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These study materials are copyright CPA Australia. They have been provided for your personal use only to
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Version 16a
Published by Deakin University, Geelong, Victoria 3217 on behalf of CPA Australia Ltd,
ABN 64 008 392 452

First published January 2010, reprinted with amendments July 2010, Updated January 2011,
reprinted July 2011, Updated January 2012, reprinted July 2012, Updated January 2013, July 2013,
January 2014, Revised edition January 2015, updated January 2016.

© 2010–2016 CPA Australia Ltd (ABN 64 008 392 452). All rights reserved. This material is owned or
licensed by CPA Australia and is protected under Australian and international law. Except for personal and
educational use in the CPA Program, this material may not be reproduced or used in any other manner
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made in writing and addressed to: Legal, CPA Australia, Level 20, 28 Freshwater Place, Southbank, VIC 3006

Edited and designed by DeakinPrime

Printed by Blue Star Print Group

ISBN 978 0 7300 0035 8

David Brown University of Technology, Sydney
Brian Clarke Consultant
Courtney Clowes KnowledgEquity
Paul Collier Consultant
Teemu Malmi Aalto University, Finland; and University of Technology, Sydney
Peter Robinson Curtin University

2016 updates
Robert Cornick Monash University
Rahat Munir Macquarie University
Ofer Zwikael Australian National University

Albie Brooks University of Melbourne
Mandy Cheng University of New South Wales
Russell Clowes KnowledgEquity
Lyndal Drennan James Cook University
Karen Drutman Consultant

Advisory panel
Daniel Langelaan Australian Drug Foundation
Desley Ward CPA Australia
Eileen Foo Pacific Brands
Jacquetta Griggs Sturrock & Robson Group
Kerry Humphreys University of New South Wales
Kylie Walsh Ford
Robert Inglis RMIT University
Sarah Scoble CPA Australia

CPA Program team

Kerry-Anne Hoad Alisa Stephens Sarah Scoble
Kristy Grady Yvette Absalom Belinda Zohrab-McConnell
Desley Ward Nicola Drury
Kellie Hamilton Elise Literski

Educational designer
Jan Williams DeakinPrime

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Subject outline 1

Module 1: Introduction to strategic management accounting 13

Module 2: Creating organisational value 113

Module 3: Performance measurement 235

Module 4: Techniques for creating and managing value 357

Module 5: Project management 485

Case study 599


Subject outline

Introduction 3
Before you begin 3
Important information
Subject description 3
Strategic Management Accounting: The CPA as a value driver
Subject aims
Subject overview 4
General objectives
Module descriptions
Module weightings and study time requirements
Exam structure
Learning materials 6
Module structure
My Online Learning
General exam information 9
Authors 10

The purpose of this subject outline is to:
• provide important information to assist you in your studies;
• define the aims, content and structure of the subject;
• outline the learning materials and resources provided to support learning; and
• provide information about the exam and its structure.

Before you begin

Important information
Please refer to the CPA Australia website,, for the CPA Program
dates, contacts, regulations and policies, and additional learning support options.

Subject description
Strategic Management Accounting: The CPA as a value driver
Strategic management accounting is a key component of the overall skills base of today’s
professional accountant.

This subject examines the management accountant’s role in dynamic organisations operating
in the global business environment. In this role, the professional accountant engages with the
organisation’s management team and contributes to strategy development and implementation,
with the aim of creating customer and shareholder value and a strong competitive position for
the organisation. The subject highlights the management accounting tools and techniques
of value chain analysis and project management that have become increasingly important
in contemporary operating environments.

The subject includes discussions on the professional accountant’s responsibilities and judgment
as introduced in Ethics and Governance. Also discussed are investment evaluation and strategic
business analysis in the context of assessing and responding to risk, as covered in the Financial Risk
Management and Advanced Audit and Assurance subjects. Candidates are introduced to strategic
management concepts which are expanded on in Global Strategy and Leadership.

Subject aims
The aims of this subject are:
• to develop the skills of the professional accountant in creating, managing and enhancing
sustainable value to the organisation through the use of various strategic management tools
and techniques; and
• to examine techniques for developing, implementing, measuring and monitoring the
performance of an organisation to provide feedback for improving strategies.

Subject overview
General objectives
On completion of this subject, candidates should be able to:
• explain the role of strategic management accounting in supporting strategy development
and the day-to-day operations of an organisation;
• explain and apply the strategic management process and organisational and industry value
analysis to understand value drivers, cost drivers and the reconfiguring of value chains;
• explain the role of performance measurement and control systems in value creation,
strategy implementation and monitoring performance to improve strategies;
• apply strategic management accounting tools and techniques to improve the contribution
and sustainability of value-creating activities; and
• discuss the role of project selection, planning, monitoring and completion in strategy

Module descriptions
The subject is divided into five modules and a case study. A brief outline of each module
and the case study is provided below.

Module 1: Introduction to strategic management accounting

This module sets the framework for strategic management accounting. It discusses traditional
management accounting and the key changes leading to the development of strategic
management accounting. The module considers how the professional accountant and
strategic management accounting systems play a critical role in business. This module
also introduces the key contemporary concepts, tools and techniques that will be expanded
on in subsequent modules.

Module 2: Creating organisational value

The ability of an organisation to deliver value and secure a competitive position depends on how
well it develops and executes its strategy. This module provides an overview of the role of the
management accountant in supporting strategy development. Part A introduces the corporate
governance framework, the concept of stakeholder value, and the organisation and industry
value chains. In Part B, two approaches to strategic analysis, value analysis and SWOT are shown
to be fundamental to understanding the organisation and its environment. A completed
strategic analysis then informs the development of a strategic management framework and
strategies designed to deliver stakeholder value. The module introduces both established and
new approaches to strategy development. The role of a management accountant in strategic
analysis, strategic planning, strategy implementation and in improving value chain performance
is emphasised. All of these activities are critical contributions to corporate governance.

Module 3: Performance measurement

Sound design and an understanding of the use and implications of strategic performance
measurement and control systems are gaining increasing importance in all organisations.
This module focuses on understanding the key role that performance measurement plays in
strategy and value creation. It discusses the characteristics of effective performance measures
and control systems, the use of performance measures, and how to apply them to motivate and
reward employees. The key themes are the importance of performance being socially responsible
and sustainable; the leadership role of the professional accountant in performance measurement;
and the importance of value adding activities.

Module 4: Techniques for creating and managing value
This module shows how, through the use of a variety of strategic management accounting
concepts, tools and techniques, the professional accountant is able to assist with the growth of
organisational value. The module uses a case study to illustrate the implementation of strategies
to enhance value. Module 4 focuses on managing the value chain and discusses the key
components of strategic cost management and strategic profit management.

Module 5: Project management

Project management is an integral aspect of management strategy. This module explores
the roles involved in project management, including project leadership and the professional
accountant. It examines the strategic management accountant’s role in project selection,
planning, implementation, control and monitoring and project completion and review.

Case study
The case study consolidates your understanding of strategic management accounting through
completion of various tasks that require you to apply the concepts, tools and techniques covered in
Modules 1 to 5. The case study is not weighted for assessment purposes (i.e. it is not examinable).
However, in order to gain the most benefit from your study of Strategic Management Accounting,
it is important that you allocate time to complete the case study, including attempting the case
study tasks and reviewing the suggested answers. Completing the case study and case study tasks
will help you prepare for the written section of the Strategic Management Accounting exam.

Please note that the specific financial and operational details of the organisations discussed in the
case study will change over time and may not be current. However, the purpose of the case study is
to provide you with an opportunity to apply strategic management accounting concepts, tools and
techniques to a given set of data. That is, whether the specific ‘numbers’ are current is less important
than applying the concepts, tools and techniques to a nominated set of information.

Module weightings and study time requirements

Total hours of study for this subject will vary depending on your prior knowledge and experience
of the course content, your individual learning pace and style, and the degree to which your
work commitments will allow you to work intensively or intermittently on the materials. You will
need to work systematically through the study guide and readings, attempt all the in-text and
online self-assessment questions and any case studies, and revise the learning materials for the
exam. The workload for this subject is the equivalent of that for a one-semester postgraduate
unit. An estimated 10 to 15 hours of study per week through the semester will be required for an
average candidate. Additional time may be required for revision.

Do not underestimate the amount of time it will take to complete the subject.

The ‘weighting’ column in the following table provides an indication of the emphasis placed
on each module in the exam, while the ‘proportion of study time’ column is a guide for you to
allocate your study time for each module and the case study.

Table 1: Module weightings and study time

proportion Recommended
of study time Weighting study
Module (%) (%) schedule

1. Introduction to strategic management accounting 10 10 Week 1, 2

2. Creating organisational value 22 25 Week 2, 3

3. Performance measurement 18 20 Week 4, 5

4. Techniques for creating and managing value 30 30 Week 5, 6, 7, 8

5. Project management 15 15 Week 8, 9

Case study 5 — †
Week 10

100 100

Please refer to the module descriptions for the Case study.

Exam structure
The Strategic Management Accounting exam is comprised of a combination of multiple-
choice and extended response questions. Multiple-choice questions include knowledge,
application and problem-solving questions that are designed to assess the understanding
of Strategic Management Accounting principles. Extended response questions can include
a combination of short-answer and case scenario based questions. All extended response
questions focus on the application of concepts and theories from the study materials to solve
a given problem. An extended response question may require candidates to apply concepts
and theories from more than one module to provide the required solution. Table 1 of this
subject outline provides details of the weighting of each module in your exam, together with
an indication of the approximate proportion of your study time which should be allocated
to each of the modules.

Learning materials
Module structure
These study materials form your central reference in the Strategic Management Accounting

Each module has a detailed contents list. This list indicates the sequence of the educational
content in the module.

Each module begins with a preview containing the following sections.

Introduction: The introduction outlines what will be covered in the module and how it relates
to other modules in the subject.

Objectives: A set of objectives is included in the study guide for each module. These objectives
provide a framework for the learning materials and identify the main focus of the module.
The objectives also describe what candidates should be able to do after completing the module.

Teaching materials: This section alerts you to the required teaching material (if any) to which you
should have ready access. It also includes a list of readings which are to be used in conjunction
with the module study material.

Study material
The study material is divided into sections and subsections that will help you conceptualise the
content and study it in manageable portions. It is also important to appreciate the cumulative
nature of the subject and to follow the given sequence as closely as possible.

Study material activities

Activities are included throughout the study material. The study material includes three
distinctive types of activities:
• revision questions;
• reflective questions; and
• case studies.

The purpose of the questions and case studies is to provide you with the opportunity, as you
progress through the subject, to assess your understanding of significant points and to stimulate
further thinking on particular issues. The self-assessment activities are an integral part of your
study and they should be fully utilised to support your learning of the module content throughout
the semester. You are encouraged to spend time reviewing and analysing the module content.
Utilising the self-assessment activities should form one part of your revision for the exam. It is
evident that candidates who achieve good results in the program and in their careers are those
who are able to think, review and analyse situations, and solve problems.

Where applicable, sample answers are included at the end of each module. These provide
immediate feedback on your performance in comprehending the material covered. Your answers
to these questions do not contribute to your final result, and you are not required to submit
your answers for marking.

Revision questions. These require you to prepare answers and to compare those answers with
the suggested answers before continuing with the study material. These questions test your
comprehension of specific sections of a module.

Reflective questions. These require you to reflect on an issue. They are not numbered,
and are set in bold italics. No suggested answers are provided for these questions.

Case studies. These are much broader in scope than revision and reflective questions.
They illustrate practical problems that accountants might face. The case studies require you
to apply the theoretical knowledge you studied in the module to a particular situation. To be
able to adequately address issues raised in case studies, a deep understanding of the module
content is required. Simply memorising definitions and lists of technical details is insufficient.

While issues may be relatively clear in some case studies, it is important to realise that often
the case studies will have no correct/incorrect outcomes. The outcomes are quite possibly best
expressed as different viewpoints on problem situations, where viewpoints are supported by
reference to relevant theoretical principles. Moreover, the essence of the case may depend
on interpretation of the relevant concept rather than a simple restatement of that principle
or concept. For this reason, no ‘solutions’ to case studies are provided. Instead, responses to
cases are included in comprehensive case notes. To obtain maximum benefit from your case
study work, and to provide the best preparation for the case scenario section of the exam, it is
important to allow adequate time for in-depth analysis of case studies and to thoroughly work
through case materials and prepare a written response to case issues before you check your
responses against the notes/answers provided.

The review section places the module in context of other modules studied and summarises the
main points of the module.

The reference list details all sources cited in the study guide. You are not expected to follow up
this source material.

Optional reading
The resources in the ‘Optional reading’ list are useful if you wish to explore a particular topic in
more detail.

Required readings
Readings are provided to assist in the clarification and application of concepts from the study
materials. The content of readings is not directly examinable. However, the concepts covered by
the readings are examinable.

Suggested answers
These provide important feedback on the numbered revision questions and case studies
included in the module learning materials. Consider them as a model for your reference.
To assess how well you have understood and applied the material supplied in the text, it is
important to write your answer before you compare it with the suggested answer.

Internet references
At various points in the subject materials you may be directed to references located on the
internet and many of these are on external websites. All the URL addresses cited are tested
prior to the start of the semester to ensure their currency; however, this does not guarantee that
changes have not been made to the websites since the tests were performed. CPA Australia
provides links to external websites as a service to candidates in the CPA Program. CPA Australia
does not own, operate, sponsor or endorse these external websites and makes no warranties or
representations regarding the source, quality, accuracy, merchantability or fitness for purpose of
the content of these external websites; nor warrants that the content of these external websites is
free from any computer virus or other defect or error.

My Online Learning
CPA Australia offers additional study material through My Online Learning to assist candidates
in their study. Your study guide forms your central reference for examinable material. You must
also check My Online Learning for any study guide updates that will be posted there, as these
are considered part of the study guide.

There are many learning resources available to you in My Online Learning, such as self-
assessment questions and online activities. We recommend that you take the time to look
through these resources and become familiar with them.

You can access My Online Learning from the CPA Australia website:

There is a demonstration video to assist you in navigating the system.

Help Desk—for help when accessing My Online Learning either:

• email; or
• telephone 1300 73 73 73 (Australia) or +613 9606 9677 (International) between 8.30 am
and 5.00 pm AEST Monday to Friday during the semester.

General exam information

CPA Program exams are of three hours and 15 minutes duration.

CPA Program exams are open book. This means that candidates may bring any reference
material into the exam that they believe to be relevant and that may assist them in undertaking
the exam. This may include, for example, the study guide, additional materials from My Online
Learning, readings and prepared notes.

It is highly recommended that all candidates have access to a calculator in the exam. Candidates
will have access to an on-screen calculator within the computer-based exam environment.
We recommend candidates sitting paper-based exams bring their own calculator. Please ensure
that the calculator is compliant with CPA Australia’s guidelines. The calculator must be a silent
electronic calculating device whose primary purpose is as a calculator. Calculators with text-
storing abilities are not permitted in the exam.

The exam is based on the whole subject, including the general objectives, module objectives and
all related content and required readings. Where advised, relevant sections of the CPA Australia
Members’ Handbook and legislation are also examinable.

As this exam forms part of a professional qualification, the required level of performance is high.
Candidates are required to achieve a passing scaled score of 540 in all CPA Program exams.
Further information about scaled scores and exam results is available at:

David Brown
David is a Professor of Management Accounting in the School
of Accounting at the University of Technology Sydney. His PhD
research examined how management-control packages operate
as loosely coupled systems. Prior to pursuing an academic
career, he had extensive industry experience. David has been
involved in winning a number of industry research grants and
has numerous publications and conference papers, including the
Peter Brownell Manuscript award for the best paper in Accounting
and Finance in 2004. He has undertaken a range of projects
with CPA Australia, including projects on the use of activity-
based costing, the balanced scorecard and predictive business
analysis in Australia. He also has a strong interest in accounting
education research.

Brian Clarke
Brian began his career as a CA and auditor with Deloitte,
Haskins and Sells in Vancouver. After moving to Australia he
worked in higher education and as a consultant. At Monash
University he obtained his MBA and taught management
accounting. He was awarded the Monash prize for team-based
educational development for his work on the Multi-disciplinary
Industrial Project. At Deakin University he obtained his PhD and
taught auditing. Brian has published auditing, management
accounting and education research, and has presented his
research at numerous conferences. Brian currently works as
an education consultant to the accounting profession.

Courtney Clowes CPA, BCom (Hons) Deakin

Courtney is a director of KnowledgEquity. Courtney provides
educational, training and consulting services to a number
of corporate, government and professional bodies. He is an
experienced author and presenter at professional development
courses, conferences and workshops. Courtney also provides
strategic and business management services to organisations in
a range of industries. Such services include detailed analysis of
financial position and performance, reviews of budgeting and
strategic planning processes, cost control strategies and use of
financial information for decision-making. Courtney was previously
a Lecturer in Accounting at Deakin University, teaching at both
undergraduate and postgraduate levels in introductory, financial,
and management accounting, and in corporate governance. He has
a number of years’ experience in the manufacturing industry.

Paul Collier CPA, PhD Warwick, BBus UTS, MComm NSW,
GradDipEd UTS
Paul is an active business investor and consultant whose interests
are in management control systems, including accounting-
based controls and non-financial performance measurement,
governance and risk management.

Paul graduated as an accountant with a Bachelor of Business

degree from University of Technology Sydney and completed his
Master of Commerce degree at University of New South Wales,
gaining his PhD from Warwick University in the UK.

Paul was Chief Financial Officer and Company Secretary,

and subsequently General Manager (Operations) of Computer
Resources Company, a stock exchange listed manufacturing
company based in Sydney, before undertaking a career change
into education and consulting.

His early career in industry saw him move from financial into general
management roles. He subsequently moved into academia,
where he has worked as Director of Executive Education with
Aston Business School in the UK, and as Associate Dean (Research
Training) and head of discipline for management accounting and
accounting information systems at Monash University in Melbourne.

Paul has retired from full-time academic work but remains an active
consultant and investor.

Paul has many academic journal publications and is the author

of two textbooks. He is currently updating the 5th edition of his
MBA text, Accounting for Managers.

Teemu Malmi
Teemu is a visiting Professor at the University of Technology
Sydney and a Professor at Aalto University, Finland. Teemu’s
teaching and research focus is mainly on managerial control
systems, strategy implementation and cost and profitability
accounting. He regularly teaches in a number of executive
education programs and has served as a consultant to a wide
range of private and public organisations. He has served as a
chairman of the board for a listed company and currently holds
board memberships in two information technology companies.
He holds a PhD from the Helsinki School of Economics.

Peter Robinson
Peter is a sessional lecturer in accounting at the University of
Western Australia. He was a full-time academic in accounting
at Curtin University until 1990 and again from 2011 to 2013,
and at the University of Western Australia from 1990 to 2011.
Peter first began his academic career in 1971 and he has taught
the breadth of financial and management accounting curriculum
at both the undergraduate and postgraduate levels. Peter has an
active research and teaching interest in strategic management
accounting. He also presents professional development courses
for CPA Australia on the development and application of
comprehensive performance measurement frameworks (in the
for-profit, not-for-profit and public sectors) and on strategic
management accounting issues. Peter has also developed and
delivered many professional development courses to private,
public and not-for-profit organisations. Courses have been
delivered to the National Australia Bank, Telstra, Peters and
Brownes, Georgiou Group, the Departments of Agriculture
and Food, Child Protection, Commerce, Corrective Services,
Indigenous Affairs, Planning and Infrastructure, Mining and
Resources, Regional Development and Lands, Water and Landgate
(WA), Public Sector Commission (WA), the Royal Automobile Club
of Western Australia, Senses Foundation, St John of God Health
and the Institute of Public Administration Australia. He has also
delivered courses and workshops to professional groups such
as the Local Government Managers Association.

Module 1

* Updated by Rahat Munir.


Preview 15
Subject map
Value 17
Shareholder value

Customer value
Stakeholder value
Which viewpoint should be taken when determining ‘value’?

Part A: The role of strategic management accounting 22

Useful information for decision-making 22
The evolution of management accounting 24
Changes to the management accounting role
Causes of change in the business environment 25
The global economy
The role of management accountants 40
Analyst, adviser, partner
Contemporary skills and techniques

Part B: Understanding and supporting management 47

What managers do—creating and managing value 47
Strategic management accounting—supporting managers 48

Part C: Management accounting systems 54

The role of management accounting systems 54
Risk management 58
Risk management system
Internal controls
Strategy and risk
Problems with management accounting systems 63
ERP software and management accounting systems 63
Environmental management accounting systems

Review 66

Preview of Modules 2 to 5 and case study 67

Appendix 69
Appendix 1.1 69
Appendix 1.1 Suggested answers 94

Suggested answers 103

References 109
Study guide | 15

Module 1:
Introduction to
strategic management

Study guide

Contemporary organisations face significant challenges. It is essential for them to create
value for a variety of stakeholders, including customers, employees, management and their
shareholders or owners. This must be achieved in a global environment that is constantly
changing and becoming more competitive. In this subject, we focus on the role that strategic
management accounting plays in creating, managing and protecting value.

We define strategic management accounting in the following way:

Creating sustainable value by:
• supporting the formation, selection, implementation and evaluation of organisational
strategy; and
• providing information that captures financial and non-financial perspectives for both the
internal and external environments to enable effective resource allocation.

Value creation is essential in modern-day organisations. You need to think of organisations,

government bodies and not-for-profit entities as linked chains of resources and activities.
These chains produce products and services of value to consumers and end users. The essential
requirements for successful performance are:
• to generate products and services with value that consumers are willing to pay for; and
• to constantly develop and improve the resources and activities used to generate that value.

In this module we consider accounting and its role in supporting management. We then describe
the key changes that have led to the development of strategic management accounting. We also
identify the challenges that management accountants face and describe the skills required
to perform their role. This module concludes with an examination of the role of management
accounting systems. At the end of the module, there is an appendix that covers traditional
accounting support tools for operational management, including budgeting.

You should note that this appendix is examinable.


The ability to support managers at a strategic level has become essential, and management
accountants must broaden their role from traditional scorekeeping tasks to business advisory
positions. Technology and information systems now capture and process the routine events
within an organisation. This allows management accountants to spend more time understanding
the organisation’s external environment and work on non-routine, complex decisions. In this
module, we introduce concepts and skills that help management accountants create, manage
and protect value in the contemporary business environment.

In this module we will introduce and use a hypothetical case study—HZ Electrical Pty Ltd—
to illustrate strategic management accounting concepts, tools and techniques. We will revisit
this case in Modules 2 and 4.

After completing this module, you should be able to:
• explain the role of strategic management accounting;
• analyse the key challenges facing the management accountant;
• apply accounting techniques that support operational management; and
• discuss the role and structure of the management accounting system and explain how
strategy underpins its design.

Subject map
Figure 1.1 provides an overview of the important concepts in this subject and how they link
together. An organisation pursues a particular direction, where it believes value can be created.
This value may be shareholder value, customer value or broader stakeholder value—depending
on the type of organisation involved. The concept of value is explored in Module 1 and in further
detail in Module 2.
Study guide | 17

Figure 1.1: Subject map

n n
v v
i i
r r
o Value o
n n
m m

e Vision/Mission e
n n
t Goals and objectives t
a a
l Strategy—Creation l
a a
n Strategy—Implementation n
l l
y Strategy—Implementation y
i i
s Control and feedback systems s

Source: CPA Australia 2015.

