strength of reputation is one such qualitative aspect of performance. Others may be employee loyalty, team spirit and quality of strategic leadership. Since qualitative information is not currently measured at RACER, there are problems in gathering and analysing information, and in accessing and retrieving qualitative information that is held on file. The information provided by a reporting system may also be of limited value, because management may not know what to do about it. Information must have a purpose, but qualitative information may not be sufficiently specific and its purpose may therefore be unclear. It may be argued that qualitative information may be of value for strategic planning rather than performance management and control. Information about the strengths and weaknesses of the company, and about

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threats and opportunities in the industry and the business environment, may be largely qualitatively in nature, but this information is used to assess strategic options and make strategic choices. SWOT analysis, however, is unlikely to be made part of a regular performance reporting system for management. The importance of non-financial information is now widely recognised: much qualitative information is nonfinancial in nature, but many aspects of non-financial performance can be measured quantitatively. If RACER’s board wants to obtain information of a qualitative nature, an appropriate approach may be to convert as many qualitative aspects of performance as possible into quantifiable aspects. Customer satisfaction, for example and aspects of service quality may be measured by means of regular customer surveys or market research surveys. (c) Quantifying data – The surveys which the management accountant has suggested will provide RACER with a means of converting qualitative data into quantitative data. RACER’s performance in key areas of the business such as service quality or customer satisfaction can then be recorded and monitored, by looking at the scores it receives for them, and for example, taking an average score for a given period. For example, this could be useful for quantifying the impact on customer service of introducing the automated calling system, and in turn allowing the directors to assess how successful the new system has been. Subjectivity – One of the major problems in interpreting qualitative data is that it based on people’s opinions and judgements, and is therefore it is subjective. For example, the quality of service which one of RACER’s customers might rate as ‘Excellent’ (and score ‘5’) another customer might simply rate as ‘Average’ (and score ‘3’). Equally, when people complete surveys there is a tendency to score towards the middle. In general, respondents are likely to feel more comfortable selecting scores in the range 2 – 4, rather than using the extremes of 1 or 5. Trends – Because of this subjectivity, the surveys may be more useful for looking at trends in RACER’s performance rather than looking at one-off performance. For example, RACER could monitor how their average score for customer service varies over a period of time, as an indication of whether customer service is improving, remaining at much the same level, or getting worse over time. Equally, if there are significant variations in the scores over time, this should prompt the Directors to investigate the reasons for these variations.

29 Auto Parts
Top tips: Note that Part (a) doesn’t ask you simply to evaluate the performance management system overall, but specifically in the context of assisting K to achieve the three objectives identified in the scenario: (i) maintaining the preferred supplier status; (ii) keeping expenditure within set limits; and (iii) developing the management skills of operational managers. Although the question asks you to evaluate the performance management system, and therefore you should try to include some strengths as well as weaknesses, it should be clear from the scenario that the current system is essentially unsuitable for achieving the three objectives. For example, the PMS does not monitor any aspects of quality management, although guaranteeing the quality of its products is one of the key conditions of AP retaining its preferred supplier status with CDM. Part (b): Your answer to part (a) - and the weaknesses in AP’s current performance management system you should have identified there – can then help you answer part (b). In effect, the FOUR improvements you recommend need to address some of the issues/weaknesses you have identified in part (a). Although the requirement tells you that you must not recommend the introduction of the balanced scorecard (or any other specific performance management model) as one of your four improvements, you could still recommend that AP looks at non-financial performance indicators rather than concentrating solely on financial ones.

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Part (c): Note that the requirement here is to recommend performance measures that link directly to AP maintaining its preferred supplier status with CDM, not simply performance measures that would help improve AP’s performance in general terms. For example, the scenario identifies that CDM has insisted that AP reduces its prices 3% year on year, so what aspects of its performance does AP need to measure to help it achieve this aim (and still remain profitable). Part (d): Your answers to part (a) and (b) should have indicated the need to improve AP’s current performance management system. However, the question is how you can place a ‘value’ on any such improvements, in order to compare this to the cost of buying a new system. (a) Maintaining AP’s preferred supplier status with CDM The business from CDM currently constitutes 90% of AP’s revenue, which suggests that maintaining the preferred supplier position is the most important of K’s objectives. AP needs to achieve three main things in order to keep the contact: Fulfil supply requirements – The business guarantee means that AP will have to supply CDM with at least $2 million worth of components each week, and in some weeks this figure will increase depending on CDM’s demand. Therefore K needs to ensure that AP has the production capacity and flexibility to meet CDM’s demands. However, the PMS system does not address any aspects of production capacity or flexibility. Maintain product quality – AP will lose its preferred supplier status if there are two reports of failures relating to its components in any one year, therefore quality control and quality assurance should be very important to it. However, the PMS does not address any aspects of quality management. Reduce prices – CDM’s insistence that AP reduces its prices by 3% per year, suggests that AP needs to be actively monitoring its prices over time. However, the PMS system does not appear to compare actual prices with the previous year. Faced with these price reductions, AP should also be looking to reduce its costs in order to preserve its margins despite the falling prices. However, the PMS does not appear to address any aspects of prospective cost or efficiency improvements. Keep expenditure within budget limits Budget control – The PMS is based exclusively on budget control, which suggests that it should be effective in allowing K to keep expenditure within budget limits. Timeliness – However, the effectiveness of the PMS as a control system is dramatically reduced by the fact that it is only based on quarterly reports. K needs to be able to identify any potential areas of over-spending more quickly than waiting for the next quarterly report. Lack of detail – It is not clear what level of detail the PMS can produce, but K’s discussions with operational managers only look at aggregate amounts. Again, this dramatically reduces the system’s effectiveness, because it will be difficult to identify (and then address) the causes of any expenditure variances simply by looking at aggregate figures. Develop management skills Exclusion from budgetary control – K’s belief that operational managers should not be allowed to know the detail of any under or overspends in their cost centres, suggests that they are not involved in budgetary control in an effective way. This exclusion suggests that rather than developing their management skills, K is suppressing them. Summary The PMS does not appear to help K achieve his objectives much at all, and therefore is ineffective in this respect.

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(b) Tutorial Note: You are asked to recommend THREE improvements, so that is what you should have done in your answer. However, for tutorial purposes, we have included four possible improvements in the answer. More timely reports – The PMS currently uses quarterly reports as the basis for comparing actual performance to budget. However, in order to improve K’s ability to monitor and control actual performance, these performance reports need to be available on a more timely basis. As a minimum, K should be looking at variances on a monthly basis, but for some areas of performance he should consider whether daily or weekly reports can be produced. Some variance reporting for key aspects of the component manufacturing process could even be done on a ‘real time’ basis. Review cost centre structure / cost centre reports – AP currently has 2,000 cost centres and it produces expenditure reports for all of these cost centres. This is likely to be very time consuming for the budget accountant to produce, and K to review, (particularly if the frequency of reporting is increased), therefore AP should consider whether it can reduce the number of different cost centres it has. In addition, rather than simply producing reports which compare actual expenditure against budget, AP should consider whether it could produce exception reports instead. In this way, rather than having to look at reports for all the cost centres in detail, K would be able to focus on those areas where actual performance is significantly different to expected (budgeted) level. Corrective action – K’s reluctance to discuss the detail of any expenditure with the operational managers appears to reduce his ability to understand the reasons for any variances, and perhaps more importantly, his ability to improve performance in the future. The operational managers are best placed to identify ways of improving performance going forward, and K should make better use of their knowledge in this respect. In this way, the PMS can be used to actively manage performance, rather than simply to report on historic performance. Non-financial performance measures – The PMS appears to focus solely on financial performance. However, as the contract with CDM highlights, non-financial aspects of performance such as quality and reliability are also very important. Therefore, AP should widen the range of performance measures it monitors, and should include non-financial measures alongside financial ones. (c) Note: The requirement specifically asked you to recommend TWO performance measures. However, there are additional measures you could have recommended in addition to the two we have recommended below. For example, you could have recommended measures to do with production quantities and production reliability (based on the requirement to supply a minimum of $2million worth of components each week). Equally, you could have recommended measures due to the timeliness or reliability of delivery to CDM (because CDM operates a JIT system and so will rely on AP delivering its components as it needs them). % annual reduction in costs – As we mentioned in part (a), CDM’s requirement that AP reduces its prices by 3% year-on-year also means that it will have to reduce its costs each year. Therefore, AP should introduce a performance measure looking at cost reduction, because if AP can improve the efficiency of its processes and reduce its costs, this should help it achieve CDM’s price reduction target whilst still preserving its profit margins. Component quality – In order to preserve its contract, AP needs to ensure the quality and durability of its components. AP will lose its preferred supplier status if there are two reports of its components failing either during production or ones CDM’s cars are being driven by customers. Therefore, AP needs a performance measure which focuses on product quality and product reliability.

Answers

201

(d)

Costs and benefits - The scenario suggests that the Board of Directors are recommending that AP buys a new system, rather than developing one in house (as appears to have been the case with the PMS). Therefore they will be a direct financial cost associated with acquiring the new system. By itself, however, the system will not make AP’s production processes any more efficient so it will not have any direct financial value to the company. Benefits of timely information - However, it is likely that the new system will address the improvements which are required to the current PMS, and in doing so will provide K with more timely information about AP’s performance. In this respect, if the new system can provide real time information about the production levels and quality, it could be vital in allowing AP to retain the CDM contract, and retaining the CDM contract appears to be vital to AP’s future. Nonetheless, the new system by itself cannot guarantee that AP will keep the contact. Management style – In addition, the potential benefits from introducing the new performance management system will still be curtailed if K maintains his policy of not discussing detailed performance with the operational managers or involving them in any discussions about how to improve performance. To achieve these changes, K will need to review his approach to management, rather than simply implementing a new system.

30 CMA Supermarkets
Text reference. Recording and processing methods, including how IT developments may influence management accounting systems, are covered in Chapter 6. Top tips. This is not an easy question to answer because there is only a limited amount of information to work with – CMA is looking at introducing a new unified corporate database and RFID technology to replace bar coding for monitoring inventory. You need to be quite imaginative in applying the basic principles of IT systems in management accounting to the operations of a supermarket company. Try to think practically though. How could the new systems help CMA manage its inventory? Or, how could improved information about customer purchasing patterns be useful to CMA? (a) IT technology in supermarkets commonly uses bar codes for identifying the products that are sold, and bar code readers enable a supermarket to monitor the quantities of items that it sells as well as to price them for customers. Bar code reader systems are therefore quite sophisticated. Inventory tracking - Radio frequency ID systems replace bar codes with a chip, and the chip on each item of inventory can hold additional amounts of information, not just product identification data. This means that RFID readers are able to detect where an item of inventory is at any time and can track inventory movements. In the case of a supermarket such as CMA, RFID readers could track the movement of inventory from a central stores depot to a supermarket store room, from the store room to the shelves in the supermarket and from the shelves to the customer checkout. Inventory management - In an industry where fast throughput of items is a critical aspect of success, the ability to monitor the movement of items in such detail, and the time between receiving stores items and selling them, may be of operational value by helping management to adjust purchasing and deliveries in order to speed up sales. From an accounting perspective, RFID may also be used for inventory counts. An RFID reader can gather information about all the product items held in store at any time, without the need for detailed manual counting. The additional benefit of having up-to-date ‘real time’ data about inventory will depend on the company’s management information systems. In principle, a company-wide IT system should be capable of comparing throughput times for different types of product, and comparing the operational performance of different supermarket outlets. The ability to locate stores items may help management to transfer items from where they are turning over slowly to where customer demand is stronger.

202

Answers

Operational performance – CMA’s store managers are rightly concerned that the number of out-of-stock products appears to be rising. This is a problem for two reasons:  If an items is out-of-stock, customers cannot buy it, and so this will reduce CMA’s revenue (unless the customers find a direct replacement they are prepared to buy instead)  If customers keep finding that the items they want to buy are out-of-stock they will stop shopping at CMA. This is potentially a bigger problem for CMA because, not only will its revenue and market share fall as a direct result of the lost customers, but it could find it harder to recruit new customers if it develops a reputation for not having items in stock. Reducing out-of-stock products - RFID tags should lead to fewer out-of-stock products. In turn, keeping CMA’s shelves fully stock should lead to increased sales and profits, and a more positive shopping experience for customers (leading to higher customer retention). Stock ordering - Because RFID technology provides real-time information it will enable CMA to manage its supply chain more efficiently, both between its stores and its warehouses, and from its stores back to suppliers. Using RFID tagging, whenever a product is scanned through a till, stock levels for that product are updated. However, perhaps more importantly, CMA could also used RFID tagging to inform product suppliers of sales and inventory levels. For example, CMA’s RFID system could send inventory messages to suppliers whenever their products are scanned through its tills. In this way, the suppliers are aware of the up-to-date inventories at the stores and can ship additional products as necessary. (If CMA pursued this approach, it might be able to switch to a vendor management inventory relationship with its suppliers, which could be used to help improve product availability.) However, for CMA to maximise the benefit it can get from using RFID in the short term, it will need its supplier to implement RFID technology on all the products they supply to it. It is not how many of CMA’s suppliers can currently do this, or even whether it will be possible to tag all the products CMA sells (for example, fresh fruit and vegetables). (b) Integrated system - The greatest value may be obtained from a new IT system by integrating it across the company. The same system should record data for and report on the performance of central inventory and distribution depots as well as individual supermarket outlets. The system should also record information about costs (which could be held within the data on RFID chips) and selling prices, so that information can be reported about gross profits of stores and product groups within each store. Unexplained losses (due to theft by customers) could also be monitored as a cost item. Real time information - The system should also operate in real time, so that users of the system are able to access information they want at any time. Stores managers, for example, should be able to obtain information about sales and gross profits for the store, and then if required drill down for further information about the profitability of product ranges, or manufacturers’ brands or even individual product items. Similarly, rather than having to wait until the end of the month for summary performance reports, senior management could receive summary trading updates at the end of each day or week. Dashboards and drill downs – At the moment, individual store accounts are prepared for each store and then presented to the store manager, alongside summary reports for the senior management team. It would be more useful for CMA if this information was all available electronically, in a way that allowed managers to drill down from summary information to more detailed information for regions and then individual stores. Having an integrated system in this way should help senior management make comparisons between different central inventory and distribution depots or between different supermarket outlets. Non-financial performance information (for example speed of product throughput) as well as financial information should be provided, all within the same system. The system should also include external data, although much of this may have to be input by the company’s own staff. For example, employees who visit rival supermarkets to check competitors’ prices should be able to insert their current prices into the system, so that supermarket managers and senior management can monitor competitive pricing and respond to rivals’ price changes.

Answers

203

Data mining - The information that is gathered about product sales should also be used to extract sales data and analyse it to produce information that might help the company to improve sales further – such as information about what products sell well in different areas and at different times of the day, week or year. Data analysis can also be used to ‘mine’ for data about individual customers. (c) Identify buying habits - In order to exploit data about individual customers, CMA needs to obtain data about a customer’s buying habits. For on-line sales (for home delivery), the system identifies individual customers, and it can prompt them to buy items (by presenting a list of the items they regularly buy as a pro-forma shopping list) or it can try to encourage them to buy more with discount vouchers. Loyalty card schemes - For other customers, some supermarket groups use a loyalty card scheme. Customers who present their loyalty card at a store checkout may be awarded bonus points which eventually build up into money-off vouchers. The customer is identified through the loyalty card, and sales details are recorded by the check-out system. Through loyalty cards, supermarkets are able to gather data about what individual customers buy, how much they spend and when they do their buying. Offers to encourage customers to buy more can be related to the known buying preferences of the individual. If required, a supermarket should be able to calculate the gross profit contributed each period by each ‘loyal’ customer. This may help the company to target particular types of customer who are more profitable than others.

31 Viga Drinks
Text reference. Procedures to ensure the secrecy of highly confidential information are covered in Chapter 6 of the BPP Study text. Top tips. The examples in the question indicate some of the ways in which confidential information may become ‘public knowledge’. You should consider the potential consequences in part (a) and then go on to consider ways in which confidentiality and secrecy can be protected in part (b). Unfortunately, control measures cannot be guaranteed to succeed, and the rigour of the controls that are put in place may depend to some extent on the potential consequences of public disclosure of the information. Part (a) There are several reasons why confidential information may be improperly released. Most reasons can be described in terms of weak or non-existent controls to protect confidentiality. (i) Confidential information may be released through carelessness. The example of Viga’s company secretary leaving their computer on a train illustrates one way in which confidential information could find its way into the public domain; but information could also be released by employees making a careless comment within the hearing of an ‘outsider’, or failing to keep confidential reports in a secure place. When confidential information is discovered due to carelessness, there is a risk that it will be read and passed on. There may be a deliberate breach of security to access confidential information. There may be a big risk to commercial organisations from external ‘hackers’. Employees may also deliberately find a way of gaining unauthorised access to confidential files. There may be loose controls over the disposal of information. There have been occasional reports in the press of confidential reports being found by investigators in garbage bins and litter bins.

(ii)

(iii)

Reasons for breaches of confidentiality may also be analysed in terms of the motivation of the individuals who acquire it. Individuals who sell confidential information to a rival organisation do so for personal selfish motives. In the case of the member of the accounts department who had details of his private life disclosed, the breach of confidentiality was probably motivated by a desire to retaliate against the whistle blower. Leaking information (even though it was not fully correct) about the closure of the production centre may have been prompted by a desire to help the employees affected; to try to prevent them losing their jobs. The consequences for an organisation of the release of confidential information depend on the nature of the ‘leak’.

204

Answers

(iv)

Information may be returned un-read and unused, in which case there has been a breach of security controls but no adverse consequence, as appears to have been the case with the company secretary’s laptop. When confidential information is released to employee representatives, there may be an immediate threat of strike action, or a change in negotiating position (when a matter such as pay is currently under negotiation). A strike would have operational and financial consequences. In the longer term, there may be damage to the trust between management and employees, and uneasy industrial relations within the company. The release of confidential information to the media, such as information about Viga’s health and safety inspection, creates adverse publicity and can have adverse consequences for the company’s reputation. The consequences of damage to reputation may be difficult to assess. The release of confidential information about an employee, leading to the resignation of the employee, can have legal and financial consequences. Employees who are victimised in this way have a right to appeal for constructive dismissal and could potentially receive substantial compensation. The loss of confidential information to a rival organisation could have serious commercial consequences, because the information could help the rival to decide its competitive strategy in a way that enables it to gain an advantage in the market. In an extreme case, the unauthorised disclosure of the secret recipe for its drink product could have a long-term impact on Viga’s business position. The recipe currently represents a source of competitive advantage for Viga, but if the recipe details were disclosed to a rival company, that could make use of the recipe information to improve its own product.

(v)

(vi)

(vii)

(viii)

Part (b) The procedures that Viga is going to put in place should be set out clearly in a policy document. (i) The company’s policy should include an element of deterrence, to discourage employees from trying to access or use confidential information. This policy should include ensuring that any breach of confidentiality is investigated, perhaps by an external firm of investigators. There should be disciplinary measures for breaches of confidentiality, ranging from an official warning (for example, for leaving a laptop on a train) to dismissal or even referral to the police for a criminal matter. Although these measures are retrospective (because they occur after the security breach has occurred) their existence should help act as a deterrent against employees committing breaches of security in the future. There should be physical protection for files or other documents containing confidential information. Paper files may be kept in a safe. Viga’s secret recipe is presumably kept off site in a secure deposit with a reputable custodian such as a major bank. Viga should also consider the use of encryption software for securing files on its computers, and/or email messages. This would prevent third parties from recovering information even if they gain access to a laptop or computer files. All confidential papers distributed to a restricted list of recipients should be marked on every page to identify the recipient, and should be signed for on receipt. If a photocopy or photograph of the document is subsequently leaked, the individual responsible can be identified. This should encourage the individual to make sure that the documents are kept secure. Access to computer files containing confidential information can be restricted to specific users and by means of passwords. Attempts at unauthorised access should be logged automatically as security violations and investigated. The company should have a strict e-mails policy, instructing managers to avoid any mention of confidential issues in the e-mails they send.

(ii)

(iii)

(iv)

(v)

(vi)

Answers

205

(vii)

Viga should review its whistle blowing procedures and consider ways in which the identity of whistle blowers (and, initially, the information they provide) is kept secret until any subsequent investigation has been completed. The problem at Viga may be due the fact that the person authorised to hear the whistle blower’s allegation did not keep the matter sufficiently hidden and out of sight, or did not investigate the allegation in an appropriate way. Confidential information may be accessed by individuals from outside the organisation, but the person responsible is often an employee. Confidential information should only be made available to individuals who can be trusted. An important control may therefore be the careful selection of individuals for appointment to jobs in the organisation, and impressions of honesty, integrity and trustworthiness may be factors to consider when making the appointment.

(viii)

32 Beachy Co
Text reference. The principal controls required in generating and distributing internal information are covered in Chapter 6 of the BPP Study text. Lean management information systems are discussed in Chapter 5 Top tips. Parts (a) and (b). Your answer should consider both formal or routine information and also non-routine information. You should also distinguish between the risks related to generating information and also those relating to the distribution of information. These are related issues but are not the same thing. Also note that the question asks specifically about internal information, so you should have focussed specifically on internal information and not spend time commenting on external information. Part (c). The main scenario should have highlighted the problems of information overload and the inefficiencies and waste that this creates. The ideas of reducing waste and improving efficiency are central to ‘lean’ thinking. However, note that the question here refers to management systems overall, not just the way information is distributed. Part (a) Information overload - The main risk from excessive generation and distribution of internal information has been identified by the finance director. This is the risk from having too much information, which may be referred to as ‘information overload’. (i) For users of information, there are problems with getting too much information. It may be difficult to identify which items of information are important, and which are not. As a result, the user may have to spend a lot of time locating the important information, or perhaps, even more detrimentally, may overlook it altogether. It takes time to read or study information. Long reports can waste management time, and may be so long that the manager does not have time to read them properly. As a consequence, reports and their recommendations may be ignored. Equally, if managers have had to spend large amounts of time reading information, this reduces the amount of time they have available for other (potentially more value-adding) tasks. Although the generation of information from IT systems may be relatively easy, it nevertheless takes time. When internal information is distributed to a large number of individuals on a large circulation list, it is likely that it will be of little or no interest to many people who receive it. Even so, it takes time to look at a report or message and decide that it is of no interest or value. The use of e-mail attachments for circulating information can be a widespread problem within an organisation, and the finance director in the question refers to managers receiving over 1,000 e-mails each day. It is difficult to imagine that most of these will be of use to the managers in their work.

(ii)

(iii) (iv)

206

Answers

Since excessive information can result in wasted management time, there is an avoidable cost of this information. The finance director expressed this cost in terms of time that could be better spent by managers on other tasks. In other words, there is an opportunity cost of spending time generating or reading valueless information. Distribution of information - When excessive amounts of internal information are generated and distributed, there is a risk of confusion. (v) The purpose of the information may not be clear. Information has no value at all unless it has a purpose, but there is a risk that information will be sent because of a regular routine for official reports or ‘for information only’ in the case of unofficial items. The reliability of the information may be questionable, especially when out-of-date information remains in circulation, with no clear indication of the date of its origin. When large amounts of information are circulated, there is a risk that information from different sources may contradict each other. The internal audit report in the question stated that information used in local offices often differed from comparable information circulating at head office. Confusion may be increased when the source and authority of some items of information is not apparent.

(vi) (vii)

A consequence of confusion in the information received may be poor decision-making based on unreliable information. Equally, the amount of confusion and uncertainty in the information may prevent managers making decisions altogether, if they are unable to establish what the ‘correct’ information should be. Confidentiality risks - There may also be occasional risks of breach of confidentiality when large amounts of information are circulated. For example, when confidential matters are mentioned in internal e-mails, there is some risk that an unauthorised person will see the confidential material. The conclusion of the finance director seems appropriate. Managers need information to do their work effectively, but excessive information can be a severe hindrance rather than an aid to their effectiveness. Part (b) If the board accepts the finance director’s recommendation, it is likely that one of the directors will be given responsibility for implementing improvements. However, in the first instance, it would be appropriate for the board to issue a statement to Beachy’s managers explaining that there is a problem with excessive internal information, and that measures would be considered and announced for reducing both the generation and the distribution of unwanted and unnecessary information within Beachy. The measures taken to deal with the problem should differ between information in routine or official reports and ‘ad hoc’ information that is generated and distributed intermittently. Cost benefit analysis - For routine reports, the need to generate the report (and the amount of information in the report) should be reviewed. The benefits of the information (in terms of how it may be used to assist control and decision-making) should be assessed and compared with the cost of producing it. A cost-benefit analysis is probably easier to carry out on entire reports than on items of information within reports, and the costs of generating information are easier to assess than the potential benefits. Even so, judgement can be used to decide whether the cost of producing the information in routine reports is justified by the benefits obtained. Where costs exceed benefits, providing the information (or the entire report) should be scrapped. Benefits from reports – In this respect, Beachy could also highlight the distinction between information (and reports) which have no value to their recipients at all, and information which has some value but not enough to justify the cost and effort or producing it. One of Beachy’s first priorities should be to get rid of reports containing the first type of information (i.e. no value at all) as soon as possible. Where routine reports or special reports are long, an executive summary should be provided at the beginning of the report, for the benefit of individuals who do not have time to read the report in full. Executive summaries encourage managers to study a report without spending too much time reading them. In control reporting, exceptional issues should be flagged for attention so that they are immediately apparent to the report user. In this respect, Beachy should consider using exception reporting, such that reports are only generated when results appear unusual or require management action.

Answers

207

Distribution lists - Circulation lists should be reviewed, and individuals who do not need to receive a report (for example, because they are sent a copy out of courtesy) should be removed from the distribution list. Reports should be clearly titled, and the title should indicate their purpose. Reports should also be dated and identify the sender/originator. If a report is urgent, this should be shown clearly. Report layouts - The layout of routine reports should be clear and consistent, so that users know what to expect in the report and where to find items of particular interest. This can save time reading the report and also avoid confusion about the meaning (or comparability) of the information. Management should also consider introducing policy guidelines within Beachy relating to the generation and distribution of ad hoc items of information. For example, if managers receive excessive quantities of e-mails, senders may be encouraged to indicate urgent messages for immediate attention. Managers should be encouraged to reserve a block of time at the beginning or end of each day for going through non-urgent items. These measures may encourage managers to use their time more effectively. Over the longer term, the sensible use of information should be monitored. One way of doing this should be to ensure that managers are meeting their overall performance objectives, and the extent of their production, distribution and use of internal information can be included as an item in a manager’s annual performance review. Part (c) Lean thinking in relation to management information systems aims to add value to the information provided by the system, and there are three levels at which it can do this. First, lean can enhance the value of the data in the system and how it is organised, exchanged and retrieved. Waste arises from effort or difficulties in retrieving and accessing information. It also arises from having to correct inaccurate information. At a second level, lean thinking can add value to information by virtue of how the information is organised, and presented; for example by not including unnecessary detail. In this context, applying lean thinking could be particularly useful at Beachy Co, because it could help reduce the volume of information that management are presented with, and therefore help reduce the problem of information overload. Thirdly, value can be added by enabling the information to flow to the users of the information more efficiently; by addressing the processes of exchange, sharing and collaboration between the management accountants and the managers in a business. Overall, the lean approach would seek to identify and concentrate improvements on eliminating waste and improving the flow of value from the management information system. The ultimate aim is to improve efficiency, productivity and quality of that information. In addition, there is always scope for improvement in the way information is managed and shared with users. Number of receipients – In this respect, lean thinking could also be applied to the number of recipients who receive reports. For example, if a report is being sent to all the managers at Beachy when it is only relevant to a small number of them, the lean alternative would be for that report only to be sent to the managers which it is relevant to. This in turn should help to reduce the volume of reports which managers receive, thereby also reducing waste.

33 Cobra golf club
Text reference. Management reports are covered in Chapter 6. Top tips. The key to this answer is given in part (a) of the question – information overload. The extract from the golf club accounts is an example of reporting that provides too much detail and too little information. This is all you need to extract from the figures; do not waste any time trying to analyse the numbers in the extract from the accounts.

208

Answers

Notice that part (a) does not require any application to the scenario: it is simply asking you to explain what information overload is. However, you do then need to apply your knowledge to part (b). Clearly one of the weaknesses of Cobra’s reporting system is that of information overload, but it is not the only one. Note also that once you have identified the weaknesses, you then need to recommend changes that could be made - to help address the weaknesses. (a) Information overload, as the term suggests, refers to the provision of excess amounts of information. In management reporting information overload occurs when management are given excessive amounts of detail in their reports. Problems of excess information - Excessive information can significantly reduce the value of the information actually provided. This is because a manager receiving the reports may not identify significant items of data that are ‘hidden’ by large quantities of unimportant data. Unless key items of information are identified, they will not be acted upon, and the value of the information will be lost. Impact on management time - Information overload can also waste management time, by requiring managers to try to absorb all the information in a report. Greater quantities of information take longer to read and understand. For this reason, managers may restrict reading reports to looking at one or two figures that they consider to be important. Although supporting information may be provided in extensive detail, an important principle of management reporting is to draw management attention to the critical aspects of performance. This may be done through exception reporting or the use of key performance indicators. (b) The main weakness of the reporting system at Cobra is information overload. The club has a problem with insufficient income or excessive expenditure, but it is not clear from the report where the problem exists. There are several ways in which the information overload may be reduced. (i) Some of the columns of information on page 1 (and so possibly on pages 2, 3 and 4 as well) may be superfluous and add little if anything of value. The annual budget figures service no purpose, because there is nothing to compare them with and for most items the annual budget is the monthly budget for the item multiplied by 12. It is not clear why figures for both the budget and last year are required. One or the other should be sufficient for control reporting; therefore the columns for the current month and the year to date should probably be removed for ‘last year’, leaving just the budget figures for comparison in the report. Some of the line items seem quite small in value. It may be appropriate to combine these into a ‘miscellaneous’ items line, provided that variances between actual and budget are not. (In this report, however, there is quite a large line item for miscellaneous administrative expenditure and the variance for the month and year to date is fairly l large. This is consequently an item where more management information rather than less might be appropriate.) It is not clear why an end-of-month balance sheet should be required. Similarly the value of a comparison between budgeted and actual capital expenditure for the year to date does not provide anything of obvious practical value. Finally, on the subject of information overload, it is not clear that the board should be concerned with a detailed list of aged debtors. Collecting money from customers should be a responsibility for the accountant, not the board, and the board should only be informed if a serious problem arises with collections or bad debts.

(ii)

(iii) (iv) (v)

Feedforward control - It would seem to be useful to provide feedforward control information, comparing the budgeted results for the year with a current forecast. Unfortunately, the current forecast appears to be constructed using weak assumptions – adding actual results for the year to date to the budget for the remainder of the year. If the budget figures are known to be ‘wrong’ and unachievable, using budgeted figures to produce a revised forecast will simply produce an unreliable current forecast. This could provide very misleading control information.

Answers

209

Exception reporting - A monthly reporting system should make use of exception reporting. Exceptional differences between budget and actual, or between budget and current revised forecast can be highlighted, for example in a different colour. In addition a covering report from the general manager should refer to the exceptional items and their apparent causes. Exception reporting will enable management to focus on what appears to be significant in the monthly results.

34 Bluefin school
Text reference. Management information and control is discussed in Chapter 6 of the Study Text. Top tips. Part (a): There are two different issues to consider in this question: (i) what are the controls over data and information that make it useful for decision-making and control; (ii) what security procedures are needed to protect that data itself. You need to address both of these issues to score well in this requirement, and to link it to the specific context of Bluefin school. Part (b): The verb requirement here is to ‘evaluate’ the information so you need to consider how useful or valuable it is to the Board. In your evaluation you should try to consider both the advantages and disadvantages of the pack’s current format, even though you should have realised that there are rather more disadvantages than advantages! Part (c): The scenario identifies that some departmental heads use graphs to present information while others use tables and figures. When presenting information, it is important that the method chosen helps the audience understand the information, so you need to consider how the different methods of presenting information could help the Board understand departmental performance most effectively. Part (d): Here again, as you are asked to ‘evaluate’ you should try to consider the potential advantages and disadvantages of the suggested improvements. Also, note there are two potential aspects of the improvements you should consider: (i) the introduction of the unified database; (ii) the internet connection.

Marking scheme
Marks

(a)

For each relevant point discussed in relation to controls and security procedures – 1 mark each. Up to a maximum of 9. Positive aspects of the pack – 1 mark each, Up to a maximum of 2 Problems of information overload – Up to 2 marks Problems of information being confusing and unexplained – Up to 2 marks Pack failing to cover overall objectives – Up to 2 marks Maximum for part (b) – 6 marks

9

(b)

6

(c)

For each different way discussed – 1 mark each Usefulness of the different methods of presenting information (and potential drawbacks of them) – 1 mark each Maximum for part (c) – 5 marks Benefits of suggested improvements – 1 mark per relevant point, Up to 4 Problems with suggested improvement – 1 mark per relevant point, Up to 3 Maximum for part (d) – 5 marks

5

(d)

5 Total = 25

210

Answers

(a)

Controls Comparisons – An important control over management information which is prepared on a decentralised basis by different departments (as at Bluefin school) is that it is prepared in a way that enables the performance of the different departments to be compared. For example, at Bluefin school, the information should allow the governors to analyse the performance of each department in the school by comparing performance in key areas (such as exam pass rates.) Standard templates and definitions – However, the fact that the department heads are using different approaches to reporting information and are presenting their performance information in different formats will make it much harder for the governors to compare performance in this way. To overcome this problem, all the departments could be asked to present their results in a standard template, and using standard approaches for reporting performance (for example, presenting both pass rates and average marks. Costs vs benefits – Another important control is that the cost of producing the reports does not outweigh the benefits of producing them. However, in practice this is likely to be hard to monitor. At Bluefin, the costs of the reports are likely to come from the cost of the heads of departments’ time spent producing them, and they may not by themselves have any direct quantifiable (or financial) benefit. However, the reports will be necessary to satisfy key stakeholders (such as the government) that performance within the school is being adequately managed. Management information used – However, any benefits from producing the reports will only accrue if the reports are actually used by the governors. In this respect, an important control is monitoring (for example, by reviewing meeting minutes) that the departmental results are discussed at the board meetings, and actions taken to investigate any unexpected variances in performance between departments. Security measures Back ups – Data and information needs to be backed up on a regular basis to prevent it being lost. The decentralised nature of the information system at Bluefin means that each department will be responsible for backing up its own data. This could be seen as a risk, because some departments may be less reliable in carrying out their back ups than others. Protecting confidential information – Bluefin’s management information contains two types of sensitive or confidential information: information about individuals’ exam performance, and information about the school’s income and expenditure. The school needs to ensure that it has adequate security procedures to ensure that this information is not accessed by unauthorised people. The decentralised nature of the school’s information systems is likely to make it harder to ensure controls are maintained, for example because of the number of PCs containing confidential information. Password controls – However, a properly applied system of password controls could help ensure the security of this information. For example, Bluefin should have a policy that all passwords should be changed regularly, and the passwords for logging on to any PCs should not be written on, or near, the relevant PC. Safeguarding memory sticks – Bluefin also needs to consider the security procedures required to manage the risks associated with information being passed to the administration office on memory sticks. For example, the memory stick could be lost or stolen; and this should be addressed by a copy of the final departmental report being saved on the departmental PC before it is transferred on the memory stick. Then any data on the memory stick should be encrypted before being passed to the administration office. A further risk associated with the memory sticks is that they could transfer viruses between different PCs. To protect against this, Bluefin should ensure that up-to-date anti-virus software is installed on all its PCs, and all memory sticks are scanned for viruses before any data from them is loaded onto a PC.

(b)

Benefits of pack Highlights financial and educational performance – The pack addresses the two of the key areas of the school’s performance (financial and educational performance) and does provide the governors with data about performance in both of these areas. This data should help the governors to assess the quality of the teaching and financial management in the school.

Answers

211

Problems with pack Information overload – However, the contents of the pack appear too detailed for their audience (who are selected from the local community and parents, rather than being academic or financial experts.) The governors only review their pack once a year, and so it would seem more appropriate for the information in the pack to be a summary of the school’s performance, rather than the detailed information currently presented. For example, if the governors are presented with 11 departmental reports similar to that from the mathematics department it will be difficult for them to identify any key trends or variances in performance. Similarly, rather than presenting the governors with a detailed income and expenditure statement, it may be more appropriate to present them with a summary of the key financial highlights. In addition, the financial information currently only focuses on the school’s income and expenditure. However, it would be useful to also show a summary of the school’s assets, in a statement of financial position. For example, it would be useful to understand the school’s cash position before making a decision about the proposed IT improvements. Lack of narrative – The governors’ pack does not appear to contain any narrative explaining any of the data provided in the detailed reports. For example, it would be useful if the departmental reports also included a short narrative explaining any significant factors which have affected the class averages provided. Although the previous years’ figures is provided as a basis for comparison, this does not help to explain any variations in performance between the two years. Limited performance measures – The pack only addresses the financial and educational performance of the school, but the school’s ethos also highlights the importance of promoting ‘citizenship and self-confidence among the pupils.’ However, there does not appear to be any analysis or measurement of how well Bluefin is achieving this. Admittedly, it may be difficult to measure the pupil’s self-confidence objectively, but some measures of citizenship could be included in the pack; for example, the number of hours pupils spend working on community projects. Lack of external comparisons – Finally, the pack only focuses on Bluefin’s own performance, although it would also be appropriate to include some external comparisons of the school’s performance. In this respect, benchmark data (for example, comparing Bluefin’s exam performance against that of other schools in the area) could also be provided, in addition to the current, internal performance information. (c) The information may be presented in a written format, or as a table, graph or chart. The use of charts, graphs and tables can often enhance the understandability of information. In particular, charts or graphs can be effective ways of communicating information, and may focus the board’s attention on key aspects of departmental performance. In this way, using graphs or charts could be more effective than presenting too much information in tables. However, it is important to remember that the usefulness of different types of chart or graph (for example, pie charts, bar graphs and line charts) depends on the sort of information being communicated. Therefore, it is important to select the most suitable type of chart or graph in any given situation: Pie Charts – are useful in reflecting percentage or other proportional relationships; in this instance they may have limited use. Bar Charts (or column charts) – are useful for making comparisons between two or more items when absolute amounts are being presented instead of proportional or percentage figures. They may be used, for example, to provide a valuable visual representation of average marks over time and between departments. Line charts (or similar scatter plots) – are most useful for presenting a trend (or a combination of trends) over a period of time and can be used to show trends, for example, in average marks. However, it is important that there are not too many charts or graphs in the report. If too many charts are used, they are likely to lose their effectiveness, because the reader will be likely to end up ignoring some of them. There also needs to be consistency in the ways that the information is presented to allow the board to make easy and fair comparisons between the departments and over time. 212
Answers

(d)

Benefits of having a unified database The improvements will result in all of Bluefin’s performance information being stored in a single database, which all the departments and the administration office can access. This should not only prevent any unnecessary duplication of files, but should also reduce storage requirements on account of all the data being unified in one database. Transfer of information – Having a single database will significantly increase the ease with which information can be transferred between the departments and the office, and will reduce the risk of data (currently transferred on memory sticks) being lost. Control over data and security - Storing all the data on one network rather than having local repositories in each department should also improve control over the data. For example, all the data can be backed up centrally, rather than relying on each department to back up its own data. Equally, standard templates for the department reports can be created on the network, which the department heads then fill in, thereby ensuring consistency in the way information is presented between departments. Data sharing – Under the new system, Bluefin’s computers will linked to the internet, which will make it easier to submit information to key stakeholders, such as the government or the governors. The internet connection may also mean that Bluefin can share data with other schools more easily, which could help in benchmarking performance between the schools. Limitations of new system Risks to data and security – Whilst there could be benefits from opening the school network to the internet, there are also risks to doing so: it will provide additional opportunities for the spread of viruses, and could make any information on the network vulnerable to hackers. Equally, if all the school’s data is stored in one place, it would mean the consequences of a system failure would be greater, because potentially all the data could be lost. However, backing up data regularly should reduce the impact of this risk. Underlying usability of information – While the new system may address some of the current problems with the control and security of the data, simply improving the information systems by themselves will not solve the problem of information overload in the governors’ pack.

35 CFD
Text reference. Chapters 1, 3 and 10. Top tips. Part (a) (i) draws on your knowledge of mission statements and their benefits and drawbacks. Begin with a definition. We use Mintzberg's version which nicely contains the elements of a mission. You aren't asked to refer to the scenario which makes it a bit easier as you are just writing down what you know. We have listed thirteen benefits and failings and the examiner gives the same number in his answer. These are all short one line points thus the examiner appears to expect many, but brief, responses here. The marking scheme gives six marks in total. In part (a) (ii) think about what value for money (VFM) means. Does CFD provide this for its customers? Will the new initiative mean CFD is still providing VFM? Part (b) (i) is a test of knowledge; so you should define what CSFs and KPIs are, and then explain how they relate to each other. The key point here is that an KPIs need to be used to help an organisation measure how well it is performing in relation to its CSFs. Part (b) (ii) needs to be related back to CSF; so make sure the three critical success factors you discuss are appropriate for for CFD. Think about which performance requirements are critical to its success and how are these measured. Quality of service is important in a service business. In part (c) think about what you would want to see in terms of quality if you had a pet and wanted to send it to CFD.

Answers

213

Easy marks. Defining a mission statement in part (a) (i) will earn you a couple of marks and listing benefits and problems up to six more. This is simply regurgitation of book knowledge, it is covered in our text and so you should have been able to get nearly full marks on part(a).

Marking scheme
Marks

(a)

(i)

Purpose Potential benefits Failings Changed circumstances Up to 2 Conclusion Up to 2

2 3 3 8 2 2 1 1 2 4 3 3 6

(ii)

4

(b)

(i)

Definition of CSFs Definition of KPIs Relationship between CSFs and KPIs

(ii)

For each CSF discussed – 1 mark For KPI highlighted for each CSF – 1 mark

(c )

Performance measures 3 × 1

3

3 Total = 25

(a)

(i)

Purpose, potential benefits and potential problems of mission statements Purpose Mission describes the organisation's basic function in society, in terms of the products and services it produces for its clients (Mintzberg). Organisations often write down their mission in a mission statement. A mission statement should be brief, flexible and distinctive, placing an emphasis on serving the customers. It often refers to key stakeholder groups including employees and shareholders. The mission statement should make it clear to employees their contribution towards attaining the mission. It should also remain the same unless the mission changes. Potential benefits of mission statements include:        A written, public statement of the reason for the organisation's existence Allied to this, communicate a clear image of what the organisation is to customers and other stakeholders. Also help in resolving conflicts between stakeholder groups over what the organisation stands for. Identify key cultural values to employees. Aid strategy by helping businesses define their nature, services and products and competences Guide policies and standards of behaviour by managers and employees by stating business principles such as social responsibility and anti-discrimination. State ways of competing, for instance on price or innovation.

214

Answers

Potential problems of mission statements include:       (ii) Vague statements which don't explain what the business is for or how it intends to achieve its aims. Jargon which obscures what the meaning of the statement is. Failure to be flexible and open ended as the mission will probably change over time as the business changes. Being unrealistic in its aims. Not taking account of external factors. Inconsistency between the elements of the mission.

Appropriateness of the mission statement for CFD Value for money is providing a service in a way which is economical, efficient and effective, and so CFD's mission statement would appear to have accorded with its overall mission (as it has operated on a profit-making basis)., and would remain appropriate as long as CFD continued offering its original services, When it decided to open a homeless sanctuary for strays, its mission and services changed and so it needs to recast the mission to include some element capturing the new charitable activity. When CFD decided to undertake this non-profit-making activity, this meant its new aims would not necessarily be profit-making and therefore could not deliver value for money.

(b)

(i)

Critical success factors (CSFs) are the key factors and processes which enable an organisation to achieve its objectives and thereby achieve future success. In effect, CSFs highlight the areas in which it is crucial for an organisation to perform well in order for it to be successful. CSFs and KPIs – However, once an organisation has identified its CSFs, it needs to know how well it is performing in relation to them. Simply identifying the areas where an organisation needs to perform well does not guarantee that it will do so. Therefore it needs to measure how well it is performing in these areas. This is done by using key performance indicators (KPIs). Key performance indicators - KPIs are the measures which indicate whether or not CSFs are being achieved, and how well the organisation is performing. This idea of measurement is vital for KPIs. KPIs must be measurable, because otherwise an organisation will not be able to measure whether or not its CSFs are being achieved.

(ii) CFD is a service business and so its CSFs are likely to relate to the services it offers, and in particular to the features of those services which are valued by its customers.  Maintaining a high standard of cleanliness of accommodation for the dogs at CFD. If prospective clients come to visit CFD’s kennels and they look dirty and untidy, it is unlikely that the owners will want their pets to stay at CFD. A performance indicator which could be used to measure cleanliness could be the number of cleans made per day or week of the dog kennels and common areas.  Guaranteed safety of the dogs whilst in CFD's care. Again, owners are not going to want to use CFD to care for their dogs unless they feel confidents their dogs will be well looked after. This could be measured by the number of accidents over a given period.  An excellent health record. This means no or minimal breakout of infections which would damage the reputation of the business. This could become particularly important if CSF does start accommodating homeless dogs, because if any of the homeless dogs have got infections or diseases it will need to ensure that none of these get transmitted to the pets in its care. This could be measured by the number of dogs that fall ill during their time at CFD.

Answers

215

(c)

Three quantitative non-financial performance measures to assess quality of service    Service availability may be measured by the number or percentage of owners able to book their dogs in on preferred dates and times. Care taken of the dogs and the quality of the service experience will be measured in return bookings and possibly word of mouth referral. Prompt and reliable collection and return of dogs to their owners. This is a key element of the service offered. This could be measured by logs of delivery and return of dogs safely and within the time promised.

36 ZTC Communications
Text reference. The external environment is discussed in Chapter 4 of the BPP Study Text. The performance hierarchy (looking at objectives, CSFs, and KPIs is discussed in Chapter 7. Top tips. Neither the scenario nor any of the requirements make use of the word 'stakeholder', but it should spring to your mind as soon as you begin thinking about this question. ZTC has some very important new stakeholder groups to consider and their interests will be the main formative influence on what the company sets out to do. Stakeholders will be a major consideration for both part (b) and part (c). Part (a) Top tips. Two models which are useful for analysing the external environment are PEST analysis and Porter’s five forces. The external environment is a source of opportunities and threats for an organisation, so, in effect, this question is asking about how opportunities and threats could affect ZTC’s performance. Opportunities and threats – ZTC needs to ensure that it understand the ways in which it is affected by the environment in which it operates. In this context, it needs to consider the wider environmental factors (which could be highlighted by ‘PEST’ analysis) as well as any factors which relate more specifically to the telecommunications industry (which could be highlighted using Porter’s Five Forces model as a guide). The most significant recent environmental influence on ZTC’s performance is likely to have come from a political factor – the deregulation of the telecommunications market in Zeeland. Impact of deregulation – Historically, ZTC held a monopoly position in the telecommunications market in Zeeland. However, now that the market has been deregulated, ZTC’s market share is likely to be eroded when new competitors enter the market. Consequently, it seems likely that ZTC will suffer a fall in revenue, at least in the short term until it identifies alternative markets which it could enter as well. New entrants - It is not clear how many competitors have entered the market so far, but another threat ZTC needs to be aware of is the threat of additional new entrants entering the telecommunications market in Zeeland in future, and potentially reducing its market share further. Telephone networks – It is likely that ZTC’s monopoly was of the fixed line network in Zeeland, rather than mobile telecommunications networks as well. However, it is also likely ZTC will face competition from mobile phone companies. In this respect, developments in technology (for example, 4G networks) could also boost the performance of mobile phone companies, and thereby increase the level of competition ZTC is facing. Overall market growth – The scenario does not indicate whether the telecommunications market overall in Zeeland is growing, or if it is, how high the growth rate is. However, this will also have an effect on ZTC’s performance. For example, if the market is growing rapidly, this could help reduce the impact on ZTC’s revenues of its market share declining. Similarly, if the global market is growing significantly, this could provide opportunities for revenue growth. It appears that one of the government’s motives behind the deregulation was to make ZTC more competitively internationally, and so the state of the global market is likely to be important for its future performance.

216

Answers

Customer bargaining power – Another consequence of the deregulation is that customers in Zeeland now have increased bargaining power in relation to ZTC. Previously, as ZTC was the sole supplier, customers had little or no bargaining power over it. However, now that there is increased choice in the market, customers’ bargaining power has increased significantly, because if ZTC’s tariffs are not competitive against other providers, or its standards of customer service are poor, customers will be able to switch to one of the competitors in the market. Employees – The deregulation of the market could also affect ZTC’s relationship with its employees. In effect, it could increase their bargaining power as suppliers. Previously, telecommunications engineers in Zeeland could only work for ZTC; but it is likely that in future there will be a choice of companies they could work for. Therefore, ZTC will need to ensure that its rewards package is competitive so that it retains its best staff. Part (b) Top tips. It is necessary to deploy a little knowledge of the public sector in order to answer this requirement properly. Simply saying what the new objectives should be will not be enough: it is necessary to think in terms of change and this implies some consideration of what the company's objectives were before privatisation. Don't overlook the demands of corporate governance; this is about both what is to be done and also how it should be done. The solution below adopts a stakeholder approach. An alternative approach would be to make a series of points related to the primacy of profit in a commercial firm compared to a state monopoly, the need to hold market share at home, the need to gain sales revenues by expanding product range and providing services abroad, and the need to protect its share price by good corporate governance and adequate communication with investors. As a state monopoly, ZTC's role was expressed in terms of its service to the nation of Zeeland as a whole. Its focus was on the public sector aspirations of efficiency, effectiveness and economy, but it was not subject to market discipline and its finances were controlled by government. The lack of market input and the highly technical nature of its operations make it likely that its main operational concern was engineering competence, rather than customer interests. However, the government, as principal stakeholder, imposed requirements around performance and service levels to be achieved. Shareholders as new stakeholders ZTC now has a new and important class of stakeholder in the form of its shareholders. They will have firm ideas about their requirements in the form of growth, earnings and dividends. Importance of customers The company faces a de-regulated market where competition will intensify. It will need to pay great attention to the views and needs of its customers; they are a stakeholder group that is likely to wield far more influence than previously, since they will be able to choose new suppliers when new providers of telecommunications services enter the market following its deregulation. Impact on objectives These influences will affect objectives at all levels in the organisation and will require a significant realignment of attitudes. In particular, there will be pressure to reduce costs; to develop new and attractive products; and to improve customer service, particularly in the matter of installing new equipment and dealing with faults. The respective requirements of shareholders and customers also highlight a potential conflict which will need to be addressed by the directors when setting the company's objectives. Shareholders will want to maximise profitability which may be achieved by raising prices. But customers will seek the lowest price they can get. Although the government is no longer the main external stakeholder, it will still be interested in ZTC's performance. The company will continue to make a large contribution to the economy of Zeeland as a major employer and taxpayer; it also has the potential to develop as a major centre of technological excellence. While the government will step back from direct involvement in the running of ZTC, it is likely that it will retain an interest in its overall success, and possibly a closer involvement in such matters as the promotion of technological development and overseas expansion, which if successful could increase ZTC's tax liability to the government.