Underlying value creation is the need to put in place a clear strategy, based on a vision and
mission that combine resources effectively (including people, technology and time) to achieve
goals and objectives.

The foundation of any business involves the implementation of broader strategic ideas and
concepts. As such, the day-to-day activities and projects that are performed provide a solid base
that allows the organisation to drive towards its desired outcomes. It is important to perform the
work required, but it is also necessary to review, monitor and improve activities and processes.
The need for clear feedback and reporting is highlighted to enable the organisation to stay in
line with its vision and mission.

At all times, the organisation must be aware of the external environment in which it operates.
Competitor activity, the broader economic and regulatory environment, and social changes may
all impact on the organisation, and so monitoring and adapting to change are critical activities.

The main theme of this subject is value. The analysis and activities, the tools and techniques,
the reporting and evaluation—all of these take place in the pursuit of value.

Value is a broad concept. It can be described as combining resources together in a manner

that creates desirable outcomes. Examples of value creation include growing food, generating
energy, providing health care and building new machines, software programs and infrastructure.

The role of management is to create, manage and protect value. Value is usually described
as increasing shareholder wealth. However, this is both narrow and simplistic. A focus purely
on shareholders is often too limited, as it ignores other important and interested parties or
stakeholders. These include:
• lenders;
• customers;
• suppliers;
• employees; and

• community groups.

Each group has its own interests and desires and therefore its own definition of the ‘value’ that
it wishes to receive from an organisation. Failure to consider stakeholder needs and desires will
make it difficult to maintain and increase shareholder wealth.

Value creation is just as relevant in the not-for-profit and public sectors. For example, national
infrastructure, education, health and social welfare need to be managed just as effectively
as privately run organisations. In the not-for-profit and public sectors, value is created for the
members, citizens or residents (or taxpayers) of the nation instead of wealth being increased
for shareholders.

Shareholder value
The ultimate outcome for many organisations is to generate wealth for the owners. The owners
have either started or invested in the organisation to obtain appropriate returns for the risk
involved. As such, many measures of value focus on shareholder value. However, pursuit of
shareholder value while ignoring other areas of value creation is not sustainable. To ensure that
an organisation is able to create shareholder value over a prolonged period, its actions and use
of resources need to be sustainable. For example, if the impact on the natural environment is not
acknowledged or minimised, long-term sustainable shareholder value is unlikely to be achieved.

Customer value
The primary task for an organisation is to create an output that has customer value. A key
requirement is to produce this output at a cost that is lower than the price the customer is willing
to pay, which leads to profitability and creates shareholder value.

Figure 1.2 shows a simple version of the organisational value chain. This provides an overview of
how the organisation performs a sequence of activities to provide outputs or outcomes to create
customer value. A more detailed version of the value chain is outlined in Module 2.

Figure 1.2: Organisational value chain

Business cycle
Operations (obtaining/producing goods or services) Sales Distribution After-sales service

These activities are supported by a variety of business functions.

Support activities
Research and development, accounting, human resources, information technology and infrastructure

Source: CPA Australia 2015.

Study guide | 19

Stakeholder value
Shareholder wealth is a by-product of generating value in other areas. To create products
or services, an organisation will require community permission to operate, infrastructure,
customers and employees—who will only supply their effort if the wages and conditions
are adequate. That is, the organisation must provide suitable value to its stakeholders.
So, consideration of stakeholders is critical to organisational success.

The primary focus of this subject is on generating customer value by improving activities in the

organisational value chain. This, in turn, is expected to generate shareholder value for private
sector organisations as a result of increased profitability and growth.

Which viewpoint should be taken when determining ‘value’?

A significant philosophical issue that must be considered with regard to value is: ‘From which
perspective should value be determined’? The most obvious perspective is from the organisation
itself. Value is linked to the concept of ‘anything that is good for the business or organisation’.
However, other perspectives also exist, including that of society. Some actions may bring value to
the organisation as well as to other groups at the same time (e.g. more efficient farming practices
may lead to higher yields, lower prices and more nutritional food). However, other actions may
benefit the organisation while causing significant harm to others.

Table 1.1: Organisational value and potential impact

Value (organisation’s viewpoint) Potential impact (society’s viewpoint)

Cost cutting—reducing the number of staff by Unemployment, financial pressure on communities

10 per cent to increase profitability and additional stress for employees who remain

Switching production to cheaper offshore Local unemployment, environmental degradation,

locations with lower standards of employee and and an increase in injuries and incidents among
environmental protections employees who receive little protection

Massive price discounting of key items by A small price reduction for individual consumers
supermarkets to gain market share, forcing suppliers but at the expense of producers who are unable to
to reduce prices remain viable

Selling addictive products or services including Social issues in communities and an increase in
gambling, alcohol and cigarettes health-related costs

Source: CPA Australia 2015.

The development of corporate social responsibility (CSR) indicates that people are interested
in more than just the pure economic value that organisations create. They are also interested in
‘how’ that economic value is created, and they assess the impact of those actions (or inactions).
CSR reporting has increased to help people understand the sustainable value or impact of an
organisation’s activities from a social and environmental perspective. Such reporting aims to
increase the level of ethics and accountability demonstrated by organisations when making
value-based decisions.

Therefore, to be truly valuable, something must offer economic value to the organisation and
provide sustainable value to other stakeholders within society. This collaborative approach is
discussed further in Module 2. Module 2 also provides useful tools for analysing value to ensure
it is occurring.

The following case study provides an opportunity to consider the idea of value for different

Case Study 1.1: HZ Electrical Pty Ltd

HZ Electrical Pty Ltd (HZ) is in the consumer products industry. Its major customers are electrical
appliance retailers in Australia, New Zealand and the South Pacific island nations. The organisation was

founded 40 years ago. It distributes consumer products to the South Pacific market under licence from
European and North American electrical appliance manufacturing organisations. It also manufactures
its own range of electrical appliances through a joint venture with a manufacturer in southern China.
HZ had experienced a significant level of annual growth, but as a result of increased competition,
the growth rate of both sales and profits has slowed.

The board of directors comprises the founder of the company, Bronwyn Jones, three members of
her immediate family, and the chief executive officer (CEO), Cynthia Grey. Ninety-five per cent of
the shares in HZ are owned by members of the Jones family. Bronwyn Jones is rarely seen by the
organisation’s senior management team, as she is involved with various charitable organisations and
prefers to leave her two eldest sons in charge. Unfortunately, the two sons frequently clash, and as
Bronwyn is unwilling to take the side of one son over the other, the organisation’s management team
feels that it has to serve two masters.

Bronwyn Jones’ eldest son, Stephen, championed the development of HZ’s own product range.
He established connections with the Chinese joint venture partner and regularly travels to China for
meetings. Although the venture has been reasonably successful in terms of revenue, the profit margins
on these sales have been lower than those from the sale of licensed products because the products
do not have a well-known brand name. Nevertheless, Stephen is recommending to the board that
they make a greater investment in new product development and manufacturing.

Using the table below, provide examples of what would be considered as value for each of
the following stakeholder groups of HZ.






Community groups

A suggested answer to the Case Study 1.1 task is provided at the end of the ‘Suggested answers’
for Module 1.
Study guide | 21

Strategic management and strategic management accounting

Consider the definition of strategic management accounting provided earlier:
Creating sustainable value by:
• supporting the formation, selection, implementation and evaluation of organisational
strategy; and
• providing information that captures financial and non-financial perspectives for both the
internal and external environments to enable effective resource allocation.

There is a clear outcome here—the creation of sustainable value. While some areas of accounting,
such as financial reporting and auditing, may have a regulatory compliance focus to inform
and protect external stakeholders, strategic management accounting is aimed specifically at
improving organisational outcomes.

Strategic management describes the process by which an organisation decides:

• the direction it will take;
• the industry it will operate within;
• the types of products or services it will provide; and
• its goals and objectives.

It also includes the development of specific approaches or strategies as well as implementation

plans and performance measurement that support this process. Strategic management is
discussed in more depth in Module 2.

Strategic management accounting provides a wide range of tools and techniques that support
each stage of the strategic management process. So, strategic management accounting
becomes an enabler, or a catalyst, that helps initiate and drive strategic management activity.
Strategic management accounting helps organisations in their desire to create long-term,
sustainable value that is of benefit to all stakeholders.

Part A: The role of strategic

management accounting
Strategic management accounting plays an important role in supporting strategy development
and the day-to-day operations of an organisation. As this role is explored in further detail,
the first thing to consider is how strategic management accounting fits within the broader areas

of accounting. Then consider how the role of strategic management accounting developed
over time and what factors currently influence it.

There is a wide range of titles used to describe the accountants who perform strategic
management accounting. These include:
• management accountant;
• business analyst;
• senior analyst;
• commercial manager;
• planning specialist; and
• profit analyst.

For the remainder of this subject the title ‘management accountant’ will be used.

Useful information for decision-making

The purpose of accounting is to provide useful information to support decision-making. The type
of accounting information required for any given situation will depend on the needs of the user
of the information. For example, a manager may want to know which customers are generating
the most revenue and profits, and a lender may be interested in knowing an organisation’s cash
flows to evaluate whether to lend it money.

With strategic management accounting, the focus is on providing useful information that supports
both the day-to-day and strategic decisions of management. Examples of these decisions are
shown in the table below.

Table 1.2: Decision-making by management

Decision areas Decisions supported by accounting information

Strategy Competitive approach, industry selection, organisational structure, target setting

Products Product mix, pricing, make or buy, quality of materials

Supply chain Choosing suppliers, customer credit checks

Infrastructure Location, information systems, organisation hierarchy, capital expenditure

Financing Obtaining finance, dividend payments

Resource allocation Allocating time, employees, physical capital and cash to various activities within
an organisation

Source: CPA Australia 2015.

Study guide | 23

The user group of strategic management accounting information is internal management.

In contrast to this, financial reporting is focused on external users, such as investors and
lenders, as shown in Table 1.3. These external users usually only receive highly aggregated
sets of financial information presented at periodic intervals (e.g. annual reports), which would
be inappropriate for the day-to-day running of an organisation.

Table 1.3: Decision-making by external users

External user groups Decisions supported by accounting information

Investors Should I buy, sell or hold investments based on expected returns?

Lenders Should I lend money? Will the principal be repaid with interest?

Suppliers Will credit purchases be repaid? What is the likelihood of future orders?

Customers Will customer support and warranties be provided and honoured?

Government and Should the organisation’s actions and performance be monitored to see if extra
interest groups accountability or intervention is required?

Source: CPA Australia 2015.

Figure 1.3 shows the main differences between financial reporting and strategic management
accounting. It is important to be aware that strategic management accounting does not
have the direct guidance that exists for financial reporting. External reporting is guided by a
conceptual framework and governed by specific standards and rules, whereas the structure
of and information contained in internal reports are decided by management to suit its needs.
This subject focuses on internal reporting and decision-making.

Figure 1.3: Accounting information

Accounting—providing useful information for decisions

External reporting Internal reporting

Financial reporting Strategic management accounting

Used by various external groups Used by management and
to evaluate the organisation’s employees to make decisions
performance, position and future about running the organisation
Information presented includes:
Information presented includes: Budgets and forecasts, performance
Statement of comprehensive indicators, costings, combining
income, statement of financial industry data with internal data
position and statement of cash
flows, notes to the accounts and Information qualities:
auditor’s report Both financial and non-financial,
specific to each situation, future
Information qualities: oriented and timely
Financial focus, aggregated,
historical focus and delayed

Source: CPA Australia 2015.


The evolution of management accounting

The International Federation of Accountants (IFAC) provides the following definition of
management accounting:
the process of identification, measurement, accumulation, analysis, preparation, interpretation,
and communication of information (both financial and operating) used by management to plan,
evaluate, and control within an organisation and to assure use of and accountability for its resources

(IFAC 1998, p. 99).

The Cambridge Dictionary defines a management accountant as:

an accountant who helps managers decide how to make profits or save money by examining
information relating to the costs of running a business and analysing how much profit different parts
of the business are making (Cambridge Dictionary 2015).

These definitions suggest that the key focus of management accounting is on planning and
controlling. Over time, the role of management accounting has developed and broadened.
More contemporary definitions expand the role to consider strategic activities, competitor
activities and the broader economic environment. The focus now goes beyond planning and
controlling towards value creation and sustainable interactions with stakeholders.

Changes to the management accounting role

As the broader economic environment has experienced significant changes over time, so has
management accounting. The historical development of strategic management accounting
has been described as having five major stages.

Figure 1.4: Evolution of strategic management accounting

Stage 5:
Stage 4: Strategic and
Stage 3: Value
Stage 2: Increasing externally focused
Stage 1: creation
Management efficiency
Technical activity

Prior to 1950s 1950–1965 1965–1985 1985–2000s 2000s to now

Stage 1: Prior to 1950 Management accounting was considered to be a technical activity. The two
major areas of focus were determining costs and providing financial
control. This was achieved through techniques including cost accounting
and budgeting.

Stage 2: 1950–1965 Management accounting developed from being a technical activity to a

management activity by expanding to include the creation and presentation
of information for planning and control. This period also saw the development
of responsibility accounting.

Stage 3: 1965–1985 In addition to the previous information provision role, attention was focused
on increasing the efficiency of business processes in an attempt to reduce and
eliminate wasted resources. This expansion was aided by the reduced cost of
technology and the availability of real-time information.
Study guide | 25

Stage 4: 1985–2000s The scope of management accounting expanded even further to include
improving the effective use of resources to create value. Essential to achieving
this was an understanding of the cause and drivers of customer value and
shareholder value, as well as the effective use of technology. Management
accounting moved from just providing information to becoming actively
involved in improving strategic and operational decision-making and resource
allocation (IFAC 1998).

Stage 5: 2000s to now Management accounting has become more strategic with an increasingly

external outlook and has focused on a broader range of stakeholders.
Social, environmental and ethical issues continue to grow as do competitive
pressures due to increasing levels of globalisation. The emphasis is now on
creating value in a responsible and sustainable manner.

Sources: Based on IFAC 1998; CPA Australia.

It is evident that management accountants have expanded their role from recording and
reporting information to providing analysis and recommendations. They have moved into
the position of being strategic business advisers.

The main activities now performed by management accountants are summarised as follows:
• providing useful information combined with analysis and interpretation to support
management in the tasks of setting strategy and making operational decisions;
• developing and implementing performance measurement systems;
• costing products and services;
• designing processes and systems that reduce errors, wastage and control costs;
• improving the effective use of resources by understanding the drivers of value for the major
stakeholders of an organisation; and
• providing risk management, internal control and assurance-type services (IFACb 2005).

➤➤Question 1.1
Why is strategic management accounting relevant in the public sector and not-for-profit sector
if these organisations are not manufacturing products or pursuing a profit?

Causes of change in the business environment

To help understand how and why there have been changes in the business environment and
in the role of management accounting, consider how companies and other organisations have
changed over time. Over the last few decades, many large multinational organisations have
grown (and declined). There have also been many smaller organisations that were ‘born global’
as a consequence of the existence of the internet.

A large number of external factors have led to changes in the contemporary business environment
and, therefore, to management accounting.

External factors include significant upheavals in the global economy, the effects of globalisation
and increased competition, as well as rapidly developing technology. An increasing focus on
corporate governance and a broader stakeholder perspective of corporate accountability
have also had an impact. Sustainability and the need to capture and report a wider range of
information have had an influence. Management accounting has also been affected by internal
factors—for example, structures within organisations have become less hierarchical and more
decentralised in their decision-making.

These major factors are briefly examined in Figure 1.5.

Figure 1.5: Causes of change in the contemporary business environment


Structural Capital
change Information equipment
Globalisation technology
Environmental MA environment
Stakeholders offshoring
Ethics Joint
Virtual ventures

Source: CPA Australia 2015.

The global economy

Economic turmoil
Economies throughout the world are more deeply integrated and accessible than they have been
at any time. This means that changes or problems in one part of the world quickly spread across the
globe. Both economic and political instability have caused serious issues for many organisations.
In a similar way to illness or disease, we talk about global ‘contagions’ such as potential bank
defaults and collapses combined with fear and panic, sending share markets tumbling.

Years after the start of the Global Financial Crisis (GFC) in 2008, the damaging effects are still
visible at the national level in many countries (e.g. Greece) as well as on individual industries and
organisations. It appears that many underlying issues have been deferred but not resolved.

Difficult times in most economies have led to lower demand and lower prices for many goods
and services. This has increased the focus of management on key areas such as cash flows,
access to funding and ensuring that supply chains are able to continue delivering products or
services. Risk management, forecasting and rapid adaptation to new circumstances are now
critical to successful management of organisations. Cost control and efficiency are also critical
as organisations deal with an extended period of stagnant or declining growth.

Structural change
Many economies are experiencing significant change in terms of:
• average growth rates;
• government philosophy on spending;
• government, company and individual debt levels;
• consumer spending habits; and
• new regulations.
Study guide | 27

Table 1.4 reveals actual and forecast gross domestic product (GDP) growth rates. Before the GFC,
economic growth rates around the world were strong (in 2005) but there was a considerable slump
by 2009. Despite some improvement since then, the high growth levels have not yet returned.

Table 1.4: Actual and forecast growth rates (GDP)

Pre-GFC GFC                Post-GFC

2005a 2009a 2013a 2015f

Global growth 3.5% (2.2%) 2.4% 3.4%

High-income countries 2.7% (3.4%) 1.3% 2.4%

Developing countries 6.6% 1.9% 4.8% 5.4%

Euro area 1.4% (4.1%) (0.4%) 1.8%

East Asia and Pacific 9.0% 7.4% 7.2% 7.1%

Europe and Central Asia 6.0% (6.4%) 3.6% 3.7%

NB: a = actual, f = forecast

Sources: Based on World Bank 2007, 2011, 2014.

There has been a focus on government austerity, which involves significant reductions in
spending so that government debt may be reduced. This has been combined with individuals
and organisations trying hard to reduce their spending and debt to more manageable levels,
as they are uncertain about the future. Although these are worthy economic approaches,
the flow-on effect for many companies is reduced demand and limited expected growth in
the future. To be more competitive, companies have to reduce prices, cut costs and keep
employee numbers down. As such, many economies are still experiencing slow or negative
growth, and so there is little hope for significant improvement in the next few years for
these economies.

Another example of structural change involves new regulations aimed at minimising or

preventing the same types of problems that caused the GFC. The Basel III Accord provides
a useful example of this.

Example 1.1: The Basel Accords

Banks lend out the majority of funds they receive from depositors and capital providers, and so they
only hold a small amount of capital reserves. A major problem for banks occurs if many customers
decide to withdraw their deposits at the same time, as this can cause a ‘run on the bank’. When this
happens, there is not enough physical cash to return to depositors, which may cause panic, prompting
more depositors to attempt to withdraw their funds, and lead to the collapse of the bank.

To minimise this risk, banks must hold an appropriate level of capital in reserve (capital adequacy),
but this of course will reduce the amount of lending they do, resulting in lower revenues and profits.

An additional problem for banks is the types of lending they undertake. Mortgage-based lending,
where residential property is provided as security, is much safer than higher-risk lending secured by
commercial property or where there is no security at all.

Lending with higher risks should be done at higher interest rates to reflect that risk. However, high‑risk
taking banks and lenders may do the opposite in an attempt to capture market share. They may offer
customers low interest rate loans without the need to provide security and also lend a higher amount
(e.g. 100% of the purchase price of a house instead of a safer level such as 80%). If too many of these
higher risk loans go bad (i.e. borrowers default on their repayment obligations), the bank may be
severely affected or even collapse. Holding additional capital to adjust for higher-risk loans is a suitable
solution, but it comes at a cost. Different banks will approach this issue differently.

The Basel Accords (Basel I in 1988, Basel II in 2004, Basel III in 2010) are an attempt by central bankers
to address these problems. The Basel Accords aim to create a robust and stable international banking
system to minimise banking problems and to avoid an international collapse of the financial system
(which nearly occurred during the GFC).

Basel III Accord

A key aim of the revised version of Basel III (Basel Committee on Banking Supervision 2011) is to
enable the banking sector to absorb shocks. Other aims include improving risk management and
transparency. The following requirements for banking institutions are to be implemented by 2019,

and each of these has relevant numerical or ratio measures to demonstrate that it has been achieved.

Capital Increasing the level of capital held (as a percentage of risk-weighted assets)

Increasing the quality of capital held

Counter-cyclical buffers are put in place when credit grows too quickly.
This means that rather than encouraging the growth cycle with extra credit
and lending (pro-cyclical), changes are made to slow credit growth (to counter
or reduce the growth cycle).

Leverage Ensuring leverage (use of debt) does not reach dangerous levels

Supervision Focusing on managing risk and off-balance sheet exposures

Ensuring appropriate compensation and valuation practices

Disclosures More detailed and transparent disclosures

Effect on business
The most likely impact on business will be a reduction in credit availability, especially for higher-risk
activities, such as trade credit financing. The cost of borrowing will also increase, although this is
expected to be quite small in most circumstances. The extra cost is estimated to be 5 to 10 basis points
(i.e. 0.05% to 0.10%), which equates to between $50 and $100 per annum on every $100 000 borrowed.

In summary, there will be a dampening effect, where excessive credit growth is tempered, and borrowing
costs are slightly higher. This will lead to (slightly) slower growth and (slightly) lower profits in the short
term. The positive trade-off from a broader economic perspective is a decreased chance of a bank
collapse and a more stable economic environment in which to operate. This should lead to higher
long-term growth and profits.

The Basel III Accord is also discussed in the ‘Financial Risk Management’ and ‘Contemporary Business
Issues’ subjects of the CPA Program.

In addition to the cyclical events of the global economy that follow a boom-bust cycle, there are
structural changes in the size and types of industries. This is often caused by new technology,
and these changes also have an impact on organisations. Electronic commerce is accelerating
these changes, and specific examples of structural change include the rapid growth of the services
sector and the decline of manufacturing in many developed countries as shown in Table 1.5.
Study guide | 29

Table 1.5: Shifting to services from agriculture/manufacturing

Percentage share of GDP of different industries (in 2010 price terms)†

Australian industries 1860 1960 2011

Health 0.3% 3.0% 5.9%

Agriculture 23.0% 11.0% 2.2%

Mining 14.6% 1.8% 7.3%

Manufacturing 4.2% 28.9% 8.2%

Education 0.3% 2.9% 4.5%

Professional and technical services 0.0% 1.5% 6.6%

Communication services 1.5% 1.5% 3.2%

Finance and insurance 3.7% 3.7% 9.8%

Property and business services 22.1% 26.2% 47.8%

Hospitality 2.5% 2.0% 2.3%

The figures in the table are not meant to total 100 per cent.

Source: Based on IBISWorld 2012, ‘Ages of progress’, email newsletter, 9 May.

Figure 1.6: T
 he decline of agriculture and manufacturing and the rise in services
in Australia



40.00% Agriculture
Share of GDP

Property and
20.00% business services


1860 1960 2011

Source: IBISWorld 2012, ‘Ages of progress’, email newsletter, 9 May.