Answers

217

Corporate governance A final influence on the strategic objectives of the privatised company will arise in the field of corporate governance. As a quoted company, ZTC will be subject to the normal regulations and codes of practice laid down by its quoting stock exchange. It may also be subject to special government regulation designed to prevent it from using its size and current dominant position to discourage competitors. These influences are also likely to have a marked effect on the directors’ attitudes and practices. Overall, the objectives of ZTC will need to change to focus on profitability and shareholder reward, as well as customer satisfaction which becomes increasingly important in a deregulated market. Alongside this, the directors will need to ensure the business' controls and governance are adequate to comply with its new regulatory requirements. Part (c) Top tips. You must think carefully here. First, note that you are not being asked for a mission statement: the objectives you select must be strategic (long term, not short term), but they can be very specifically aimed at particular aspects of strategy. Approaching the problem from the stakeholder angle would be a good way to proceed here, but make sure you explain why the objective is appropriate to ZTC. The second important point is that the objectives you provide must be SMART. However, note (c) is only worth four marks so do not spend too long on this requirement. Objective 1 To achieve an average of 5% annual growth in share valuation for the next five years or until competitors achieve a total of 25% market share. This objective is relevant to the concerns of shareholders. It is specific, measurable and time-bound. It is also realistic, in that it acknowledges that the company's existing privileged position is likely to be damaged by the entry of competitors into its markets. Objective 2 To create, within twelve months, an affordable and humane restructuring plan that will reduce staff costs by 20% and to implement the plan over the following three years without provoking a major labour dispute. This objective addresses the continuing strategic need for cost efficiency to allow ZTC to compete effectively in a deregulated market. It recognises the need to balance that need against the interests of the existing employees and the practical difficulties of implementing a headcount reduction. Part (d) Top tips. Although the question requirement doesn’t specify that the CSFs you recommend need to relate to the objectives you have identified in part (c), it seems sensible to identify CSFs that link to these objectives. However, make sure you identify CSFs and not KPIs (which are the measures ZTC could then use to assess how well it is performing against its CSFs). Also, before you recommend your TWO CSFs you need to explain briefly the link between objectives and CSFs in general terms. Once an organisation has established its objectives, it needs to identify the key factors and processes that will enable it to achieve those objectives. These key factors are its critical success factors. In effect, the CSFs are the building blocks which will enable an organisation to implement its mission and thereby achieve future success. In an effective organisation, the factors that are crucial to success will influence all aspects of its operations, especially those relating to people. For example, if a company identifies excellent customer service as a CSF, then its recruitment process, training, appraisal and reward systems should all be geared towards promoting customerservice skills in its staff. However, once an organisation has identified its CSFs, it also needs to know whether it is delivering on them. This is done by using KPIs, which measure how well the organisation is performing against its CSFs. The KPIs are the hard data which tells the organisation how well it is performing.

218

Answers

The change in ZTC’s circumstances and the increased competition for market share highlights the importance of delivering value to customers. Therefore two appropriate CSFs for ZTC could be: Customer satisfaction – ZTC must be able to keep its existing client base happy. ZTC’s share price will affected, in part at least, by the company’s financial performance, and the number of customers ZTC retains will have a significant influence on this. Ensuring customers are satisfied with the products and service which ZTC offers them will be vital in ensuring they remain ZTC’s customers rather than switching to one of its rivals. Competitive prices – Now that the market has been deregulated, ZTC faces competition from national and international rivals. This suggests that customers will have a relatively high degree of choice for what appears to be a fairly undifferentiated product (telephone services). Therefore the ability to compete on price will be important to ZTC’s success.

37 Large conglomerate
Top tips. Make sure that you are clear on the calculation of residual income, return on investment and net present value. At this level in your studies, such calculations should be very familiar to you. Read the question carefully and make sure that your answer addresses all of the requirements. For example, for the worst case scenario you need to use the higher cost of capital so that the imputed interest charge is high. Note that the NBV used is that of the project at the beginning of the time period. Easy marks. If you couldn't get the NPV calculation right in (a) you really need to do some serious revision of the topic as the calculation was a gift. Part (b) also contains opportunities for easy marks, but make sure that after explaining each measure you can highlight the strengths and weaknesses. You really should have no trouble picking up at least six marks here as you do not even have to relate your answer to the scenario. We have listed some additional material in an Additional answer box for your information only. You would not need to write all of this for eight marks. Under a previous syllabus, this was an examination question. The examiner made some useful comments on mistakes that we thought would be useful to reproduce here. The mistakes are ones you should avoid. 'The answers provided to this question were most disappointing. A common mistake was to treat depreciation as a cash flow – such a mistake should not occur at this level under any circumstances. The strengths and weaknesses of each measure were often presented only superficially or simplistically. In part (c), a large number of candidates made reference to issues that were not specifically associated with project appraisal.' (a) (i) Best outcome Revenues (W1) Incremental costs (W2) Net cash flow Less depreciation Net profit Imputed interest charge at 8% on NBV of investment Residual income NBV ROI ((profit/NBV)  100%) Year 1 $m 84.00 (45.00) 39.00 (18.00) 21.00 (4.32) 16.68 $54m 38.9% Year 2 $m 94.50 (54.00) 40.50 (18.00) 22.50 (2.88) 19.62 $36m 62.5% Year 3 $m 105.00 (63.00) 42.00 (18.00) 24.00 (1.44) 22.56 $18m 133.3%

Answers

219

NPV calculation Year 0 1 2 3 Workings 1 Revenue

Net Cash flow $m (54.0) 39.0 40.5 42.0

Discount factor 8% 1.000 0.926 0.857 0.794

PV $m (54.00) 36.11 34.71 33.35 50.17

Expected Best × 1.05 Worst × 0.95 2 Cost

Y1 80 84 76

$m Y2 90 94.5 85.5

Y3 100 105 95

Expected × 0.90 (ii) Worst outcome Revenues (W1) Incremental costs (W2) Net cash flow Less depreciation Net profit Imputed interest charge at 13% on NBV of investment Residual income NBV ROI ((profit/NBV)  100%) NPV calculation Year 0 1 2 3 Workings 1 2 (b) (i) Revenue – see Working 1 above. Cost = expected cash flow plus 10%. Net Cash flow $m (54.0) 21.0 19.5 18.0 Discount factor 13% 1.000 0.885 0.783 0.693

Y1 50 45 Year 1 $m 76.00 (55.00) 21.00 (18.00) 3.00 (7.02) (4.02) $54m 5.6%

$m Y2 60 54 Year 2 $m 85.50 (66.00) 19.50 (18.00) 1.50 (4.68) (3.18) $36m 4.2%

Y3 70 63 Year 3 $m 95.00 (77.00) 18.00 (18.00) 0.00 (2.34) (2.34) $18m 0.0%

PV $m (54.00) 18.59 15.27 12.47 (7.67)

Residual income (RI) is a measure of profit after deducting a notional or imputed interest cost on the capital employed. It focuses decision making upon the fact that projects use up scarce and costly funds, and that the project under consideration may not represent the best use of those funds. The imputed cost of capital might be the organisation's weighted average cost of capital. Alternatively, the cost of capital can be adjusted to allow for risk characteristics, with a higher imputed interest rate being applied to higher risk projects.

220

Answers

Strengths of using RI (1) Residual income increases in the following circumstances.   (2) Investments earning above the cost of capital are undertaken. Investments earning below the cost of capital are eliminated.

Residual income is more flexible since a different cost of capital can be applied to investments with different risk characteristics.

Weaknesses of using RI It does not facilitate comparisons between projects, and neither does it relate the size of a project's income to the size of the investment, other than indirectly through the interest charge. In addition, difficulties can arise in deciding an appropriate measure of the capital employed on which to base the interest charge. (ii) Return on investment (ROI) compares profit with the operational assets used to generate that profit. Profit is taken before tax and interest because tax is an appropriation of profit made from the use of the investment, and the introduction of interest charges introduces the effect of financing decisions into an appraisal of operating performance. ROI is normally used to apply to investment centres or profit centres. These normally reflect the existing organisation structure of the business. Advantages of using ROI (1) Financial reporting. It ties in directly with the accounting process, and is identifiable from the income statement and statement of financial position, the organisation's most important communications media with investors. Aggregation. ROI is a very convenient method of measuring the performance for a division or company as an entire unit, permitting comparisons to be drawn between projects or business units, regardless of absolute size. If an investment centre maintains the same annual profit, and keeps the same assets without a policy of regular non-current asset replacement, its ROI will increase year by year as the assets get older. This can give a false impression of improving 'real' performance over time. It is not easy to compare fairly the performance of one investment centre with another. Noncurrent assets may be of different ages or may be depreciated in different ways. Inflation and technological change alter the cost of non-current assets. If one investment centre has non-current assets bought ten years ago with a gross cost of $1 million, and another investment centre, in the same area of business operations, has non-current assets bought very recently for $1 million, the quantity and technological character of the noncurrent assets of the two investment centres are likely to be very different.

(2)

Disadvantages of using ROI (1)

(2) (3)

Additional answer (4) Measuring ROI as return on gross assets ignores the age factor. Older non-current assets usually cost more to repair and maintain. An investment centre with old assets may therefore have its profitability reduced by repair costs. A target ROI set by a conglomerate makes no allowance for the different risk of each investment centre. In a conglomerate, an identical target return may be unsuitable for many businesses in a group. Since managers will be judged on the basis of the ROI that their centre earns each year, they are likely to be motivated into taking those decisions which increase their centre's short-term ROI. Profit figures and asset values can be subject to manipulation. An investment might be desirable from the group's point of view, but would not be in the individual investment centre's 'best interest' to undertake. Thus there is a lack of goal congruence. 221

(5) (6) (7)

(8)

Answers

(9) (10)

In the short term, a desire to increase ROI might lead to projects being taken on without due regard to their risk. Any decisions which benefit the company in the long term but which reduce the ROI in the immediate short term would reflect badly on the manager's reported performance. There may therefore be an incentive to delay necessary asset replacement.

(iii)

Net present value (NPV), unlike the previous measures, takes into account the time value of money. Using this approach, it is important to consider when the money is received, not just how much. Advantages of using NPV (1) The emphasis on cash flows means that if the NPV of a project is positive, expected shareholder wealth will be maximised, because the project will earn a return in excess of the cost of capital. This is obviously appealing to shareholders. The use of cash flows rather than profits is subject to less manipulation of figures, and 'subjective accounting'. The cost of capital can be adjusted to take account of other risks that the project under evaluation may be facing. It can be difficult to come up with an appropriate discount rate that remains applicable over the life of the project. For simplicity, cash flows are often assumed to arise at year ends. This is unrealistic. It is difficult to predict cash flows accurately. There is a heavy reliance on estimates that may not be easily disproved at the time that the project is being appraised.

(2) (3)

Disadvantages of using NPV (1) (2) (3) (c)

Broader issues to consider (i) (ii) (iii) Investment decisions need to be taken in the light of the strategic and tactical decisions of the organisation as a whole, and should be consistent with it. There may be a high degree of risk and uncertainty associated with the project. It may alternatively reduce the amount of risk facing the company. Sources of necessary finance will need to be considered, as there may not be enough funds in place to suit the timing of the project and so it may need to be postponed, or ranked behind another project. There may be non-financial factors affecting the decision, such as legal issues, ethical problems or the level of competitor activity in the area under which the project falls.

(iv)

38 CSG
Text references. Chapter 10b is useful here as it gives a long list of non-financial performance indicators that you could use. Chapter 8 contains information on financial performance measures in the private sector and is a useful source of information on growth. Top tips. In part(a) you just need to put down three measures for each director. These can be quite simple as you will only earn an average of one mark for each. However, we have written more in parts of our answer where we feel a discussion or explanation is needed. You will see this particularly for the Finance director. Financial performance measures have advantages and disadvantages, which need to be discussed as they are not appropriate in all situations and must be used with care. The criteria part of your answer is making sure that you relate the measures to the primary focus. Take note of the 'quantitative' aspect of your measures. They must be capable of being measured even if they are not financial measures.

222

Answers

Part (b). There is no requirement to link your answer to CSG, so you could earn the marks available purely by displaying your knowledge. However, it may actually help you answer the question by linking it to the scenario. In essence, the contrast between survival and growth can be seen in terms of risk and return. But, for example, if CSG decided to continue operation in its current markets – which would be seen as the low risk option – how would its chances of survival be affected by the economic climate which is subject to significant variations? In part (c) you need to explain how growth might be assessed. Keep your points brief as the examiner gives only four marks for this. We have made more than four points to give you an idea of the range of answers you can make. Then think how a growth objective might be achieved and discuss the advantages and issues of pursuing a growth objective. This will earn you up to another four marks. Examiner’s comments. When this question was set as an exam question, the examiner remarked that many candidates did not answer part (a) and only provided details of how each director should run their departments. Using models such as Ansoff was unnecessary and failed to score extra marks. (a) Criteria and performance measures for each director Research and development (R&D) director The R&D director needs performance measures to assess how well products and services emerge that meet with new and current customers' approval. Measures may include (i) (ii) (iii) The number of new products developed in a year. Sales revenue from new services over a year. Sales of individual innovations and how well they have performed.

Finance director (FD) Investors are generally looking for earnings, growth in earnings, dividends and reduced risk. This can be measured using financial performance measures that report capital growth or income generation. Measures could include: (i) (ii) Residual income or RI deducts a notional interest cost from a centre's profits to reflect the finance cost of funding. ROCE, which indicates how productive the capital in the business is. However ROCE does not necessarily take a long-term view as asset values can be manipulated to improve the ratio at the expense of future investment. NPV is a measure that looks at the long-term profitability of projects measured by their cash flow and achieving a hurdle rate of return. This hurdle rate is a measure of the opportunity cost of the funds invested in the project. This shares a long-term perspective with the dividend model of valuation whereby the market value of a share is based on the income stream from future dividends.

(iii)

Additional answer (iv) Finally, EVA is a measure using economic profit that is current values by adjusting accounting profits for non-cash flow items and deducting a capital charge so it aims to avoid understating asset values which is problem with ROCE and RI. EVA is more likely to develop goal congruence than ROCE where decisions are being made to acquire or sell assets. It is claimed that EVA focuses on real wealth thus satisfying shareholders. However it has a relatively short-term focus on performance, compared to measures such as NPV.

Human resources director (HR) Measures here need to reflect the organisation's reputation with current and future staff. These measures should be made against targets or prior period levels. Typical performance measures may be include: (i) (ii) (iii) Absenteeism. The number of applications for each job vacancy. Staff turnover.
Answers

223

Corporate affairs (CA) director Measures need to indicate whether the organisation's reputation as socially responsible is founded. CSG could measure this by (i) (ii) (iii) (b) Chemical waste produced in tonnes or by the cost of disposal. Charitable donations made to community and international charities. Finally the number of complaints received concerning its business practices.

Survival Survival strategies are often based around strategic choices which entail relatively low risk, for example staying in an existing profitable market where returns are stable and predictable, rather than looking to expand into new markets. However, the danger with such a survival strategy is that, in the future, the existing market may start to decline, meaning that revenues and profits also start to decline. Equally, the fact that Swingland’s economic climate is subject to significant variations may mean that a survival strategy may not be successful for CSG even though it has avoided taking any the risks associated with growth strategies. In addition, survival strategies often focus on cost-cutting as a means of increasing profit. However, that could mean that options for increasing revenue get overlooked, for example, if marketing expenditure is reduced. Other opportunities to increase revenue, such as entering new markets, or developing new products, are also likely to be overlooked if a company focuses purely on survival. However, the fact that CSG has a research director whose focus is on developing new products and services suggests that the group’s focus is not solely on survival. Growth By contrast to survival strategies, the pursuit of growth can require a business to seek new opportunities, for example by expanding internationally, or by introducing new products. However, in order to pursue growth, an organisation may have to sacrifice its current security against the prospect of higher returns in future. In the longer term, pursuing a higher risk strategy may result in higher profits. However, there is no guarantee that it will. And while CSG’s shareholders, for example, are keen to see the company try to grow, they may be less happy if it accepts higher risk strategies but they do not result in higher profits. In the worst case scenario, if a quest for growth proves totally unsuccessful it could even jeopardise the survival of an organisation altogether.

(c)

Growth can be assessed across several areas. (i) Revenue In the long term, growth in revenue is only valuable to investors if it means growth in profits. This requires control of cost. Profitability Profitability can be assessed using a range of financial measures such as margin or EBITDA. Growing profitability is more useful if it is related to the level of investment. Measures such as ROCE or residual income, can be used and these relate performance to the underlying investment made. Comparisons of growth need to be made over time or with other measures. They are also useful if compared against other companies or industries. Return on investment A growing return on investment suggests that capital is being used more productively. Investors would use dividend payouts and capital growth to measure the return on investment. Market share Growth in market share is generally seen as a good thing as it can generate economies of scale.

(ii)

(iii)

(iv)

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Answers

(v)

(vi)

(vii)

Employee-based measures Shareholders are interested in productivity and profit per employee as measures. An increasing head count indicates success if people are needed to deliver a service but only if they are employed productively. Number of products or services Growth in the number of products or services offered is only useful if these are profitable and have a long-term future. Cash flow This is one of the most important measures of growth as it determines how much the business has to invest.

Issues Achieving growth of the business ultimately depends on making profits and having the resources available to fund that growth. A business that does not strive for growth will stand still and is likely to fall behind its competitors who do pursue growth. Advantages Growth is allied to the long-term survival of the organisation. A growing and profitable business can protect itself against environmental threats such as competition or unstable economic conditions. CSG operates in an economic environment that is prone to significant variations. So CSG would wish to go for growth to protect its position. However, a growing and profitable business may also become a desirable target for competitors to take it over.

39 SEC
Text references. Chapter 8 should help you to answer the requirements of this question. Top tips. In part(a) there are only eight marks available (or 14 minutes) for calculations and commentary so don't spend too much time calculating lots of ratios. Seven or eight relevant ratios should be enough. However, more importantly make sure you also comment on the what the ratios you have calculated indicate about the performance of the two operations. Part (b) wants you to think about the limitations of the data in the question. What else would you need to know to be able to assess performance? Think strategically here: what tools would you use to make comparisons? Part (c ) requires some thought about the different markets and circumstances of the two operations. Part (d) should be a straightforward review of EBITDA, and doesn’t require any application to the scenario so there should be some easy marks available here. For Part (e), think about the sort of measures you might be interested when considering where to study. Remember, the organisation in the scenario is a training college, so what non-financial measures of performance are likely to be important there? Although the measures we have suggested focus on aspects of student performance, you could equally have suggested measures such as market share (which SEC could measure by looking at the number of students on its courses as a proportion of the total number of exam candidates.) Monitoring its share of the market could help SEC assess how well it is performing relative to its competitors.

Answers

225

(a)

Financial performance of SEC and its operations 20X6 Homeland Growth in revenue (%) Increase in operating costs (%) Increase in total costs (%) Net margin before interest (%) EBITDA ($'000) Non-current asset turnover (×) Gearing ratio Assessment (i) (ii) Both operations and SEC have seen a double digit growth in sales revenue over the two years. Of note is the growth for Awayland of 30% in its first full year of trading. Operating costs have also increased over the same period but at a lower rate than the increase in revenue. These costs have increased by less than 5%, which indicates good cost control. The combined increase in materials is just over 2%. Total costs have also increased by single figure amounts. Interest costs have fallen reflecting a decrease in loan stock outstanding. The difference between the increases in operating and total costs for Awayland arises from a near doubling of marketing and depreciation costs (albeit from a low base). Margins have been maintained and improved in all three cases. Awayland, which booked a loss in 20X6, has booked a small profit of $15,000 in 20X7. SEC's margin has seen a significant improvement, mainly due to improved revenue and it has enjoyed a near doubling of its profit in the two years. EBITDA for SEC has improved by $565,000. Non-current asset turnover has improved, suggesting improved utilisation of non-current assets but that for Awayland has declined from 4 times to 2.6 times. This could reflect the need to purchase non-current assets during the growth phase of the division and may well stabilise in further years. Gearing has decreased for SEC due to the decrease in loan stock as well as new purchases of noncurrent and current assets. 20X6 Awayland 20X6 Combined 20X7 Homeland 11.1 4.2 4.9 20.0 – 13.2 1,125 1.8 38.5 24.5 20X7 Awayland 30.0 3.3 9.4 1.2 20X7 Combined 11.5 4.0 5.2 19.7 1,690 1.9 26.2

1.6

4.0

1.8

2.6

(iii)

(iv) (v)

(vi) (b)

Additional information The analysis above has suggested the need for additional information. (i) A budget for each division and SEC for 20X6 and 20X7 to compare actual results. At present there is no indication of how well the operations and company have performed with reference to expected performance. Comparisons with equivalent companies using benchmarking. This could involve looking at financial or market share comparisons. By comparing the operations and SEC with data from direct competitors, if this is available, it can be established how well they are actually performing in the markets in which they operate. SEC's long-term funding projections including cash flow. From this, we can establish whether it intends to continue to repay debt and what its plans for expansion into the future are. Financial data for 20X5 so that a further year's worth of financial data is available to make comparisons between Homeland and SEC and see the complete picture for Awayland.

(ii)

(iii) (iv)

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Answers

(c)

Comparative financial performance of the two operations Homeland and Awayland operate in different geographical markets. Homeland has been established for longer than Awayland. They are not directly comparable. Any comparison needs to consider factors such as those listed below. (i) (ii) (iii) (iv) Relative market size and the operations' ranking in their domestic market, that is, the nature of the competition. Availability of local resources such as lecturers and the cost of recruitment and retention. The strength of the SEC brand in these markets. If SEC is a well-known brand then it will be easier to attract students than if it is an unknown presence. Domestic government policy on attracting business, encouraging competition and taxation of business.

(d)

Advantages of using EBITDA (i) (ii) (iii) (i) It is a good proxy for cash flow from operations, and therefore is a measure of underlying performance. It can be seen as the proportion of operating profits converted to cash. Tax and interest are effectively distributions to the government (tax) and a finance charge (interest). They are not relevant to the underlying success of this particular business. EBITDA is easy to calculate and understand. EBITDA can be used to assess the performance of a manager who has no control over acquisition and financing policy, which is the case here, as it excludes costs associated with assets (depreciation) and debt (interest). In addition, EBITDA removes the subjective judgement that can be required to calculate depreciation and amortisation, such as allocating useful lives or residual values to assets. By eliminating these, EBITDA makes it easier to compare the financial performance of different companies.

(ii)

(e)

Pass rates: SEC’s main purpose is to help students prepare for, and then pass, their accountancy examinations. When students, or their employers, are deciding where to study they are likely to be influenced by the pass rates which different colleges have. If SEC’s pass rates are higher than its rivals, it can use this as a marketing message. However, the pass rates by themselves may not necessarily give a true indication of the quality of tuition which SEC is providing its students. Pass rates will also be influenced by how hard the quality of the students SEC is teaching and how hard they work towards their exams. Student satisfaction ratings: There are a number of factors which could affect how satisfied students are with the tuition they receive from SEC (apart from whether they pass their exams or not): for example, the quality of tuition they receive; the quality and presentation of their tuition materials; the size of their classes; and the quality of SEC’s premises where their classes are held. It would also be useful for SEC to know how students score these individual elements of their tuition, so that it can identify if there are any particular aspects which need improving. However, a summary overall rating may be more suitable for the Board pack, with the directors asking for more information about the ratings if they are concerned about them.

Answers

227

40 CD
Text references. Transfer pricing is discussed in Chapter 9 of the BPP Study Text. Top tips. Part (a) looks at the theory behind transfer pricing, and by doing so should help you answer the rest of the question when you have to apply this theory to the scenario. You do not have to apply your answer for Part (a) to the scenario, but you may find it useful to do so to illustrate the points you are making. This is what we have done in the suggested solution below. In part (b) you need to consider how transfer prices must be set to promote divisional autonomy and motivate divisions to perform whilst maintaining overall corporate profit maximisation. Transfer prices are arrived at by a process of negotiation and are sometimes imposed by top management. The general rule of transfer pricing is that the transfer price should reflect the opportunity cost of sale/purchase to the divisions involved. You should use the data in the question but you will need to make up an illustrative price for the marginal cost base and for costs not incurred in internal transfers. Part (c) looks harder than it actually is. Read the two tables together as the second table just states the probabilities for the total component costs in the first table. The data-table shows the range of values of product unit cost for product A for a range of value of number of cut in Shaping AND quantity of timber (square metres) required. We can check the current value of product unit cost of $41.21 which is the value in the data-table where the number of cuts per unit in Shaping is 40 and the timber required is 0.60 square metres. Part (a) A transfer pricing system is a mechanism for charging for goods or services transferred between the divisions of a company, as happens where the Creative Division (CD) at Unique Components (UC) transfers wooden components to other divisions within the company. If such a system were not in place, CD would not receive any income for the components it produces for use within UC. Equally, the other divisions within UC would not incur any costs for the components which have been made by CD. Divisional performance measurement – Transfer prices are necessary to prevent the internal transfers of components having an unfair impact on the performance measures of either CD or the divisions receiving the components. For example, UC will not be able to measure CD’s performance accurately if it does not receive any income for the components it sells internally. Equally, transfer prices will be necessary if UC wants to assess divisional managers’ performance on the basis of divisional profit. Divisional autonomy – By giving a price or a cost to the services transferred, transfer pricing allows the divisional managers to retain autonomy. For example, CD sells its wooden components to external customers as well as transferring them to other divisions within UC. If the proposed transfer price is lower than the price CD can get from selling the components externally, the divisional manager can choose to sell the components externally. Goal congruence – However, perhaps the most important function of a transfer pricing policy is to ensure that divisional managers within UC take decisions which are in the best interests of the organisation as a whole, as well as for their own individual divisions. Transfer prices should be set so that divisional behaviour is aligned to the best interests of the group as a whole. In this respect, the price should reflect the true cost (the opportunity cost) to the group of the transfer. For example, if CD can only supply the internal transfer by sacrificing an external sale, the transfer price should reflect this. However, if CD has surplus stock of components that it would not be able to sell externally, this suggests that a lower transfer price may be more appropriate.

228

Answers

(b)

(i)

External selling price and adjusted selling price The external selling price is $(41.21  1.35) = $55.63 and this would be used as the basis for a transfer price. The opportunity cost of an internal transfer is the actual sales revenue foregone. Use of this basis assumes that Creative Division can sell all of its production at market price. Creative Division (CD) would then be earning the same profit as it would from external sales and the other divisions would be paying a commercial price for transfers made. However, using a market price may have disadvantages such as being a disincentive to using up spare capacity. Using a price based on marginal cost will encourage the use of spare capacity to at least make a marginal contribution to profit. It is likely that internal transfers incur lower costs of delivery and sales than external transfers. So a compromise could be arranged whereby the two divisions share the cost savings from internal transfers. An adjusted selling price would then be agreed. So if the saved costs are $5/unit, an adjusted transfer price of $50.63 could be agreed which would mean CD had the same reported profit as it is not incurring these costs when it transfers internally. The receiving division would have lower costs in buying in compared to the market and so could make decisions that could result in overall profit maximisation (other things being equal).

(ii)

Marginal cost and marginal cost plus annual lump sum A marginal cost approach means that CD would charge its marginal cost in supplying the product to the receiving divisions. If CD has fixed costs of $6/unit this would mean it charges $35.21/unit to the other divisions. This approach applies where CD has no external market for the product transferred as otherwise there would be an opportunity cost in charging marginal cost rather than market price and the transfer price should ideally reflect this. However using marginal cost means that CD would not breakeven and so the two divisions could share the fixed costs under an arrangement whereby a lump sum fixed cost was added to the marginal cost charged by CD.

(iii)

Dual pricing Dual pricing means that two separate transfer prices are used. So CD could charge other divisions a price based on marginal cost, which encourages decisions based on profit maximisation for these divisions. Unless an alternate source was available at a price less than the marginal cost charged these divisions would be encouraged to buy internally. However, for profit reporting purposes, CD would be credited with a higher market price for the transfers, which satisfies its requirements for profit maximisation. Adjustments are made on consolidation at the year end.

(c)

(i)

A reduction of 12% on existing total cost reduces the cost of $41.21 to $36.26. A cost of $36.26 or less is achieved (looking at the first table) if 25 cuts are made and 0.5m² of timber, or if the timber required is reduced to 0.4m². Reading from the second table, the probability of achieving costs at or below $36.26 is only 18% so there is an 82% chance of not meeting this target reduction. If management were to proceed with the redesign given these probabilities, their approach to risk can be seen as risk taking. The probability of total unit cost exceeding $41.21 is 32% (using the same approach as above) and the probability of remaining below this cost level, is 66%. Management here are taking a risk-averse approach to making a decision as it is unlikely [at 32%] that costs will rise above the existing level. The expected value solution is $39.84. This is a weighted average of the outcomes and their probabilities. It covers a range of outcomes from the most risky to the least risky and so could be said to be risk-neutral. As it is less than the current cost of $41.21 management should proceed with the redesign.

(ii)

(iii)

Answers

229

41 Alpha Division
Text reference. Read Chapter 8 which refers to residual income and NPV. These should also be revision from F5. EVA appears in Chapter 9. Top tips. In part (a) (i) you must adjust the cash flows for the depreciation charge when you calculate residual income (RI) as this is a profit measure. Part (ii) is asking for a commentary on the controllability of costs and how these are used to evaluate performance. It has elements of transfer pricing too so think about how transfer prices can be fairly charged between divisions or whether they are imposed. We have drafted a table as part of the notes to this answer showing you the key points to put in your answer. The table picks out the three profit measures, divisional profit and economic performance, for the five items on the list. Don't use the table in your answer though – it is part of your workings when you are planning out your answer. Part (b) tests your knowledge of calculating EVA which appeared in a nearly identical form in an examiner's article in October 2007. The examiner often uses articles to reveal his approach to a topic though this does not guarantee the topic appearing in the next exam! You need to read the question carefully to pick out the elements needed for the WACC calculation. You will also need to update the capital employed figure bwfd to calculate the capital charge. Make sure you read the assumptions made in part (b) (i) so you are clear where figures come from. We have listed four points in part (b) (ii) but you are only asked for three. Easy marks. Part (a) (i) calculating RI. Examiner's comments. A large number of candidates did not attempt all parts of this question. Marks in part (a) were either very good or very poor. A number of candidates earned maximum marks in part (b) (i) but others made no attempt at this at all. Many candidates gave the advantages of EVA, not the disadvantages as asked for in part (b)(ii).

Marking scheme
Marks

(a)

(i)

Calculations of RI Comments (on merit)

3 3 6 66 33 3 3 1 1 1 31 Maximum 8

(ii)

For each of measures 1 to 3 including reference to managerial/economic performance and illustrative items given the question and to illustrative items given in the question Adjusted profit after tax Adjusted capital employed WACC EVA Comment Disadvantages of EVA

(b)

(i)

Maximum 8 3 Total = 25

(ii)

230

Answers

(a)

(i)

Residual income for the proposed investment and comments on the short-term and long-term decision views of management on the viability of the proposed investment Yr 1 $m 12.5 (15.0) (2.5) (4.5) (7.0) Yr 2 $m 18.5 (15.0) 3.5 (3.0) 0.5 Yr 3 $m 27.0 (15.0) 12.0 (1.5) 10.5

Net operating cash inflows Depreciation Profit or (loss) Less imputed interest (w) Residual income Working

Imputed interest at a cost of capital at 10% as follows: Y1 10%  $45m = $4.5m Y2 10%  $(45 – 15) m = $3m Y3 10%  $(45 -15-15) m = $1.5m Comments If management take a long-term view and use NPV as their measurement of project success the investment will go ahead as it has a positive NPV of $1.937m at a 10% cost of capital. However if they use RI as their measure, then the project will only be successful from year 2 onward and make income of $4m overall. As the bonus scheme is based on short-term performance evaluation the negative RI in year 1 may sway management away from taking on the investment if they use RI as their measure. This short-term focus may lead to the rejection of investments that take a while to become profitable which may not be in the long-term interests of Alpha. (ii) Divisional profit measures Notes to the answer This question clearly needs more detail than many students expect. Before the answer is written, it needs planning as follows: Profit measure 1 2 Divisional management Contribution is controllable - fair Profit is controllable Illustration As it contains (i) Even if it contains (ii) (iii) are fixed costs that are controllable unless decision made before new manager appointed (v) is not controlled by manager Shows economic contribution of division to group Divisional economic Not the whole picture Illustration As missing fixed and other costs (iii) are the sorts of items that are fixed that should be included in divisional profit assessment Assume (v) will not be incurred by group if division closed down

3

Can't be used

This leaves (iv) – where can I use this? Depreciation is a fixed cost – is it controllable by managers? This is affected by two factors: Controllability of asset acquisitions and disposals by managers – could be head office decision Depreciation policy may be a head office decision The measurement of divisional performance is a sensitive area for managers who are concerned with the control they have over the performance they are measured by and especially where it is tied into their bonus scheme. Managers would prefer to be measured only in areas where they have a direct control over the revenues and costs.

Answers

231

1.

2.

3.

Variable short run contribution margin The use of such a measure can be deemed unacceptable by divisional managers if it includes revenue and costs from inter-divisional transfers. Transfer prices are unpopular where they are imposed rather than negotiated. However an adjusted market price uses the external selling price and adjusts this for savings on packaging and delivery costs for instance. This means that the price is more likely to be acceptable to the divisions involved. Sales to customers outside the Delta group would be at market price. However a central sales force may negotiate the sales rather than the division so they may have less discretion than would appear over these revenues. Controllable profit This measure is calculated by deducting controllable fixed costs from the variable short run contribution margin. These costs are likely to include labour or equipment rental costs that are fixed in the short term. These costs can be controlled to some extent by divisional management who may be able to influence working practices affecting productivity and therefore efficiency in the use of labour and equipment. They may also be able to negotiate separately agreements for equipment though it is unlikely that they would have much control over wage negotiation or the hiring of suitable employees. Depreciation may be controllable to the extent that the division has some control over the purchasing of non-current assets. Divisional profit This is controllable profit less non-controllable avoidable costs. Head office staff costs such as finance staff are largely unavoidable and cannot be controlled by the division unless through a service level agreement which is an annual negotiation. Depreciation may be seen as unavoidable and not controlled by the division if the charge is centrally imposed and relates to assets acquired centrally rather than at divisional level. The divisional profit figure is useful in evaluating the economic performance of the division in that it represents the contribution made by Alpha Division towards the overall profitability of the Delta Group. 20X6 $m 67 5 12 4.2 88.20 20X7 $m 82 5 12 4.2 103.20

(b)

(i)

EVA of the Gamma Group 20X6 and 20X7 Profit for the period (after tax) Add Goodwill amortised Non-cash expenses Interest expense (W1) Adjusted profit Adjusted capital employed Capital employed b/f Non-capitalised leases Goodwill (W2) Adjusted capital employed Calculation of EVA Adjusted profit Less capital charge (W3) EVA Workings 1 2

279 16 45 340 88.2 (39.1) 49.1

340 16 50 406 103.20 (50.75) 52.45

Interest expense = Interest payable  (1 – tax rate) = $6m  0.7 = $4.2m Goodwill 20X6: Amount brought forward from 20X5 = $45m 20X7: $45m b/f at start of 20X6 + charge to revenue during 20X6 of $5m = $50m.

232

Answers

3

Capital charge.

Step 1

Calculate the WACC. 20X6 Equity 16%  50% = Debt 10%  70%  50% =

8% 3.5% 11.5%

20X7 Equity Debt

18%  50% = 10%  70%  50% =

9% 3.5% 12.5%

Remember to adjust the cost of debt for the tax rate.

Step 2

Apply the WACC to the capital employed to get the capital charge 20X6 capital charge = 11.5%  $340m = $39.1m 20X7 capital charge = 12.5%  $406m = $50.75m

Assumptions made EVA is based on economic profit which requires a series of adjustments to be made to the accounting profits of $67m and $82m. Depreciation is usually adjusted so that the accounting depreciation is added back and an adjustment made based on the wear and tear of assets. In this case (Note 8) economic depreciation is stated to be the same as accounting and tax depreciation and so no further adjustments are needed. Lease charges are usually added back in the calculation of NOPAT but note 2 states that the leases were not amortised so no adjustment has been made. EVA is based on economic profit which approximates to cash flow so any non cash costs are added back to the accounting profit (see note 10). Interest costs are added back when calculating NOPAT as they are charged as part of the capital charge. Interest costs of $6m less tax at 30% (see note 9) have been adjusted. The net of tax adjustment reflects the fact that the post tax profit is used as the starting point for the NOPAT calculation. The replacement cost of net assets is used in the calculation of the capital charge. This usually requires adjustment to the NBV of assets to their replacement cost. There are no replacement costs given for the assets in the statements of financial position at the start of 20X6 and so the capital employed figure of $279m is used as a starting point to calculate replacement costs. The book values of assets need to be adjusted for capitalised costs. Therefore the non-capitalised leases are added back. EVA also adjusts the asset figure for investments for the future. This would include goodwill of $45m which needs to be adjusted as noted above. Comments on the Group's performance The EVA measures are positive which show increases in the real wealth of Gamma Group based on economic values. (ii) Three disadvantages of using EVA in measuring financial performance 1 2 EVA tends to focus on short-term performance rather than looking at the long term. EVA depends on historical data, which may be a limited guide to the future. The accounting adjustments made to this data may not be completely eliminated by the adjustments made by EVA. EVA requires a large number of adjustments to be made to accounting information, and the number of adjustments required can make EVA difficult (and time-consuming) to use.
Answers

3

233

Additional answer 4. EVA is not easily used to compare different organisations or divisions as it is not a ratio and can be distorted by size.

42 BAG
Text reference. Chapters 9 and 11. Top tips. This question is in two parts. These can be answered independently. You will not pass the question without attempting the transfer pricing part of the question as this is worth 12 marks, however. Part (a)(i). You may find it helpful to sketch the information so that you can see the various transactions and prices charged. You need to consider what the options are for B and C independently: can they sell outside or buy in from outside? Remember though that the question asks for the maximisation of the profit for the group and not the divisions. B can also source a suitable chemical externally so the cost of this needs to be considered too. Part (a)(ii). Use the decisions made in part (a)(i) and the new data to make a comparison. Draw up a table and list the two alternatives side by side. We have listed all of the costs and revenues even where they net out as this makes it easier to keep track of everything. The examiner also provides an alternative which analyses the net profit for each division and then aggregates them. Refer to his answer at the back of the Study Text which shows his approach. This is probably how divisions would report in practice but either method is acceptable. Part (b). This is quite straightforward. Just list the categories of cost and give examples of each. The marks awarded suggest two marks for a cost plus example given from the scenario. Easy marks. Part (b) asks you to identify four categories of quality costs. If you know the four types then you should get at least four marks. Examiner's comments. Answers were generally poor. Few candidates answered both parts well. Transfer pricing principles are not understood by many candidates and they failed to set out the principles by which the divisions made their pricing decisions. In part (b) a significant number of candidates gained maximum marks. Nonetheless many did not know what quality costs were and lost marks.

Marking scheme
Marks

(a)

(i)

40,000 kgs of CC at $105 60,000 kgs of CC at marginal cost of $50 per kg B requires 90,000 kgs of CC B would purchase 60,000 kgs of CC from C B would purchase 30,000 kgs of CC from IS Revenue Costs Profit 42

1 2 1 1 1 6 2 3 1 6 8 8 Total = 20

(ii)

(b)

Categories of quality costs

(a)

(i)

Price(s) per kg at which Division C should transfer chemical CC to Division B so that BAG profit is maximised 1 Division C The minimum transfer price for C to transfer chemical CC to B is its marginal cost plus opportunity cost. C wants to sell 60,000 kg to B to use up its capacity. Its minimum transfer price is the variable cost of production of $50/kg. The opportunity cost of this 60,000 kg is nil.

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Answers

It could also sell the remaining 40,000 kg to B at $50/kg plus $55 kg lost contribution (ie $105 per kg). 2 Division B B needs 360,000/4 or 90,000 kg of chemical CC or its substitute from the independent supplier. B can buy up to 60,000 kg from C at $50/kg or from an independent supplier at $55/kg. Rationally, B would buy the 60,000 kg from C as this is cheaper. It should buy the remaining 30,000 kg from the independent supplier at $55/kg rather than from C at $105/kg. (ii) Detailed analysis of revenue, costs and net profits of BAG Selling price of $105/kg $'000 43,200 4,200 3,000 50,400 Selling price of $95/kg $'000 43,200 6,650 1,500

Revenue B sales of BF C- External 40,000 kg × $105 70,000 kg × $95 C - Internal 60,000 kg × $50 30,000 kg × $50 Total revenue Costs In B External purchases 30,000 kg × $55 60,000* kg × $55 Internal purchases 60,000 kg × $50 30,000* kg × $50 Other costs in B In B variable conversion costs/litre ($15 × 360,000 l) In C variable costs/kg ($50 × 100,000 kg) Fixed costs ($18,000,000 + $2,000,000) Total cost of Chemical CC Net profit

$'000

$'000

51,350

1,650 3,000 5,400 5,000 20,000 35,050 15,350

3,300 1,500 5,400 5,000 20,000 35,200 16,150

Conclusion: the revised pricing strategy benefits the group so it should be adopted. *90,000 kg – 30,000 kg now available from C Other considerations that need to be made. If C sells 70,000 kg externally, it means there are only 30,000 kg available for B. B is able to source 60,000 kg from outside but this means B's purchase costs will increase by $150,000 (3,300+1,5001,650-3,000) and its divisional profits decrease by this amount. This is outside B's control so will B be given allowance for this when performance is measured? In a similar way, C has seen an increase in its revenues of $950,000. Will credit for this improved performance be taken by C as the decision appears to be under its control? How certain is the additional demand if C lowers its price of the chemical? Sensitivity analysis could be carried out to assess this.

Answers

235

(b)

Quality costs Costs of conformance are those costs which are incurred in meeting quality standards before or during manufacture. These are prevention costs and appraisal costs. Costs of non-conformance are the costs that result from faulty products before or after they are shipped out. These are internal failure and external failure costs. Prevention costs. These are costs incurred before or during production to prevent substandard or defective output. For BAG an example would be training of staff involved in the production process for the chemical. Appraisal costs. These are the costs of ensuring inputs and outputs meet required quality standards. In BAG, quality control would be an example of an appraisal cost. Internal failure costs. These are the costs of inadequate quality identified before the transfer of ownership. Reworking or wastage of chemical in the process of manufacture would be examples in BAG. External failure costs. These are costs of inadequate quality discovered after the transfer of ownership. This might take the form of compensation to customers who had bought the chemical when it was faulty.

43 SSA
Text reference. Chapter 9 covers transfer pricing. Top tips. Read the question carefully and pick out the relevant points. We have done some workings in our answer to part (a) to show from where we have obtained our figures. You may not have time to make detailed calculations in the exam. If you can show how you have calculated a figure even in brackets next to the figure that shows the marker you know what you are doing. Part (a) (i) There is a maximum production capacity, that is a limiting factor, but this only applies for Quotation 2. Use the information in the table in the question to work out the existing capacity used and whether there is any surplus capacity. If production needs to be switched from existing products, then you must work out the contribution each product makes for Division A. When preparing Quotation 2, use your workings on each product's contribution to decide which product to switch production from. See working 2 below for how we have done this. Remember there is an opportunity cost incurred by Division A as it switches production from an existing product to fulfil Quotation 2. The question states that Division A intends to use market price less 30% to set its transfer price. Division B can pay an external price of $9 per support. Start with these prices as the basis of your calculations. However don't forget the opportunity cost from switching production and other possible bases of charging. In limiting factor analysis, it is assumed when management make decisions on what products to make, that profit is maximised. Profit is maximised when contribution is maximised. In other words, marginal costing is used. Division A would set a price based on contribution or marginal cost. Division B can buy in a product equivalent to the ankle support from an external supplier and may do so under Group policy. Finally both divisions may set their own transfer prices but within an overall contribution to the Group. Part (a) (ii) wants you to state the general principles for setting transfer prices that maximise group profit. This information is in the Study Text Chapter 9, mainly in Sections 3 and 4 and the later opportunity cost sections. Remember to apply your comments to the Group. Part (b) – Note you don’t have to relate your answer here relate specifically to SSA, so this part of the question should be a relatively simple discuss about the problems associated with setting transfer prices for divisions in different countries.

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Answers

Part (c) wants you to show the after tax net benefit to the Group if Division B buys the ankle supports externally compared to an internal transfer from Division A. Do two sets of calculations, one for each scenario and showing the net benefit to the Group. You only need to include the costs and revenues affected by the two decisions. That means the costs and revenues associated with wrist supports and ankle supports only. Remember to advise management based on your figures!

Marking scheme
Marks

(a)

(i) (ii)

Quotation 1. Up to 4 Quotation 2. Up to 4 Comments (on merit). Up to 2 each

8 4 5

(b)

Problems discussed – 1 mark per relevant point; Up to 5

(c)

Calculations (on merit): Purchase from local supplier Purchase from Division A Conclusion

3 4 1

8 Total = 25

(a)

(i)

Advice on the appropriateness of adjusted market price for a transfer between the two divisions Quotation 1 Division A intends to use a transfer price of $10.50 per unit (W1) which would mean a cost to Division B of $105,000 for the 10,000 units. Division B has an alternative supplier which would charge $9 per unit, resulting in a cost of $90,000. Clearly Division B would choose the lower cost to maximise its reported profits and Division A would lose this potential revenue. However Division A could (assuming no drop in sales price and unlimited sales) earn $15 per unit for the ankle supports in its own markets. This would maximise its reported profits but not necessarily those of the group. As management want the transfers to happen, the two divisions will need to agree an internal price that will encourage Division A to sell to Division B if this supports the overall aim of group profit maximisation. There is spare capacity, however, as a maximum of 160,000 support products can be manufactured and the number budgeted for is 150,000 (20,000 + 50,000 + 20,000 + 60,000). So Division A could transfer the 10,000 units at its marginal cost of $7 per unit ($350,000 VC/50,000 units) or $3.50/unit less than its preferred transfer price. It does encourage Division B to buy in-house at a cheaper cost than $9/unit from the external supplier so there are savings of $2/unit for Division B or $20,000 overall for the group. The price quoted is lower than that Division B would be paying by buying outside. Therefore this encourages Division B to buy in-house. Quotation 2 There is spare capacity to manufacture 10,000 units only. Division A will need to switch existing production of 8,000 units to supply the full 18,000 units. The product with the lowest contribution per unit is the wrist support at $5/unit (W2) so production should be transferred from production of the wrist support to production of the ankle support. Division A could again quote $10.50/unit as a transfer price but this would make Division B go to an external supplier where it can get the product for $9/unit.

Answers

237

The price Division A should charge is the $7/unit marginal cost for the 10,000 units. For the extra 8,000 units the cost will be the marginal cost plus the $5/unit opportunity cost (W3) of switching existing production from the wrist support to the ankle support, or $12/unit in total. The total charged by Division A to Division B would be $70,000 + $(8,000 x $12) = $166,000. This time, Division B can buy outside for $9/unit or $162,000 overall, however. It would therefore be cheaper for Division B to buy in the product from an outside supplier. Workings 1. Division A - basis for setting a transfer price. Selling price of ankle support Less 30% ($) Transfer price to division B 2. Contribution per product based on 20X0 budget Support appliance Sales units (‘000)(from question) Revenue ($'000)(sales units  selling price per unit) Variable cost of sales ($'000) (from question) Contribution ($'000) Contribution per unit ($) Knee 20 480 (200) 280 14 Ankle 50 750 (350) 400 8 Elbow 20 360 (160) 200 10 Wrist 60 540 (240) 300 5 Total 150 Market price less 30% $ 15.0 4.5 10.5

Conclusion. Existing budgeted demand is for 150,000 units. The maximum capacity is 160,000 units. Therefore there is extra capacity of 10,000 units. This will satisfy the extra demand for 10,000 units in Quotation A but not the 18,000 units requested for Quotation 2. Thus production will have to be switched from another product. The product with the lowest contribution per unit should be chosen. Based on the contribution per unit to the division, the wrist makes the lowest contribution. If production needs to be switched from a product, the wrist should be chosen. 3. Opportunity cost of switching production from wrist to ankle support The $5 per unit loss of contribution from switching production to ankle supports from wrist supports is the opportunity cost. (ii) The basis of transfer price to maximise the group profit An ideal transfer price should reflect the opportunity cost of sale to the supplying division and the opportunity cost for the buying division. It should allow the supplying division to earn a fair return and the cost be reflected in the buying division. However it should also be a ‘commercial' price so the buying division doesn't suffer by comparison to its available market (if any). The aim ultimately is to maximise group profits so prices set should be agreed but also be in line with the organisation's aims. The division and management need to know external and internal costs and prices so suitable comparatives can be established. Management also need to have information about spare capacity so this can be used most effectively. In using marginal cost plus opportunity cost, the Group seek to encourage using up spare capacity plus reflect the lost contribution from switching production. Marginal cost encourages Division A to use up its spare capacity. The addition of opportunity cost to marginal cost shows that, in this case, it is cheaper for Division B and the Group overall to source its supply externally.

238

Answers

(b)

The basic object of transfer pricing is that relevant divisions within an organisation are evaluated effectively and the transfer price does not distort divisional performance evaluation. The level at which a transfer price should be set, however, is not a straightforward decision for organisations. The situation is even less clear cut for organisations operating in a number of countries, when even more factors need to be taken into consideration. Some of these factors and their impact on the transfer price are set out below. Moreover, the manipulation of profits through the use of transfer pricing is a common area of confrontation between multinational organisations and host country governments. (i) Exchange rate fluctuation The value of a transfer of goods between profit centres in different countries could depend on fluctuations in the currency exchange rate. (ii) Taxation in different countries If taxation on profits is 20% of profits in Nearland and 50% of profits in Distantland, SSA will presumably try to 'manipulate' profits (by means of raising or lowering transfer prices or by invoicing the subsidiary in the high-tax country for 'services' provided by the subsidiary in the lowtax country) so that profits are maximised for a subsidiary in Nearland, by reducing profits for a subsidiary in Distantland. Artificial attempts at reducing tax liabilities could, however, upset a country's tax officials if they discover it and may lead to some form of penalty. Many tax authorities have the power to modify transfer prices in computing tariffs or taxes on profit, although a genuine arms-length market price should be accepted. (iii) Import tariffs/customs duties Suppose that Distantland imposes an import tariff of 20% on the value of goods imported. In such a situation, SSA would minimise costs by keeping the transfer price to a minimum value. (iv) Exchange controls If a country imposes restrictions on the transfer of profits from domestic subsidiaries to foreign multinationals, the restrictions on the transfer can be overcome if head office provides some goods or services to the subsidiary and charges exorbitantly high prices, disguising the 'profits' as sales revenue, and transferring them from one country to the other. The ethics of such an approach should, of course, be questioned. Alternative suggestions Competitive pressures Transfer pricing can be used to enable profit centres to match or undercut local competitors. Repatriation of funds By inflating transfer prices for goods sold to subsidiaries in countries where inflation is high, the subsidiaries' profits are reduced and funds can be repatriated. Minority shareholders Transfer prices can be used to reduce the amount of profit attributable to minority shareholders by artificially depressing a subsidiary's profit.

Answers

239

(c)

Quotation 2 - purchasing ankle supports from Division A or locally Division B – buy from local supplier Division A Sales of wrist supports externally Less tax at 40% After tax benefit (A) Division B Buy in 18,000 ankle supports Less tax relief at 20% After tax cost (B) Net benefit to the Group (A) - (B) Division B – buy from Division A Division A Sales of wrist supports externally $ 60,000  $5/unit contribution 300,000 (120,000) 180,000 162,000 32,400 129,600 50,400 $ 52,000  $5/unit contribution 260,000 Notes (60,000 – 8000) units ( i.e. 18,000 -10,000)  ($9/unit sale price less $4/ unit variable cost) Division A will only transfer at $10.50/unit. Variable cost/unit is $7. 323,000 (129,200) 193,800 Notes See W2 above

18,000  $9/unit

The cost will be tax deductible

Sales of ankle supports internally

18,000  $3.50/unit contribution

63,000

Total net contribution Less tax at 40% After tax benefit (A) Division B Buy in 18,000 ankle supports from Division A Less tax relief at 20% After tax cost (B) Net benefit to the Group (A) – (B)

18,000  $10.50/unit

189,000 37,800 151,200 42,600

The cost will be tax deductible

The Group is worse off overall by $7,800 ($50,400 – $42,600) if Division B purchases the ankle supports from Division A, rather than purchasing them from an external supplier.