The data in the table above must be interpreted with care. Although Australian agricultural
activity as a percentage of GDP has declined from 23 per cent to 2.2 per cent, this does not
mean that there has been a physical or monetary decline in terms of activity, produce or output.
Rather, this data indicates that the rest of the Australian economy has grown even more rapidly.

Despite the decline of Australian manufacturing starting over 50 years ago, this structural change
has caused significant difficulty for many organisations. For example, at the time of writing,
car makers that have stopped producing vehicles in Australia include Mitsubishi, Nissan and
Renault. By 2010 there were only three car makers remaining in Australia (Ford, Holden and
Toyota). Ford has indicated it will stop manufacturing cars in Australia in 2016, and Holden and
Toyota have also stated they will withdraw from making cars in Australia in 2017. The economic
impact for the hundreds of suppliers and thousands of employees as well as the general
community has been significant, and this will continue as this industry slowly disappears.

These changes are not limited to Australia. Even many Chinese manufacturing organisations
are struggling to stay profitable because of rising labour costs and an inability to pass higher
costs on to consumers.

Globalisation can be described as the integration of international economic activity and the
creation of global production systems to service global markets. Significant reductions in trade
barriers, lower transport costs, increasing competition across national borders, large multinational
corporations, unrestricted capital flows and faster information transfers have all had a significant
effect on organisations.

As organisations have been exposed to an increasingly tough business environment, they have

struggled to survive or have even failed. However, as a result of globalisation, many opportunities
have also arisen. Organisations that are flexible have been able to take advantage of these
opportunities and take sales and profits away from those who have been too slow or unable
to adapt.

The consequences of globalisation have forced managers to have a greater understanding of

the competitive environment and to achieve higher levels of customer and employee satisfaction.
This requires an increased focus on flexibility and responsiveness, coupled with innovation of
both products and internal business processes.

Globalisation creates difficult issues that must also be addressed. These include:
• taxation;
• protection of intellectual property;
• cross-border money laundering; and
• financing of illegal activities.

Such issues often arise because of different cultures, rules and levels of enforcement in
different countries and regions.

According to Lasserre (2003), there are four main drivers of globalisation:

1. global competition;
2. physical and capability factors;
3. social factors and national cultures; and
4. legal and political systems.

Global competition
Organisations have a variety of reasons for expanding globally. The local market for their
products may be saturated or in decline; they may be pursuing rapid growth; or alternatively they
may be focusing on obtaining lower-cost raw materials and labour. It may even be a defensive
strategy because low-cost competitors have entered their domestic market. It may also be a
strategy to avoid trade barriers such as quotas, which limit the level of goods one country is
allowed to export to or import from another. The internet has also enabled smaller organisations
to immediately compete globally, rather than spending years developing a local market before
expanding into new countries.
Study guide | 31

Example 1.2: Background to globalisation

The beginning of the current phase of globalisation was marked by the arrival in the 1960s of Japanese
manufacturers competing in markets that were previously dominated by US or European organisations.
As trade barriers opened, and because they had not at that stage invested in national subsidiaries,
Japanese (and later Korean) manufacturers engaged in rapid international expansion, exporting
products designed for global markets. They created global brands such as Sony and Panasonic.
This  raised quality standards (with quality production systems) and lowered prices simultaneously.
As US and European manufacturers quickly lost market share in their home markets and internationally,

they realised they had to become globally competitive if they were to survive.

The current wave of globalisation has seen these global leaders fall behind, as powerful new
organisations set the benchmark. For example, combined losses for Sony, NEC and Panasonic have
been in the tens of billions of dollars over the last few years, and newer competitors are taking over.

Physical and capability factors

A series of breakthroughs, particularly rapid advances in transport and communication,
have provided a technological platform for global activity. These advances, in turn, have
encouraged both economies of scale (because goods produced in a central location could
be cheaply distributed around the world) and outsourcing of component supplies to low-cost
countries (because the transport costs across long distances were now more affordable). At the
same time, as the cost of shipping goods by air or sea has fallen substantially, advances in
telecommunications are dramatically reducing the cost of international business communication.

Technology changes, such as the use of wireless communications for phone calls and internet
use throughout Africa and India, have meant that many areas previously cut off from the global
economy are now able to participate without the need for significant infrastructure expenditure.

Social factors and national cultures

There appears to be a convergence in global consumer tastes, as mass markets are created for
new global products. Youthful demographics are at the forefront of this change in consumption.
The diffusion of lifestyle by movies, television, advertising and music, especially over the internet,
has increased the awareness of consumer brands worldwide. This convergence of tastes is
compounded by increasing urbanisation and industrialisation across the world, with populations
adapting quickly to new products such as tablets and smartphones. Many nations are multicultural
in that they have significant migrant populations who have blended their cultures into their
adopted nation. This has increased similarities and convergence between countries.

Legal and political systems

Trade barriers such as tariffs are one of the main obstacles to successful globalisation.
These are usually enacted by countries wishing to protect their domestic economy from
foreign competition.

Example 1.3: Rice tariffs

To protect Japanese rice farmers from global competition, Japan has a tariff or duty on imported
rice of 777.7 per cent. Imported butter and sugar also have duties of over 300 per cent. These types
of policies often make local competitors very inefficient because they are protected from global
competitors. They also lead to much higher prices for consumers who end up subsidising the local
farmers. Negotiations with other countries are in place to reduce this type of protection and put in
place free-trade agreements. This will lead to significant change in how Japanese farmers compete
in the future (The Economist 2013).

International political forces have responded with a progressive series of negotiations intended
to reduce tariffs and create greater liberalisation of trade. The World Trade Organization
(WTO) has proved central to this effort. In addition, regional economic and trade organisations,
such as the European Union (EU), the North American Free Trade Agreement (NAFTA) and the
Asia‑Pacific Economic Cooperation (APEC), have become increasingly prominent in recent years.
Many countries are also harmonising their commercial law and accounting practices, increasing
uniformity and making international business more accessible and less risky.

As globalisation increases, the ability to obtain relevant information and evaluate decisions
across a wider level of issues becomes important. For example, issues such as transfer pricing,
insurance, political risk, intellectual property risk and foreign currency management all arise in
the global context and add complexity to management accounting roles.

➤➤Question 1.2
Identify three competitor-related issues that an organisation faces as a result of changing foreign
currency levels.

➤➤Question 1.3
Consider your organisation or one that you are familiar with and list how this organisation has
been affected by globalisation.

Two areas in which technology is having a significant effect are capital equipment and information
and communication technology (ICT). Capital equipment transforms organisations and industries
by allowing faster and cheaper production and by accelerating product life cycles. ICT is changing
how information is collected and analysed as well as interaction with clients and suppliers.

Capital equipment
Rapid development has meant that current technologies are significantly advanced compared to
technologies of earlier generations, and future technologies will only accelerate this advancement.
Physical systems and processes allow organisations to convert raw materials into outputs faster,
with more efficiency and less waste.

A recent example is additive manufacturing, which is also commonly known as 3D printing.

Figure 1.7 shows a metal glove that was ‘printed’. The machines produce one layer of material at
a time, and this may occur with plastics, metals and alloys. This enables both rapid prototyping
of new products and the replacement of production lines with machines that can produce goods
that are made to order.

Figure 1.7: A ‘printed’ metal glove

Source: De Angelis, S. F. 2011, ‘3D printing and the supply chain’, Enterra Insights, 25 March, accessed
July 2015,
and-the-supply-chain.html. ©
Study guide | 33

Additive manufacturing can create significant savings because specific moulds and tools are not
needed to produce a product; there is no ‘excess’ to be cut off and machined; and small batch
sizes can be generated, with no need to produce substantial inventory during each production run.

However, the cost associated with these technologies, and the cash requirements to purchase
and support them, are also increasing rapidly. Many industries now have significant barriers to
entry due to capital infrastructure costs. A further impact on costs that needs to be managed
effectively occurs because a large proportion of funding is often committed when the product

and production process are designed.

Products are developed faster but superseded quickly, as current forms become obsolete at
a rapid rate. Therefore, investments need to be recovered or recouped in a shorter period.
The solar power industry highlights some difficulties in pursuing successful and profitable
strategies. Significant capital investment is required to build solar power facilities, which often
require several years to generate a suitable return. However, during that time, technology
will improve so rapidly that new competitors can enter the market with lower cost structures,
meaning that the initial capital investment may never be realised.

Information and communication technologies

Information systems and technology have also increased the ability of organisations to
capture data, information and knowledge. The need for effective knowledge management
that both controls and uses this resource is essential. As with other technological investments,
significant cash outlays are often required, and effective implementation of information systems
is a challenging task that often ends in failure.

There are constant developments in the ICT area. Many of these affect the management
accounting role in terms of cost control, risk management, data capture and analysis,
and communications within the organisation and with stakeholders.

Some important trends that have arisen and need to be managed carefully are described below.

Cloud computing
Faster internet access has enabled the development of internet-based storage, software
applications and programs, including whole information technology platforms (including
operating systems), provided from the ‘cloud’. Key services include SaaS (software as a service),
IaaS (infrastructure as a service) and PaaS (platform as a service).

This creates many benefits including reduced costs in purchasing capital items such as storage,
reduced need for in-house technical knowledge and the ability to deploy employees globally
with instant access to organisational information. Risks of this approach include exposure to
data loss, theft, privacy issues and jurisdictional issues. These risks increase and are of particular
concern when the data or information is stored or hosted in a different country than where it is
being used. Privacy and jurisdictional issues overlap here because the privacy or other laws in
the hosting country may differ from those in the user country.

Employee-owned devices and open systems

As more employees want to bring their own devices (BYOD) to work, organisations have to
decide how open or closed their systems will be. Employee-owned smartphones, tablets and
laptops all provide significant opportunities for a more flexible work environment, but they
also bring compatibility and security issues. There is a much greater risk of loss of confidential
information or intellectual property in more open systems, which must be carefully managed.
Policies that encourage efficiency and protect assets as well as technical integration with
company-owned software are key areas that management accountants may be involved in.

Big data
The amount of data that is now being collected and stored is growing exponentially. The data
is often in unstructured or difficult-to-analyse formats, but the ability to analyse this information
provides significant insights into customer behaviour and business activity. Developing the ability
to analyse and interpret this data is an important requirement for improving performance. This is
discussed further in Module 3 in relation to performance measurement.

➤➤Question 1.4
Discuss the impact that technological developments have had on management accounting.

Long-term sustainability is a significant area of discussion and business activity that has been
gradually gaining momentum over the past 20 years. A short-term approach to decision-making
can often have undesirable long-term consequences. For example, the news media is often
filled with discussion about dwindling natural resources (e.g. oil), toxic outputs from commercial
processes, food security and access to water. Considering sustainability when conducting
strategic analysis and making decisions places the focus on taking action that is not only
beneficial now, but beneficial or at least not harmful in the future.

Sustainability can relate to economic, social or environmental activity. From a business

perspective, the focus is often on economic sustainability for the business itself (i.e. profitable
growth). However, from the perspective of society, a much broader focus is required that includes
both economic growth alongside social development and maintaining the environment.

Example 1.4: The island of Nauru

The island of Nauru (which is located to the north-east of Australia) provides a good example of the
lack of focus on longer-term environmental sustainability that has led to severe economic and social
consequences. Phosphate was discovered in 1900 on Nauru. Within seven years the first shipments of
phosphate began, and over the next 100 years extensive mining of the reserves occurred. For a short
period in the late 1960s, Nauru had the highest per-capita net income in the world. However, by 2006
the reserves were almost exhausted.

Despite a trust being set up to manage funds earned during the mining period, mismanagement meant
that once the phosphate reserves were exhausted there was little left to provide for the population.
The island now has significant environmental damage, unemployment is estimated to be 90 per cent
and there are many health issues (e.g. nearly three-quarters of Nauruans are obese with 10 per cent
having type 2 diabetes due to dietary changes that came with increasing wealth). These economic,
environmental and social issues that have arisen are all closely intertwined and demonstrate that a lack
of sustainable action can have devastating consequences (Asian Development Bank 2007; LoFaso 2014).

From an economic sustainability perspective, a useful example is the banking crisis that arose
during the 2000s as a result of unsustainable lending practices. Easy access to credit resulted in
loans to many people and businesses that were not in a position to service or repay their loans
over the long term. The consequence of so many people and countries living beyond their
means was a contributing factor to the GFC.

Examples of unsustainable social activities include sweatshops in the textiles industry, which use
extremely poorly paid labour in dangerous working conditions to produce low-cost clothes and
shoes. Similar examples exist in the electronics assembly industry, where employee deaths have
led to greater awareness and monitoring of working conditions. At a broader level, demographic
changes, such as increased population growth and migration from rural to urban areas, are also
having a significant impact on sustainable living.
Study guide | 35

Industries that have seen, or may see, significant decline due to unsustainable environmental
practices include fisheries, where fish stocks have been overfished and are not reproducing at an
adequate rate, and agricultural production, where soil nutrients have been completely eroded.
Organisations within those industries therefore need to adapt or change to assure their longer-
term, sustainable future. The most obvious example of this adaptation is in the energy industry,
where clean energy and sustainable technologies, such as wind and solar power, are replacing
fossil fuels and non-renewable resources, such as coal and oil.

Corporate social responsibility—a stakeholder focus
The focus on sustainability is causing several changes in the business environment, which in turn
affects strategic management accounting. First, there is a broader consideration of qualitative
and non-financial factors when making decisions about long-term projects. Second, there is a
much stronger focus on reporting a broader range of information and being held accountable for
more than just economic results.

Organisations are no longer just accountable to their owners. There is a growing body of opinion
that argues for greater accountability of organisations to a broader body of stakeholders.

This growing focus on a wider range of stakeholders has also led to significant change within
organisations, especially with regard to how they report and what information is reported.
Important non-financial information is now presented, and in many cases, environmental data is
legally required to be measured and reported. Accountability for financial performance has been
expanded to consider both the social impact and environmental impact based on ever-increasing
amounts of regulation.

Management accountants will be involved in preparing various types of reporting:

• Environmental reporting—involves capturing and preparing information to inform
stakeholders about an organisation’s impact on the environment. This information may
then be used for either management reporting or external reporting purposes.
• Social reporting—is the process of acknowledging an organisation’s social impact and
incorporates both the positive and negative aspects of its performance. Social reporting
also encompasses the effect on employees (i.e. conditions of work), the external impact on
the community and disclosing social performance information for both internal and external
• Sustainability reporting—combines environmental and social information with economic
performance. ‘Sustainability reporting can help organizations to measure, understand and
communicate their economic, environmental, social and governance performance, and then
set goals, and manage change more effectively’ (GRI 2015).

This broadening focus on stakeholders is not just limited to business. Governments, the public
sector and not-for-profit organisations are being held to greater levels of accountability as the
community becomes more informed and demands more information. For instance, government
departments and agencies are subjected to performance auditing with a strong focus on outputs
and outcomes, rather than just an account of the income received and expenses incurred.

Environmental management accounting

There is an increasing level of scrutiny being placed on organisations in terms of the resources
they are consuming and disposing. There is also a broader group of organisational stakeholders
that organisations must communicate with. Therefore, it is critical that strategic management
accounting expands and adapts to properly capture, analyse and report on environmental
information. ‘Environmental management accounting’ (EMA) is a term used to describe this
approach; it involves the development of environmental management accounting systems
(EMASs) to capture, report and help improve performance in these areas.

The concept of EMA has been in existence for many years, and has been defined as:
The management of environmental and economic performance through the development and
implementation of appropriate environment-related accounting systems and practices. While this
may include reporting and auditing in some companies, environmental management accounting
typically involves life cycle costing, full cost accounting, benefits assessment, and strategic planning
for environmental management (IFAC 2005a, p. 19).

The Expert Working Group of the United Nations Division for Sustainable Development (UNDSD)

emphasised both the physical and monetary aspects of environmental management accounting
in its definition of EMA:
… the identification, collection, estimation, analysis and use of physical flow information
(i.e., materials, water, and energy flows), environmental cost information, and other monetary
information for both conventional and environmental decision-making within an organization
(UNDSD 2002, p.11).

EMASs have developed over the past decade. Standard accounting information systems typically
capture financial transactions. EMASs do more much more than this by also recording the
physical flows of resources, including volumes and weights of inputs, outputs, waste, recycling
and emissions. Having access to this information often leads to increased incentives to change
and improve as people become more aware of the unnecessary cost and waste associated
with poorly managed resources. As more organisations adopt external sustainability reporting
approaches such as the Global Reporting Initiative (GRI) guidelines, this functionality will become
expected and normal.

Ethics and its relationship with strategic management accounting should be considered in several
ways. First, it is important to incorporate ethical implications in organisational decision-making.
As management accountants provide significant input into these decisions, it is important to
be aware of such non-financial issues and ensure they are properly considered in the decision-
making process. Sometimes choosing the most profitable or cost-effective approach may have
significant ethical implications. For example, consider the decision to terminate the employment
of a workforce in one country and replace it with a new workforce in another, cheaper location.
The cheaper location may have limited safeguards for employees for occupational health and
safety (OHS) and minimum wages that reflect local standards.

The management accountant should ensure that these ethical issues are included in the
organisation’s decision-making process.

Example 1.5: O
 utsourcing in the textiles and garment-
making industry
In Bangladesh there have been many terrible incidents including fires and building collapses because
of poor safety standards. In 2013 a building called the Rana Plaza in the capital city of Dhaka collapsed,
and over 1100 workers died. Over 2500 workers were rescued from the building alive, but some suffered
dreadful injuries and now have permanent disabilities. As a result, there have been changes in how
the industry operates, although there is still a lot of improvement required.

CPA Australia members are expected to act ethically at an individual level when performing their
roles. Members are expected to comply with the Code of Ethics for Professional Accountants,
published by the Accounting Professional and Ethical Standards Board (APESB), which has
an overarching requirement to act in the public interest. The fundamental principles that a
member is required to abide by are integrity, objectivity, professional competence and due care,
confidentiality and professional behaviour. In the above example, the accountant may not be
considered to have acted in the public interest or in accordance with the fundamental principles
of ethics if they were to ignore serious OHS issues.
Study guide | 37

A detailed examination of different stakeholders, corporate social responsibility and ethics is

provided in the ‘Ethics and Governance’ subject of the CPA Program.

The term ‘organisational structure’ describes how an organisation is organised. This may involve
having different departments that work on specific functions (e.g. sales, marketing, accounting,
customer service) or on particular product lines (e.g. mortgages, credit cards, personal loans).
Some organisations have many managers, senior managers and executives. There may be several
levels in the hierarchy from the lowest level employees up to the CEO. In other organisations,

there may be only one level of management that directly interacts with employees. This is known
as a flat hierarchy.

An organisational structure includes all the people, tasks and responsibilities given to different
areas and the authority delegated to different positions within an organisation. A traditional
functional structure separates the organisation into distinct groups based on the functions they
perform. Each of these functions is a centre of responsibility for individual managers, who may
be held accountable for performance in their specific area. For example, the general manager of
sales is usually in charge of the sales department, and the chief financial officer (CFO) is in control
of the accounting department.

Organisations that are structured in a functional way usually create accounting systems that
match this. This type of accounting system is called a responsibility accounting system (RAS).
The RAS collects revenues and costs and also measures the performance of these responsibility
centres. This enables the organisation to hold managers of these centres accountable for their
performance. The following examples describe what managers of the various responsibility
centres are held accountable for:
• Cost centres—the ability to control and reduce costs are the primary responsibilities.
• Revenue centres—performance measurement is focused on increasing revenues.
• Profit centres—successful performance requires the ability to control costs and increase
revenues simultaneously.
• Investment centres—controlling costs, increasing revenues and investing in assets
appropriately and efficiently are the main responsibilities. These are the most autonomous
of the responsibility centres, as they have more authority to make a wide range of decisions.

Flatter hierarchies
As a response to external changes, and to generate improvements in efficiency and effectiveness,
the structure of many organisations has undergone significant change. Hierarchies have become
flatter, with fewer levels of management and reduced bureaucracy between senior management
and the lowest level of employees. A key influence on this change in hierarchy has been an
attempt to eliminate costs by reducing the number of middle managers and replacing them
with information technology. Another influence has been the attempt to create organisations
that are more flexible as information and decisions move rapidly between the layers of the
organisation. Less middle management has resulted in the transfer or delegation of authority to
lower levels of the organisation (often described as employee empowerment) and a greater need
to attract and develop highly skilled staff.

As part of the move towards flatter structures, significant changes have occurred to this traditional
organisational structure, including:
• offshoring and outsourcing;
• virtual offices and global teams; and
• joint ventures and alliances.

Offshoring and outsourcing

Offshoring is where an organisation moves some of its activities to subsidiaries in overseas
locations. The organisation is still performing the work internally, but in a new (and likely
cheaper) location.

Outsourcing, on the other hand, is when an organisation pays another organisation to perform
work that was previously done internally. Work may be outsourced locally or to companies based
overseas. This has altered the traditional hierarchical structure of organisations.

Traditionally, organisations have focused on shifting low-skilled work from high-labour cost areas
to low-cost locations. Over time, organisations have also been able to shift large parts of their
highly paid, highly skilled work (e.g. computer programming) to low-cost economies (e.g. in
India) where technical skills are available.

Viewing organisations as a chain of activities and processes that flow across departments has also
led to structural change. Instead of thinking of an organisation in terms of its final product, it is
viewed in terms of the activities that add value and those that do not. Many organisations have
found they are very capable in one activity, but poor or mediocre in other areas. This has led to
an increasing trend towards outsourcing non-core activities, which allows an organisation to focus
its attention on the areas where it generates value most effectively.

Examples of outsourced activities include warehousing and logistics, data processing, payroll,
and information systems installation and maintenance. A further expansion of this concept is a
franchising relationship, where the whole business model is outsourced. Franchising has become
a popular way for the original creators of businesses to accelerate their growth and for other
entrepreneurs to develop a business faster through the use of an existing brand name and
business process (IBM 2004; Walker 2004a).

Management accountants have a variety of roles to perform as a result of this change. These
include evaluating choices of whether to make or buy an item and where production should
occur. Once these decisions are made, it is also important to develop performance measurement
systems and control mechanisms to protect assets and ensure accountability.

Offshoring and outsourcing are also discussed in the ‘Contemporary Business Issues’ subject of the
CPA Program.

Virtual offices and global teams

Teams of people who work in the same business or department or on the same projects can
be located around the globe. Many team members may never meet in person—only via phone
or videoconferencing technology. The benefits of this include using the best qualified people
for the job regardless of location, work being carried out 24 hours a day (due to time zone
differences) and using lower-cost labour locations. Some negative outcomes include language
barriers, cultural differences and difficulties in supervision. Virtual offices provide similar benefits,
where the employees of an organisation from the same region or location may not be fixed to a
specific office location.

Management accountants have a variety of tasks to perform in these environments, including

project planning, budgeting, performance measurement and reporting across time zones and
cultures. Virtual projects and global project teams are discussed further in Module 5.
Study guide | 39

Joint ventures and alliances

Strategic alliances and joint ventures have become a popular means for organisations to become
actively involved in new markets, products or technologies by collaborating with partners. They can
help implement faster, less-costly and less-risky market penetration strategies, with alliance partners
and parties to the joint venture providing access to, and knowledge of, the new market.