44 Seatown
Text references. Performance measurement in not-for-profit organisations is covered in Chapter 10a. Service level agreements are covered in Chapter 14. Top tips. It’s probably best in both parts of the question to list the information required when you make each point. You need to think about what performance measures are relevant, also whether performance can be compared or benchmarked with other departments or councils. Note in (a) that measures of efficiency need to take into account time taken and distance covered. Your answer needed to recognise that it isn’t just a question of measuring quantity of rubbish picked up. Public reaction to litter remaining on the beach has to be taken into account. Thus although the tractor sweeping may not pick up much litter, it is justified if it picks up the litter that would concern the public.

240

Answers

Part (c) – It will be important for the council to ensure that the quality of the beach cleaning is maintained if it uses an outsource partner instead of providing the cleaning services itself. A service level agreement will be an important tool which it can use to measure and monitor the outsource partner’s performance. However, don’t forget that it is also important that the outsource partner knows the council’s expectations of it; so think how the service level agreement can assist with this as well. (a) Economy Costs of labour Controlling labour costs will be an important element of economy. The council needs to break labour costs down for sweeping the sands and emptying the bins. To judge whether the costs are being limited sufficiently, the council will need to compare actual costs with benchmarks. These include comparing actual costs with budget, with costs of previous years, with comparable costs for the other areas of the council’s activities and costs incurred by other councils responsible for beaches. The council’s management will need to investigate fluctuations from any of the expected benchmarks. The council’s management accounting data should provide most of the information required, assuming that a proper system of budgeting is in place. It should be possible to obtain labour cost information from other councils. Costs of machinery Similar comparisons for labour costs should be made for machinery costs such as vehicle running costs. The analysis made will need to take into account the cost drivers such as the number of tractors and the number of vehicle miles covered. As well as management accounting cost information and budgets, details of vehicle miles covered will also need to be maintained. Efficiency Efficient use of labour and machines The council needs to find out how resources are being used. It needs to know how much time is being spent sweeping the sands and how frequently bins are being emptied. The actual frequency of emptying bins should be compared with the standards the council set, to review whether bins are being emptied more frequently than required or whether the schedule for emptying bins is unrealistic. It would also be helpful to have more detail about how much time is being spent on different areas. Some beaches may be more problematic to clean because of obstacles such as rocks. The time and costs spent on these beaches could be reduced by limiting access to them to popular times of the year. To judge efficiency fairly though, the council will also need to take into account the area of different beaches and the number of litter bins. Employees will need to maintain detailed records of the time spent on each beach and when they empty the litter bins. It will also be important to keep the permanent data, the areas covered by cleaning and the number of litter bins, up-to-date. (b) Quantity of refuse collected The council will need to ascertain how much refuse has been collected. Again it will be helpful if the refuse collected from sweeping can be recorded separately from the refuse collected from bins, in order to judge both activities fairly. When quantities are reviewed over time, it will be useful to see how much the litter generated is proportionate to the number of visitors. The Council should also try to identify whether other seasonal variations have a significant influence (visitors being less likely to consume food and hence drop food litter during the autumn and winter, and also fewer refreshment kiosks being open during these seasons). The council will need to assess whether more staff resources are needed at the busiest times of the year to keep the litter under control.

Answers

241

Records kept will therefore need to include the quantity of litter disposed of each week. There are various ways in which the number of visitors can be estimated, including number of users of tourist information centres, car park records and estimates based on physical space occupied by each beach user. Quantity of refuse not collected As well as assessing how much litter has been collected, the council needs to have an idea of whether all litter has been collected from the beach (or how long litter remains on the beach before it is collected). Complaints or feedback from beach users will give indications. Management also needs to consider whether litter bins have been emptied frequently enough to avoid overflowing. It should be possible to compare records of how frequently litter bins have been emptied compared with the standards set by the council. Management should investigate if bins are being emptied less frequently than required by standards. The council should maintain records of complaints it has received about litter, ratings made by external parties and other indications of problems, for example adverse media comment or injuries caused by litter left on the beach. The council should also try to collect feedback systematically throughout the year from visitors, for example through issuing questionnaires in tourist information centres. Spot checks of beaches after sweeping and of bins, particularly during the busiest seasons of the year, by internal audit will also provide evidence of whether litter is being collected thoroughly and promptly. Spot checks of beaches will need to distinguish between different types of litter. Larger items, or items that could cause injury, will be of most concern. This will also help determine whether the standard frequency for emptying bins is appropriate and whether the frequency should vary at different times of the year. (c) It seems likely that the internal audit department believes that a commercial cleaning company (the outsourced partner) could provide the beach cleaning work more cheaply than the in-house cleaning department currently does. However, as the cleanliness of the town’s beaches is a major factor in its success as a family holiday destination, it cannot afford for the quality of the cleaning to fall as a result of the outsourcing. In particular, the council will need to be confident that if it outsources the cleaning contract the frequency and quality of cleaning will be maintained at their current levels. The service level agreement should help to ensure this is the case. Define work to be done – The service level agreement will specify the different cleaning tasks which the outsource partner needs to carry out: including sweeping and skimming the beaches, and emptying the litter bins. Setting standards for services – As well as defining the work to be done, the agreement should help define performance standards. For example, the council knows that litter bins need to be emptied regularly, and so the service level agreement could either define how frequently the bins need to be cleaned, or else it could define that the bins need to be emptied within a certain time limit after they become full. Measuring performance – The service level agreement will also help the council monitor whether the outsource partner is performing to the standards it requires. In order to measure whether the partner is meeting the council’s requirements, these requirements first have to be established. As we have noted, they are established in the service level agreement. Dispute resolution - If the council subsequently has any concerns or disputes with the outsource partner about the frequency and quality of the cleaning work being carried out, the service level agreement should help resolve them, by identifying what the partner has agreed to do.

242

Answers

45 LGHD
Chapter references. Performance measurement in not for profit organisations is covered in Chapter 10a. Top tips. The question covers value for money (VFM) in some detail and relates it to services. In part (i) you need to refer to a VFM audit which is covered in the text. Be careful though and include references to principal and agent. You need to think who is a principal and who an agent in this scenario. Part (ii) is also testing knowledge but think about using examples to illustrate each of the three ‘E's in the scenario. Part (iii) is now looking at services and the four ‘SHIP' aspects of services. Why would these make performance difficult to measure? Part (b) – The key point behind the quote is that if performance targets focus predominantly on one particular aspect of performance, that will be the aspect of performance which an organisation will tries hardest to achieve. But, by implication, other aspects of performance will be neglected. So, for example, if performance measures focus too much on ‘economy’, this may lead to aspects of ‘efficiency’ or ‘effectiveness’ getting overlooked. Examiner comments. Candidates needed to use the scenario to answer this question properly. In part (i) some candidates failed to realise there were multiple principal/agent relationships for instance home occupants/LGHD and contractors/LGHD. Part (ii) was well answered and most candidates showed they knew what the three ‘E's were and could apply them in the scenario. Unfortunately part (iii) was poorly answered and most candidates failed to show the four terms relate to services rather than tangible products. A detailed analysis for inclusion in a report on the installation of air conditioning units in local government housing (i) Value for money audit A VFM audit looks at whether value for money (economy, efficiency and effectiveness) has been achieved in accordance with the objectives set. This is especially relevant in not-for-profit organisations where it is difficult to tie in financial measures with non-financial objectives. LGHD's main objective is to upgrade air conditioning units with the aim of enhancing the quality of living for the housing occupants. This is a non-financial objective which is difficult to measure in terms of effectiveness. It could be measured by satisfaction surveys but ‘quality of life' is somewhat subjective and data may be hard to process. A subsidiary objective is ensuring the tenants are happy with the quality and ease of use of the upgraded system. Cost-benefit analysis needs to be applied to the upgrade so that the objectives are weighed up by the benefits arising as well as the costs incurred in the upgrade and ongoing service contract. The audit is necessary to monitor the activity of the contractors who are agents on behalf of the LGHD as a principal in the upgrade and maintenance of the air conditioning units. The tenants also act a principal in relation to the contractors who provide advice services during the first two years of the upgraded service. (ii) Economy, efficiency and effectiveness as part of the VFM audit A range of preferred contractors will be responsible for the upgrades in a proportion of the houses. This activity can be measured using value for money as the average cost per house of the contractors (economy), the number of units installed for the money available (efficiency) and whether they meet the objectives especially quality of life (effectiveness). Quality could be measured by looking at the level of improvement compared with the old air conditioning system for instance is there a better regulation of temperature or more responsive system. There is possibly a conflict between the aim of economy which is to minimise costs and quality, which is not captured by the aim to ensure the lowest cost. Contractors are also engaged to provide maintenance and operational advice service during the first two years of the upgraded systems. This is a service which may also be measured using value for money criteria. A measure of economy would be the cost of the contractors providing the service. Efficiency would be measured by the number of call outs for maintenance or contacts made to the

Answers

243

advice service. Effectiveness would be measured by whether these call outs and contacts met the objectives especially quality of life by residents giving their feedback on the service provided. (iii) The extent of intangibility, heterogeneity, simultaneity and perishability Intangibility, heterogeneity, simultaneity and perishability are all features of services distinct from products. The contractors are providing a service for two years after the installation of the air conditioning. This is the only service element of the proposal as the upgrade itself is likely to involve modification or replacement of physical assets and would not be a service. Intangibility relates to the lack of physical substance in a service. The maintenance could prolong the life of an asset but the advice service doesn't create a tangible product. This could be a problem when coming to measure the outcomes of the service as there is no tangible evidence. For instance how would the professionalism of the contractors be measured? However service quality can be measured using non-financial measures and typical measures include the number of complaints or customer waiting times. Heterogeneity or the consistency of output is a problem with services although many services do strive for it, for instance call centres. The advice service therefore may need to set standards to ensure a consistent quality of response for all tenant queries. Difficulties may arise with the quality of advice being given if the engineers differ in their level of experience for instance. Simultaneity refers to the manner in which a service is consumed at the same time it is produced. Food or hairdressing are examples of this. The advice centre provides advice that is ‘instantly consumed' whilst the upgrade is a more lasting outcome. Again, there would be difficulty in measuring the service provided unless service standards were set during the two year period which could be monitored and brought up during the period if the service is found to be lacking. Finally, perishability refers to services not lasting so food would be consumed for instance. That suggests there would be a problem measuring the advice service because it doesn't produce anything permanent though this presumes the advice doesn't produce any lasting changes for instance advice on better use if the air conditioning may prolong the life of the units or reduce climate change. (b) What gets measured, gets done – The quote suggests that if targets focus predominantly on one particular aspect of performance, that will be the aspect of performance which an organisation will most want to achieve. Value for money – As the idea of ‘Value for Money’ highlights, the three aspects of economy, efficiency and effectiveness are all important for LGHD. Therefore it is also important that, collectively, the range of performance measures chosen encourages LGHD to achieve the three different aspects of performance. For example, if the performance measures chosen focus mainly on ‘economy’ this could lead to LGHD paying less attention to the aspects of ‘efficiency’ and ‘effectiveness’, and concentrating only on ‘economy’. But, if that is the case, the performance measures will not help LGHD to achieve ‘value for money’. Stakeholder interests – The idea that ‘What gets measured, gets done’ is also particularly important in public sector organisations (like LGHD) due to the number of different stakeholders they have, and the different goals those stakeholders may have which may be in conflict with one another. For example, occupants’ objectives and aspirations relating to quality of life, may conflict with local authorities’ or taxpayers’ objectives related to controlling the cost spent on each house. However, if one of these objectives is prioritised as a key performance measure but the other one isn’t, the objective which is prioritised is likely to be the one which LGHD will focus on. In this way, the performance measures could lead to the interests of one group of stakeholders being prioritised to the detriment of the other group. If this second group is a key stakeholder group, however, then it is important that they are kept satisfied. But if the performance measures encourage LGHD to focus on other aspects of performance instead, the changes of the stakeholders being satisfied could be lessened.

244

Answers

46 CFE coffee shops
Chapter references. Branding is discussed in Chapter 10b of the BPP Study Text. Top tips. Part (a): The marketing director’s proposal is that CFE should introduce a loyalty card scheme in order to improve customer loyalty and strengthen CFE’s brand. The key question, however, is what impact this customer loyalty or brand awareness will actually have on CFE’s performance? Notice that you are asked to ‘evaluate’ the importance of brand awareness so you need to think of its potential benefits for CFE’s business performance, but you should also think whether there are any potential limitations on its impact. Part (b): The success (or failure) of the Finance Director’s plan is likely to depend on customers’ reactions to it. So it is important that CFE understands its customers and their buying decisions. This highlights the importance of looking at CFE as an open system, and how its activities and decisions are affected by the external environment. Part (c): The scenario has identified that some of the managers think CFE would be able to increase its profits if it stopped using ‘Fair Trade’ coffee. Clearly this argument has some merits. However, you also need to consider the counter arguments. Are there any potential benefits to CFE from being seen as a socially responsible company? (a) Competitive market - The high number of branded coffee shops in Teeland suggests that the market there is likely to be competitive, because customers will have a high degree of choice about where to buy their coffee. In this respect, branding, and the loyalty card scheme, could be valuable to CFE if it encourages customers to keep returning to CFE shops to buy their coffee rather than going to rival shops. Customer loyalty – By creating customer loyalty a strong brand identity is a way of increasing or maintaining sales; for example, by improving customer retention rates and encouraging repeat purchases. This is the logic behind the loyalty cards being proposed by the marketing director. However, whilst increasing sales will allow CFE to increase its profits overall, it may not, by itself, have as much impact as the Marketing Director might hope. Importantly, CFE currently generates more revenue per shop than the market leader, although its profit margins are significantly lower. Comparison of financial performance CFE Revenue per shop ($'000) Gross margin (%) Gross margin per shop ($'000) Operating profit margin (%) 1,434.5 64.5% 925.0 9.77% Market leader 1,384.6 68.9% 953.8 12.50%

In this respect, it seems that CFE’s cost structure and its product mix may have a greater impact on performance than brand awareness. For example, CFE makes the highest profit margins on coffee sales, so if it could sell relatively more coffee drinks compared to food and snacks this would improve its profit margins. The loyalty card scheme could help here, by encouraging customers to buy hot drinks so that they qualify for their free drink. (Obviously, though, margins will then be reduced by the ‘free’ seventh drink.)

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245

Product mix Coffee % of total revenue Gross margin (%) earned per product 34.0% 80.7% Other drinks 9.7% 52.4% Food & snacks 56.3% 56.8%

However, although there appear to be more important factors affecting CFE’s performance than its company profile, branding could still have a positive impact on its performance. Brand awareness – Brand awareness would be an indicator of CFE’s position in the coffee shop market, and would indicate whether customers or potential customers do actually differentiate CFE from its customers, for example as offering higher quality products and service. If customers don’t associate CFE’s products as being higher quality than the competitors, then the money spent on higher quality ingredients and service staff is effectively being wasted. Quality and trust – One of the key attributes of a successful brand is that it conveys a sense of quality and trust to potential customers, thereby encouraging them to buy the product or service in question in preference to a rival product. Quality seems to be very important to CFE: it uses high quality ingredients for its food and drinks, and seeks to ensure customer receive a high standard of service (by paying its staff wages above the industry average). Differentiation – In this respect, CFE appears to be trying to differentiate itself from its competitors on grounds of quality. If it can ensure that its brand becomes synonymous with quality, then this will help CFE compete successfully with other branded coffee shops. Premium price – Branding messages are usually qualitative rather than focusing, and therefore reduce the importance of price differentials between a product and its rivals. This could be very important for CFE. Customers do not appear to be price sensitive, yet CFE is charging broadly the same prices as its competitors. If CFE is able to strengthen its brand, by focusing on quality and service, this may in turn allow it charge a higher price for its products. This could be crucial for CFE’s profitability, because it could allow CFE to reverse the current situation in which its gross margin percentages are lower than its competitors’. (b) Demand for the product – When deciding whether or not to increase the price of its coffee products, CFE needs to consider what impact the changes in price are likely to have on customer demand for them. Therefore market research will be important to assess how demand (and consequently revenue) will be affected by any change in price. It seems that CFE’s customers are not particularly price sensitive, which should increase the chances of the Finance Director’s proposal. However, CFE should still research their reaction to any change before implementing it. In this respect, it would also be useful for CFE to gauge the strength of any brand loyalty towards it. Amount of increase – Equally, market research will give CFE an insight into what price customers are willing to pay for their coffee. CFE’s competitive strategy (of differentiation based around quality) might enable it to charge higher prices than its customers to an extent and still retain its customers. However, if CFE increases its prices too much, it is unlikely that the customers will remain loyal to it, even if it offers higher quality coffee and service that its competitors. Competitors’ pricing policies – Currently, CFE’s are largely the same as those charged by the multi-national competitors. However, these competitors might also be planning to change their prices. For example, if CFE’s competitors increases their prices, that could give CFE greater scope to increase its prices. Competitors’ plans – Currently, CFE seems to serve a higher proportion of ‘Fair Trade’ products than its competitors, and this might help it justify its higher prices. However, if its competitors are also planning to use more ‘Fair Trade’ coffee, or increase the quality of other ingredients, this would reduce the basis of

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differentiation between CFE and its competitors. In this respect, any insights which CFE could gain into its competitors’ plans before it changed its prices would be useful. Input prices – The Finance Director’s suggestion is designed to help CFE increase margins. However, if the price of coffee beans rises, it might need to increase prices in order to maintain its current margins. Equally, if costs such as the rents CFE has to pay for its premises rise, these may also increase the pressure on CFE to increase its prices in order to maintain its profit margins. (c) Social responsibility - The directors have been keen to stress that CFE is a socially responsible company, and their commitment to using Fair Trade suppliers is a way that they can demonstrate this. Acting responsibly, and being seen to act responsibly, can help CFE build trust with consumers, and enhance the image of its brand. Fair Trade marketing – As well as demonstrating their social responsibility, using fair trade brands can also provide CFE with a marketing opportunity. An increasing number of customers care about how suppliers in the developing world are treated, and wish to support them by buying fair trade brands. Therefore, by positioning and promoting itself in support of fair trade brands, CFE may be able to attract ethical consumers away from its rivals if they do not offer similar brands. In this way, Fair Trade marketing could allow CFE another point of differentiation from some of its competitors. Cost and Price premiums – Because Fair Trade brands pay their suppliers an agreed ‘fair’ price, which is slightly higher than other coffee growers often receive, the cost to CFE of using Fair Trade will be slightly higher than if it used non-Fair Trade coffee. Normally fair trade brands are normally sold at a slight price premium to reflect this cost differential. It is not clear from the scenario whether all the major branded coffee shops sell Fair Trade coffee. However, if they are not, and CFE is selling its coffee at the same price as theirs, then CFE’s margins will be slightly lower. This may the point that the regional managers are making when they suggest that CFE could increase its profitability if it stopped using Fair Trade coffee. Nonetheless, CFE still earns a gross margin of 80% on its coffee sales, which suggests that the increase in profitability if CFE’s shops stopped selling Fair Trade coffee might not be as significant as the regional managers might think. Moreover, the adverse public relations impact of discontinuing sales of Fair Trade coffee may outweigh the short-term cost savings from doing so. Economic responsibilities - However, it is important not to overlook the fact that ultimately CFE exists to make a profit for its shareholders, so this is also a vital part of its social responsibility. It is not clear whether the directors are also the shareholders, but if they are not then they need to balance their ethical and philanthropic responsibilities with their economic responsibilities to the shareholders. In this respect, they do need to consider what effect selling Fair Trade is having on CFE’s profitability, but they need to do so in the context of considering the marketing opportunities and benefits to the brand image of being seen as a socially responsible company.

47 JIT systems
Top tips. The principal areas you would need to cover to score well would be: (a) (b) (c) (d) Explanation of present system of inventory control Explanation of JIT system Explanation of need for quality supplies of material Explanation of need for quality during processing

Easy marks. Using a report format would earn you at least one mark.

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247

(a) To: From: Date: Subject: 1 Managing director of SW Management accountant 13 November 20X6 Inventory control systems

REPORT

Introduction

This report looks at the differences between the inventory control system currently being used within SW and a just-in-time (JIT) system and then considers the extent to which the introduction of JIT would require a review of the organisation's control procedures. 2 2.1 2.2 2.3 3 3.1 3.1.1 3.1.2 3.1.3 3.1.4 3.1.5 JIT The objective of a JIT system is to produce products or components as they are needed by the customer or by the production process, rather than for inventory. A JIT production system therefore only produces a component when needed in the next stage of production. In a JIT purchasing system, purchases of raw materials are contracted so that, as far as possible, the receipt and usage of material coincides. Current inventory control system versus a JIT system A JIT inventory control system for the purchase of chemicals would be fundamentally different to the one currently being used. Raw materials would not be ordered when a reorder level is reached but when they were actually needed in production. Inventory levels would therefore be reduced to near zero levels, there would be no maximum and minimum levels. Supplies would be delivered on a long-term contract basis as soon as they were needed, but in small quantities. This would obviously increase ordering costs. The costs of space for holding inventories of chemicals, and costs such as damage or deterioration in stores, stores administration and security would be minimal, however. In particular the interest cost and opportunity cost of tying up working capital in large inventories would be avoided. The economic order quantity model would therefore not be relevant, not only because the exact quantity needed would be delivered, but because holding costs would be kept to a minimum while no direct effort would be made to minimise ordering costs. JIT and the implications for quality control procedures JIT purchasing

3.1.6

4 4.1

4.1.1 If raw material inventories were to be kept at near-zero levels, the company would have to have confidence that suppliers would deliver on time and that they would deliver chemicals of 100% quality. There could be no rejects or returns; if there were, production would be delayed because no inventories are held. 4.1.2 The reliability of the organisation's suppliers would therefore be of the utmost importance and hence we would have to build up close relationships with them. This could be achieved by doing more business with fewer suppliers and placing long-term orders so that the supplier would be assured of sales and could produce to meet the required demand. 4.1.3 A supplier quality assurance programme (such as BS EN ISO 9000) should be introduced. The quality of the chemicals delivered would be guaranteed by suppliers and the onus would be on the supplier to carry out the necessary quality checks, or face cancellation of the contract. 4.2 JIT production

4.2.1 Because inventories of components would not be held, production management within a JIT environment would seek both to eliminate scrap and defective chemicals during production and avoid

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the need for reworking. Defects would stop the production line, thus creating rework and possibly resulting in a failure to meet delivery dates. 4.2.2 Quality control procedures would therefore have to be in place to ensure that the correct cleaning liquid was made to the appropriate level of quality on the first pass through production.      5 Products would need to be designed with quality in mind. Controls would have to be put in place within processes to prevent the manufacture of defective output. Quality awareness programmes would need to be established. Statistical checks on output quality both during production and for finished goods would be required. Continual worker training would be necessary.

I hope this information has proved useful but if I can be of any further assistance please do not hesitate to contact me.

Signed: Management accountant (b) Top tips. Introduce your report by defining what JIT is and then apply your knowledge to the scenario by stating how JIT would affect profitability in X Group. Therefore, it would be wise to concentrate effort on applying JIT specifically to the X group. The examiner is looking at your application of knowledge. Easy marks. It is possible to gain a couple of marks from introducing and defining JIT. REPORT To: From: Date: Subject: Introduction This report addresses how the adoption of a JIT system might affect the profitability of the X Group. JIT definition JIT is a customer led production system, also known as a 'pull' system. The objective is to produce products as they are required by the customer rather than build up inventory to cater for demand. Just in time production A JIT production system is driven by demand for finished products whereby each component in a process is only made when needed for the next stage. Just in time purchasing A JIT purchasing system requires material to be purchased so that as far as possible it can be used straight away. The effect on X Group's profitability The introduction of a JIT production and purchasing system would have the following impact on profitability: (i) (ii) (iii) (iv) (v) A reduction in inventory holding costs as inventories of raw materials and finished goods will disappear. An increase is possible for raw material costs to encourage suppliers to deliver to a JIT schedule and so additional flexibility is required. As demand may fluctuate, additional labour costs to cover production where no buffer inventories exist. Additional requirements for quality control by suppliers to ensure materials and by others to ensure finished goods are acceptable for the customer. Increased administration costs to plan throughput. Managing Director Management Accountant 11 November 20X5 How the adoption of a JIT system would affect profitability

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48 Tench
Text reference. Quality issues are discussed in Chapter 11 of the BPP study text. Top tips. Part (a): A common theme across a number of areas of performance management is: ‘What gets measured, gets done.’ And this theme is relevant here too. If Tench starts focusing on quality and quality costs, this should help it increase the quality of its cars. However, before you start discussing the impact of quality costs in this way, it would be sensible to explain what quality costs are. The analysis of costs into ‘prevention’, ‘appraisal, ‘internal failure’ and ‘external failure’ costs could be a useful way of thinking about the range of quality costs which could affect Tench. Whereas part (a) asks you to discuss aspects of Tench’s current costing system, parts (b) and (c) focus on its planned new systems. In effect, then this question as a whole is highlighting the contrast between traditional views of quality costs (part a) and the Japanese approaches based around the ideas of continuous improvement (kaizen) and just in time. Part (b) picks up on this point specifically, and a key point to note here is the distinction between cost reduction (in kaizen costing) and cost control (in traditional approaches). However, note that there are two sub-requirements to this part of the question: the impact of Kaizen costing on: (i) Tench’s costing systems, and (ii) employee management. Part (c) then considers the related issue of moving to a JIT system. Note that you are asked to ‘evaluate’ the effect, so you need to consider the advantages and disadvantages of doing so. In this respect, it is important you appreciate the context in which Tench currently operates. It is based on a former communist state and still seems to have a very bureaucratic culture; how suitable is such a context for introducing JIT systems? Part (d) then considers the related issue of TQM. This should have been a straightforward part of the question. However, time management is important here to make sure you get time to gain these easy marks. Importantly, to score well in all four parts of this question, you need to answer the question set. Answers which simply describe quality costs, Kaizen costing, TQM and JIT systems in general terms will earn very few marks.