Acquiring an organisation that is already in a market is another alternative. An acquisition

strategy can bring more immediate results, possibly with less expense and risk than starting a

new subsidiary from scratch in a new market. Of course, blending the culture and operational
practices of the purchased organisation into the parent organisation may take considerable
time and effort.

Striving to succeed in unknown or fast-moving markets usually requires frequent collaboration—

hence, the importance of building strategic alliances. Through collaboration, organisations
seek to achieve ‘leverage’ of their core resources. This means they try to add value to their
basic resources by coupling or combining them with other companies’ resources to make them
more valuable than they would otherwise be. Management accountants should constantly be
on the look-out for these opportunities and be involved in costings, investment decisions and
performance reporting.

Example 1.6: Qantas and Emirates—strategic alliance

An alliance between Qantas Airways and Emirates shows the benefit of a strategic alliance. Examples
of sharing or leveraging core resources include flight coordination, with Emirates flying to London
from several Australian cities instead of Qantas, and a joint marketing budget. Additional benefits to
customers include easier access to a greater number of destinations and access to more flight times
(Freed 2014, Sidhu 2010).

➤➤Question 1.5
List three advantages and three disadvantages of outsourcing business operations.

Management reporting
In response to the significant changes that are happening with internal structures and externally,
there has been significant development in how management reporting occurs. In the past,
organisations may have produced a monthly management report 10 to 15 days after month-
end. Now, many organisations are able to perform month-end processes in only a few days
and sometimes within a few hours. The management reporting role has also expanded from
just producing the numbers, to analysing and interpreting the numbers that are generated
from the information systems.

Beyond this, the opportunity to have ongoing access to real-time data means that it is possible to
report on critical performance indicators in real-time. Weekly summaries and constant monitoring
have replaced monthly meetings, leading to rapid identification of issues and opportunities,
as well as faster response times.

Management reports need to convey much more than just financial performance. They should
also include many of the items below, which are discussed in detail throughout Modules 2 to 5.

Leading indicators that are causing or driving results

• External economic factors such as interest rates, GDP and foreign exchange rates
• Internal factors such as customer satisfaction
• Commodity price changes

Competitor activity
• Estimates of competitor cost structures and pricing
• Analysis of competitor strategies and potential responses

Industry analysis
• Growth and profitability including life cycle and business cycle analysis
• Impact of current or potential regulations or political changes
Non-financial performance
• Physical volumes and flows, including throughput, emissions and waste
• Employee performance, satisfaction and engagement
• Efficiency and quality results

• Core criteria including cost, quality and time
• Business cases, approvals and post-implementation reviews

Designing and implementing effective management accounting systems that capture and report
this data in a quick and efficient manner is an important role for management accountants.

➤➤Question 1.6
Apart from the factors described above, can you identify other factors that have affected
organisations and driven change?

The role of management accountants

Accountants have had to adapt to changing circumstances. The role of management accounting
has expanded to include a focus on helping managers solve problems and improve their
competitive position. For example, management accountants now conduct product life cycle
costing and customer profitability analysis, and prepare balanced scorecards. This is coupled
with technological advances that enable electronic data capture and automatic system updates,
which provide management accountants with the opportunity to focus on non-routine and
strategic decisions.

The term ‘strategic management accounting’ captures this new and broader role. The focus
is now on assisting the formation, selection and operational implementation of strategies.
This has led to operational management being viewed as strategic implementation, rather than
something that was separate or divorced from the strategic process. A key part of the strategic
management accounting concept is its focus on the organisation’s external environment.
By collecting information on competitors, customers and suppliers, and gaining an appreciation
for the broader economic environment (including political, social and environmental factors),
an organisation is able to respond more quickly to change.

For these reasons, it is important to revisit the definition of strategic management accounting:
Creating sustainable value by:
• supporting the formation, selection, implementation and evaluation of organisational
strategy; and
• providing information that captures financial and non-financial perspectives for both the
internal and external environments to enable effective resource allocation.
Study guide | 41

The emphasis on the external environment can be seen in many ways. For example, internal
information (e.g. product costings) is more useful when it is compared against industry and
competitor information. Likewise, evaluating the operating efficiency and profitability of an
organisation can no longer be limited to internal results, but must be compared to external
benchmarks. Therefore, management accountants must focus on obtaining and using this
external information, which is not always easily available. This approach brings the strategic
management accounting function in much closer alignment to both the marketing function
(with its focus on customers) and the strategic planning function of the organisation.

This places greater pressure on people working in these roles to increase their level of skills.

You should review Table 1.6 and consider the expanded level of work and responsibility that is
expected from management accountants.

A variety of techniques have been linked together under the banner of strategic management
accounting. These include target costing, life cycle costing, competitor cost analysis,
activity based costing and management, and strategic performance measurement systems
(Langfield-Smith 2008).

Table 1.6: T
 raditional management accounting compared to strategic
management accounting

Traditional management accounting Strategic management accounting

Job costing and process costing Product costing and activity-based costing

Budgets Life cycle analysis (including social and environmental

costs and benefits)

Variance analysis Value chain analysis

Financial data Financial, operational and qualitative data

Competitor cost structures analysis
Industry and broader economy analysis

Source: CPA Australia 2015.

Analyst, adviser, partner

Advertised job descriptions for management accountants use a wide range of job titles including
business analyst, commercial analyst, decision support, commercial manager, finance business
partner, business adviser and business support. Regardless of the description, these positions
generally include some or all of the traditional roles of costing, variance analysis and budgeting.
Reconciliations, maintaining fixed asset registers, inventory management, accounts receivable
(AR) and accounts payable (AP) management, and reporting on key performance indicators are
also common tasks. The ability to use enterprise resource planning (ERP) systems, databases and
spreadsheets is often essential.

Most roles are split into several areas including technical tasks, working with internal stakeholders
such as sales and marketing teams, and project or team management. This will include managerial
work such as supervision, running meetings and ensuring timelines are met.

The move to providing strategic support is combined with the traditional cost management
services that management accountants have always provided. Management accountants are
often placed in different areas of the organisation or within project teams, to provide other
employees with greater access to their capabilities. This also helps management accountants
develop a much greater understanding of the organisation’s products, services, customers and
suppliers, as well as the issues faced by different parts of the organisation.

Risk management is another important part of enhancing overall performance. In addition to

financial risk management, operational risk throughout the organisation needs to be assessed
and managed effectively. The effective use of controls to manage risk is a valuable role that is
often performed by management accountants (Cooper 2002).

Helping design and manage information systems and develop effective reporting methods is
often incorporated into the management accounting role. This will typically involve showing
others how to access information themselves rather than being an information gatekeeper.

Example 1.7: Business partner or objective overseer?

The business partner
This approach suggests that accountants should now act as engaged business partners. Rather than
being seen as number-crunchers or as impartial spectators in the game of business, they are getting
involved throughout the organisation to help improve results and pursue value. No longer just
scorekeepers of past performance, accountants are now information facilitators who help and guide
management actions, instead of just evaluating and controlling them.

Accountants bring unique skills to the business adviser role. They are traditional information providers,
understand financial information and are disciplined in the use of control mechanisms. This brings a
seriousness and analytical approach that can help control risk during the pursuit of new opportunities.
Accountants are also perceived to bring an independent, objective and credible approach.

To maintain this advisory position, accountants must provide a valuable service in areas such as
strategic business planning, customer profitability management, revenue generation strategies,
cost management, information management, competitive intelligence, forecasting, decision analysis,
productivity improvements and cash flow maximisation. When possible, accountants should move
away from their own department and join project teams and other business units to work closely on
specific activities and issues.

An opposing viewpoint—the overseer

There are several risks that arise when accountants start acting in a performance-focused advisory role.
The first risk is the loss of independence when an accountant becomes closely engaged in guiding
and setting strategy and making decisions.

Another risk is the possible tension that arises in the ability to switch between encouraging and
pursuing new opportunities, and also ensuring that effective controls and oversight are put in place.
Having the same person attempt to perform both these roles may lead to difficulty. Providing oversight
on top of deep involvement may involve conflicts of interest or time pressures that make it difficult to
perform either role effectively.

It may therefore be worth considering whether specific and different roles are developed within an
organisation for different accountants—some with a focus on compliance and control, and others who
are more engaged in performance improvement and strategy.

Increased pressure and perceived or actual loss of objectivity are some of the biggest issues facing
accountants as they become more heavily involved in the decision-making process (CIMA 2010).
Study guide | 43

Do you agree with the arguments presented for the business partner or the overseer in relation
to the role of accountants within an organisation?

At more senior levels within the accounting function, accountants must do more than just be
familiar with the numbers. Financial skills need to be coupled with:
• detailed knowledge of the specific business and industry;
• the ability to manage team members and the accounting function; and
• the ability to negotiate and communicate with other executives and external stakeholders.

Contemporary skills and techniques
Accountants are often in high demand, but many senior accounting roles are often left unfilled
for a considerable amount of time. This is sometimes because potential employees are missing
‘soft skills’ (including negotiation, presentation and communication skills). The ability to analyse
information, present arguments and influence people, speak and give presentations to the
board, senior managers or employees is very important. Written communication skills, such as
writing concise and understandable reports, and sending appropriate emails and letters,
are essential. For these reasons, traditional skills must be supplemented with better personal
and behavioural skills.

A matrix of skills has been prepared by the International Accounting Education Standards Board
(IAESB). It details what is required of today’s professional accountant in business. The main
categories include:
• intellectual skills;
• technical skills;
• personal and interpersonal skills;
• communication skills; and
• organisational or business management skills (IAESB 2004).

A report by IFAC (2011) looked at how management accountants drive sustainable organisational
success. It identified four specific ways in which management accountants support an organisation:
1. Creators of value—developing the plans and strategies that set the direction of the
2. Enablers of value—by supporting management decision-making and implementation
3. Preservers of value—protecting value through effective risk management, controls and
4. Reporters of value—clear and detailed reporting.

A summary of some of the specific types of skill required within each category is presented
in Figure 1.8.

Figure 1.8: Management accountant skills

Research and organise information Self-management and initiative

Critical analysis and logical reasoning Influence and assess priorities
Solve unstructured problems Meet deadlines and adapt to change
Monitor internal financial performance Work in teams and interact with a
Designing performance management diverse range of people
tools Negotiate and listen effectively

Intellectual skills Personal skills

Management accountant

Technical skills Business management skills Communication skills

Numeracy (mathematical Organise and delegate Deliver and defend opinions

and statistical) tasks Use formal and informal
IT and software ability Lead and motivate people approaches
(spreadsheets and Project evaluation Listen, read and speak
databases) Information for planning effectively
Compliance requirements and decision making Written communication
Cost analysis and control Cultural sensitivity

Source: Adapted from IAESB 2004.

Strategic management accounting requires an extension of the traditional skills to incorporate

many of the following tools and techniques, which will be examined in later modules of this subject:
• competitor analysis, customer cost and profitability analysis, supplier analysis and external
benchmarking (including sustainability perspectives);
• industry- and organisation-level value analysis;
• strategic costing, life cycle costing and target costing for strategy formulation;
• activity-based costing and management for implementing strategic plans;
• cost driver analysis, value analysis, benchmarking of operational processes and various forms
of budget variance analysis for managing and controlling the implementation process;
• applying strategic management accounting techniques to the management, selection,
planning and implementation of projects; and
• strategic performance measurement systems (such as the balanced scorecard) for managing
and controlling the implementation process (and for supporting strategy formulation).
Study guide | 45

Some of the key challenges facing management accountants include:
• using technology effectively while guiding others to effectively use management
accounting systems;
• managing resources; and
• promoting innovation.

All this is occurring at a time when globalisation and technological advances are changing the

structure of organisations, with many roles now being outsourced. With an increasing focus on
environmental and social outcomes, accountants are facing challenges from other information
providers who are skilled in capturing and reporting physical information, including engineers,
who will be competing to provide this type of service to organisations.

There are technology-linked challenges at both the day-to-day operational level as well as
at the strategic level. These include keeping information secure and maintaining customer
privacy (Gelinas & Sutton 2002). Establishing new and secure sales and distribution channels
to customers over the internet are opportunities that must be managed carefully.

Maintaining records and audit trails for data verification in a computerised environment is also
a significant issue. Effective implementation of major information system projects presents both
a challenge and an opportunity. Technology has allowed the automation of traditional number-
crunching activities and provides the tools to improve the quality of information to management.
This, in turn, has increased management’s expectations of management accountants.

Viewed from a broader perspective, technology is transforming how people compete within an
industry, which is forcing rapid change and innovation.

Example 1.8: The end of the video store

For over 25 years, the local video store rented out movies and was part of the landscape in many
towns and cities. However, the video rental business has decline d with revenues falling by over
15  per  cent every year over the five years from 2009 to 2014. This situation will likely deteriorate
further, with expected declines of over 20 per cent per year until 2019 (IBISWorld 2014). The traditional
‘movie rental’ product has been replaced by pirated (illegal) downloads from the internet, digital video
on demand, low-priced retail sales instead of rentals, and online ordering systems that mail DVDs to
the customer’s home.

A wide range of skills are required of management accountants working in this industry, in both the
‘old’ organisations as well as the ‘new’ competitors. Surviving a decline in the industry life cycle involves
both specific operational action and strategic plans. Trying to streamline operations, cut costs and
move into new distribution channels such as digital downloads is critical for the ‘old’ organisations if
they are to successfully transition to the new industry structure.

Things are also difficult for the new competitors. Capturing market share, setting prices that lead to
profitability in a fiercely competitive market, managing technology and gaining customer confidence
are essential. Therefore, management accountants need a strong mix of general business skills,
as well as research, analysis, scenario-modelling and numerical skills to effectively advise and guide
companies through this period.

Managing resources
Effective use and control of assets is required for superior results. Mastering areas such as cash
flow management and supply chain management is essential. Using forecasting and scheduling
tools, achieving reductions in inventory levels and maintaining effective links with suppliers
are necessary. In addition to the tangible assets base, it is important to improve in the areas of
recognising, developing and managing intangible assets, including knowledge (Carlin 2004).

It is more difficult to deal with organisational knowledge, customer and employee loyalty,

and brand management than to focus on traditional cash flow and inventory issues.
However, with such intangibles being a significant contributor to the value of organisations,
the management of intangibles is an essential task for protecting and improving business value
(James 2004).

One factor that leads to strong performance is innovation. It drives competitiveness by creating
efficiencies and new and better products. Innovation is both an outcome (i.e. a new product or
service) and a process (a combination of decisions, structures, resources and skills that produce
outputs and outcomes). In a more competitive environment, constant innovation is required to
achieve objectives. This can often be incremental innovation (small, minor improvements), but it
may also involve radical changes (Dodgson 2004). Consistently generating new and improved
products, services and processes (e.g. Apple Inc.) is essential to creating customer value.
Investment in research and development requires significant cash outlays, but is necessary to
maintain superior performance.

Example 1.9: Innovation helps improve both financial and

environmental performance
Ferguson Plarre Bakehouses, located in Australia, demonstrates the benefits of innovation that cover
the key themes of process redesign, performance measurement, environmental waste reduction and
cost improvement.

With over 200 employees, the organisation has a turnover of up to $40 million per annum. It has
successfully reduced its carbon output by reusing the heat generated from the baking process for cake
and pastry production. The estimated saving is approximately 5000 tonnes of emission per annum
and over 75 per cent reduction in gas per square metre as a result of turning a waste by-product into
a useful input.

It has also implemented a real-time monitoring system for energy consumption, and rainwater is
used for flushing toilets. Over 95 per cent of waste is recycled (including plastic, tin, wood and food).

With an estimated $300 000 investment on green initiatives, the financial cost has already been paid
back just from annual electricity savings of $290 000 (McKeith 2009; Ferguson Plarre 2014).

Successful innovation requires a clear understanding of customers. Innovation must lead to

customer value for it to be of any use. This may occur by creating similar goods and services
more efficiently than before, which leads to the ability to provide lower prices for customers,
or by offering enhanced services or products that provide a better customer experience.
Those who can guide or anticipate the needs of their customers will be able to cater for those
needs more effectively. Management accountants are required to integrate market research
information into their systems and analysis. They are also expected to support the development
of strong relationships with customers and suppliers to develop ideas and solve problems
(Walker 2004b).
Study guide | 47

Part B: Understanding and supporting

Management accountants must understand what managers do to be effective in supporting
managers with useful information. Part B examines the key roles of management and describes
how strategic management accounting supports these roles.

What managers do—creating and
managing value
The role of management is often described as planning and controlling. Strategies and plans
are developed and then monitored closely when implemented to ensure they stay on track.
While this is accurate, the role of management encompasses more than this. The overarching role
of management is to guide the organisation in attempts to create, manage and protect value.

Leading organisations
Managing is not an exact science of planning and controlling, as it involves coordinating physical
resources and the actions of people. Treating people as resources without consideration of their
needs and desires is likely to end in dysfunctional management. There is a need to be able to
lead people effectively—to provide them with a sense of purpose and direction, clear goals and
develop an appropriate culture in which to perform their work. The ability to lead groups, teams,
departments or whole organisations will make achieving goals easier.

Leadership is becoming increasingly difficult because organisations are operating in a more

complex, global environment that has experienced significant economic problems and
environmental concerns. Implementing change can be disruptive and very challenging for
managers. In difficult times especially, the pressure to hit targets and win bonuses increases
the temptation to act unethically.

Value creation is just as applicable in the not-for-profit and public sectors. For instance,
national infrastructure, education, health and social welfare need to be managed just as
effectively as privately run organisations. In the not-for-profit and public sectors, instead of
maximising shareholder wealth, value is created for the citizens/residents of the nation (and/or
taxpayers). Leading these types of organisations with less quantifiable objectives may be even
more difficult than leading a profit-driven organisation.

Understanding the external environment

Strategic management accounting takes an external focus that considers competitors, customers,
suppliers, the industry and the economy when collecting and analysing data. This external focus
is crucial, as managers need to develop a strong understanding of the external environment in
which they are operating or competing.

Most assessments of an organisation are relative. For example, an acceptable level of profit is
usually relative and a combination of a specified return on assets or sales (internal focus), but it is
also determined by a comparison against competitors or industry benchmarks. Customer service,
levels of quality and cost leadership are important when conducting comparisons against
competitors. Therefore, it is important for those within an organisation to have a comprehensive
understanding of the key parts that interact within the industry they are in. In addition to
understanding the industry, managers also need to consider the state of the economy in their
analysis. This will have a significant effect on product demand, prices, wages and the predicted

future success or failure of the organisation.

The macro-economic business cycle

Organisations, products, services and even industries have a life cycle. They experience different
periods such as birth or introduction, growth, maturity and eventually decline. In addition to this
cycle, there are also broader macro-economic cycles that occur within economies. These are
often described as ‘boom and bust’ cycles that have great bursts of growth (often called bubbles
when the growth is too high), followed by periods of recession or economic crashes, where the
growth declines significantly.

An organisation that is poorly run may still be successful in times of positive economic growth.
But, even the best run organisations may fail when faced with a prolonged period of decline
or recession.

Strategic management accounting—

supporting managers
Management activities can be classified into the broad categories of:
• strategic management, which focuses on determining the direction and structure of the
organisation and developing plans and objectives for achieving this; and
• operational management, which can be considered as the implementation phase of
strategic management—turning the strategy into reality.

Strategic management accounting provides a supporting role to managers in both categories.

This section examines the activities that managers are involved in and the types of support
management accountants can provide to help managers perform these activities better.

Strategic management
The strategic process involves addressing key issues, including determining the vision, mission or
purpose of an organisation; setting specific objectives; and creating and implementing the
strategies to achieve these objectives. Important phases in the strategic management
process include:
• strategic analysis—both internal and external;
• strategy planning and choice;
• strategy implementation; and
• strategy evaluation (performance measurement, feedback and review).
Study guide | 49

This strategic process is continuous, and the phases are closely interwoven rather than clearly
separate events. Significant amounts of information are required to successfully complete each
of these stages. Table 1.7 outlines a variety of ways management accountants can support
managers. Many of these approaches are described in detail in later modules.

Table 1.7: S
 trategic management accounting and the strategic
management process

Strategic tasks Tools, techniques and accounting information that may be useful

Internal analysis Examine balanced scorecard results, product life cycle costing, market
share, product profitability, activity evaluation and costing. Create and
report on financial and non-financial (quality, time, innovation, customer
satisfaction) performance measures and customer profitability analysis.

External analysis Estimate competitor costs and capital investment projects. Conduct
industry life cycle growth and profitability analysis. Obtain supplier
and customer intelligence to identify their bargaining strengths and

Strategic planning and choice Evaluate and rank the feasibility and profitability of strategies, considering
both capital budgeting (discounted cash flow measures) and strategic

Strategic implementation Provide accurate and timely costings as well as financial and non-financial
performance results during the implementation process.

Strategic evaluation Provide accurate key performance indicators that measure the success
achieved by the strategy. Review the effectiveness of the strategic
management process in terms of accurate estimates and costings,
and the appropriate use of performance measures and incentives.

Source: CPA Australia 2015.

Operational management
The relationship between senior strategic managers and operational managers is usually
drawn as a pyramid. The senior management team is at the top and focuses on strategic tasks.
Underneath this are the operational managers who focus on the medium- to short-term tasks
of running an organisation. There should be a strong link between these levels via the strategic
implementation phase. However, strategy often fails at the implementation phase due to poor
integration between the strategic and operational levels. Formal strategies are often ignored or
postponed as day-to-day issues receive all the attention.

Managers need to produce short-term operational objectives and implementation plans to

achieve long-term strategies. Strategic management accounting supports operational planning
with tools including budgeting, costing systems and variance analysis. Constant feedback
is required for an organisation to achieve short-term plans. If there is a deviation from the
plan, the objective may need to be adjusted or controls put in place to correct the situation.
Management accountants provide support for this controlling function by giving feedback with
financial and non-financial information. Table 1.8 provides further examples of how strategic
management accounting supports general operational management tasks.

Table 1.8: G
 eneric operational management tasks and strategic management
accounting support

Operational tasks Activities and strategic management accounting information

(strategic implementation) that may be useful

Planning Budgets and forecasts, costing systems and historical data.

Evaluating Benchmarking—collect, analyse, classify, record and report on financial


and non-financial information.

Controlling Identifying causes of variance analysis, establishing performance

incentives and criteria, reconciliations and internal controls.

Communicating Budgets communicate organisational priorities by showing where

resources are allocated. They provide information to employees about
what they are expected to achieve.

Coordinating Collating budgets allows coordination between departments/functions

such as sales, productions and logistics.

Rewarding Individual, departmental, team or organisational performance is

measured and reported as a basis for incentives and rewards.

Decision-making Providing costings, alternative pricing strategies and potential

competitor responses with other information, as required, to support
routine and non-routine decisions.

Source: CPA Australia 2015.

➤➤Question 1.7
Will the role of strategic management accounting change if the roles and functions of management
identified so far in Part B—or the factors that have caused change in the business environment
outlined in Part A—change in any way?