Marking scheme
Marks

(a)

Impact of quality costs – 1 mark for each relevant point made, Up to 4 marks. Use of quality costs and explanation of traditional view of quality costs – 1 mark for each relevant point made, Up to 3 marks. Maximum of 6 marks Description of Kaizen costing – Up to 4 marks Comparison of standard costing with Kaizen costing – 1 mark for each relevant point, Up to 3 marks Effect of Kaizen costing on employee management – 1 mark for each relevant point, Up to 3 marks

6

(b)

8 Maximum of 8 marks

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Marks (c) Description of JIT purchasing and production – Up to 2 marks Benefits of JIT for Tench – 1 mark for each relevant point, Up to 2 marks Problems of introducing JIT at Tench – 1 mark for each relevant point, Up to 3 marks. Maximum of 6 marks 6

(d)

Explanation of importance of TQM – up to 2 marks for each relevant and fully explained point, up to 5 marks.

5

Total = 25

(a)

Quality costs hidden – It is likely that Tench’s quality costs are currently hidden within overheads and the standard costing system. Tench’s quality costs are likely to relate to designing and developing quality control equipment; inspection and performance testing; and repairs and reworking. The current costing system will need to be modified to allow Tench to view its quality costs separately. The quality costs can be categorised into two groups: Costs of conformance – These are the costs of achieving the desired quality standards. They will include prevention costs (such as staff training and building quality into the design of the cars and Tench’s business processes) aimed at preventing cars being rejected on the grounds of poor quality. They will also include appraisal costs such as the costs of inspecting components coming in from suppliers, and inspecting the cars while they are being built and once they are completed. Costs of non-conformance – These are the costs which arise if Tench’s cars do not meet the required quality standards. They will include internal failure costs and external failure costs. Internal failure costs arise if a fault is identified before a car leaves the factory and has to be rectified. External failure costs arise if the fault is identified by the customer once they have bought the car. External failure costs could include both the cost of repairing cars returned from customers, and the administration costs of maintaining a customer complaints department. Opportunity costs There could also be opportunity costs related to quality which are not currently recognised by Tench. For example, the loss of possible future sales resulting from dissatisfied customers, or the impact on the manufacturing process of having to repair faults rather than working on new cars. Impact of quality on Tench’s costing systems Tench’s management appear to have already recognised the need to focus more on the quality of their cars in order to compete with the new (foreign) entrants into the market. However, identifying and collecting quality costs will reinforce the importance of quality, and will sustain management’s focus on quality. In addition, applying the logic that ‘What gets measured, gets done’ the focus on quality should allow Tench to make the quality improvements they need to compete more effectively with the new imports. Traditional view of quality The discussion of costs of conformance and non-conformance represents the traditional view of quality which suggests that there is any optimal effort that minimises quality faults, although it never entirely eliminates them. This approach recognises that there is a trade-off between the costs of conformance and non-conformance, up to a point where the cost of reducing the error rate any further is greater than the benefit from preventing that additional fault.

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251

(b)

Kaizen costing – In contrast to traditional costing systems which focus on cost control, Kaizen costing systems focus on cost reduction. Kaizen costing involves a process of continuous improvement in which the costs of producing a product are constantly reduced over the product’s life. Functional analysis is applied at the design stage of a new product, and a target cost for each function is set. The functional target costs are added together and the total becomes the product target cost. Once the product has been in production for a year, the actual cost of the first year becomes the starting point for further cost reduction in the second year, and so on into subsequent years. Impact of Kaizen approach at Tench Kaizen costing vs Standard costing – Tench currently applies standard costing system, where the focus is on cost control rather than cost reduction. However, because Kaizen focuses on continuous improvement and cost reduction, standard costs have much less value for monitoring performance as they are fixed over the relevant period. However, the nature of kaizen costing means that the ‘standard’ costs themselves should be reduced over time. Therefore, the impact of introducing Kaizen costing at Tench is likely to be significant. Whereas standard costing doesn’t provide any motivation to improve performance levels, the whole focus of kaizen costing is on cost reduction and performance improvement. Employee management Attitude to employees - Kaizen costing will also have a significant impact on employee management at Tench, because the management attitude to employees will be different under Kaizen compared to a standard costing approach. In standard costing systems, employees are often viewed as the cause of problems in an organisation. Under Kaizen, employees are viewed as the source of solutions, and they are empowered to find, and implement, these solutions. Culture change - This idea of employee empowerment indicates the way that changing the costing system will also lead to a major cultural change at Tench. Tench appears to have a history of bureaucratic control, but now employee teams will be empowered to make changes themselves rather than having to have them approved by a management hierarchy first. Implementing Kaizen - In time, the Kaizen system should increase staff motivation through empowerment. However, in the shorter term there could be difficulties in encouraging workers who are used to a command and control structure to change their behaviour and suggest possible improvements themselves.

(c)

Demand-pull system – The essence of Just-in-time (JIT) systems is that they are demand-pull systems, rather than supply-push ones. Materials are only purchased (JIT purchasing), and finished products are only produced (JIT production) as needed to meet actual customer demand. This is in contrast to traditional manufacturing systems in which manufacturers forecast demand for their products in the future and then try to smooth out production to meet that forecast demand. Effect on Tench Benefits of JIT systems - However, one of the main characteristics of traditional manufacturing systems is that they lead to high levels of inventory being held. By contrast, by only producing goods as they are needed, JIT systems significantly reduce inventory levels, factory floor space required and reduce working capital requirements, all of which could be beneficial to Tench.

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Moving to a JIT system should also make Tench’s production processes more flexible and should reduce throughput times, leading to faster response times to changes in product specification or customer demands. Potential drawbacks of JIT systems Supplier reliability – In order to implement JIT successfully, Tench will need to be able to rely on its supplier. With no inventories to fall back on, any disruption in supplies (in relation to either the quality or timeliness of deliveries) could force production to cease, which is likely to be costly for Tench. If there is not already a JIT culture in Essland, it may be difficult for Tench to find suppliers who are capable of meeting the required quality and delivery standards needed to run a JIT system. Performance measures Quality measures/supplier performance – The increased importance of quality and reliability which are necessary in JIT systems, mean that Tench’s performance measures will need to include quality measures, and will need to monitor supplier performance in delivering the quality required. Multi-skilled teams – Another feature of JIT production is that teams are multi-skilled. Teams need to be formed to work by component or product rather than by the type of work performed. This means that functional divisions of cost become less appropriate. By contrast, performance measures focusing on spare capacity or bottlenecks in production are likely to become more important. Also, as staff will need training to work in the new teams, measures surrounding the amount and effectiveness of training will be required. (d) Just-in-time (JIT) systems incorporate: (i) JIT production, which is a system driven by demand for finished products so that work in progress is only processed through a stage of production when it is needed by the next stage. The result is minimal (or in some cases non-existent) inventories of work in progress and finished goods. JIT purchasing, which seeks to match the usage of materials with the delivery of materials from external suppliers. This means that material inventories can be kept at near-zero levels. Production management within a JIT environment therefore needs to eliminate scrap and defective units during production and avoid the need for reworking of units. Defects stop the production line, creating rework and possibly resulting in a failure to meet delivery dates (as buffer inventories of work in progress and finished goods are not held). TQM should ensure that the correct product is made to the appropriate level of quality on the first pass through production. For JIT purchasing to be successful, the organisation must have confidence that the supplier will deliver on time and will deliver materials of 100% quality, that there will be no rejects, returns and hence no consequent production delays. This confidence can be achieved by adopting supplier quality assurance schemes and stringent procedures for acceptance and inspection of goods inwards, which are integral parts of TQM.

(ii)

49 TAW
Text reference. Chapter 11 covers costs of quality. Top tips. This question is split into two fairly even parts which you must answer in order as the analysis in part(a) will help with your answer to part (b). Read the requirements in part (a) carefully and draw up your answer to show % of turnover, and total cost of quality. The examiner's answer shows percentages for each cost but the question only asks for each cost heading. By all means do this if you have time. We also show whole percentages as the question doesn't state you must calculate these to a certain number of places. The examiner only asks you to comment on the inclusion of opportunity costs but actually also includes them in his answer. They are easy enough to calculate. Part (b) wants you to work out the costs of each option and the savings from adopting the option. The savings come from avoiding the costs of non-conformance associated with poor quality.

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253

Part (c) – Don’t just explain what Kaizen principles are here; but make sure you explain how they could be used by TAW in the way the question asks. Examiner's comments. This was the least popular of the option questions. However some answers were excellent and earned very high marks. Poorer answers revealed confusion over what the cost categories meant. Some poorer answers to part (b) had poorly laid-out, incorrect calculations. (a) Cost analysis
Year ended 31 May 20X8 $'000 Prevention costs Training (Note 3) Design engineering (Notes 1 and 2) 48,000 × $96 Process engineering(Notes 1 and 2) 54,000 × $70 Appraisal costs Inspection (Notes 1 and 2) 288,000 × $50 Product testing (note 3) Internal failure costs Rework (Notes 1 and 2) 2,100 × $4,800 External failure costs Repairs (Notes 1 and 2) 2,700 × $(4,600 + 240 +280) Total cost of quality Opportunity costs – lost contribution (Note 4) Total cost of quality 13,824 13,824 46,944 12,960 59,904 4 17 4 10,080 10,080 3 180 4,608 3,780 $'000 % of turnover

8,568

2

14,400 72

14,472

4

Opportunity cost is the contribution associated with the loss of potential sales arising out of a poor public perception of quality. The estimate of lost sales is 4% of turnover. These are not ordinarily included in the four standard categories of quality cost but could be classified as external failure costs. Quality cost statements frequently omit costs that result from poor quality but are difficult to estimate. These opportunity costs include:    Profit from lost sales Lost production Lower prices as a consequence of poor quality.

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(b)

Financial consequences of options for improving quality
Option 1 Costs Prevention cost Savings Internal failure cost External failure cost Description Physical inspections 10,000 × $50 $'000 500.0

Extra sales (contribution) Net saving Option 2 Costs Prevention cost Savings Internal failure cost External failure cost

Variable costs of rework 720 × $1,920 Variable cost of customer support 600 × $96 Transportation 600 × $210 Warranty repair 600 × $1,700 300 × $7,200

1,382.4 57.6 126.0 1,020.0 2,160.0 4,746.0 4,246.0

Redesign cases 2,000 × $96 Process engineering 5,000 × $70 Variable costs of rework 960 × $1,920 Variable cost of customer support 840 × $96 Transportation 840 × $210 Warranty repair 840 × $1,700 360 × $7,200

$'000 192.0 350.0 1,843.2 80.6 176.4 1,428.0 2,592.0 6,120.2 5,578.2

Extra sales (contribution) Net saving

Option 2 has a larger estimated net saving at $5,578,200 and should be chosen as this is $1,332,200 more than the estimate for Option 1 ($4,246,000). (c) Kaizen - Kaizen principles are built around the theory of gradual, continuous improvement and focus on obtaining small incremental cost reductions during the production phase of the product life cycle. Cost reduction – Although the directors have suggested that TAW will be unable to save any of the fixed costs of interenal and external failure, they have also indicated that it could be possible for TAW to achieve improvements in quality. Consequently, it may be possible for the improvements in quality to reduce the level of variable costs resulting from quality issues at TAW (for example, as a result of a reduction in the number of items needing to be reworked). Moreover, because Kaizen focuses on the idea of continuous improvement, it could also lead to an on-going reduction in the cost of quality issues from one year to the next.

50 Thebe
Text reference. Quality issues and Six Sigma are considered in Chapter 11 of the BPP Study Text. Top tips. Part (a). The scenario highlighted that customer service is likely to be key to helping the business grow. However, the absence of any non-financial information in the performance report presented to the Board suggests that the Board aren’t monitoring customer service levels. You should have identified that this seems odd, given the importance of customer service to the business’ success. But, if the non-financial performance information was included in the performance report alongside financial information, this would help redress the balance. Parts (b) and (c) of this question provide a good illustration of why it is important to read all the requirements before starting to answer a question.

Answers

255

In Part (b) of the question you are asked to discuss the general ways in which Six Sigma could help improve quality. You shouldn’t spend time discussing how Six Sigma is implemented in this part of the question, but rather how does the process of implementing Six Sigma (in general terms) improve the quality of performance in an organisation The reason why shouldn’t discuss how Six Sigma is implemented in part (b) becomes clear when you look at part (c) of the requirement: to explain and illustrate how the DMAIC method could be applied at Thebe. Part (c). A sensible approach to this question would be to use ‘DMAIC’ as the framework of your answer, and then to work through each of the elements (Define, Measure etc.) in turn. However, note that you aren’t asked simply to explain DMAIC in general terms, but to illustrate how it could be applied specifically at Thebe, so make sure you include examples of issues from the scenario. Examiner’s comment. Part (b) was poorly answered, with much evidence of candidates trying to use DMAIC as a template for their answer although the question asked about the six sigma method in general rather than a specific implementation method. This was possibly caused by candidate not reading the whole question before starting to their answer, and not identifying the links between parts (b) and (c).

Marking scheme
Marks

(a)

1 mark per relevant point up to 2 marks for each benefit of non-financial performance measures evaluated Up to 8 marks 8

(b)

1 mark per relevant point up to 2 marks for each way Six Sigma can improve performance Up to 8 marks 8

(c)

Up to 3 marks for each stage of the DMAIC process; being 1 mark for a general description and 2 marks for application to the scenario. Up to 9 marks 9 Total = 25

(a)

Importance of non-financial measures – The CEO has identified that customer service is crucial in growing the business, and differentiating it from competitors (such as FayTel) which suggests that providing excellent customer service is a critical success factor for Thebe. By performing well in this area of the business, Thebe should be better placed to perform well financially than if it offers poor customer service. In this case, there would seem to be a clear link between non-financial performance and financial performance. However, if the board are not aware of how well Thebe is performing in key operational (nonfinancial) areas of the business they may not notice performance issues which could subsequently have an impact on Thebe’s financial performance. What gets measured gets done – Thebe’s employees and line managers are likely to pay more attention to those areas of the business in which performance is being measured, compared to those areas of which are not being measured.

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Answers

Similarly, there is a danger that what doesn’t get measured, might not get done. The focus of the board meetings, on financial performance, suggests that this might be prioritised over non-financial aspects of performance. However, the fact that the CEO has championed the project to improve billing accuracy suggests that he believes it is important. In turn, however, this suggests Thebe should be measuring its performance in relation to billing accuracy – for example, through measuring the number of complaints it receives from customers who are complaining that they have been billed incorrectly. Information for decision-making and control – The current position suggests that it could be difficult for the board to know how to improve Thebe’s performance, if they do not have adequate information about its current performance. Although the CEO is aware that all telephone businesses (including Thebe) have problems in relation to applying incorrect tariffs, it seems unlikely that he will have any actual information about how Thebe is performing in this area of the business. Again, having this information would have been useful before deciding to undertake the project to improve the quality and accuracy of billing – both to decide whether the project was necessary, and also to see how much impact the project has on the quality of Thebe’s billing. Linkages – However, directors will need to be careful which non-financial measures they choose to monitor, and in particular how the non-financial measures link to Thebe’s financial performance. For example, there will be little value in monitoring aspects of operational performance which add little value to Thebe’s financial performance. Indeed, the CEO may find that, ultimately, customers choose their telephone provider based on price rather than the quality of customer service they receive. In this respect, it is also important that the Directors continue to monitor financial performance as well as non-financial performance, because there is no guarantee that favourable performance in customer service or other non-financial areas will necessarily translate into favourable financial performance. For example, even though Thebe may provide its customers with accurate bills, and may provide a very high level of customer service, its revenues may still fall if FayTel introduces new tariffs so that customers can get a cheaper phone service by switching to them. Despite the increased importance of non-financial performance measures, the ultimate measure of Thebe’s performance will be how well it generates financial value for its owners. (b) Focus on the customer – One of the key aspects of Six Sigma methodology is that it requires organisations to have a genuine focus on the customer. Thebe’s CEO has clearly identified that customer service is crucial to the success of the business, and so the project to improve customers’ bills is an important element of this. Importance of facts and data – Another important element of Six Sigma is that it highlights that decisions should be taken on the basis of facts and data, rather than intuition, and this in turn highlights the importance of performance measurement. This is evident at Thebe in the way that data has been sourced from customer feedback. This data could relate, for example, to the number of customer complaints, or to customer satisfaction ratings. Business process improvement – One of the key themes in Six Sigma is that processes are the key to success. Therefore implementing Six Sigma will encourage Thebe to identify which processes (and which activities within a process) are critical to its success, so that it can then focus on understanding those process and improving them where necessary. Involvement of management – When an organisation commits to Six Sigma, it will normally appoint an implementation leader and a steering committee at a senior level, to oversee the implementation. By involving management in this way it highlights a business’ commitment to improving quality; as appears to be the case at Thebe where the CEO is championing the project to improve service quality. Increased profile of quality issues – Six Sigma project teams are made up of staff experienced in the process under review. By involving team members in the project, they will realise the importance of quality issues, and improve their knowledge of quality management.

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257

The nature of Six Sigma project leadership means that managers should learn from working with layers of trained experts. For example line managers who are be ‘Green Belts’ helping to lead a Six Sigma project can learn from ‘Master Black Belts’. Collaboration – Another key theme in Six Sigma projects is the need for collaboration between staff from across different departments or divisions within an organisation. In this way, Six Sigma implementation highlights the importance of the whole organisation focusing on quality, not just individual departments. For example, the project team at Thebe brings together line managers from all three business units, as well as from the billing department. (c) Define customer requirements / Define the problem Customers underlying requirement is that they are billed accurately, and if they aren’t this could lead either to delayed revenue (while the customers dispute their bills) or lost revenue (if customers switch to an alternative provider). However, the organisational structure at Thebe highlights that this project also needs to focus on complaint handling as well as billing itself, and in this respect customer requirements may need to be defined further. It is likely that there will be is a minimum acceptable level of service (for example, that billing errors are corrected), but Thebe should identify ways which its customers feel would improve its service above that minimum level: for example, in relation to how quickly any complaints are responded to; or by offering some form of compensation as a goodwill gesture. Measure existing performance The CEO’s customer service project has highlighted two key areas of focus: the accuracy of customer’s bills, and the handling of complaints. Accordingly, Thebe needs information to assess how well it is performing in both of these areas; so it needs to measure its performance in both areas. For example, Thebe could measure the number of customer complaints per million bills issued, or the average time it takes to resolve a customer complaint fully. (Measures such as that looking at the number of complaints links directly to Six Sigma methodology which identified that there should be less than six defects per million.) However, when selecting the aspects of performance to measure, it is important that Thebe focuses on those areas where improvement will be valued by the customer, rather than, for example, areas which are easy to measure. Analyse the existing process In part (a) we identified that the Six Sigma methodology highlights the importance of facts and data, rather than intuition. This stage of the DMAIC process focuses on collecting the data, which can then be analysed to identify the root causes of problems in Thebe’s existing processes. Thebe can then focus its improvements towards those issues which lead to the most problems (complaints). If a relatively small number of problems give rise to the majority of complaints, then this will highlight the importance of tackling the causes of those problems as the most urgent priority. For example, if a large proportion of customer complaints relate to the length of time it takes Thebe to issue revised bills, then it will be important to analyse what factors are slowing down the process. Improve the process Once the causes of problems have been analysed, Thebe should then be able to identify potential changes which could be made to improve performance in these areas of its business. For example, in relation to the time taken to reissue corrected bills, Thebe may need to consider whether it needs more staff to be authorised to make changes to bills. However, before any specific improvements are recommended it will be important for Thebe to check that they are feasible; for example, that they will not be prohibitively expensive to implement, and that Thebe has the resources necessarily to implement them.

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Control the process Once the improvements have been implemented, the line managers (and the board) need to continue monitor performance to ensure that the benefits from reduced complaints and improved customer satisfaction are maintained. At an operational level, Thebe can do this by continuing to monitor complaint numbers – perhaps by means of exception reporting, so that managers are only alerted of a potential issue if the number of complaints increases above a specified threshold level. However, Thebe can also measure its success in relation to customer service levels more generally in relation to customer retention rates or the churn rate (the percentage of existing customers lost each year.) If the company has successfully improved its performance in those areas which customers value as important, then the number of customers who switch to another service provider should be reduced. This in turn will mean that a greater proportion of the new customers which Thebe acquires will contribute to growing the business rather than replacing lapsed existing customers.

51 T4UC
Text reference. Six Sigma and the DMAIC methodology are covered in Chapter 11 of the Study Text. Top tips. There is a lot to read here, but don't be put off by that! Make notes on the question paper as you read through on the different aspects. For instance note the customer comments, data and benchmarking information. In part (a) you must explain what Six Sigma is before you list out the DMAIC methodology which is a step-by-step approach to quality. This part of the question doesn't ask you to apply it to T4UC so you can keep your comments general. There are eight marks available for the first part of this question and a bullet point list won't earn you all of these. You need to explain what is happening at each stage of the methodology. Also, note the short second part of the question relating to the different grades of leadership of Six Sigma projects. Don’t overlook this because, although it is only worth 3 marks, these should be relatively easy marks. In part (b) you need to apply the methodology to T4UC and come up with some ideas for improving performance. Go through the methodology step by step to apply it correctly. There is plenty of information in the question to help you apply the steps to the company. When you define the problem you need to quantify it so state in measurable terms what the problem is. We have a lot of information in our answer and so does the examiner. You may not be able to do quite so full answer in 22 minutes (1.8 minutes × 12 marks). You need to stick with the DMAIC framework and work through an analysis of the scenario using the methodology you have just written about. Don't skip any of the steps even if you don't have much to write on in each. Practise taking one of the problems defined and working it through using the steps to get used to the methodology. With practice you should be able to do this with the problems identified in the scenario. Easy marks. Part (a) offered some easy marks for showing your knowledge of Six Sigma. Examiner comments. Part (a) was well answered with most candidates able to identify and explain the DMAIC methodology. Likewise, part(b) was well answered and candidates applied the Six Sigma methodology to the scenario. Weaker answers to this part omitted to analyse T4UC and include suggestions, confining themselves to a list of problems.

Answers

259

Marking scheme
Marks

(a)

Comments (on merit): Explanation of process – DMAIC Explanation of different grades of leadership (Black Belt etc.) Application of DMAIC to analyse and address problems

8 3 14

11 14 Total = 25

(b)

(a)

Describe the Six sigma methodology for the improvement of an existing process Six Sigma is a rigorous operating methodology designed to ingrain a culture of excellence, responsiveness and accountability in the organisation. It aims to deliver defect-free products or services at a level of 99.9997 percent so only 3 per million errors or faults would arise. It has been applied in a variety of functions from service centres to manufacturing plants. Six Sigma uses programmes to analyse processes continually for defects. Statistical techniques are used to work out what improvements are needed to minimise defects. These programmes also collect customer feedback. There are five consecutive steps involved in improving processes. A project team would be set up to run all five steps from defining the problem to implementing and measuring outcomes.

Step 1 Step 2 Step 3 Step 4 Step 5

Define. The team would identify the customer's requirements, and clarify the problem and set goals. Measure. Decide what needs to be measured, where information can be gathered. The team would analyse the current process to see what is causing the problem(s) and concentrate on the main causes to start with. Analyse. The team would develop hypotheses, identify the key variables and root causes. Improve. The team can now work on generating solutions and implementing them to remove the problem. This is achieved by modifying existing processes or developing new ones. Costs and benefits would be quantified at this step. Control. The team would devise new controls for monitoring to ensure continued high-quality performance. The controls should reveal whether the new processes are delivering the desired improvements.

Leadership grades Staff involved in the leadership of projects may possess varying grades of qualification in Six Sigma. Master Black Belts are in-house consultants in Six Sigma and spend all of their time on it. They are especially skilled in the statistical techniques involved and will contribute to several projects simultaneously. Black Belts also spend all of their time on Six Sigma and lead specific projects. Green Belts also lead projects. They are managers who retain other job responsibilities alongside Six Sigma. (b) Analysis and improvement to processes at T4UC using Six Sigma methodology.

Step 1

Define. Customers want a twenty-four hour hotline, and right-first-time servicing. Neither is available at present. They also want, engineers who turn up when they are supposed to, with the correct parts (not arriving after the engineer has left). Finally they want consistent and standard service so engineers take the same time to do the same job.

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In quantifiable terms, the problems are that the customer satisfaction rating is lower than the industry average and alleged market leader. Remedial visits are higher than industry average or market leader. The number of contracted clients has fallen from 20X7 to 20X8 and the number of recommendations has fallen year on year since the business began. The number of product support issues resolved by telephone has fallen since 20X7 and the number of visits to contracted clients has risen since the business began (this is despite a fall in the number of contracted clients and suggests a number of repeat visits).

Step 2

Measure. T4UC needs to measure customer satisfaction, number of visits, problems resolved by telephone, number of clients gained by recommendation and remedial visits. Much of the data is already available from the customer survey undertaken by Ken or from benchmarking data. The data could be supplemented by collecting information on times taken to answer telephones, qualifications and backgrounds of the best engineers for future recruitment, reason why engineers fail to turn up, reasons for repeat visits and efficiency of manufacturers who send parts direct to customers. Analyse. T4UC can then start to develop hypotheses on the causes of these problems. Possible reasons for the problems identified so far include:     Staff utilisation as the key measure of profitability. This would be at the expense of quality of service if staff are solely measured on their utilisation. Unavailability of the contact centre at weekends. This is cited as a problem by customers who wanted weekend service. Reliability of service. Why are remedial visits necessary? Is this down to engineer training and/or problems with delivery? Consistency of service. Why is it that there is so much variety in the time taken and the necessity for repeat visits.

Step 3

Step 4

Improve. Once problems have been identified T4UC can look at removing the problems. Ideas include:  Measuring profitability using more than just staff utilisation. T4UC could consider looking at the number of repeat visits per engineer and how long each engineer takes on each visit. They could also consider employing more engineers who might solve some of the problems such as unavailability and remedial visits being necessary. As the data obtained shows, T4UC engineers have more clients per engineer than their competitors. This would probably support further recruitment especially with some of the problems fed back by clients on availability and consistency of service. Ensuring the call centre is fully staffed especially at the weekends when many clients call. Training all engineers to the same high standard to ensure a consistent service is provided to all clients. Engineers could specialise so that they become experts in certain machinery or be trained across all machinery. Ensuring parts are available by managing stock and relationships with suppliers.

 

Step 5

Control. T4UC then needs to measure these areas on an ongoing basis to ensure improvements are sustained. It is important that T4UC continues to monitor the relevant problems variables during the course of its routine performance measurement. In particular, it should monitor the number of clients, client recommendations, the proportion of remedial visits requirement, the level of weekend accessibility, staff training, stock availability and overall customer satisfaction. T4UC should aim to exceed industry average scores on remedial visits and customer satisfaction rating and should try to attain similar results to those achieved by Appliances R us.

Answers

261

52 SSH
Text reference. Chapters 3, 8 and 10. Top tips. Part (a).Set out your table using the headings suggested in the question – results for two years for the two divisions plus the combined results. You will want to think about comparisons year on year and between the divisions. Consider what performance measures might be appropriate for the operations as opposed to the group company. You will need to comment on your calculations as the question asks you to 'assess' which means to 'determine the strengths/weaknesses/importance/ significance/ability to contribute'. For fourteen marks aim for around seven relevant calculations and commentary plus three marks for suggesting what else you need to be able to assess the financial performance. In part (b) think why the operations manager is pushing for delivery at all costs. What does this suggest in terms of problems with performance? Are his statements ethical? In part (c ) the requirement may throw you – what is meant by quality software? Try to think broadly about what makes software fit for use. Are there any industry standards? Do quality costs come into this? Part (d) is typical of the examiner. He asks you to consider non-financial performance measures in these longer questions so you get a more balanced view of performance measurement. You don't need to write much as there is only half a mark per measure. Examiner's comments. Many candidates provided quantitative ratios or commentary but not both. In many cases, answers to Part (a) were brief suggesting candidates did not recognise that 14 marks were available. Parts (b) and (c) answers were generally reasonable. Part (d) provided some confusion as poorer answers suggested performance criteria eg responsiveness, rather than performance measures (see the suggested answer for examples).

Marking scheme
Marks

(a)

Comments (on merit) and calculations Items of additional information Comments (on merit) Comments (on merit) Performance measures Max 41 41 6  0.5

11 3 14 4 4 3 11 Total = 25

(b) (c) (d)

(a)

Financial performance of SSH and the two operations Bonlandia 20X8 4.3 36.6 17.5 Karendia 20X8 40.0 14.7 (12.4) Combined 20X8 8.8 $2,760,000 33.0 7.8 16.7 43.7 1.3 Bonlandia 20X7 Karendia 20X7 Combined 20X7 2,450,000 30.9 6.6 15.8 57.7 1.3

Revenue growth % EBITDA (W1) Gross margin % Net margin % ROCE % (W2) Debt/equity % Asset turnover (W3)

37.1 19.3

(12.5) (37.5)

1.3

1.4

1.27

1.53

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Workings

20X8 $'000 17,400 11,648 5,752 2,992 2,760 2,760 560 2,200 13,150 16.7

20X7 $'000 16,000 11,050 4,950 2,500 2,450 2,450 500 1,950 12,300 15.8

1 EBITDA Revenue Costs Marketing EBITDA 2 ROCE EBITDA Depreciation and amortisation PBIT Capital employed ROCE %

Note. The examiner used PBIT/ (total assets) in his calculation. Either method is acceptable. Asset turnover The examiner uses revenue/non-current assets for his calculation to arrive at a non-current asset turnover ratio. We use revenue/(total assets – current liabilities). Either method is acceptable. Revenue growth Both operations and the combined company have grown from 20X7 to 20X8. Karendia has grown by 40% by comparison but it starts from a smaller base. EBITDA EBITDA has improved from 20X7 to 20X8 by $310,000. This is due solely to the $1,400,000 improvement in revenue as total costs have increased in the year. Gross margin Combined has improved from 30.9% to 33% year on year solely from the improvement in revenue as costs have all risen but less than the growth in revenue. Bonlandia has seen a fall in its gross margin but Karendia has seen its gross margin turn from a negative figure to a positive 14.7% due to $800,000 extra revenue. Net margin This has improved for Combined and Karendia but fallen for Bonlandia. Karendia still remains a loss maker but the loss margin has shrunk as the growth in revenues has outstripped the increase in costs in the year. Bonlandia has seen an absolute fall in net profit by $152,000. Karendia continues to make a loss but has reduced this from $750,000 to $348,000. This suggests Karendia should look at controlling its costs even though this is only the second year of operation. Overall profit has improved by $300,000 or 29%. Interest has fallen due to the fall in the tense of long term debt. Increased marketing could be one of the factors that has led to increased turnover. The increase in costs in Bonlandia ($752,000) above those in Karendia ($398,000) reflects difficult operating conditions or poor cost controls. ROCE The percentage has improved from 15.8 to 16.7% as the percentage growth in PBIT has outstripped that of the capital employed in the business. The reason is mainly revenue growth. Total assets have increased by $1,350,000 whilst short-term debt has only gone up by $500,000. Debt to equity Share capital and reserves have increased by $1,350,000, which is the profit for the period, but long-term debt has fallen by $500,000, so the gearing ratio will fall.

Answers

263

Asset turnover This has declined for Karendia as revenue has grown faster than capital employed (total assets less current liabilities). It has remained broadly the same for the other two. Additional information needed to make a comparison Intergroup transfers of software between Bonlandia and Karendia need to be split out and eliminated on consolidation or else there will be a double counting of transactions. Figures for payables and receivables would be needed for a detailed look at the cash cycle. The level of inventories would be useful to enable a calculation of liquidity ratios such as the current ratio. It would also be useful to have comparatives going back some years so that trends can be revealed. (b) The statements of the operational manager of Bonlandia The operations manager's first statement reveals he is fixated on achieving installation by the deadline irrespective of whether all software problems have been fixed. This is an example of measure fixation: he is determined to attain a specific performance indicator whatever it takes. The problem is that a large 40% of his basic salary bonus is based on this one activity. It affects SSH's ultimate performance as fixing software problems after installation may be expensive and clients may not make repeat purchases if they are unhappy with the service and software they received. It may also have a detrimental effect on their business performance. It also results in a bonus being paid where the intention was to award timely and correct installation of software but because of the way the bonus is framed, it is being awarded for timely installation. This also sends out messages to staff that certain behaviours are more important than others even if they are not beneficial in the long run. His second statement strays into the unethical: he is effectively stating if customers might complain they have no choice but to keep the software once installed. This is clearly not good, fair business practice and does not set a good example for his staff in the way they might behave in business. (c) Criteria for software to be considered quality software Quality software should be software fit for the purpose it is designed for. It should comply with the user specification, be tested prior to implementation, and signed over to the client only once all tests have been completed satisfactorily and it is operational. There may be industry standards for software, such as ISO9002 quality standards, which govern the quality of software development and installation. Quality costs can also be considered as these consider the costs of building in quality in the process of manufacture against testing for faults prior to shipping out or waiting for warranty claims to be invoked. Shipping on time can also be a quality measure though of course the product shipped needs to be a product fit for the user. (d) Six performance measures to assess quality of service (only six asked for) On-time delivery of software. This does however have the problem that it may not be error free and is indeed one of the measures easily achieved by the operation! The correct installation of software to the satisfaction of the client including a sign-off of systems testing. This builds in a quality element. Number of complaints received. This is an external failure cost. Number of return visits to fix software problems. The number of complaints is a measure of external failure. Competence of staff in providing training to client. Client feedback on installation and training for using the software. The responsiveness of staff to client enquiries. The availability of staff to meet clients' emergency needs.

264

Answers

53 KPG Systems
Text reference. Aspects of quality and quality management are covered in Chapter 11 of the BPP Study Text. SWOT analysis is covered in Chapter 1. Top tips. In our answer to requirement (b), we enumerate a number of models that could be used. You will often find in the field of general strategic analysis that any one of several models could be used. If this happens, it is simplest to confine your answer to one model for each aspect of your answer. However, there may be valid extra points that can be made using another model as well. If you want to do this, try to keep the models separate and your reasoning clear. Here there are really two elements: analysis of the current position and recommendations for the future, so we use both SWOT and TOWS. Easy marks. The two requirements to this question are quite different in style: Part (a) is very specific, while part (b) is more open-ended. Therefore, provided you know the various quality models, part (a) should be easier, since it requires little more than knowledge. Part (b) requires thought and the careful application of theory to the scenario. Part (a) Andy Rowe is right to be concerned about the quality of his products. Purchasers of IS take a great deal on trust, since they rarely understand the nature of the software they purchase or how it works. Poor design and coding produce IS that are difficult to use, maintain and enhance. This leads to excessive costs, undermines user confidence and harms business efficiency. A key area to assess the KPG's ability to deliver its product. Andy should look at this through the capability maturity model. Capability maturity model (CMM) The CMM identifies five levels of capability that an organisation may attain in the efficiency and completeness of its working practices. We do not know the details of Andy's quality problems, but judging by the description of his company and its way of doing things, it seems unlikely that it has progressed beyond a Capability Maturity Model Level 2. At this level, success becomes to some extent repeatable and the organisation has some established procedures for project management, such as the use of time and cost plans and development milestones and review points. However, cost and time overruns are still likely, as Andy has experienced. To progress to Level 3, the company would need standard processes that are defined, consistent across the organisation and subject to continuing improvement. The critical distinction from level 2 is that, while standards and procedures may be tailored to suit a project, they are all based on a comprehensive established library rather being largely designed afresh for each project. Therefore Andy needs to establish such a library to improve the consistency of his products. There are several approaches to quality improvement that might be of use to Andy. We do not know in detail the procedures his company uses at the moment, but we might suggest an overall quality management system such as SixSigma or the ISO 9000:2000 standards. SixSigma SixSigma is a methodology for improving process quality, with the aim of improving a process to the extent that there is only a minimal probability that it will produce unsatisfactory results (which is what Andy is trying to achieve). SixSigma adopts a five phase pattern:      Define customer requirements Measure existing performance Analyse the existing process Improve the process Control the new process

Answers

265

At the moment although KPG has had problems with product quality and cost overruns, it does not appear that anyone has analysed these to understand why they have happened. Also, if he is not already using the V model of IS testing, Andy should consider doing so. The V model Testing is a major aspect of quality control in the development of IS because of the complexity inherent in them. That complexity also means that testing cannot be regarded as something that is done when all the other aspects of a IS development project are complete: it must be incorporated at each stage of development. This approach is the essence of the V model of IS development. Its strength is that it requires the design of both the testing regime and of the system itself to be run as two linked and converging streams. Quality management systems If an organisation is to deliver products and services of the necessary level of quality, it must actively manage all the factors that have an impact on quality. The ISO 9000:2000 approach is largely built around the concept of a quality management system (QMS). Again, KPG need to introduce a QMS to ensure a consistently high quality in their products. A QMS provides procedures and methods of implementation to ensure the capability of an organisation to meet quality requirements'. It contains two aspects: quality control is about fulfilling quality requirements; quality assurance is the focus on providing confidence that quality requirements will be fulfilled. Quality control (QC) is about the things the organisation has to do to be sure that the quality of its output is as it should be. It is about activities such supervision, inspection, checks and measurements and applies to all parts of the organisation's value chain. Quality assurance (QA) is about providing confidence that all the necessary QC activities are operating as they should and that a proper level of quality is being achieved. QA is therefore concerned with the things that make quality control systems and activities effective, such as quality policies; relevant management and training; and documentation such as quality records. At the moment, KPG does not have any of these systems in place so introducing them should improve product quality. Part (b) There is a variety of models that could be used to assess the current position of KPG Systems, including PESTEL, gap and SWOT analysis; and Porter's five forces model. In this answer we will use a SWOT analysis. A SWOT analysis is a critical assessment of the strengths, weaknesses, opportunities and threats facing the organisation in relation to the internal and environmental factors affecting it, carried out in order to establish its condition prior to the preparation of a long-term plan. Strengths and weaknesses are discovered by internal analysis, whereas opportunities and threats are diagnosed by environmental analysis. The internal analysis should determine strengths that can be exploited and weaknesses that should be improved upon. Opportunities are areas that can be exploited, while threats need to be recognised and assessed for their potential effect on the organisation itself and its competitors. Strengths The main strength of the business seems to be the commitment, enthusiasm and technical ability of the owner, Andy Rowe, whose efforts are largely responsible for KPG systems' current level of success. Andy has obviously gathered other skilled people about him, since technical expertise also appears to be an important strength: in that products are designed to the different requirements of individual customers, which gives the company a competitive edge. Allied to this is the importance of the technical support provided by the company. As technology becomes more complex, it is likely that companies will rely more on specialist technical support rather than on in-house abilities. Technical support is an important aspect of KPG's operations, but it is not an unalloyed success as there have been problems with providing support nationwide.

266

Answers

Weaknesses One of the major weaknesses of the firm, and one that Andy has recognised, is that it may have lost its direction. There is a feeling that the firm is losing ground to larger competitors. Although the technical support activities of KPG are a strength, there is also a problem with providing support throughout the UK. Finally, there would appear to be an over-dependence upon Andy Rowe, which may mean that there will be senior management problems as the firm grows further. Opportunities In this age of high-technology, there is little doubt that KPG's market will continue to grow and expand, though the exact nature of that market in the future is uncertain. It is finding it difficult to win larger customers, though it is doing well with smaller ones. There seems to be an opportunity here for KPG to concentrate on this market segment. In this area there are likely to be many innovations and advances that KPG could adapt and embody in its products. Threats One major threat to KPG is that it is only a small player in this market with a small and vulnerable market share. Many of its competitors are larger companies with heavy investment in market, product and competitor research, which may give them a competitive edge over KPG. Changes in technology are considered as an opportunity if KPG has the technical expertise to capitalise on them; however, if KPG cannot keep abreast of changes in technology, the company may fall behind its competitors. Future development Weirich suggested that SWOT analysis could form the basis of four groups of strategies.     SO strategies employ strengths to seize opportunities. ST strategies employ strengths to counter or avoid threats. WO strategies address weaknesses so as to be able to exploit opportunities. WT strategies are defensive aiming to avoid threats and the impact of weaknesses.

One useful impact of this analysis is that the four groups of strategies relate well to different time horizons and levels of available resources. SO strategies may be expected to produce good short-term results, generating profits that can be used to invest in medium-term WT strategies, such as improving areas of weakness. This could lead into a longer-term WO strategy of exploiting opportunities with the remedied weaknesses. ST strategies are relevant to the medium-term and are likely to be resource neutral. In the case of KPG systems, a suitable SO strategy might be to concentrate effort in the short-term on the smaller business segment in which it is doing well. This could drive enhanced expansion in this segment, generating funds for a WT strategy of investment in capabilities and competences that will enable the company to bid successfully for larger contracts in the medium term. Such capabilities and competences would probably include a comprehensive solution to the service support network problems and a deeper understanding of the reasons for failure (and success) with larger customers.

54 Universal Pottery Company
Text reference. Chapters 8 and 11 (Quality; Six Sigma approach). Top tips. Part (a) requires you to analyse 3 different aspects of quality: quality itself, quality control, and quality assurance. The marking guide indicates that each of these was given equal weighting, with 2 marks being available for a definition of the relevant term and 3 marks available for analysing its role at UPC. Note the question also asks you to analyse current and potential role. This is perhaps most important in the context of quality assurance. Quality assurance currently plays very little role at UPC, but it has the potential to play a significant role. Requirement (b) contains both a knowledge element, and also an application element: What is Six Sigma? (knowledge element); What are the quality problems at UPC and how could Six Sigma help address them? (application element). You need to explain what a Six Sigma approach is before being able to explain how it could address the quality problems at UPC.

Answers

267

The marking scheme reinforces these two elements: there are three marks available for a description of Six Sigma, and then 7 marks available for the application of Six Sigma to UPC. The answer presented below uses 'DMAIC' as a framework for applying Six Sigma to the scenario. However, if you looked at other aspects of Six Sigma provided they were relevant to addressing the quality problems at UPC you would gain credit for this. Easy marks. There are 6 marks available in (a) for definitions without any application to the scenario. If you have a good understanding of this subject area these should be easy marks. Equally, if you had a good understanding of the Six Sigma approach, then requirement (b) should have offered you 3 easy marks for describing the concept before you need to relate it to the scenario. Conversely, if you have only a limited knowledge of Six Sigma, you will struggle to answer (b). Examiner's comments. Many candidates appeared unclear about the distinction between quality, quality control and quality assurance. Also many answers were too theoretical and failed to refer to the specific context of UPC, despite comprehensive information being provided in the scenario. Part (b): some candidates appeared unprepared for a question on Six Sigma, while others knew some of the key concepts such as DMAIC, but failed to apply them to the scenario.

Marking scheme
Marks

(a)

Up to 2 marks for the definition of quality Up to 3 marks for issues of quality at UPC Up to 2 marks for the definition of quality control Up to 3 marks for issues of quality control at UPC Up to 2 marks for the definition of quality assurance Up to 3 marks for issues of quality assurance at UPC (15 marks)

(b)

Up to 3 marks for description of Six Sigma Application of Six Sigma to UPC – up to a maximum of 7 marks (10 marks) (Total = 25 marks)

(a)

Quality Quality is the degree to which the inherent characteristics of a product consistently fulfil its purpose or requirements. In a retail context, these requirements are reasonable customer expectations – and may include product construction, reliability, and durability. Customer expectations will also reflect the price paid, to some extent at least. In UPC's market quality is likely to be constrained by the relatively low price consumers are prepared to pay for their souvenirs. Quality at UPC At UPC, quality is measured in terms of the physical condition of its products: no breakages, cracks or chips, and the images accurately positioned. It is problems in these areas that have prompted complaints by UPC's customers, the gift shop owners. However, when thinking about customer expectations UPC should re-consider who it perceives to be the customer. Currently, UPC appears to consider the gift shop that sells the product as the customer. However, the ultimate customer is the person who buys the product from the shop and uses it, or even - in the case of giftware - the recipient of the gift.

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Answers

So quality should also be considered in terms of this end user's expectations. For example:    Can they wash the item in a dishwasher Can they use the product repeatedly without it chipping or cracking Will the image remain clear, or will it fade after washing

If UPC investigates quality issues from the perspective of the end user it may identify additional problems that need addressing. However, there is another supplier-customer relationship which also needs addressing in terms of quality. UPC uses a courier company to deliver its products to the gift shops. In this, UPC is the customer, and its expectation is that gifts are delivered on time without breakages. Therefore, the condition in which gifts arrive in the gift shop depends both on the courier's care and also the care with which the goods were packed. Quality control Quality control is the aspect of quality management focused on fulfilling quality requirements. This involves checking and reviewing work that has been done to ensure that pre-determined quality standards are being met. In many quality control systems, sample products are removed from the production line and inspected. This is the type of quality control process in place at UPC, where 1 in 20 packed packages are inspected for accuracy of printing and correctness of packing. However, because UPC's quality control only inspects a 5% sample of all the packages it is very likely that some defective batches will still get through to the customer. The director's criticism that the 'quality inspection team is just not working' fails to recognise the sampling nature of the role, although it is possible that the sample size (5%) is too small given the current problems with product quality. Quality control issues at UPC At UPC there are three factors that are affecting the level of quality control. 1 There is evidence that managers have asked the quality inspection team to overlook defective items so that order deadlines could be met. This readiness to sacrifice quality in order to achieve a deadline, suggests that quality is not seen as a priority, certainly by some managers within the business. The reward system for packers is based on the quantity they pack rather than the quality of the packing. Consequently, the reward system acts as a barrier to quality, because the packers are incentivised to prioritise speed over quality. This again suggests that quality is not seen as a priority in the business. The quality control work on the positioning of the images takes place too late in the process. It should take place before packing, not after it. Valuable packing time and materials can be wasted by packing items with defective images which are then found when the package is inspected. This again may encourage defective items to be overlooked.

2

3

Quality assurance Quality assurance is the part of quality management focussed on providing confidence that quality requirements will be fulfilled. Quality assurance involves ensuring that all the necessary quality control activities are operating as they should and that a proper level of quality is therefore being achieved to satisfy customer expectations. Quality assurance also sets the pre-determined standards required for effective quality control. Quality control is primarily concerned with detecting defective products, whereas quality assurance is primarily concerned with preventing defective products, through planned and systematic activities. Quality assurance at UPC There is currently little evidence of quality assurance processes at UPC.

Answers

269

However, it could potentially play a key role in the following areas: 1 Setting quality targets. UPC should consider setting quality targets and delegating responsibility for achieving them to the people who are meant to achieve them. It would be preferable to give responsibility for product quality to the employees who actually make the products rather than the packers, and to reflect quality control targets in the production line's reward structure. Quality improvement initiatives. One of the roles of quality assurance is to enable quality improvement initiatives. One such initiative would be to investigate the possibility of upgrading the imaging machines with a facility to assess the accuracy and alignment of the image before printing, and correct any images which fall out pre-set tolerance limits. This facility should then reduce the risk of incorrect alignment of the images. Train employees in quality matters. Quality assurance includes advice and training for employees in quality matters. At UPC, this could include setting standards for the materials used in packing, and improving the way items are laid out in the package to reduce the risk of damage. The internal layout of the package could also be constructed in such a way that products can only be packed in a prescribed way. Quality assurance would be involved in defining the approved way of packing and training packers to use it, as well as monitoring that they are doing so. Quality certification. Many customers now demand some proof that a supplier is capable of consistently producing quality products, to give them confidence in the quality of the product they are buying. This proof may be demonstrated by a third party certification such as ISO 9000:2000. Quality assurance will be concerned with gaining and maintaining such certification, and should assist the company in securing new contracts in the future.

2

3

4

The inspection team at UPC currently focuses on quality control. However, the responsibility for this quality control should be moved to supervisors in the production process, and the inspection team should re-focus on a quality assurance role. This should involve setting standards for quality, establishing how those standards should be monitored, and ensuring that such monitoring is being performed. In making this transition, the company will move from a culture of simply trying to detect faults to a culture of trying to prevent faults as well as detecting them. (b) Six Sigma was originally a quality control methodology, which used statistical techniques to assess manufacturing process performance, and minimise faults. However, it has now developed into a much more widely applicable process improvement system, which can be viewed at three levels. Metric. This is the statistical representation which describes quantitatively how a process is performing. Methodology. At this level, Six Sigma becomes a problem-solving process, using DMAIC and a comprehensive toolkit including brainstorming, balanced scorecards and process dashboards. Philosophy. At this top level, a business adopts a philosophy of wanting to reduce variation, and taking customer-focused, data driven decisions. Six Sigma methodology also defines team roles for managers and employees and stresses the importance of charismatic leadership in projects, with the grades of leadership being given martial arts names – master black belts, black belts and green belts. Nevertheless, some commentators feel Six Sigma is still best applied to the incremental improvement of fairly narrowly defined processes and sub-processes. This should make it appropriate to use at UPC, where the operating processes are fairly simple and easy to define. Following the DMAIC problem solving process (and in particular the first three phases) would help address the quality problems at UPC, and could then in turn generate process improvements and new process controls. Define requirements One of the key themes in Six Sigma is a genuine focus on the customer. It is important to understand what customers really want and value. 270
Answers

UPC currently defines its quality requirements in terms of physical condition of the goods and the alignment of the image. It is likely that this focus is mainly driven by complaints received from gift shop owners. However, this may be taking too narrow a view of quality because there is no evidence that UPC has undertaken any research of its own to find out the things which are important to the customer. Moreover, the gift shops are not the end-user consumers who actually buy and use the products. Therefore as part of getting to understand its customer requirements UPC should also consider its consumer requirements. This may highlight that there are different areas of quality which need attention, which would in turn change the scope of UPC's quality control processes. Measure performance Measurement is a fundamental part of Six Sigma, and includes the gathering of data to validate and quantify a problem. The key areas to measure at UPS would be outputs and customer satisfaction. The scenario does not give us any details about customer satisfaction, but we know that the inspection team was created following the initial evidence about an increase in breakages. This needs to be quantified to understand the scale of the problem. Approximately 500 images are misaligned each month out of a total of 250,000. This represents a failure rate of 0.2%, meaning that 99.8% of products have a correctly aligned image. Although this sounds quite reasonable, the misaligned images till cost UPC $10,000 per month, and can lead to unhappy customers and bad publicity. Six Sigma aims for a failure rate of 3.4 per million, and if UPC achieved this the cost of defective goods would be reduced to $17 per month. Analyse the process The analysis phase of Six Sigma methodology is concerned with understanding how processes operate in order to find the root causes of problems. Again there is no evidence that UPC has currently undertaken any analysis, in which case it is making assumptions about the causes of its quality problems. Misaligned images. The alignment problem needs to be investigated to find out what causes the imaging machine to misalign images. Management are assuming that there is a fault in the machine, but the problem may be due to the way that certain operators are setting up the machine. Breakages. There are two key aspects of the breakages problem to analyse: where they occur, and why they occur. It is currently unclear where breakages occur. Some items may be broken before they leave UPC's despatch facility, or alternatively all of them may be broken in transit. Without knowing where the breakages occur, UPC cannot introduce a solution to fix the problem. Similarly, management are convinced that the increased breakages are due to packers not following the correct packing method. However, they do not appear to have evidence to support this. It is possible that the cause of the breakages may be that the material is not strong enough to withstand the handling and delivery methods used by the couriers. Or alternatively they may be due to a problem in the manufacturing process or a raw material imperfection which has inherently weakened the goods. Again, UPC needs to understand the real cause of the problem before solving it. In this way, Six Sigma analysis should be able to improve its processes. However, even when the processes have been improved, it is important that controlling them remains an on-going part of management's role. Six Sigma highlights that it is important to retain some quality measurement processes to retain control on an on-going basis. This would hopefully prevent UPC suffering a recurrence of its current quality problems.