The example below highlights how strategic management accounting information can support
operational management.

Example 1.10: S
 upporting operational management with
management accounting information
Alpha Pty Ltd (Alpha) sells educational toys for children aged 1–4. One of its products is an electronic
reading support toy that is expected to have good sales before the start of the school year at the
end of January. The budget for the next quarter (January–March) is set in mid-December; it includes
a sales revenue target of $165 000 for January. A bonus will be paid to sales staff in mid-April if both
revenue and profit targets are achieved for this product.

Plan Sales target

The planning phase is supported by the use of previous sales figures, consumer confidence in the
economy and required profit targets to achieve a minimum return above the cost of capital. The plan
is then communicated to staff about expected levels of performance.
Study guide | 51

On 5 February, the results for January are reported and actual sales for the toy are $130 000. Not only
are January’s figures short of the target, but there is also doubt about achieving the sales target for
the whole quarter. The cost of producing each unit has risen because of raw material price increases
due to unfavourable foreign exchange fluctuations. It appears that there will be no bonuses for the
sales staff for quite some time.

Actual result Sales target

Evaluation occurs continuously, and in this situation, it was supported by the use of actual versus budgeted
figures to identify current performance and establish whether bonus criteria were being achieved.

An analysis of the sales revenue variance uncovers two major issues. The first, an external issue,
was caused by Alpha’s main competitor, Zeta Pty Ltd (Zeta). During the Christmas period, Zeta heavily
discounted a similar toy to successfully attract market share away from Alpha. This had a flow-on effect
on January’s sales. The second issue was an internal problem caused by a delay in the product being
delivered to several large retailers who had sold out. Several days’ worth of sales was lost as a result.

Analysis of the causes of the variance indicates that coordination within the organisation needs to be
examined and decisions must be made about how to take control of the situation.

Alpha decides to reduce the selling price by 15 per cent and increase advertising to generate sales and
maintain market share. Sales estimates for February and March are also slightly reduced. A series of
meetings are arranged between sales, purchasing and logistics personnel to ensure that the company
has enough stock and that it is being distributed to retailers on time.

1 January 31 January 31 March

Sales target decreased

Planned result

Variance to be controlled

Actual result

The company is off target. Several approaches to control the situation are made: changing the target
(reduced sales target), changing the course to the target (reduced sales price) and attempting to
improve coordination within the company.

In the above example, the decisions made at each stage needed to be based on rigorous
financial and qualitative analysis. This required an understanding of different cost concepts,
as well as various tools and techniques to support the analysis. For example, the original
variances would have been identified by variance analysis, and the decision to reduce the price
by 15 per cent and increase advertising to increase market share could have been modelled
using cost-volume-profit analysis.

Appendix 1.1 examines cost classifications, cost-volume-profit analysis, product costing, budgeting
and working capital management. It provides a review of operational support techniques that are
regarded as assumed knowledge for the ‘Strategic Management Accounting’ subject. Use this as
an opportunity to review these techniques, including the ability to perform relevant calculations,
analyse scenarios and make recommendations.

All of the material in this appendix is examinable.

You should read Appendix 1.1 now.


Strategic management accounting and line managers

Organisations have become leaner (fewer employees) and have had their hierarchies flattened
(reduced levels of management). As a result, greater levels of authority and decision-making
power have been given or delegated to lower-level employees. This has been essential to
improve flexibility and responsiveness within organisations. Management accountants were
once the providers of all accounting information, but the tasks of collecting and communicating
key performance information are now often delegated to line managers and employees.

Instead of merely recording and providing the information, management accountants are
required to provide support and training to allow line managers and employees to undertake
these tasks for themselves. Advantages of this approach include transferring routine tasks to other
employees to allow time to be devoted to more complex, non-routine and strategic-level tasks.

Strategic management accounting and service industries

Many management accounting examples involve the manufacture of products. These products
are tangible, easy to visualise, and often produced systematically, so costs can be easily identified
and allocated. However, service industries also require the support of management accounting
tools and techniques. A detailed case study at the end of this subject demonstrates this by
considering the Australian domestic airline industry.

The same approaches and tools are used to analyse services, but the main characteristics of
services can make this analysis more difficult. Services differ from products in the following ways:
• A service is intangible, so it can be more difficult to define or measure systematically.
• Once a service is provided, it cannot be consumed or used again in the same way as a
product. This means there is no ability to store a service as inventory, which makes it more
difficult to manage supply and demand levels.
• A service is more of a unique offering than a product. So providing it in a systematic and
identical way is much more difficult.
• Unused capacity is lost forever. It cannot be used to create something that is stored for later
(i.e. inventory cannot be created).

An important issue in a service environment is the proper management of excess capacity—

because once excess capacity is wasted, it can never be recovered. For example, an airline
provides a service by flying passengers from one city to another. But, if half of the seats on the
flight are empty, that ‘excess capacity’ can never be recovered once the service is provided.
Similarly, managing customer call centres is an area in which employees must be available to
answer queries even if there are no customers using the service at a particular time. In these
situations, the idle resources can cause significant costs.

Other important issues include measuring and maintaining quality, which can be difficult
because providing a service can be more individual or unique than producing identical products.
Therefore, accurately costing the provision of services to different customers is challenging.
Study guide | 53

Strategic management accounting and the public sector

The main difference between the public and private sector is that many (but not all)
public sector organisations do not use profit as their primary measure. An example of this
different focus is shown in Question 1.8, in which important themes for local government
are well planned urban growth and fostering liveability (an enjoyable place to live). From a
strategic management accounting viewpoint, there is still the need to support both the
strategic and operational processes.

The key question to consider is: what decisions do public sector managers need to make and
how does strategic management accounting support these choices? For instance, in performance
assessment, strategic management accounting can help establish metrics for measuring:
• economy—the extent to which resources of a given quality were acquired at the lowest cost;
• efficiency—the maximisation of outputs for a given set of inputs; and
• effectiveness—the extent to which an organisation achieved its objectives.

➤➤Question 1.8
Read this extract from a local government planning document. What strategic management
accounting information may be used to support these themes and goals?

Strategic objectives for 2013–2017

Theme Objective

1. Urban growth Create a well-planned city that facilitates change while

respecting our heritage and neighbourhood character

2. Liveability Foster a connected and welcoming city by providing

well-designed places and quality services

3. Economic prosperity Support local business, attract investment and

employment opportunities and improve pathways for
education and training

4. Transport Plan and advocate for a functional, sustainable and safe,

bicycle and pedestrian friendly transport and traffic
management system

5. Environmental sustainability Educate and promote environmental sustainability

6. Organisational accountability Implement a transparent, engaging and accountable

governance structure

Source: Maribyrnong City Council 2013, Council Plan 2013–17, Maribyrnong, Victoria, Australia, p. 16,
accessed July 2015,

Part C: Management accounting

The role of management accounting systems

If management accountants are to support managers and, more specifically, provide strategic
support, accounting systems must be robust and capable. Supporting managers requires an
understanding of:
• what managers do and the decisions they make;
• what information they require; and
• how to capture, analyse and transform organisational data into the appropriate information.

Part C focuses on the second and third points—identifying the information that managers
need and then capturing the relevant data and turning it into useful information. Accounting
involves identifying, analysing, classifying and then recording data. This requires a systematic
process and is often a combination of manual and electronic systems. In many organisations,
the manual parts of the process often include the use of paper-based source documents,
including invoices, receipts, delivery dockets, purchase orders and statements. These documents
are physically moved between activities or functions, and data from these documents is then
generally recorded in electronic format. More recently, virtually all stages of a transaction may be
automated, including the generation and transmission of electronic invoices, receipts, payments
and statements.

A management accounting system (MAS) is defined as the organised process or system

that identifies, collects, processes and communicates financial (and relevant non-financial)
information. The MAS is a small part or subset of the overall management information system
(MIS) of an organisation. The MIS is an integrated system that combines all of the organisational
areas, including sales and marketing, production, accounting, human resources, logistics and
other parts of an organisation. It is important that the MAS is properly integrated into the overall
MIS so that data and information are easily accessible and useful (Gelinas & Sutton 2002).

An MAS should help managers create, manage and protect value by capturing data relating to
activities and assist in identifying whether those activities are adding value. This should include
costs, revenues, efficiency, quality, benchmarks and satisfaction. But, many MASs are based on
financial accounting reporting systems, so this is not always easy. Traditional classification of costs
may not enable easy tracking of, or focus on, value-adding activities.
Study guide | 55

Figure 1.9: The MAS and the MIS

Management information system (MIS)

Operations Research/
Sales/ and logistics development Human
marketing system system resources

system system

General ledger and reporting — AR/AP — Costing systems — Order entry/sales — Purchasing

Management accounting system (MAS)

Combines data from the accounting system, other systems in the MIS and
the external environment to provide information for value creation
throughout an organisation.
 Matching customer revenues and costs to determine profitability of
individual customers.
 Managing cash flows through the business cycle.
 Improving product mix and pricing based on accurate costs and
revenue projections.

Source: CPA Australia 2015.

A significant level of complexity arises when trying to capture all the relevant data from
organisational transactions and processes. The following example shows that even a simple
business activity, such as reordering stock to be sold in a retail store, has many small tasks and
data requirements that must all be carefully sequenced.

Example 1.11: Reordering stock for a retail store

Ordering the right amount of stock to minimise holding costs and cash outflows, while avoiding missed
sales, requires a considerable amount of information.

Automatic notifications from the information system should be able to advise the right time to order
and also the right amount of stock to order. For this to occur, the following information is required.

Data or information Source

Forecast and actual sales level of the stock item Sales forecasts
Sales results by stock item

Product code, supplier, cost, discounts, Previous purchase orders

number of units, date purchased, Supplier contract
delivery location

Lead time for delivery Comparison of delivery docket dates and

purchase order dates
Supplier contract

Minimum order quantity that supplier is willing Supplier contract, vendor information
to provide

Stock levels Delivery dockets, inventory records


Consider a situation where all the following information exists:

• The sales estimate for the next month is 200 units per week.
• Delivery lead time is usually two weeks from order placement.
• Current stock levels are at 600 units.

From this information, it can be established that the store has three weeks’ worth of stock and that it
takes two weeks to replenish stock. Once stock levels drop to 400 units (which will occur in one week’s
time), the store must place an order to avoid a stock out. The order size will depend on whether the store
prefers to order small quantities on a weekly basis, or make a large order to obtain a volume discount.

Not only must data be captured, but it must also be analysed and presented in a variety of ways
to determine how costs are being incurred and how activities are being performed.

Consider an electricity bill that arrives as a supplier invoice. In the first instance, the important
data will be the amount due and the date it must be paid by. But other pieces of data include
the electricity usage, where that usage was incurred within the business, how much of that
usage was wasted or unnecessary, and the level of emissions that arose as a result of the usage.
This data can then provide a foundation for improvement (i.e. energy efficiencies and cost
reductions) throughout the business.

Example 1.12: Understanding activities

Products and services incur costs through the activities they require (i.e. design, engineering,
manufacturing, marketing, sale, delivery, invoicing and customer service).

When management accounting goes beyond reporting on a particular department or product and
starts to focus on tasks and activities, it creates a whole new way of understanding the organisation.

This focus helps identify which activities are worthwhile and which are not adding any value. It shows
where resources are being consumed and helps evaluate efficiency in these areas. Waste is highlighted
and links between departments are analysed—which may also reveal inefficiencies caused by confused
communication or different departmental objectives or strategies.

By considering alternative ways of structuring work, many opportunities exist to produce the same
services in a better way, or make products more effectively (e.g. with fewer parts and with less toxic
raw materials).

This activity-based costing and activity-based management approach is linked to the value chain
concept. It is also holistic in that it encourages an overall view of the organisation and the needs of
customers. Individual tasks are not viewed as ends in themselves, but rather as part of the overall
chain to produce valuable outputs. The aim should be to develop higher levels of interaction between
employees as well as integration between different work areas. This shifts the focus from managing
cost to improving performance based on improved cost, quality and flexibility.

A significant difficulty in achieving this approach is that many MASs are not able to provide the relevant
information in a timely manner. Management accountants must work creatively to ensure the systems
that are in place can support this type of analysis.

Activity-based costing and management are discussed in detail in Module 4.

As strategic management accounting shifts from cost determination to the provision of information
that helps analyse activities and create value, management accountants are expected to operate
as managers of business value. This requires a greater understanding of the areas they will support,
including procurement and logistics, human resource management, financial management,
knowledge management and information technology (Sharma 1998). Specific areas that the MAS
will be required to support include those outlined in Table 1.9.
Study guide | 57

Table 1.9: Areas of MAS support

People management Measuring productivity and efficiency, revenues and profits per person,
costing of employee turnover and hiring; reward and bonus systems

Marketing and sales Profitability analysis, helping determine prices, returns on particular
marketing campaigns

Performance management Benchmarking, developing KPIs, and measuring and managing

shareholder and customer value creation.

Asset management Working capital management, capital expenditure decisions and

appraisal, product life cycle management and asset registers

Business controls Corporate governance and internal control frameworks

Environmental/social Balanced scorecard and triple bottom line accounting, costings to

management support evaluation and implementation of environmental strategies

Financial management Activity-based costings and activity management, and measuring and
managing risk

Intellectual capital Measuring and managing customer and employee satisfaction and
management levels of information technology (IT) literacy, and maintaining strict
controls on intellectual property such as patents and licences

Information management Ensuring data security and controls; implementing and generating
value from e-commerce and electronic data interchange (EDI),
and using IT to support ‘just in time’ inventory management

Quality management Performance measures and costings to implement and manage total
quality management (TQM)

Source: Adapted from Sharma, R. 1998, ‘Management accounting: Where to next?’,

Australian CPA, December, pp. 24–5.

Management accounting systems should clearly distinguish between two types of information:
1. strategic profitability (costing) information; and
2. administrative control information.

The first type of information relates to the strategic variables that create value for an organisation.
This requires identifying what each product or service contributes to profitability over the long
term. The strategic support tools are outlined in Module 4, which includes detailed descriptions
of what information is required for target costing, customer profitability analysis and activity-
based costing and analysis.

The second type of information relates to generating relevant information for controlling
operational activities and processes. This component must also provide a control feature
that can protect assets, document transactions and provide a reliable source of verification.
The following section examines the role of the MAS in ensuring internal controls are
implemented and effective.

Risk management
Management accounting systems are devised to help streamline operations, make activity more
efficient and minimise risk. The term ‘risk’ is used to describe the chance of potential losses or
problems arising from particular actions. Organisations face a large variety of risks—including
financial, administrative and operational risks.

Without structure and systems, it is very easy for mistakes to happen. Some obvious financial risks

that may arise include:

• paying the same invoice multiple times (or not paying the invoice at all); and
• fraud involving fake (ghost) employees on the payroll system or paying suppliers who have
submitted false invoices.

Example 1.13: Fraud can cost millions

In Australia, Brian Quinn, who was the chief executive of Coles Myer (now Coles), was sentenced to
four years in jail for defrauding the company of nearly $5 million.

Invoices for private expenses, including work on his own personal home, were channelled through
the company. The invoices were modified to look as if they were related to work done on company
properties, and they involved collusion by multiple people within and outside the organisation.

Source: Director of Public Prosecutions 2007, The Pursuit of Justice: 25 Years of the DPP in Victoria,
p. 27, accessed July 2015,

Because of the variety of risks and the significant amount of damage that may arise from poor
management of these risks, it is essential that management accounting systems form a core part
of the organisation’s risk management systems.

Risk management involves a planned and methodical approach to identifying, measuring,

managing and controlling risks to protect the organisation from significant problems. The
management accounting system can contribute to risk management in two important ways:
1. by providing controls and procedures for minimising financial risks; and
2. by offering a broader perspective—it is useful in collecting and reporting information
that may inform the identification and management of risks in other areas, including
environmental performance.

Risk management is required as a day-to-day operational activity, but it also holds a much
broader and strategic role. It is now expected that the overarching corporate governance
systems for the organisation include systems that address risk in a structured manner.
This includes the creation of suitable policies for the identification, disclosure and mitigation
of risks, as well as the design and implementation of a system of risk management and sound
internal controls (ASX CGC 2014).

Risks can relate to a variety of areas including:

• operations;
• environment;
• reputation;
• intellectual property;
• financial reporting; and
• quality.
Study guide | 59

Operational risk
Linking together all the tasks and activities that happen within organisations is essential for value
creation. However, at each stage in these processes, there is the risk that mistakes or errors may
occur, resulting in significant financial, environmental or social issues. Cost control is an important
part of the management accounting function, but when pressure to contain cost leads to risky
actions or behaviour, this can create more issues than are solved.

Environmental risk
Complex production processes within organisations and environmental issues throughout the
supply chain (e.g. suppliers who use toxic materials in their manufacturing processes) lead to
risks of increased emissions and long-term damage to a physical location.

Reputational risk
The reputation of an organisation and its brand are often important drivers of revenue growth
and successful value creation. Consumers trust established brand names and are willing to pay
a premium for them, so developing and protecting reputation is important.

Intellectual property risk

The most important asset for many organisations is intellectual property (IP), not physical assets.
There are many difficulties in managing IP assets; they are harder to control in terms of denying
their use to competitors and can be more easily stolen than physical assets. Enforcing IP rights
is normally the responsibility of the owner. There are also technical requirements that may need
to be followed in order for IP rights to exist, and failing to comply with procedures may lead to
these rights not being enforceable.

Financial reporting risk

The risk of not providing external users with accurate and clear information is significant and
the ramifications have never been greater. An example of this is the case of Centro in Australia,
where class actions brought against the company for misreporting its current liabilities led to a
settlement of AUD 200 million. There are chances for errors or mistakes to occur because of the
high volume of transactions being processed, the number of people involved in the recording
and reporting processes, and the complexity of many transactions.

Quality risk
Failing to design things appropriately, not following designated policies and procedures,
or failing to support customers with their issues are all problems that can harm an organisation.
There are many ways of managing quality, and comprehensive data collection and analysis
form the foundation of techniques such as total quality management and quality costing.

Management accounting systems, which are already used to capture and report internal
information, are well-suited to capturing information in many of these areas and providing
appropriate disclosure and identification of issues.

Risk management system

Effective systems need to be put in place to manage the risks within an organisation. A risk
management system should provide a coherent framework that specifies how risks within the
organisation are identified, measured, monitored and managed. Approaches to dealing with
risk include transfer, elimination and mitigation (reduction). This may involve using specific
controls and following a clear and well-defined process. Particular actions may include:
• taking out insurance;
• better training for employees;

• redesigning the way activities are performed, including new checks and reviews;
• building safer and more reliable infrastructure; and
• using protective equipment.

A risk classification matrix is a useful tool for determining when to initiate risk management and
mitigation. The matrix helps classify risks by both their probability of occurring (e.g. low, medium,
high or certain) and their severity if the event occurs (e.g. low, medium, high or catastrophic).
Tables 1.10 and 1.11 provide example classifications of likelihood or probability as well as
severity or the consequences. Note that it is common to use quantitative figures to describe the
severity or consequence of an event (e.g. the dollar impact or the number of injuries sustained).
Identifying and classifying risks in this way makes it clear which risks should receive the highest
priority and which may be deferred.

Table 1.10: Classifying the probability or likelihood of a risk event occurring

Probability Description

Rare Not expected to occur at any time

Unlikely Is not expected to occur at any time, but it could happen

Possible May occur at some time in the future

Likely Is expected to occur within the next three years

Almost certain Is virtually certain to occur within the next 12 months

Source: CPA Australia 2015.

Table 1.11: Classifying the severity or consequences of an event

Severity Description

Insignificant Very small impact that still requires a formal response

Minor Small impact

Moderate Noticeable impact on the organisation or employees

Major Significant impact on the organisation or its employees, but the organisation
is able to survive

Catastrophic Severe impact likely to mean the organisation will not continue to operate

Source: CPA Australia 2015.

Study guide | 61

These two classifications are combined into a particular risk rating (see Figure 1.10). For example,
if the probability of an event occurring is unlikely, but the severity will involve major consequences,
then this is classified as high risk. This event should be immediately reviewed and plans should be
devised to eliminate or mitigate the risk.

Figure 1.10: Risk classification matrix


Probability Insignificant Minor Moderate Major Catastrophic

Almost certain High High Extreme Extreme Extreme

Likely Moderate High High Extreme Extreme

Possible Low Moderate High Extreme Extreme

Unlikely Low Low Moderate High Extreme

Rare Low Low Moderate High High

Extreme or high risk — Review and eliminate/mitigate immediately

Moderate risk — Review and focus on risk reduction
Low risk — Periodic review
Source: CPA Australia 2015.

One specific area of risk management is the creation and implementation of internal accounting
controls to minimise or eliminate unwanted issues and problems.

Internal controls
Management accounting systems provide valuable internal controls to support risk management.
This involves the use of procedures and mechanisms to ensure that mistakes and fraud do not
occur. Process controls are required for most organisational activities, but the focus of the MAS
is chiefly on accounting controls. These accounting controls are necessary to minimise or prevent
fraud and theft of assets, unacceptable accounting methods, and mistakes during data entry.
Documented policies and procedures, combined with well-programmed computer systems,
are quick and effective ways of making these controls part of everyday activity that cannot be
avoided. Helping avoid the loss of valuable assets—both physical and intangible (IP, data)—
is another important way of protecting value (Gelinas & Sutton 2002).

It is essential for management accountants to be actively involved in preventing internal control

failure, and there are a variety of procedures that help to achieve this, including:
• separation of employee duties;
• independent verification of important employee activities;
• effective security measures to protect valuable assets;
• careful document design (capturing all relevant data), document handling and filing; and
• cash control measures, including reconciliations and limiting electronic access to accounts.

Internal controls are discussed in greater depth in the ‘Advanced Audit and Assurance’ and
‘Financial Risk Management’ subjects of the CPA Program.

➤➤Question 1.9
Describe how each of the procedures listed above is used to provide internal control.

➤➤Question 1.10
Describe how the internal controls listed above may be useful in the following situation.
Beta Pty Ltd is a computer hardware wholesaler. There are two office staff (Jan and Simon) and

three workers in the warehouse (Peter, Paul and Mary). Jan is in charge of customer accounts and
administration, and Simon takes care of purchasing. Jan receives customer orders, enters them
into the computer system and ensures the warehouse dispatches them with an invoice attached.
She collects and opens the mail, and processes all the customer payment cheques before taking
them to the bank and depositing them every second day.
Once stock in the warehouse reaches a minimum level, Simon calls up the relevant supplier and
places an order. The goods are received in the warehouse, and the delivery docket and invoice
are given to Jan who processes the invoice, writes the cheque and sends it to the supplier.

Strategy and risk

Consideration of risk must also be linked to strategic decisions, not just day-to-day (operational)
management activity. One of the greatest risks an organisation faces is that the strategy it selects
is not suitable. There may be many reasons why it is a poor choice. An organisation:
• may not have people with enough skill;
• may not have enough financial resources or managerial skill to successfully implement its plans;
• may not have access to technology required to stay current; and
• may be hampered by more nimble competitors or even government regulators.

Strategic risks often occur when the management team pays too little attention to the
external environment. Ignoring or failing to notice important trends, such as new technology,
economic decline or a change in the industry life cycle, can cause problems to escalate until they
are unmanageable. Companies that were once large and powerful often refuse to acknowledge
that the market has changed and that they will need to behave differently in the future to
continue successfully.

To help ensure these types of strategic risks are carefully monitored and managed, the risk
management system needs to be seen as part of the top-level decision-making processes of an
organisation. This approach is supported by ASX CGC’s ‘Corporate Governance Principles and
Recommendations’ (2014), which emphasises that boards of listed organisations in Australia are
responsible for ensuring a sound risk management framework is in place.

The strategic management accounting function becomes an important source of data for
ensuring strategic risks are properly considered. By carefully analysing broad economic
data, combined with industry trends and financial and strategic analysis of competitors,
management accountants are able to help make sure that strategic decisions are not made in
a vacuum that ignores reality. Having a detailed understanding of internal activities and processes
will also lead to more informed decision-making. Knowing the organisation’s areas of strength
and competence, and those where it is lacking resources and ability, should also help guide
decisions to avoid undertaking overly ambitious projects that are not feasible.
Study guide | 63

Problems with management accounting systems

A problem with many MASs is their failure to provide information that addresses or solves
problems. A secondary issue is that this information may not be available in a timely manner.
This has been an ongoing issue, despite the increasing power and ability of enterprise-resource-
planning (ERP) software. Many organisations complain that they cannot capture, access or
view data they need in a way that makes it easy to assess specific issues. Unreliable or delayed
information can inhibit growth because it makes it difficult to focus attention on the most

promising opportunities and greatest weaknesses.

A related issue with an MAS is that the structure it is designed to represent may not match the
organisational reality. If the MAS is designed on a departmental basis, it may be very difficult to
evaluate processes, products or services that flow through different departments from a value
chain perspective. As value is created when products or services move through an organisation,
it is imperative that the MAS tracks how products or services move through the organisation.
However, this task is hindered when costs are allocated to departments, and interlinkages and
transfers are ignored.

One possible solution is to deploy more powerful and integrated organisational software that
is now available. ERP software allows for the development of activity-based management
accounting systems, but the cost of these packages and implementation challenges are
two very important considerations.

ERP software and management

accounting systems
Well-known proprietary ERP software includes SAP, JD Edwards/Oracle and Dynamics.
There are also a considerable number of smaller software packages for small to medium-sized
organisations, as well as free or open-source software. Key components of any ERP system will
be strong integration between important business activities (e.g. sales or customer relationship
management, payroll, purchasing, logistics, production or workflow planning, projects and
financial management), as well as a modular design that allows users to select only those
components of the software that are relevant to their business. There should also be the ability to
customise the software to meet the needs of the organisation, including creating special reports.

Other useful features of these systems include the ability to automate workflows and decision-
making processes. For example, leave application forms for employees may be created within
the ERP system and automatically submitted to managers. Failure of a manager to approve
or decline a request in time will automatically route the electronic document to a designated
alternative, and once approved, the leave form will be routed to payroll to update the relevant
employee records. This eliminates manual handling and delays, and reduces errors in payroll.

The same approach can be used for other activities such as approving purchasing requisitions.
In operational areas, bills of materials (lists of raw materials and components for products) may
automatically be rolled into requests for quotes from suppliers or purchase orders, which should
automatically link to job and process costing sheets to keep track of individual product costs
within the organisation.

ERP systems can become very expensive and complex, especially once they have been
customised, and management of these systems often falls to the accounting team. Management
accountants must therefore have considerable skills in areas such as understanding systems,
databases, data integrity and software management.

Environmental management accounting systems

The ever-increasing focus on sustainability, the environment, and corporate social responsibility

(CSR) increases the requirements being placed on MASs. Over time, the focus of MASs has
transformed from producing simple financial costings, to also include non-financial information
such as quality and timeliness. However, this is no longer enough. It is essential for the MAS to
support management to act in an ethical, responsible and sustainable manner.

The development of EMA is a response to an increased focus on sustainability. This in turn

requires an EMAS that captures, collates and reports this information. A report by the UN (2001)
describes a successful EMAS as being able to effectively combine monetary information with
physical information to support analysis and decisions in areas including:
• assessing annual environmental costs and expenditures;
• product pricing;
• budgeting;
• evaluating investment opportunities, including for environmental projects;
• setting performance targets;
• developing cleaner production, reducing pollution and enhancing the supply chain
performance; and
• external disclosure and sustainability reporting.

However, there is evidence that many managers are largely unsure or unaware of how CSR and
environmental analysis should be addressed within their organisations. One reason behind
this lack of internal information is that the accounting systems are not structured to provide it.
It is therefore crucial that MASs be capable of supporting CSR through the appropriate capture
of both financial and non-financial information relating to items such as emissions, waste and
consumption of raw materials.

In addition to reporting resource usage, it is necessary to expand the role of the MAS to perform
value-added analysis. This requires a consideration of not only the financial implications of
products and services, but also their physical impact and sustainability.

Techniques for project evaluation and capital budgeting also need to capture the total cost of
ownership and overall impact of business activities, including the types of raw materials used,
the pollution generated and the sustainability of the approach used.

Example 1.14: Including environmental costs in capital decisions

Electricity distribution requires a large number of poles, which can be made of a variety of materials,
including timber, steel, concrete and fibreglass. Traditional capital decisions focused on the initial
purchase price of these poles. However, this failed to consider the environmental effects of the
different materials used. For example, growing timber uses significantly less energy than either steel
or concrete poles. However, weight is also an important consideration in terms of transportation and
installation, and timber poles are twice as heavy as steel (and concrete is twice as heavy as timber).
Making the analysis even more confusing is the impact of the potentially toxic treatment (with copper
chrome-arsenic) of timber poles.

A management accounting system should be able to assess the financial costs and benefits of each
alternative, and should also be able to include the environmental impact of the raw materials and the
pole’s end-of-life treatment. Transportation, installation and the environmental impact of the installed
poles should also be able to be reviewed and analysed (Deegan 2008).
Study guide | 65

Example 1.15: M
 easuring and capturing economic and
environmental benefits
Each year the airline Virgin Australia prepares an Energy Efficiency Opportunities report. This report
describes its improvement projects that have had environmental benefits and cost savings.
Two examples are:

1. Changing from two engines to a ‘single engine taxi inbound’ when moving the aircraft from the
runway to the arrival gate has saved nearly half a million dollars, while reducing energy usage by

19 990 GJ and CO2-e emissions by 1390 tonnes (Virgin Australia 2012).

2. A project to upgrade the way flight plans and routes are determined is expected to take nearly
two and a half years to generate a positive return. However, it will lead to expected cost savings of
over $6 million and save over 250 000 GJ of energy and nearly 18 000 tonnes of CO2-e emissions.
Changes are being made to flight paths to take advantage of winds at higher altitudes combined
with altering the speed of aeroplanes to operate in the most fuel-efficient way (Virgin Australia 2013).

New product design must carefully consider the types of raw materials used, the energy used in
the production, the impact of product packaging and the ability to recycle the product after it is
no longer required. The focus on sustainability also needs to extend throughout the supply chain.
For example, a consideration of the social and environmental performance of suppliers should
be included in any assessment and selection of appropriate suppliers.

Defining environmental costs and overhead cost allocation

When designing an EMAS, a key decision is what environmental costs it will include.
Some environmental costs (e.g. pollution or waste) might not presently be included because
they are seen as externalities, even though they could provide information that is useful to
support decisions and change. Often costs, such as energy costs, which could be regarded
as environmental costs, are hidden within the organisation as overheads or other cost types.

A related and significant issue is the development of a more appropriate and detailed approach
to overhead cost allocation. In many circumstances, waste items (such as excess or scrapped raw
material) are actually allocated to the product cost or placed into an overhead account and then
allocated over the whole range of products. This ‘hides’ the cost of waste, leading to overstated
product costs and impacts on pricing and performance. It also hinders a detailed examination as
this information is not easily brought to the attention of management. This shows that despite
the benefits that strategic management accounting brings to the organisation, there are still
many areas where improvement is needed.

This module provided an introduction to strategic management accounting and the role of the
management accountant.

Part A defined strategic management accounting and examined the contemporary environment
and its impact on organisations and on management accounting. It also explored the development

of management accounting over time into its current strategically focused role.

Part B described the various roles that managers perform and how strategic management
accounting supports those roles. It also discussed a variety of techniques that are available to
support operational management.

Part C detailed the role of the management accounting system. It explored the link between this
system, the value chain and risk, as well as the need for effective internal controls. Additionally,
Part C discussed problems associated with management accounting systems, links with ERP
software, as well as extending these systems to consider environmental data and issues.
Study guide | 67

Preview of Modules 2 to 5 and

case study
In this module we have discussed the role of strategic management accounting in the
context of the contemporary environment. This discussion provides the overall context within
which we can consider the tools, techniques and concepts that are covered throughout this

subject. The objective of the following modules is to help equip you with the skills required in
management accounting roles. We can see from the subject concept map that there are a wide
range of activities and concepts that need to be carefully interwoven to successfully achieve value.

As we progress through the following modules, which expand on the increased strategic focus
that strategic management accounting is taking, we will consider each of these areas in detail.

Figure 1.11: Subject map—overview of Modules 2 to 5

E Module 2 E
n n
v v
i Module 1 i
r r
o Module 3 o
n n
m Module 2 m
e Vision/Mission e
n n
t Goals and objectives t
a a
l Strategy—Creation l
Module 5
a a
n Strategy—Implementation n
a Module 4 a
l l
y Strategy—Implementation y
i i
s Control and feedback systems s

Source: CPA Australia 2015.

In Module 2 we explore the concept of value in more detail and examine how organisations
create and manage value. This includes a specific focus on how strategy is developed
and important parts of strategy, including a vision, mission, clear goals and objectives,
and competitive strategic approaches. We also provide a detailed examination of the
value chain and external analysis.

We consider control and feedback systems in Module 3 and explore the essential role of
measuring performance. As multifaceted performance metrics are required, management
accountants have the dual role of helping to design performance measures and collect and
analyse results. We discuss techniques including the balanced scorecard and benchmarking,
which can be used to enhance both operational and strategic performance measurement.

In Module 4 we expand on the concept of how value is created through the linked activities of
the value chain, by demonstrating a variety of techniques that help organisations manage value.
By combining these techniques with appropriate performance measurement, both management
accountants and managers perform an essential role in developing an organisation’s sustainable
competitive advantage.

Our focus in Module 5 is on the importance of managing projects as part of successful strategy
implementation. These unique events must be carefully integrated into the organisation so that

they enhance the day-to-day value-creating activities. It is therefore essential that we accurately
evaluate, select and implement projects.

It is important for you to understand how to apply the skills and techniques covered in this
subject, and so at the end of the subject we introduce an in-depth case study. This provides an
overall synthesis of the subject. You will need a good understanding of the material covered in
Modules 1 to 5 and be able to apply this knowledge to the specific information contained in the
case study to successfully complete the case study tasks.
Appendix 1.1 | 69


Appendix 1.1
Accounting techniques for supporting operational

This appendix provides a review of operational support techniques that are assumed knowledge
for the Strategic Management Accounting subject. You should use this as an opportunity to
refresh your knowledge and familiarity with these techniques, including the ability to perform
relevant calculations, analyse scenarios and make recommendations.

All of the material in this appendix is examinable.

Cost classifications
Costs exhibit different types of behaviour. This means that when activity levels change,
different types of cost respond differently, depending on the circumstances. For example,
some may increase or decrease, while some may remain unchanged, and the impact of these
behaviours needs to be understood. These costs can be classified in a variety of ways to support
different types of decisions. For example, when cost-volume-profit analysis or sensitivity analysis
is conducted, there should be a clear separation of fixed and variable costs. Or, when preparing a
list of performance measures for a management team bonus plan, it is important to clearly identify
controllable versus non-controllable costs. Different types of cost classification are described below.

A direct cost is capable of being directly traced to a specific cost object such as a product.
Indirect costs, often called overheads, are not capable of being traced directly in a cost-efficient
or accurate manner and are allocated in a more arbitrary way. A cost object is any item for
which cost information needs to be obtained. This may be a job, product or service, or even
a department, customer or the whole organisation. When more costs are directly linked to
products or services, the accuracy and usefulness of costing information is significantly improved,
which supports efforts such as determining which product lines are profitable and setting prices.

A cost is either fixed, and therefore stays the same regardless of volume, or is variable, meaning
the cost varies with changes in volume. Costs may exhibit both fixed and variable characteristics,
including step-fixed costs and semi-variable (mixed) costs. Consider the costs of a telephone
that include the monthly line rental (fixed) and the cost of each call made (variable). This is very
important in making short-term decisions, such as pricing a special order, and determining break-
even points.

Variable costs do not just include those items used in the production of goods or services.
They may also include other expense items such as selling or transportation. Each cost needs
to be assessed to determine if it varies with volume or if it stays fixed.

An important concept to use when describing costs as fixed is the ‘relevant range’. This is the
range of activity or volume within which the pattern of behaviour (i.e. being fixed) still occurs.
Consider the rental of a warehouse that can hold between 0 and 5000 storage pallets. The rent
is fixed and any number of pallets being stored within this relevant range will not alter the fixed
cost. But, if the organisation needs to store 6000 pallets, then this will be outside the relevant
range, and additional storage costs will be incurred (e.g. by renting another warehouse).

Actual expenditures or payments may be described as outlay costs, while opportunity costs
represent the cost of an alternative that has been foregone. In many situations, analysis only
focuses on the physical amount paid. However, this ignores important costs and potential
benefits that should be included in the analysis. For example, if an asset is purchased with cash
rather than through a lease agreement, part of the analysis must include the opportunity cost of
deploying the cash elsewhere—possibly in a term deposit—or purchasing an alternative asset.
If this up-front cash payment is treated as ‘cost-free’, then the analysis will be inaccurate.

Relevant costs include those that will occur in the future and differ between alternative decisions.
Some costs should not be included when making decisions about particular issues or projects.
These are costs that are irrelevant because they either:
• will be incurred regardless of the choice made; or
• have already been incurred and cannot be avoided.

While no-one would argue against the need to exclude irrelevant costs, this area needs attention
because decisions often mistakenly consider costs that have already been incurred and are not
recoverable. Including such sunk costs in the analysis can lead to incorrect decisions. This can
involve incurring even greater costs, which is sometimes described as ‘throwing good money
after bad’.
Appendix 1.1 | 71

Example A1.1: Sunk costs

A typical example of sunk costs is mine exploration. Before a mining company commits to a mining
project, which will involve significant cost and capital outlay, it must conduct studies on the land,
mineral content, extraction mechanisms and transport methods.

When management needs to make a decision on whether to proceed with the mining project
(i.e. whether the mine will be profitable), the costs incurred during the feasibility study are considered
‘sunk’. Examples of such costs include wages, hiring equipment, drilling holes and testing samples.

That is, the initial costs are irrelevant to the decision of whether to proceed with the mine as there is
no opportunity cost involved and their inclusion may distort the analysis by requiring a very high return
on investment. It means sunk costs are irrelevant because they are the outcome of past decisions and
should therefore be excluded from future decisions. Managers should not say, ‘We have spent this
much money already—we really should go ahead’, because those costs cannot be retrieved, regardless
of whether the mining company goes ahead with the project.

The mining company’s decision to proceed should be made by determining the expected future
profits (i.e. future revenues and future costs) from the mine. The company should not include these
sunk costs in its evaluation.

Examining each activity in a process and determining whether it is adding value to the end
product or service help effective management of value. Those activities that add value should be
improved and enhanced, while activities that do not add value should be reduced or eliminated.
This concept is explored in Modules 2 and 4.

Some costs are committed or locked in. This may be the result of contracts already in place
that cannot be avoided (e.g. for long-term lease of land, property, plant and equipment).
Some costs are committed because a particular design of an item may require certain raw
materials or components that cannot be avoided. Discretionary costs are those that can be
avoided at the discretion of a manager. These include items such as training, preventative
maintenance, advertising and bonuses.

When evaluating and rewarding performance, assess only outcomes and costs that are
under the control of the particular individual or department. This is because the person or
department under assessment cannot influence uncontrollable costs. The inclusion of such
costs in performance evaluation may produce unjustified negative performance results that can
have the undesirable effect of causing demotivation and disillusionment. Therefore, identifying
the controllable versus uncontrollable costs provides the foundations for holding managers
accountable for performance in a responsibility accounting system.

It is important to recognise the degree of influence managers have over certain revenues and
costs. Where a manager does not have direct control but may influence other departments’
costs, there may be an argument for evaluating their performance in relation to these costs.
This may encourage a team environment and cross-functional decision-making that leads to
better organisational outcomes.

There are two problems that arise when considering the concept of controllability:
• It is difficult to pinpoint controllability as there is often more than one factor affecting a
particular cost/outcome.
• Performance evaluation is often focused on the short term, while the effect of some current
actions may only be evident in the longer run (i.e. beyond one financial period).

Performance measurement and controllability are discussed further in Module 3.


Example A1.2: Uncontrollable costs

An area of concern in many organisations is the collection of cash from credit sales. The manager of
the accounts receivable (AR) area is expected to make sure that cash is collected in a timely manner
and to follow up slow-paying customers promptly.

Methods for ensuring systematic collection include making sure credit terms (e.g. 30 days from sale)
are properly explained, doing credit checks on customers, setting credit limits and using stop supply
(refusing to sell any more goods or services) when a customer is late with a payment.

It is expected that AR managers will be held accountable for any issues or costs from slow collections
because they are in charge. But, uncontrollable costs (from the AR manager’s perspective) may arise
without careful management of the end-to-end function, from sales to cash collection.

When strict credit terms and cash collection methods are used, it can make it difficult for the sales team
to reach its sales targets. If there are bonuses available, then the sales team will have an incentive to
provide payment flexibility to customers in order to win a sale. A salesperson may offer an extended
payment period (60 days instead of 30) or try to sell goods above the customer’s credit limit. In more
extreme circumstances, they may collude with the customer to avoid the stop supply being put in
place by the accounts team.

This creates conflict between the sales manager and the AR manager. The sales team’s actions will
lead to costs that are outside the control of the AR manager if the team continues to overrule the
company processes and procedures.

Potential solutions in this situation are to give the AR manager authority over any sale that deviates from
the policy or to not link the manager’s performance to cash collections. A more beneficial approach
may be to link sales bonuses to the prompt collection of cash rather than winning the sale itself.

Sportz Watch Pty Ltd (Sportz Watch) is a fictitious company that is used in this appendix to help
you apply concepts. Sportz Watch is a company that produces a variety of watches. Special sport
related features of these watches include:
• stopwatch capability for timing activities;
• heart rate monitor function;
• GPS function that provides speed, distance covered and inclines/declines over terrain;
and database that stores records of fitness sessions.
Appendix 1.1 | 73

➤➤Question A1.1
Identify the appropriate cost description for each of the following items:
(a) Raw material (plastic) for the watchband is imported and costs USD 3000 per kilogram
(b) Advertising expenditure of AUD 50 000 has been incurred to market the product.

Cost classification item Raw material Advertising

Direct or indirect

Fixed or variable

Outlay or opportunity

Relevant or sunk

Value-added or non-value-added

Committed or discretionary

Controllable or uncontrollable

Cost-volume-profit analysis
One benefit of having an understanding of different types of costs is the ability to forecast
different scenarios. It is necessary to know the fixed and variable costs when performing cost-
volume-profit (CVP) analysis. This type of analysis is useful in making decisions about volume
and pricing, as well as decisions about whether to accept customer orders that are below the
full cost of a product.

A company will usually set a desired or target profit level based on a set level of return on
assets (ROA) or a similar measure. For many organisations the current estimated level of profit
may not be high enough to achieve the profit target. This may be because costs are too high,
sales volumes are too low or prices are not high enough. For example, a company with $10 million
in assets may want an ROA of 20 per cent. This would be an ROA of $2 million ($10 million × 20%).
However, after preparing its budget, the company finds that the estimated profit based on current
sales levels and costs is only going to be $1.5 million. It can then try and cut costs or increase the
volume of sales to increase the estimated profit from $1.5 million to the desired level of $2 million.

CVP analysis often helps work out effective ways of successfully reaching the target (budgeted or
desired level) profits. For example, it will help an organisation to decide to increase prices or cut
costs, and by how much.

CVP analysis is used to calculate three key measures:

1. Contribution margin—this describes the amount of sales (in units or dollars) that contributes
to fixed costs and profit. That is, the contribution margin is the excess of sales revenue over
variable costs (i.e. Revenue – Variable costs). This can be calculated for total revenues or on
a per unit basis to see how much each unit contributes towards fixed costs and profits.
2. Break-even point—this is the point (in units or dollars) where revenue equals costs.
3. Sales required to achieve the budgeted or target profit—this calculation determines the
amount of sales (in units and dollars) needed to achieve the desired profit target.

With this information, we are able to model the results of a variety of possible options that relate
to changes in sales price, volume sold and the level of variable or fixed costs. For example,
if all the fixed costs for a period have already been covered by previous sales, a reduced sales
price that is above the variable cost may still be beneficial to the company.

In its basic form, CVP analysis uses some assumptions that may limit its usefulness, including
assuming that selling prices are constant and that variable costs are also linear, which means
they stay at the same level per unit rather than decreasing as volumes get larger. This may not

match reality, where larger purchases will often receive price reductions and higher volumes will
also lead to lower variable costs per unit. However, CVP analysis is still a useful starting point for
considering sales and relevant production and purchasing estimates. Financial models can be
developed to conduct more advanced forms of CVP analysis and to remove the need for the
assumptions mentioned above. Table A1.1 details some of the formulas required for CVP analysis.

Table A1.1: Formulas required for CVP analysis

Contribution margin (CM) = Total revenue – Total variable cost

Contribution margin per unit (CMU) = Sales price per unit – Variable cost per unit

Contribution margin ratio (CMR) = CMU / Sales price per unit

Break-even point in units (BPU) = Fixed costs / CMU

Break-even point in dollars (BP$) = Fixed costs / CMR

Estimated profit = (Unit sales × CMU) – Fixed costs

= (Unit sales – BPU) × CMU

Target profit = Total assets × Target return on assets

Units to achieve a specific profit level = (Fixed costs + Target profit) / CMU

Revenue to achieve a specific profit level = (Fixed costs + Target profit) / CMR

Source: CPA Australia 2015.