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271

55 CCT Computer Systems
Text reference. Chapter 11 (Quality in information systems development). Top tips. The requirement contains two distinct requirements: (i) Discuss the importance and characteristics of software quality; (ii) explain how each of these characteristics might by measured. To score well, you would need to cover both parts in relatively equal measure. Although the requirement does not ask you to make specific reference to the scenario, the testimonies quoted in the scenario raise some important issues to do with software quality, which you could use to help with your answer. The diversity of software available means that software quality is often difficult to define. However, there are four key aspects of quality in software that we can consider: functionality, reliability, usability, build quality. Functionality This is concerned with the software performing the tasks expected of it correctly, and doing what the user wants it to do. The key issue here is meeting expectations. Change requests. Software functionality might be measured by the number of change requests submitted immediately after the system has gone live. If the system performs as required, there should be very few change requests until the system has been in operation for some time. Evidence at CCT suggests that functionality is a major issue, and the problems identified by a major customer, Tony Osunda, illustrated this because the system didn't work as required and some key areas were missing. The fact that Tony had to ask for a number of changes after implementation so that the system would work as it should is a clear illustration that there are problems with the functionality of the software. Reliability Software reliability means that the system keeps working and is not out of service frequently or for extended periods. Reliability also means that it does not produce unexpected or bizarre outputs. Availability and downtime. The reliability of software can be measured by availability and downtime. Reliability is often defined within service level agreements, and reliability issues concerning the availability of the software are relatively easy to measure. There is no evidence of any problems with the reliability of CCT's software. Usability Software usability means that the system is easy to use. If software is not easy to use, it will mean that the information system is complex and costly to operate in respect of staff time, especially as users will need extensive training so that they can use it. Error rates may also rise. The usability of software can be measured by: (i) (ii) (iii) Logging the nature and number of calls to an IT Help desk. There should be relatively few calls if the software is easy to use. Observing users using the software and recording the problems and difficulties they encounter when using it. By getting feedback from the users on how easy they found the system to use. This can be done through a feedback questionnaire.

Again, Tony's anecdotal evidence as a customer is that the system was 'cumbersome' – indicating usability problems. Build quality The software should exhibit features of good build, such as ease of maintenance, flexibility in use, expandability, and portability between platforms. Software quality is about long-term design potential, and poor build quality will impede system development in the future, as well as complicating maintenance and upgrades. However, long-term design potential is quite difficult to measure. There are technical measures which allow the modularity of the software to be assessed. 272

Answers

There is evidence that CCT's software has long-term design problems. Amelia Platt, the Software Development Manager, highlights that the original software was not designed with future developments in mind, and that uncertainty about some of the purposes of the programs makes changing and upgrading difficult due to the unforeseen impacts of changes. Importance of software quality Software quality is extremely important to end users. They expect systems to function correctly and reliably, and to be easy to use. If software does not show these qualities, then users will become frustrated with the product, but more importantly they are likely to use the systems inefficiently. If users are using the software inefficiently, this is likely to have a negative impact on the productivity of their organisations. Moreover, if the software is not reliable and generates erroneous outputs this could lead to financial losses – for example, if a costing or pricing module is producing incorrect figures. The elements of build quality are likely to be less immediately obvious to an end user of the software. However, over time, if a system needs lots of maintenance work, this will be an operating cost to the business and will adversely affect net profitability.

56 Astrodome
Top tips. Part (a): There are two elements to this requirement: explaining the different problems of performance measurement, and then identifying how the directors’ views illustrate different problems. However, you shouldn’t assume that each problem will necessarily be represented by one of the views. As a guide to how long your answer to each explanation in part (a) should be, the examiner's model answer had for each problem one sentence defining each problem and another illustrating this using the question. In other words, your answers can be quite brief. There is an article in Student Accountant (May 2007) called 'The pyramids and pitfalls of performance measurement' which covers a lot of examiable material, including the issues covered here. Make sure you read it! (a) (i) Tunnel vision is undue focus on performance measures to the detriment of other areas. For example, view (a) reflects this as the statement focuses on the maintenance of one measurable aspect of the business at the expense of interaction with customers. Sub-optimisation is undue focus on some objectives so that others are not achieved. For example, view (c) reflects this. The strategy of focusing on opening hours ignores the importance of a number of other issues in the operation of the company facilities. Misinterpretation is failure to recognise the complexity of the environment in which the organisation operates. Management have focused on a number of performance measures as demonstrated by view (e), which fail to recognise the more complex economic problems that exist. The area served by the complex has high unemployment, for example, which may lead to economic decline. This decline will undermine many of the initiatives being proposed as unemployed customers may not be able to afford to use the facilities without allowance for their needs. Myopia is short-sightedness leading to a neglect of longer-term objectives. Again view (e) reflects this. A short-term reduction in the buildings budget may free up money for other immediate uses, but it will possibly lead to the need to spend more in the future on buildings when under investment leads to greater wear and tear. Measure fixation is measures and behaviour in order to achieve specific performance indicators which may not be effective. For example, view (b) focuses on increasing equipment utilisation, but problems of unemployment may mean that more equipment will not improve profit levels. Misrepresentation is 'creative' reporting to suggest that a result is acceptable. For example, statement (d) takes no account of the significant share of overall use of the complex represented by

(ii)

(iii)

(iv)

(v)

(vi)

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273

the three customers who have complained. The directors should recognise that complaints of any kind are bad news! (vii) Gaming is a deliberate distortion of a measure to secure some strategic advantage. This may include deliberate under performance. For example view (f) seems to be out to 'play the system' as management would be deliberately neglecting to fund a shortage of equipment so that they can secure grants which are given for needy causes. Ossification is an unwillingness to change the performance measure scheme once it has been set up. An example could be that expressed in view (g), which again ignores the issues and problems raised in the scenario. Focusing on and improving the measurement of customer satisfaction Without monitoring customer satisfaction and attempting to improve reported levels, an organisation is likely to underachieve. Tunnel vision and sub-optimisation are examples of measurement problems that may reduce if there are moves to improve customer satisfaction. For example, a focus on maximising opening hours may lead to a lack of consideration being given to other aspects of performance which customers rate. Involving staff at all levels in the development and implementation of performance measures Staff are involved in the achievement of performance measures at all levels of an organisation, and in all areas of an organisation's activities. It is therefore important that all staff are willing to work towards performance measures that are developed for their area of the organisation. This should help to reduce gaming, for example. The directors should realise that if the shortage of bowling equipment continues customers will take their business elsewhere. Being flexible in the extent to which formal performance measures are relied on Formal performance measures should not be relied upon exclusively for control purposes. A measure may hide activities being carried out to improve levels of performance in the long term. A degree of improved performance is possible through more informal arrangements between individuals and groups. Such informality, where appropriate, could help to reduce measure fixation and misinterpretation. For example, plans to increase the availability of equipment implies that there is demand for it. Giving consideration to the auditing of the performance measurement system It is important that any audit is objective and conducted independently. Audit findings 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 are fixated on the availability of equipment, and misinterpret this as being fundamental to sales volume, profitability and customer perceptions. The audit may also provide other evidence of gaming, such as that referred to in view (f).

(viii)

(b)

(i)

(ii)

(iii)

(iv)

57 TRG
Text reference. Read Chapter 2 which considers behaviour and budgets and Chapter 16 which covers behavioural aspects of performance. Top tips. This is a lengthy question to read and it is not clear that it is asking you about problems with budgets until near the end. The most important tip therefore is to read the whole question before starting to write anything and try to keep a clear mind even if you are raring to get writing. Over half of the marks can be earned in part(a) and the remainder are evenly spread. The mark allocation suggests that you need to make two points per problem in part (a) and then two more marks relating to each of five of the problems selected in (a) can be earned in parts (b) and (c). The examiner combined the three parts under each problem in his model answer, and this is a sensible approach to this question. This will save you time but you need to make clear that this is what you have done. We have followed the same approach which the examiner took, and answer the three parts of the requirement together. Part (a) requires a general explanation of the problems so this is knowledge rather than application.

274

Answers

Part (b) is asking you to illustrate or apply the information in the scenario to the points that you made in part (a). The question is not explicit on how many times you could use the same example to illustrate your answer. Therefore it has been suggested by ACCA that students could refer to an example up to three times in their answer. Part (c ) then wants you to suggest ways of remedying the problems. This wants you to use information from the scenario not just offer general advice. Note: Parts (b) and (c) of the requirement only ask you to address FIVE of the problems highlighted, but in our solution below we have covered all eight for revision/completeness purposes. Examiner's comments. The majority of candidates produced satisfactory answers. Weaker answers ignored the scenario given or didn't answer the question.

Marking scheme
Marks

Comments (on merit): (i) (ii) (iii) Nature – Up to 2 marks for each problem Illustration – 1 mark for each problem Remedy – 1 mark for an appropriate remedy 15 5 5

Maximum 25 Total = 25

(i)

Meeting only the lowest targets (a) Managers might put in just enough effort to achieve the minimum budget target to avoid penalties because there is no motivation to achieve above budget targets. When this happens, the rest of the organisation may suffer because overall, optimisation is not achieved unless the budget target is optimal. (b) The lowest target set is a budgeted output of 100,000 tonnes linked to the payment of a bonus. So if the division reaches this level of output, they will get a bonus. There is no incentive to achieve more than this target. This sub-optimal behaviour can be remedied by setting incentives for exceeding the 100,000 tonnes and encouraging the division to look at cost savings especially for the standard variable costs.

(c) (ii)

Using more resources than necessary (a) This is an issue of efficiency where the division is using a higher level of resources than they should be for the desired level of output. It may suggest an undue emphasis on the particular outcome as the manager is throwing as many resources as possible into attaining the particular target. An example of this for the division is the current level of quality checks which runs at 25% of daily throughput compared with 10% for 'consistent acceptable quality' which is deemed acceptable in some competitors. This may reflect a response to poor quality though. It may be possible to set a level of quality checks nearer or at 10% to maintain a 'consistent acceptable quality' as a target so the division is rewarded both for reaching quality targets and using the lowest level of resources.

(b)

(c)

(iii)

Making the bonus – whatever it takes (a) Managers may become fixated on a particular target and strive to achieve this meanwhile neglecting all other targets. Clearly this is sub-optimal as only one target is being met out of a range of those that have been set. Another name for this is tunnel vision where some performance measures are focused on, to the detriment of others. The clear example from the scenario is again focusing on achieving an output of 100,000 tonnes to receive the bonus of 5%. All other measures are subordinate.

(b)

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(c) (iv)

Clearly if the division had other targets and these had to be achieved before the bonus was paid then the division would no longer focus on just the achievement of the bonus output level.

Competing against other divisions, business units and departments (a) This is a problem if the competition leads to a sub-optimal result for the organisation. In many cases some competition can lead to an improvement in performance overall. However this competition needs to be managed and balanced with the need for co-operation too. Group profits would be improved if Bettamould sourced 40% of its material from another division which has spare capacity. Problems overcome by explanation and implementation of an appropriate transfer pricing system.

(b) (c) (v)

Ensuring what is in the budget is spent (a) Managers will often try to make sure they spend up to their full budget allowance without overspending. They can then avoid accusations of having asked for too much as they have demonstrated that they needed to spend the full budget allocation and won't get a reduction in the following year. The division has a fixed cost budget allowance of $50,000,000. The salaries of management and employees are fixed. Bettamould will not want a reduction in the fixed budget allowance as this may lead to having to reduce the number of employees. They may then see this as impairing the ability of the division to meet its budget output. One way of overcoming this problem would be to get management to understand the importance of budgeting for costs that are committed and those that are discretionary. They will have to be willing to consider cutting some discretionary costs to spend under budget.

(b)

(c)

(vi)

Providing inaccurate forecasts (a) This can be deliberate as well as a result of faulty data or poor calculation. Examples would include basing forecasts purely on past data, not taking a zero-based approach and not checking the robustness of the data used or the assumptions made. Another common problem with forecasting is where slack is built into the budget. The division may produce inaccurate forecasts by mistake or deliberately. An example of the latter is making a 10% provision for processing losses because ageing machinery leads to reduced efficiency of outputs. One way of overcoming this problem is to integrate all aspects of setting the budget so engineers and production management would have to agree on an accurate levels of processing losses arising due to the age of the machinery.

(b)

(c)

(vii)

Meeting the target, but not beating it (a) Managers might put in just enough effort to achieve budget targets without trying to beat targets. This can be a result of experience whereby extra effort is not rewarded so that provided targets for the division are met the manager is rewarded but not for going beyond this. The manager may also want to avoid being set a higher target next year so he has something in reserve. The division is required to meet the two provisions, (in relations to losses and idle time) and an output target which is a budgeted output of 100,000 tonnes linked to the payment of a bonus. So if the division reaches this level of output, they will get a bonus. This sub-optimal behaviour can be remedied by setting incentives for exceeding the 100,000 tonnes or looking at cost savings especially for the standard variable costs.

(b)

(c) (viii)

Avoiding risks (a) Managers may be drafting budgets and taking decisions that avoid risk wherever possible. So a budget would be set that includes low growth estimates for revenue or output figures and conservative cost savings. Bettamould appears to continue operating with a 5% idle time provision rather than take the 'risk' of outsourcing machine maintenance. Targets for replacing machinery could be agreed when setting budgets and used to replace the provision at least in part so that this reflects a more realistic level of idle time.

(b) (c)

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58 UU
Text reference. Chapter 12. Top tips. Part (a)(i). Agency theory is well covered in the Study Text but you will need to apply general principles to the scenario and use your imagination as it is normally applied in relation to shareholders and managers not public organisations which have multiple stakeholders. Start with a short definition of what agency theory means and the key issues of controllability and accountability underlying it. Outcomes can be observed so measures such as pass rates are outcomes. Effort is more difficult to observe especially in the short-term. Thus in the short term a lazy lecturer may have good pass rates and a diligent one less so in a particular exam sitting. Over time steady effort can be more readily measured. Part (a)(ii) tests expectancy theory which you may not remember from Paper F1 or old syllabus Paper 1.3. We have included an explanation taken from F1 in the additional information box. This is not part of the answer and is there to help you with your revision. The examiner does describe the formula but it may still throw you may still be confused. What it is describing is the motivation to do something in order to achieve an outcome. Part (b) continues the theme of agency and how agents can be made accountable. The areas can be answered straight from the Study Text. Part (c) - The reference to the different ‘management styles’ should have indicated that Hopwood’s management styles were relevant here. In effect, the requirement is asking you to analyse – and critique – a budget-constrained style (in which short-term cost control is the highest priority) and a non-accounting style which places more emphasis on non-financial performance than financial performance.

Marking scheme
Marks

(a)

(i)

Agency theory Observability of outcomes Observability of effort Strength of motivation to do (X) Strength of preference for outcome (Y) Expectation that doing (X) will result in (Y) Comments (on merit) Comments (on merit) Comments (on merit)

2 2 2 2 2 2 3 3 3

6

(ii)

6

(b)

(i) (ii) (iii)

Maximum 8

(c)

For each style (budget-constrained; non-accounting) - Up to 3

5 Total =

5 25

(a)

(i)

Application of Agency Theory to lecturing staff in UU Agency theory looks at the relationship between a principal who owns an organisation and an agent who runs it on the principal's behalf. The agent must account for their actions to the principal who therefore holds the agent to account. The principal also needs to consider the risks taken by the agent on their behalf. As the agent doesn't own the organisation they may be more or less risky in their actions than the principal who has a stake that they could lose or win. The senior management as principal at UU want to measure the staff as agents on their outcomes and their effort. The agent may take a risk-seeking stance by innovating in course design, teaching and learning methods. The principal or senior management may prefer to be more cautious and stick with what has worked in the past.
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277

Outcomes could be measured using student pass rates as a measure of the quality of education received. Research citations would also be a measure of staff activity keeping up to date in their field. Effort is more difficult to measure if it cannot be observed. Thus a lazy lecturer may have a gifted class which pass despite his efforts. In the long term it will be clearer whether lectures have made an effort as pass rates will be consistent and students will gravitate toward certain classes. (ii) Application of expectancy theory Additional information – from Paper F1 Victor Vroom stated a formula by which human motivation could be assessed and measured. He suggested that the strength of an individual's motivation is the product of two factors. (a) The strength of his preference for a certain outcome. Vroom called this valence: it can be represented as a positive or negative number, or zero – since outcomes may be desired, avoided or regarded with indifference. His expectation that the outcome will in fact result from a certain behaviour. Vroom called this 'subjective probability' or expectancy. As a probability, it may be represented by any number between 0 (no chance) and 1 (certainty).

(b)

In its simplest form, the expectancy equation may be stated as: F=VE Where: F V E = = = the force or strength of the individual's motivation to behave in a particular way valence: the strength of the individual preference for a given outcome or reward and expectancy: the individual's perception that the behaviour will result in the outcome/ reward.

In this equation, the lower the values of valence or expectancy, the less the motivation. An employee may have a high expectation that increased productivity will result in promotion (because of managerial promises, say), but if he is indifferent or negative towards the idea of promotion (because he dislikes responsibility), he will not be motivated to increase his productivity. Likewise, if promotion is very important to him – but he does not believe higher productivity will get him promoted (because he has been passed over before, perhaps), his motivation will be low. Expectancy theory measures motivation as the product of an individual's preference for a reward and their expectation that their behaviour will result in the reward. This may be expressed as F = V × E. The question states an equivalent where F = X and V = Y. Using the example of new course design, a lecturer may be keen for promotion (V) and expect his hard work devising new course materials and units will get him that promotion (E). Thus his motivation will be high (F). However if he is not too bothered about promotion (V is lower) but knows he will get it anyway (E), he will be less motivated (F). (b) Hard accountability The staff may be measured on their performance using financial and quantitative information in three areas. (i) Accounting for numbers. This may be achieved by converting activities and outcomes into numbers. An example would be the number of students signing up to a course. Another example would be pass rates. Ensuring numbers are accounted for. This requires reporting on the numbers and how and why they have occurred. The lecturers would produce regular monitoring reports covering their activities and giving explanations, based on numerical data such as pass rates and published articles. Being held accountable for events and circumstances leading to the numbers. This goes beyond merely reporting the numbers and explaining them to taking responsibility for performance. For

(ii)

(iii)

278

Answers

instance a lecturer who set up a new course would be responsible for its success or failure, rather than being responsible just for reporting on how many students enrolled, their pass rates, why they chose that course, how they heard about it, and the teaching methods. The innovation and application of teaching staff may be monitored over time consistently. This may ensure accountability is being equitably measured by a numbers of publications or student enrolments for instance. (c) Hopwood identified three distinct management styles; and, of these, the budget-constrained style appears to have been the style used at the financial controller’s previous company, while the non-accounting style appears to be the style used at UU. Budget-constrained style – At the financial controller’s previous company, the most important measure of managers’ performance appears was whether they achieve short-term financial targets, such as budgets. This indicates that a budget-constrained style was being used. Consequently, it is likely that managers would be criticised by their superiors if actual costs exceeded budget, regardless of other considerations. So for example, even if a manager ran a marketing campaign which led to an increase in revenue, he would still be likely to receive unfavourable feedback from his superiors if the cost of the campaign meant his costs were over budget. Short term approach – Unfortunately, however, the budget-constrained style’s focus on cost control could hinder the company’s future performance in the longer term. Marketing is likely to be necessary to help the company increase its revenues or market share (or even to maintain its existing market position) but if the manager reduces marketing expenditure as a result of the unfavourable feedback he has received, this is likely to be detrimental to the company’s performance in the future. Non-accounting style – By contrast to the retail company, budgets and financial information appear relatively unimportant when evaluating the heads of departments’ performance at UU. However, in this context, a non-accounting management style could be appropriate for UU if it is public sector organisation, whose performance objectives are not primarily financial. Nonetheless, it is important that UU doesn’t overlook financial performance entirely. Whilst measures of non-financial performance (such as research publications) are important, UU does still need to ensure that it keeps its cost under control, for example.

59 Elegant Hotels
Text reference. Management reward schemes form part of chapter 10 and the DMAIC methodology is covered in Chapter 11. Top tips. This should be a relatively straightforward question, and the first part in particular should not present many difficulties. The reward scheme is clearly in conflict with the strategy of the hotel and causing it to fail. There are lots of opportunities for quoting directly from the scenario to reinforce the points you make. As long as you refer back to the scenario and justify your arguments, you should be able to score highly. Part (b) should also be straightforward if you are familiar with the DMAIC methodology. If you have not learnt the methodology, however, it would be very difficult to score any points here. This is not the first time that this has been examined and is a simple model to learn. If you know the model, you should be able to score highly in this question.

Answers

279

Marking scheme
Marks

(a) (b)

Up to 1 mark for each relevant point up to a maximum of 15 marks Up to 1 mark for an appropriate description of each of the 5 stages and up to 1 mark for its application to Elegant Hotels

15 10 Total = 25

(a)

The main focus of the managers' reward scheme is on room occupancy rates. Therefore, the managers are concerned with simply filling rooms rather than looking at other aspects of performance. They are using a variety of ways to fill rooms, but these are proving damaging to the hotel: Broker sales Elegant advertises on online brokerage sites such as lastsecondhotels.com. These sites allow customers to compare prices, so in order to attract guests Elegant has to offer low prices. The quote on the website stating that it is a ‘Value for money hotel' indicates they are doing this. This suggests Elegant will now be making a lower profit margin than it historically did as a mid-market hotel. Customer comments on the lastsecondhotels.com are also likely to encourage potential guests to wait until the last minute to book, to get bargains. If occupancy looks like it will be low, managers will reduce rates as illustrated by the quote ‘very easy to get rooms at half the advertised rate.' Again, this puts downward pressure on the hotels' profit margin. In addition to the lowering of prices, Elegant will also have to pay a commission for guests who have come to them via the brokerage website. This further reduce the profit margin it earns. Group sales Another way Elegant has been increasing occupancy rates is through offering packages for school groups. However, again the profit margins on these will be lower than those earned when the hotel catered for midmarket guests. The use of the hotels by school parties along with the fact that a large percentage of its bookings are now received through lastsecondhotels.com. has led to a shift in customer perceptions. Elegant are now viewed as a budget hotel rather than a mid-market hotel which has historically been its market position. The presence of school groups may deter mid-market, higher value customers. Manipulation of rates Because the bonus is based on a percentage occupancy rate, the managers have an incentive to reduce the number of beds available for use, as well as get bookings for the rooms. Some managers are declaring rooms unfit for use. If the rooms are not unfit for use, this means the managers are artificially increasing their bonus while not generating any revenue by having guests staying in the room. Cutting costs Because room rates are being offered at a discount, managers need to cut costs even more to make a profit on. There is evidence that costs are being cut in a number of areas:  Cheap ingredients: Customer feedback on the website noted that the restaurant food was poor quality, suggesting managers are trying to reduce costs by using cheaper ingredients in the restaurant. Repairs and maintenance: Customer feedback on the website also noted that ‘The bath was cracked and the windows were dirty.' So it appears that managers are saving money but not arranging repairs when they are needed and by reducing how often the hotels are cleaned.

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Low capital investment: Guests have commented that there were no internet connections in the rooms or public areas. This suggests that managers have preferred to save money rather than investing in their hotels. This illustrates a short term focus because it will deter guests in the future. No investment in staff: Guests have also commented that the staff were not very helpful and were uncommunicative. Again, this suggests that either costs have been cut either by hiring cheap, less competent staff, or by not giving staff proper training when they join the hotel. Either way, measures that have been designed to save costs are leading to a decline in the service being offered to customers. High prices on ancillary services: the scheme is also leading to inconsistencies in the hotel's strategic approach. Whilst managers are trying to cut costs in a number of areas, they are trying to boost profit by charging high prices on food. This has led to a reduction in demand as guests on cheap, last minute deals are less likely to want to dine in the restaurant, than the guest Elegant traditionally catered for. This is evidenced by the quote “Cheap, but don't eat there. The price for breakfast was extortionate.” The conflict between the high prices charged for meals and the poor quality food offered is indicative of a confused strategy.

Ultimately, measures to cut cost have led to a decline in levels of customer service and perception of the hotel. However, this is unlikely to change as there is no incentive in the bonus scheme to improve customer service. The management reward scheme has entirely the wrong focus and has led to a severe decline in the reputation and performance of the hotels. Rather than rewarding occupancy rates, the scheme should focus on customer service, quality and providing a good experience for its customers. (b) Top tips. The ‘define' in the DMAIC methodology relates to defining customer requirements not defining performance measures as some candidates suggested. The main problem with Elegant hotels is that is has lost focus of what its customers want, and even of who its customers are. The reward scheme is in conflict with the strategy a successful hotel chain should have and its reputation and profit have suffered as a result. Implementation of the DMAIC methodology would help Elegant focus on the needs of its customers and could assist them meet those needs as follows: Define customer requirements Elegant should first define who their customers are, and then what they want (i.e. internet access, peace and quiet, helpful staff, good food etc). Elegant currently pay little attention to what their customers want, despite the feedback on the website, and would benefit greatly from doing so. Measure existing performance Elegant do not currently measure customer satisfaction and instead measure performance based on occupancy rates. They have to define new ways of measuring performance based specifically on the customer requirements defined above, perhaps using feedback questionnaires and re-book rates. They then need to use this to find out how well they are currently performing. Analyse the existing performance The analysis should involve identifying the gap between current and target levels of performance. Root causes of problems should be identified along with opportunities for improvement. Improve the process Design solutions for correcting existing problems and preventing others, with the aim of meeting and exceeding target performance. The improvements should be clearly defined, explained and managed. Improvements Elegant could make might include refurbishing guest rooms, installing internet connections and providing staff with customer service training.

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Control the new process Measures have to be put in place to keep the new processes on track and prevent people slipping into old habits. This could be done using new systems and structures that support the process as well as providing training to staff. Elegant wil