Example A1.3: Sportz Watch cost-volume-profit

The following information on the Mark II watch has been extracted from Sportz Watch’s accounting

Forecast sales volume (units) 12 000

Sales price (per unit) $150
Variable cost (per unit) $120
Fixed costs $300 000
Total assets $750 000
Target return on assets 20%

From this information we can calculate the following:

Contribution margin (CM)

Total revenue 12 000 units × $150 $1 800 000
Total variable cost 12 000 units × $120 $1 440 000
Contribution margin (CM) $1 800 000 – $1 440 000 $360 000
Appendix 1.1 | 75

Contribution margin per unit (CMU)

Sales price per unit – Variable cost per unit $150 – $120 $30 per unit

Contribution margin ratio (CMR)

CMU / Sales price per unit $30 / $150 20%

Break-even point in units (BPU)

Fixed costs / CMU $300 000 / $30 10 000 units

Break-even point in dollars (BP$)
Fixed costs / CMR $300 000 / 20% $1 500 000

Estimated profit
(Unit sales × CMU) – Fixed costs (12 000 × $30) – $300 000 $60 000
(Unit sales – BPU) × CMU (12 000 – 10 000) × $30 $60 000

Target profit
Total assets × Target return on assets $750 000 × 20% $150 000
Units to achieve target profit
(Fixed costs + Target profit) / CMU ($300 000 + $150 000) / $30 15 000 units

Revenue to achieve desired profit

(Fixed costs + Target profit) / CMR ($300 000 + $150 000) / 20% $2 250 000

Example A1.4: Telstra broadband cost-volume-profit

After a detailed three-month analysis, Telstra, Australia’s largest communication provider, radically
reduced prices for high-speed internet connections. This action completely changed the market and
drew complaints from both competitors and the government competition regulator. While some
argued the drop in prices was a mistake that would cost Telstra in reduced revenues, the decision was
a considered strategy. Not only was it able to gain relative market share from competitors, but it was
also successful in increasing the size of the market. By reducing prices to a comparable level to dial-up
internet, many subscribers switched services. The end result: Telstra added over 110 000 broadband
subscribers during this period, a 21.7 per cent increase.

Source: Adapted from Crowe, D. 2004, ‘Manoeuvring to get out of the slow lane’,
Australian Financial Review—Special Report, 13 May, p. 2.

Product costing
Product costing information is essential for service organisations as well as manufacturing and
retailing companies. It is useful for both internal decision-making and for compliance purposes
in terms of reporting various inventory figures and cost of sales. To cost a product or service,
the direct costs need to be traced and recorded. Indirect costs (overhead) may then be allocated
to the item to provide an overall cost. There are several useful methods for costing, including:
• job costing—for larger, specific tasks or where unique products or services are produced; and 
• process costing—for when large amounts of a similar (homogeneous) product or service
are produced.

There are four points in traditional product costing when recording (i.e. journal entries),
are required. These are when:
1. resources are obtained;
2. resources are used in the production process;
3. the production process is completed and there are finished goods; and
4. the finished goods are sold.

When the finished goods are sold, the asset value (Inventory – Finished goods) is transferred
to an expense account (Cost of sales) to reflect that these assets are no longer in the business.
An entry for the sale is also required, which reflects an increase in revenue and a corresponding
increase in assets (either cash or accounts receivable).

Job costing
Job costing is used if the product or service being costed is a clearly identifiable task or job.

The main journal entry required, which relates to point 2 (in the previous list) when resources are
used in the production process, provides an overall total for transfers of direct and overhead
(indirect) costs across all jobs. Control accounts are then used to trace all of the direct costs and
allocate overheads to each particular job.

This use of control accounts is similar to the use of control accounts and subsidiary ledgers for
accounts receivable. For example, if a company makes a sale on credit, the journal entry will
increase accounts receivable and sales revenue. The journal entry does not reflect who the
customer is, which products were sold and other specific information. When payment is received,
it is just as important to make sure that the correct customer’s debt is updated in the system.
Control accounts make this achievable. Note that in a computerised environment this is done
automatically, but it is still important to understand the underlying principles.

The same process is required for job costing. While the main ledger will record the total amounts
going in and out of the accounts, the control account (job sheet) for each job will contain the
amounts relevant to a specific job. Budgeted estimates for each part of the job could then be
compared to the actual results to determine variances and identify potential problems.

Process costing
Process costing is used in situations when there are a large number of similar products or services
being produced. Instead of each individual unit being costed, the total amount of costs incurred
is collated and averaged across the total units produced.

The focus of cost accumulation is usually on the departments that the product or service
passes through. The work-in-process (WIP) is allocated to specific departments. This process of
performing additional processes and transferring costs to WIP continues until all processes are
complete and the WIP costs (i.e. direct materials, direct labour and overhead) are converted into
finished goods. At this stage, the cost of finished goods can be divided by the volume of units
produced to calculate the product cost per unit.

Overhead allocation
A large number of costs are not directly traceable to a cost object—for example, the final
product or service that is created. These indirect costs are called ‘overhead’, and it is necessary
to find a way to allocate these costs to the specific object to be costed. Overhead costs include
all of the business’s running costs (not including direct labour and direct materials).

Overhead costs are allocated to products using an ‘overhead allocation base ’ in order to
determine the ‘true’ cost of manufacture. So even though direct labour and direct materials are
direct costs, they can be used as a foundation (or ‘allocation base’) for allocating overhead costs
that cannot be easily traced to a cost object. Other allocation bases, such as ‘machine hours’,
can also be used.
Appendix 1.1 | 77

A process is then needed to determine how much overhead is allocated. A brief summary of the
overhead allocation process is shown below.
1. Collect or estimate all relevant overhead costs (this is often called a cost pool). There may be
more than one cost pool because of the different types of overhead (indirect manufacturing
costs, indirect departmental costs—for instance, marketing and administration costs).
2. Select an allocation base for each cost pool. The allocation base should be determined on
the basis of the cause–effect relationship between the overhead costs incurred and the cost
object. Examples of allocation bases include:

(a) direct labour hours
(b) direct labour dollars
(c) machine hours
(d) direct materials dollars.
This does not mean that these allocation bases are the overhead cost. Rather, the costs or
time incurred in these areas will be used as a foundation for allocating other overhead costs
that cannot be easily traced.
3. Collect or estimate the total quantity of the allocation base.
4. Determine the cost allocation rate by dividing the cost pool by the total quantity of the
allocation base.
5. Allocate overhead costs to a particular job or process based on this rate.

Example A1.5: Overhead allocation using direct labour hours

This example shows each step in the process.

Step 1: A business has an overhead cost pool of $150.

Step 2: The business decides to allocate this overhead cost using direct labour hours as an allocation
Step 3: Total direct labour hours are estimated to be 300.
Step 4: The cost allocation rate would be $0.50 per direct labour hour (i.e. $150 / 300 hours).
This means that for every hour of direct labour that is spent producing a particular product,
in addition to the direct labour cost, $0.50 of overhead would also be allocated to that product.
Step 5: If one product requires 50 hours of direct labour, it will be allocated $25 of overhead
(i.e. 50 × $0.50). If another product requires 100 hours of direct labour, it will be allocated
$50 of overhead (i.e. 100 × $0.50).

Management accounting information can sometimes be irrelevant because of inaccurate

allocation of overhead. This may happen if an allocation base is used that does not have a
strong relationship with how the overhead costs were incurred (e.g. it would not be useful to
use direct labour hours as an allocation base in a technology-driven process involving minimal
direct labour).

➤➤Question A1.2
A manufacturing organisation has three jobs planned for the next financial year.
Its manufacturing overhead is expected to be $350 000.
Estimated operating data is provided below.

Job 1 Job 2 Job 3


Direct labour costs $50 000 $60 000 $90 000

Direct material dollars $35 000 $25 000 $40 000

Direct labour hours 1 250 2 000 3 000

Machine hours 150 450 650

(a) Using each of the four allocation bases above, calculate for each job the:
(i) overhead application rate.
(ii) overhead allocation.
Complete your answer in the tables below.
(i) Overhead application rate

Total Application
Allocation base Job 1 Job 2 Job 3 quantity rate
Direct labour costs

Direct material dollars

Direct labour hours

Machine hours

(ii) Overhead allocation

Overhead allocated
Overhead Application
allocation base rate Job 1 Job 2 Job 3 Total
Direct labour costs

Direct material dollars

Direct labour hours

Machine hours

(b) Using machine hours as the allocation base, prepare control accounts for each job. Complete
your answer in the table below.
Control accounts

Job number Direct materials Direct labour overhead Total




(c) How would switching from machine hours to direct material dollars as the allocation base
affect the profitability of Job 1?
Appendix 1.1 | 79

A short-term master budget is required to help turn long-term strategic objectives into
operational short-term plans. The master budget may be for a period of weeks, months,
quarters or even a year and combines the relevant information into a short-term operational
plan. The budgeting process helps management to allocate resources (time, people and money)
to a coherent set of financial and numerical plans. The starting point of the budgeting process
is the organisational goals and strategic plan. These are combined with a detailed assessment
of the financial position and integrated with external and internal projections about how the

organisation will operate in the future environment. Information required will include sales
forecasts, production capacity and costs, and employee data.

A series of short-term budgets not only assists in planning, but is also useful for coordinating and
integrating the variety of activities within an organisation. It also communicates to staff what is
expected to be achieved, and the allocation of resources to key areas informs employees about
the relative importance of activities and areas.

Important budgets include:

• sales budgets;
• production budgets;
• stock/merchandise budgets;
• material purchases and usage budgets;
• direct labour budgets;
• overhead budgets;
• capital expenditure budgets;
• cash flow budgets;
• income statement (profit and loss) budget; and
• balance sheet budget.

There are many different approaches to budgeting, some of which are more flexible than others.
Flexible budgets are commonly used and are updated during a period based on changing
events. Another popular method is the use of a rolling forecast. This is where, instead of an
organisation forecasting in calendar or financial year blocks, new budgets or forecasts are
continuously created, and the organisation continues to look 12 to 18 months ahead at all times.
For example, as a three- or six-month period passes, that period drops off the budget and
another three- or six-month period is then added.

Forecasts, or dynamic budgets, are now common in most organisations and allow for increased
control over costs and short-term planning. These forecasts use actual costs incurred during
the financial period to date, in addition to the remaining budget for the period, to enable
more accurate forecasts of revenues, expenditures and cash flows for the full financial period.
These forecasts do not take the place of the original budget, but provide an additional tool that
may be used to adjust or refocus planning where variations to budgets occur.

Planning activity and resources

The main types of budgets are similar for most organisations, although differences do exist
between service, trading and manufacturing organisations. Although the examples reproduced
below are very simple, the conceptual structure is unchanged even when there are hundreds
of product lines.

Sales budget July August September

Forecast sales (units)

× Unit sale price

= Revenue

Important things to consider when creating a sales budget include external factors such as
market demand at different price levels and internal factors such as production and storage
capacity. Failure to integrate these factors may create unachievable budgets and, in turn,
lead to decreases in employee motivation. The cash collections from the sales budget will be
incorporated into the cash budget.

To determine the amount of goods to be produced in a particular period, first determine the
level of sales and then consider the current and required levels of inventory. Setting sales and

production budgets is usually an iterative process in which the sales and production teams need
to communicate to ensure that the number of units expected to be sold can be produced.

Production budget July August September

Forecast sales

+ Finished goods inventory required at the end of the period

– Finished goods inventory from the start of the period

= Production requirements (units)

If goods or services are being produced, a direct labour budget and a raw materials purchases/
usage budget are required. The final data from the production budget (production requirements)
becomes the starting point for both of these budgets.

Direct labour budget July August September

Production requirements (units)

× Direct labour hours per unit of production

× Direct labour cost per hour

= Total direct labour cost

A raw materials budget is created by combining the production requirements identified earlier
with the required levels of raw materials inventory. From this, the amount of raw materials to
purchase as well as the cost can be calculated. The cost information from the direct labour
budget and raw materials budget will be fed into the cash budget, which will project when
payments will be required.

Raw materials (RM) purchases and usage budget July August September

Production requirements (units)

× Volume of RM required per unit of production

= Usage of RM

+ RM inventory required at the end of the period

– RM inventory from the start of the period

= RM purchases volume

× RM cost

= Total RM cost
Appendix 1.1 | 81

➤➤Question A1.3
Twinkle Toes Ltd is a company that makes and sells shoes for women. A new shoe made from
recycled materials is being considered, and the following estimates have been made:
Expected selling price: $220 per pair of shoes
To make each pair of shoes, the following items are required:
• 800 grams of raw material that costs $50 per kilogram;

• direct labour of two hours, at $17 per hour; and
• variable overhead of $24.
Expected unit sales for the second half of 20Y1 are as follows:
July 1300
August 1900
September 2200
October 2300
November 2500
December 3200
To ensure there are no shortages of stock or production bottlenecks, the following are required:
• Finished goods (FG) inventory at the end of each month should be 20 per cent of the following
month’s estimated sales. Note that Twinkle Toes will require inventory to be built up in June
for July sales.
• Raw materials inventory at the end of each month should be 35 per cent of the following
month’s estimated raw material usage needed to meet the production requirements.
Prepare the following for Twinkle Toes Ltd for the period July–September 20Y1:
(a) sales budget
(b) production budget
(c) direct labour budget
(d) raw materials budget.
Notes: The production budget will need to include October so that raw materials purchases for
September are identified, and ending June inventory for both raw material and finished goods
is required to determine July starting balances.

Evaluating and controlling with variance analysis

Variance analysis is conducted to ensure budgets are being achieved and to help with control.
The variance that is analysed is the difference between the actual costs and quantity used
(of direct materials, labour and overhead) and the amounts budgeted for at the start of
the period.

The first type of variance examined is the difference between a budgeted level of activity and the
actual level. The second type of variance is the difference between the consumption of resources
that should be incurred for a ‘given level of activity’ as compared to what is actually consumed.

For example, if production of 1500 units is budgeted but, because of a large sales order,
2000 units are actually produced and sold during the period, there are two variance issues.
The first issue revolves around why there is a 500 unit variance in units produced. The second
issue relates to the amount of resources used to produce 2000 units. The actual resources used
must be compared with the budgeted estimates to ensure resources are being used effectively.

However, if the amount of resources actually consumed (to produce 2000 units) is compared
with the amount expected to be consumed (based on a sales estimate of 1500), there will be
a significant difference that has nothing to do with inefficiency. Rather, 33 per cent more direct
material or labour may have been required to produce the extra 500 units. Unless the budgets
are adjusted or ‘flexed’ to reflect the increased levels of production before the variances are
calculated, the analysis will be inaccurate.

Cash budgets
Managing cash flows is an important issue. A crucial area that often causes problems is customer
collections. Slow collections can make it difficult to pay suppliers on time and to plan for longer-
term and strategic investments, such as hiring new staff or capital expenditure. Clearly identifying
when large outflows such as loan repayments are to arise is also essential.

The inputs for a cash budget are mainly found in the general budgets that have already been
considered, including the sales budget and the purchases and labour budgets. For example,
based on the total revenue estimates, it is possible to try to identify when these funds will
be collected. This can be done by examining the accounts receivable ageing data, and an
organisation should be able to determine the usual time periods when revenue is collected as
cash. For example, a possible structure may be as follows:
• 20 per cent of sales received under 30 days;
• 60 per cent between 30 and 60 days;
• 15 per cent between 60 and 90 days; and
• 5 per cent over 90 days.

A schedule of cash receipts can be prepared to map out how revenue is collected over time.
For example, if a company had $100 000 in sales in the month of January, based on the
percentages outlined above, this would be collected as follows:

Month collected Collection Collection

January 20% $20 000

February 60% $60 000

March 15% $15 000

April/May/June 5% $5 000

Total collected 100% $100 000

The accounts payable ageing data shows when invoices are due for payment.

Effective cash budgeting ensures that an organisation highlights any cash issues well before they
arise (see Table A1.2 for a monthly cash budget template). If an organisation is going to require
extra cash in line with its operating cycle, from purchasing raw materials up until the collection
of cash from sales, then this needs to be organised promptly. Note that organisations with strict
bank overdraft credit limits, or those experiencing cash flow problems, may prepare weekly or
daily cash budgets, with a running cash balance calculated after each cash transaction.
Appendix 1.1 | 83

Table A1.2: Cash budget template

Cash budget July August September

Starting cash balance

Cash flows from operations

+ Receipts from customers
− Payments to suppliers and employees

– direct labour
– raw materials
– variable and fixed overheads
− general expenses (e.g. selling and admin.)
− Tax payments

Cash flows from investing

+ Sales of non-current assets
− Asset refurbishments or upgrades
− Purchases of capital equipment

Cash flows from financing

+ Borrowings
+ Equity issued
− Interest payments
− Repayment of loans
− Dividend payments

Closing cash balance

Source: CPA Australia 2015.

➤➤Question A1.4
Based on the following estimates for Zeta Ltd, prepare:
(a) a schedule of cash receipts (in April 20Y1) from sales;
(b) a schedule of cash payments (in April 20Y1) from material purchases; and
(c) a cash budget for April 20Y1.

• The cash balance on 1 April is $75 000.

• Sales revenues are for the first six months of 20Y1 are estimated to be as follows.
January $230 000
February $300 000
March $500 000
April $565 000
May $600 000
June $560 000

• 20 per cent of all sales per month are for cash.

• 70 per cent of all credit sales are collected within the month of sale.
• 20 per cent of credit sales are collected in the month following the sale.
• 7 per cent of credit sales are collected two months after the sale.
• Raw materials costs are equivalent to 20 per cent of the sales revenue.
• Raw materials are always purchased and turned into finished goods in the month before

they are sold.

• 50 per cent of raw materials purchases are paid for with cash. The amount outstanding is
settled in the next month.
• Wages total $50 000 each month and are paid in the month they are incurred.
• Budgeted monthly operating expenses total $125 000, of which $22 000 is depreciation and
$3000 is rent (prepaid in January).
• $15 000 in interest payments are made on 15 April.
• Selling and administration expenses are approximately $25 000 per month; these are paid
• On 10 April, new equipment will be purchased for $70 000 (with a $10 000 cash deposit,
and then 12 monthly instalments starting on 1 May). The old equipment it is replacing is
expected to be sold for $13 000 cash in mid-April.

Working capital management

Management accountants also support managers by ensuring the financing functions are well
managed and cost-effective. Working capital management is crucial and often leads to significant
improvements in business performance. It can also protect an organisation from significant cash
flow problems.

Working capital is the difference between current assets and current liabilities. This difference will
be funded by long-term debt or equity capital. It is described as ‘working’ because this capital is
constantly being converted from cash into inventory, accounts receivable and back to cash again.

The key parts of working capital are:

• cash;
• accounts receivable;
• accounts payable; and
• inventory.

Effective management of each of these parts is essential. Not collecting accounts receivable
on time creates cash flow problems that, if left unsolved, may lead to insolvency. Not paying
creditors on time can harm business relationships, and holding too much inventory ties up capital
that could be used elsewhere in the organisation or repaid to lenders. However, finding a balance
is important. While an organisation can suffer from undercapitalisation (where there is too little
long-term finance to support operations), it can also experience overcapitalisation (where funds
are not fully used, providing a lower return to investors).

This section discusses the operating cycle and cash cycle, and provides an overview on each of
the parts of working capital. It concludes with a summary of working capital formulas for creating
ratios to benchmark and assess the effectiveness of working capital management.
Appendix 1.1 | 85

The operating cycle and cash cycle

The operating cycle and the cash cycle are fundamental aspects of cash flow management
as they seek to manage the three key balance sheet accounts that are at the core of business
• accounts receivable;
• inventory; and
• accounts payable.

The operating cycle represents the time taken for an entity’s purchased inventory to be converted
into cash through sales (see Figure A1.1).

As inventory is often purchased on credit, the cash outflow does not always take place when
the raw materials are acquired. The cash cycle represents the net time taken from obtaining and
paying for resources, to selling goods and receiving cash.

Figure A1.1: The operating cycle

1 2
Acquire materials Convert materials
or resources to goods or resources
or services

The operating cycle

Collect payment for 3
goods or services Sell goods
or services

The operating cycle and cash cycle can be calculated as follows:

Operating cycle = Inventory days + Receivable days

Cash cycle = Operating cycle – Payable days

Inventory days—The average number of days inventory is held. The fewer days the better,
otherwise it indicates slow-moving stock.

Receivable days—The average number of days customers hold accounts receivable balances.
The fewer days the better, otherwise it indicates risk of bad debts.

Payable days—The average number of days creditors have to wait to be paid. The more days
the better, taking into account supplier relationships and availability of discounts.

The method for calculating these items is explained below.


Inventory cycle
For the inventory part of the operating cycle length, determine the ratio ‘inventory days’.
One way to determine the average time that inventory is held within an organisation is to
determine inventory turnover.

Cost of sales
Inventory turnover =
Average inventory

Inventory turnover identifies the average number of inventory cycles occurring in one year
(the more the better). This can also be expressed in terms of inventory days.

Inventory days =
Inventory turnover

An alternative way of expressing inventory days is:

Average inventory
Inventory days = × 365
Cost of sales

Accounts receivable cycle

For the accounts receivable part of the operating cycle length, determine the ratio ‘receivable
days’. To determine the average time accounts receivable balances are held by customers, it is
necessary to determine receivables turnover. Use the accounts receivable balances before they
are adjusted for bad debt provisions, as deducting the provision would distort the ratio.

Receivables turnover =
Average receivables

Receivables turnover identifies the number of times debtors pay their accounts in full during the
year. This can also be expressed in terms of receivable days.

Receivable days =
Receivables turnover

An alternative way of expressing receivable days is:

Average receivables
Receivable days = × 365

Accounts payable cycle

For the accounts payable part of the cash cycle length, determine the ratio ‘payable days’.
Payable days refer to the average number of days creditors have to wait to be paid. The more
days the better, as it indicates the organisation’s ability to take advantage of interest-free credit,
although excessive use beyond the agreed terms may result in poor supplier relationships and/or
a poor credit record.

Cost of sales
Payables turnover =
Average payables
Appendix 1.1 | 87

Payables turnover identifies the number of times creditors are paid their accounts in full during
the year. This can also be expressed in terms of payable days.

Payable days =
Payables turnover

An alternative way of expressing payable days is:

Average payables
Payable days = × 365
Cost of sales

Reducing the cash cycle

Assuming that the inventory days is 30 days (average time held in inventory) and receivable days
is 20 days (average time that inventory sales remain with debtors), then the operating cycle for
the entity would be 50 days. If the average time that it took creditors to be paid was 15 days,
then the cash cycle length would be 35 days. It is therefore important in managing working
capital to be able to reduce the cash cycle, or ‘funding gap’.

Positive funding gap

If an organisation is able to purchase inventory, sell it and collect the cash on the sale before it
has to pay the creditors for the inventory, then this is called a positive funding gap. It is called
positive because it is a good situation for the organisation. This is a desirable position from a
cash flow perspective and indicates that an increase in sales leads to an increase in cash flows,
which in turn does not constrain the organisation in its plans for expansion. Be careful that a
positive funding gap does not come at the expense of worsening trade relations with creditors
who are waiting longer to get paid. A positive funding gap may indicate problems if the primary
reason is late payment of creditors.

Figure A1.2: Positive funding gap

Sale Collection

Positive funding gap

Purchase Payment

Negative funding gap

A negative funding gap occurs when the required payment on the purchase of the inventory
is before the collection of the cash on the sale of the inventory, which most often occurs.
The consequence of such a gap is that it requires the organisation to commit funds from
other sources to finance short-term working capital.

Figure A1.3: Negative funding gap

Sale Collection

Negative funding gap

Purchase Payment

Cash management
Having an adequate supply of cash is essential for paying debts and being able to take
advantage of business opportunities. Cash refers to an organisation’s actual cash and near-
cash holdings at a given point in time. Near-cash holdings include highly liquid investments
such as at-call money market instruments and bank deposits, bank bills and promissory notes.
Also included in cash is the bank overdraft balance, which forms an integral part of a company’s
cash management process.

Although cash itself is essential for the operation of a business, it can be described as an idle
asset. That is, it rarely generates the returns that other business assets or investments would be
expected to achieve. As such, there is a trade-off between having enough liquid assets to fund
the operations of the organisation and having excess cash, which leads to lower returns for the
organisation. It is therefore important that cash balances be managed effectively.

Effective cash management provides a number of benefits to an organisation, including ensuring

that the organisation has sufficient funds for growth and for unexpected investment opportunities.
Improved cash management will increase an organisation’s profit and return on funds employed
through reduced borrowings. It will also produce a higher level of internal cash generation and
more effective use of cash resources, resulting in reduced interest expense to the organisation.

Figure A1.4: The main steps in cash management

1 2 3 4 5 6
Forecasting Daily cash Intercompany Investment of Cash Performance
and planning procedures flows surplus funds disbursements measures

These steps are discussed in more detail in the ‘Financial Risk Management’ subject of the CPA Program.

For our purposes, we will briefly address steps 1, 4 and 6.

1. Forecasting and planning

Routine and realistic cash forecasts are essential for effective cash management. Cash
forecasts are the basis for determining an organisation’s future cash position and borrowing
requirements. Cash forecasts therefore provide an early warning system of impending cash
problems, which allows the organisation time to develop plans to correct the shortfall or
obtain funds to finance it. Cash forecasts bring management discipline into an organisation
and help reinforce the importance of cash to the organisation.

It is often easier to accurately forecast payments or disbursements than to forecast cash

receipts, as it is easier to control when payments are made. Considerable variation can
occur between the date at which receivables should be received and the date when they
are received. This can be compounded by internal factors, such as sales staff taking overly
optimistic views of sales receipts.

4. Investment of surplus funds

The investment of surplus funds must meet the following objectives:
(a) Safeguard the organisation’s assets.
(b) Maximise the return earned on the funds invested.
(c) Be consistent with the organisation’s liquidity objectives and with the current cash
forecast. Where cash forecasts are unreliable, there will be a tendency for a conservative
investment strategy to be adopted.
Appendix 1.1 | 89

The simplest form of cash management is investing surplus funds into an interest-bearing
deposit account. Listed below are four factors that need to be taken into consideration when
investing cash.

Maturity The time taken to realise the investment. ‘At-call’ accounts and ‘term deposits’ are the
most common way of investing surplus cash, with term deposits typically having one-,
three-, six- or 12-month durations. Usually, the longer the maturity, the higher the yield.

Liquidity How easily the organisation can access its cash from the investment. Usually, the longer
the term of the investment (i.e. 12-month term deposits), the less liquidity there is and
the higher the interest rate or yield.

Risk The chances of losses or gains on the investment, primarily gauged by the financial
institution’s credit rating (e.g. ‘investment grade’ status) by ratings agencies. With cash,
investors generally seek a lower-risk investment, as a key objective is to protect the
value of the asset. A higher risk will generally provide a higher yield.

Yield The yield or rate of return is determined by the other three factors, namely maturity,
liquidity and risk. Generally speaking, the longer the term to maturity on the investment,
the less liquid the investment, the higher the risk, and the higher the yield.

6. Performance measures
Performance of managers is often biased towards the measures on which they are to be
appraised or evaluated. Where these performance measures do not include a benefit
(or penalty) for the efficient (or inefficient) use of cash resources, it will invariably lead to a
lack of resolve in that area. Cash-based measures should apply to all managers who have a
significant impact on the company’s cash cycle.

The cash generated by a business unit is the simplest performance measure that can be used.
It is easy to measure and assess, and is directly related to the overall group objective of cash
maximisation. We discuss performance measures in more detail in Module 3.

Accounts receivable management

This area is often overlooked, but the negative effects of a poorly managed accounts receivable
function are significant. Many organisations that produce and sell products in a profitable manner
run into difficulty by not managing the accounts receivable function properly.

Credit sales may help an organisation to grow sales, but granting credit can mean that
administration and funding costs will increase, as will bad debts if there is poor management
of accounts receivable.

Accounts payable management

Efficient payment to creditors is essential to maintain strong relationships, and it requires an
organised process and an appropriate amount of cash. Taking advantage of discounts is one
possible way to improve value for an organisation, provided there are cash reserves to do
this. Assume an organisation is required to pay an invoice within 90 days from the date on the
statement. While paying at 90 days might provide the organisation with 90 days’ worth of free
short-term credit, a greater return may exist if there is the possibility of negotiating a discount
for paying early (e.g. within 30 days).

The formula to determine the return generated from paying an invoice early and obtaining
a discount is:

(1 + D/P)(365 / d) – 1

D = Dollar saving from taking the discount

P = Amount to be paid by taking advantage of the discount
d = Number of days between the day the discount ends and the day the invoice is otherwise due

A simple example demonstrates the power of paying invoices early and obtaining an associated
discount. Consider an invoice that requires a $500 payment in 30 days. There is an opportunity of
receiving a 5 per cent discount ($25) if the invoice is paid immediately. One way to consider the
benefit of paying early is to see the return you would normally get by investing these funds. If you
invested $475 in a term deposit for 30 days that pays 5 per cent per annum, you would receive
$1.95 in interest ($475 × 5% × 30 / 365). So, getting a $25 return (in money saved) by paying
immediately may be a much better investment than keeping your funds in the bank and paying
the supplier in 30 days.

The equivalent annual return from paying the invoice early and obtaining the discount is
calculated as:

(1 + ($25 / $475))(365 / 30) – 1

= (1.0526)12.1667 – 1
= 86.58% (rounded)

This means that the 5 per cent discount over 30 days actually equates to an annual rate of return
of nearly 87 per cent. An organisation may save hundreds or thousands of dollars each year by
taking advantage of such discounts, and it would be unlikely that the organisation could find such
a return elsewhere. The following table provides further examples (assuming an invoice amount
of $500) of the annualised rate of return achieved for different levels of discount.

Table A1.3: Effective rates of return on early payment of $500

Discount 20 days early 30 days early 60 days early

1% 20.1%† 13.0% 6.3%

2% 44.6% 27.9% 13.1%
5% 155.0% 86.7% 36.6%
10% 584.0% 260.3% 89.8%

Note: (1 + ($5 / $495))(365 / 20) – 1 = 20.1%.

Source: CPA Australia 2015.

The management of payables is an important function of the organisation’s day-to-day activities.

Poor management of payables can lead to the disruption of the production or supply chain
process if suppliers refuse to supply until payment is received. It could ultimately end up with a
cancellation of credit from suppliers. This in turn can lower the organisation’s credit rating and
make it more difficult and costly to obtain credit in the future.
Appendix 1.1 | 91

Inventory management
For organisations involved in selling merchandise (e.g. retail shops) or manufacturing goods,
management of cash flows associated with inventory is essential. Inventory can take many forms,
from raw materials, to partially completed goods on the production line (work-in-progress),
to finished goods or merchandise ready for sale.

There are two important tasks associated with inventory management: controlling inventory
(knowing where it is and what has been transported) and managing the costs. Constantly

recording the inflow and outflow of inventory (using perpetual systems of inventory management)
combined with either continuous (cycle) counting of stock or monthly/quarterly stock takes will
provide stronger control.

The key tasks of inventory management include balancing the costs related to:
• acquisition costs, which include the price paid, ordering costs and consideration of possible
discounts for larger quantity orders;
• storage (and transfer) costs; and
• opportunity costs because of stopped production (if no raw materials are available) or lost
sales (if no finished goods are available).

The intuitive approach to avoiding the third set of costs generally involves holding a vast quantity
of inventory. But this will lead to holding too much inventory, which decreases efficiency, increases
overall costs and makes managing cash more difficult. Balancing these costs effectively is a
useful skill. One model for supporting decisions is the economic order quantity (EOQ) model,
which helps to determine the order quantity that minimises total cost.

The EOQ formula is:

EOQ = 2aD /c

= (2aD/c)0.5

a = acquisition cost per order placed;
D = demand over a period; and
c = carrying cost per unit.

A simple example of this formula is shown in the following scenario. Calculating the EOQ formula
can determine how many orders should be placed annually. Assume an organisation purchases
8000 bottles per year. The cost of processing each order is $4.00 and carrying costs are $0.10 per
bottle. Therefore:

a = 4.0
D = 8000
c = 0.1

EOQ = ((2aD)/c)0.5
= ((2 × 4.0 × 8000) / 0.1)0.5
= 800 bottles

This shows that the order quantity that minimises costs is 800 bottles. Once the EOQ has been
calculated, it is possible to determine how many orders need to be placed over the time period
of estimated demand. In this situation, the ideal number of orders per year is 8000 / 800, which is
10 orders per year. Therefore, any more than 10 orders per year will mean that the acquisition costs
outweigh any savings achieved by reducing the carrying cost per unit. Larger order sizes might lead
to a reduction in total acquisition costs, but because inventory is being held for longer periods,
the carrying costs will outweigh these savings. This model can also be extended to consider issues
such as maintaining a buffer of stock to avoid running out (this is also called ‘safety stock’).

A detailed explanation of this formula is found in most management accounting and business
finance textbooks.

Many companies do not record the cost of lost sales. These costs are not directly incurred by the
company. Rather, they are opportunity costs—the cost of missing out on the sale as a result of
holding lower levels of inventory. By capturing this information, companies can assess whether it
is worthwhile increasing their inventory holdings. Estimating the opportunity cost incurred from a
stock-out involves calculating the ratio of actual stock available to stock demanded. For example,

if 950 units were available, but there was demand for 1000 units, the ratio would be 950 / 1000;
that is, 95 per cent of customer orders would be satisfied.

Working capital formulas

The formulas in Table A1.4 are helpful in evaluating working capital. The results calculated
for a company should be compared against previous performance, budgets or forecasts and,
if possible, industry or competitor results. They are very useful in identifying trends over time,
such as declining performance in collecting cash from customers or a deterioration in the
cash cycle.

Efficiency and liquidity are two important areas to consider when evaluating working capital.

1. Efficiency focuses on how quickly the organisation moves through the operating cycle,
the inventory cycle and the cash cycle (discussed earlier).
2. Liquidity is the ability to convert current assets into cash and is often used to describe the
organisation’s ability to pay its debts as and when they fall due. This is because cash will
be needed to pay debts. Measuring the level of current assets (which are usually able to be
converted reasonably quickly into cash) against the level of current liabilities (which must
be paid relatively quickly) will provide an indication of the organisation’s ability to pay debts
as and when they fall due.

In working capital management, there needs to be an appropriate balance between:

• having sufficient liquid assets to meet all debts as and when they fall due; and
• having too many liquid assets that do not generate a sufficient return for the organisation.

Current assets (the numerator in the working capital ratio shown below) are typically made up of
cash, accounts receivable and inventory. If the working capital ratio is less than one, it means the
company has fewer current assets than current liabilities. This is usually an undesirable situation
as it may be difficult for the company to pay its debts on time, which places the company in a
weak position.

If the working capital ratio is close to two, then this means current assets are close to twice the
size of current liabilities. This places the company in a position to be able to pay its debts on
time. This may be referred to as a strong position. However, if the working capital ratio is above
three, the company’s current assets level is too high (e.g. it may have too much inventory), as the
company may not be generating a sufficient return on those assets.

The quick asset ratio gives an even better indication of the organisation’s ability to pay its
debts promptly. This is because the quick asset ratio excludes inventory from the calculation,
as inventory can be difficult to turn or convert into cash rapidly, especially in difficult trading
times. A ratio of less than one indicates the organisation has difficulty paying its short-term debts
immediately. The higher the ratio, the stronger the liquidity position.
Appendix 1.1 | 93

Table A1.4: Formulas for evaluating working capital

Evaluating short-term liquidity

Working capital = Current assets – Current liabilities

Working capital ratio = Current assets / Current liabilities

Quick asset ratio = (Current assets – Inventory) / (Current liabilities – Bank overdraft)

Evaluating efficiency

Receivables turnover = Sales / Average accounts receivable

Receivables days = 365 / Receivables turnover

Payables turnover = Costs of sales / Average accounts payable

Payables days = 365 / Payables turnover

Inventory turnover = Cost of sales / Average inventory

Inventory days = 365 / Inventory turnover

Source: CPA Australia 2015.

➤➤Question A1.5
Sportz Watch operates in a highly competitive industry. The following items were extracted from
its financial statements.

Cash $40 000 Cost of sales $396 000

Sales $840 000 Net cash from operations $88 000

Land and buildings $400 000 Inventory $120 000

Accounts payable $100 000 Net profit after interest and tax $50 000

Accounts receivable $130 000 Long-term loan $150 000

Capital $390 000

a) Calculate the following:

(i) total current assets.
(ii) total current liabilities.
(iii) working capital.
(iv) working capital ratio.
(v) quick asset ratio.
(b) Calculate the following ratios for evaluating working capital efficiency:
• receivables turnover
• receivable days
• payables turnover
• payable days
• inventory turnover
• inventory days.
(c) Prepare an evaluation of Sportz Watch’s working capital situation.

Appendix 1.1 Suggested answers

Question A1.1
(a) Raw material

Direct or indirect Direct cost. The plastic used for each watch band can be

directly linked or traced to the product.

Fixed or variable Variable cost. Although the cost per kilogram may be set,
the kilograms required will depend on the number of units
produced. So, the cost of the plastic will vary with the volume
of production.

Outlay or opportunity Outlay cost. Actual expenditure is required in this situation.

Relevant or sunk Relevant cost. This cost is incurred each time the product is
made, and it would be required for any decisions to produce
the product in a different manner.

Value-added or non-value-added Value-added cost. This cost is necessary for the product to be

Committed or discretionary Committed cost. This cost cannot be avoided as, based on the
product design, it requires this raw material.

Controllable or uncontrollable This can be viewed from two perspectives or stages in time.

Controllable cost. In the first instance, the cost is controllable

because the company can influence the product design and
components. Costs may also be partially controllable by good
management of the procurement function (i.e. having multiple
suppliers and strong negotiating skills).

Uncontrollable cost. Once the product has been designed

and is being manufactured, the cost of components is less
controllable. This lack of controllability depends on the level of
substitutes or alternative suppliers. Further, to the extent that
the raw materials are commodities with fluctuating prices based
on global markets, the ability to control these costs is limited
(even if appropriate hedging policies are in place).

(b) Advertising

Direct or indirect Direct cost. This cost can be directly traced to the watch.
Advertising is often an indirect or overhead cost, especially
when it is done for a whole range of an organisation’s products
or services. However, it is not automatically classified as an
indirect cost in all situations. Just because a cost is not part of
making the product, it is not automatically an indirect cost.

The important thing to determine is whether the cost incurred

can be directly traced to the item being analysed. In this
situation, the advertising can be linked to the watch in an
accurate, timely and cost-effective manner, so it is a direct cost.

Fixed or variable Fixed cost. The amount of $50 000 will be spent regardless
of the volume of watches produced or sold.

Outlay or opportunity Outlay cost. Actual expenditure is required in this situation.

Appendix 1.1 Suggested answers | 95

Relevant or sunk Sunk cost. Once the money has been spent, then it is sunk.
This means that any future decisions should not consider this
spending (e.g. whether to continue manufacture and sale of
the product).

Value-added or non-value-added Value-added cost. This cost is perceived to be necessary for

the product to generate sales and so this adds value.

Committed or discretionary Discretionary cost. This cost could have been avoided at the

manager’s discretion.

Controllable or uncontrollable Controllable cost. The managers of the company had full
control over whether this expenditure was incurred.

Question A1.2
(a) Overhead allocation
(i) To calculate the amount of manufacturing overhead to be allocated to each job, we first
need to calculate the overhead application rate.

Total Application
Allocation base Job 1 Job 2 Job 3 quantity Formula rate

Direct labour costs $50 000 $60 000 $90 000 $200 000 ($350 000 / $200 000) $1.75

Direct material dollars $35 000 $25 000 $40 000 $100 000 ($350 000 / $100 000) $3.50

Direct labour hours 1 250 2 000 3 000 6 250 ($350 000 / 6 250) $56.00

Machine hours 150 450 650 1 250 ($350 000 / 1 250) $280.00

(ii) Once the application rate has been calculated, apply overhead to each job. For example,
if direct labour costs are used as the allocation base:
|| the application rate for direct labour costs is $1.75
|| the direct labour cost for Job 1 is $50 000
|| the overhead to be applied to Job 1 would be 1.75 × $50 000 = $87 500.

Overhead allocated

Overhead allocation base Application rate Job 1 Job 2 Job 3 Total

Direct labour costs $1.75 $87 500 $105 000 $157 500 $350 000

Direct material dollars $3.50 $122 500 $87 500 $140 000 $350 000

Direct labour hours $56.00 $70 000 $112 000 $168 000 $350 000

Machine hours $280.00 $42 000 $126 000 $182 000 $350 000

(b) Control accounts

Direct materials and direct labour figures for each job are sourced from the original estimated
operating data. The total manufacturing overhead is given as $350 000. To calculate the
manufacturing overhead allocation for each job, the following information is needed:
(i) the machine hours for each job; and
(ii) the overhead application rate calculated in part a, being $280 per machine hour
(i.e. $350 000 / 1250 hours).

Manufacturing overhead for each job is therefore calculated as:

Job 1: 150 hours × $280 = $42 000
Job 2: 450 hours × $280 = $126 000
Job 3: 650 hours × $280 = $182 000

Job number Direct materials Direct labour overhead Total

1 $35 000 $50 000 $42 000 $127 000

2 $25 000 $60 000 $126 000 $211 000

3 $40 000 $90 000 $182 000 $312 000

Total $100 000 $200 000 $350 000 $650 000

(c) Effect on profitability of Job 1

From the answer to a (ii) above, the overhead applied to Job 1 using the two allocation bases is:
–– direct materials dollars $122 500
–– machine hours $42 000

This means that the overhead cost using direct materials dollars is $80 500 higher than the
cost when using machine hours. As such, the profitability of Job 1 should fall by $80 500
if direct materials dollars were used as the overhead allocation base instead of machine
hours (i.e. $122 500 – $42 000). The table below shows the difference in total estimated cost
(and hence profit) between these two overhead allocations bases.

Using machine Using direct

Job 1 hours material dollars

Direct materials $35 000 $35 000

Direct labour $50 000 $50 000

Manufacturing overhead $42 000 $122 500

Total costs $127 000 $207 500

Question A1.3
Sales budget July August September

Forecast sales (units) 1 300 1 900 2 200

× Unit sale price $220 $220 $220

Revenue $286 000 $418 000 $484 000

Appendix 1.1 Suggested answers | 97

Production budget June July August September October† November

Forecast sales (units) 1 300 1 900 2 200 2 300 2 500

+ Ending FG 260‡ 380 440 460 500

inventory (units)

– Starting FG –260‡ –380 –440 –460

inventory (units)

= Production 1 420 1 960 2 220 2 340
requirements (units)

October’s figures are needed to calculate the raw materials budget in part (d).

June’s ending FG inventory of 260 is calculated as 20 per cent of July sales of 1300. This number
then becomes the starting FG inventory for July.
Direct labour budget July August September

Production requirements (units) 1 420 1 960 2 220

× Direct labour hours per unit 2 2 2

× Direct labour cost per hour $17 $17 $17

= Total direct labour cost $48 280 $66 640 $75 480

(d) (i) To create a raw materials (RM) budget, do not start with the estimated sales figure.
Base this budget on the production requirements that were identified in the production
budget (see answer (b) above). Production requirements are in number of units (pairs of
shoes). That is why the production requirements for July are 1420 units, not 1300 units.
(ii) We need to convert the number of shoes into RM inventory volume (kg) to meet the
production requirements. This is done by multiplying production requirements (units) by
the RM per unit (0.8 kg). That is, each pair of shoes uses 800 grams or 0.8 kilograms of raw
material, which equates to $40 per pair of shoes (0.8 kilograms × $50 per kilogram).
(iii) Once the RM usage (kg) required for production is known, consider the ending and starting
RM inventory levels (in kilograms). This gives the total RM kilograms to be purchased.
(iv) The final step is to multiply the RM (kg) by the RM cost per kilogram ($50).

RM budget June July August September October†

Production requirements (shoes) 1 420 units 1 960 units 2 220 units 2 340 units

× Volume of RM per unit (kg) 0.8 kg 0.8 kg 0.8 kg 0.8 kg

= RM usage (kg) 1 136 kg 1 568 kg 1 776 kg 1 872 kg

+ Ending RM inventory (kg) 397.6 kg‡ 548.8 kg 621.6 kg 655.2 kg

– Starting RM inventory (kg) –397.6 kg‡ –548.8 kg –621.6 kg

= RM purchases (kg) 1 287.2 kg 1 640.8 kg 1 809.6 kg

× RM cost per kilogram $50 $50 $50

= Total RM cost $64 360 $82 040 $90 480

October’s raw material usage figures are needed to calculate the ending raw materials inventory
for September.

Ending raw material for June is calculated as 35 per cent of July’s raw material usage of 1136 kg.
This number then becomes the starting raw material figure for July.

Question A1.4
(a) Schedule of cash receipts (in April 20Y1) from sales

Item Description Calculation April 20Y1

April cash sales 20% of April sales of $565 000 are 20% × $565 000 $113 000
collected in April.

April credit sales (i) 80% of April sales of $565 000 are 80% × $565 000 = $452 000 $316 400
collected on credit; 70% × $452 000 = $316 400
(ii) 70% of the credit sales are
collected within April, the month
of sale.

March credit sales (i) 80% of March sales of $500 000 are 80% × $500 000 = $400 000 $80 000
collected on credit; 20% × $400 000 = $80 000
(ii) 20% of the March credit sales are
collected in April, the month after
the sale.

February credit sales (i) 80% of February sales of $300 000 80% × $300 000 = $240 000 $16 800
collected are on credit; 7% × $240 000 = $16 800
(ii) 7% of the February credit sales are
collected in April, two months after
the sale.

Total cash receipts $526 200

(b) Schedule of cash payments (in April 20Y1) from material purchases
Key items:
(i) Raw materials costs are 20 per cent of sales revenue.
(ii) Raw materials are purchased in the month before they are converted into final
products and sold.
(iii) 50 per cent of these RM purchases are paid for immediately with cash.
(iv) 50 per cent of these RM purchases are paid in the month after they are bought.

So, the relevant months to include are:

– March credit purchases paid for in April; and
– April cash purchases paid for immediately.
We do not include raw material purchases for March sales because these were purchased
in February, with the final instalment actually paid in March.

Item Description Calculation April 20Y1

March credit – March purchases are 20% of April 20% × $565 000 = $113 000 –$56 500
purchases sales of $565 000 50% × $113 000 = $56 500
– 50% of this is paid for in March, and
50% is bought on credit and paid
for in April, one month later.

April cash purchases – April purchases are 20% of May 20% × $600 000 = $120 000 –$60 000
sales of $600 000. 50% × $120 000 = $60 000
– 50% of this is paid with cash
immediately in April (the remainder
is settled in May)

Total cash payments –$116 500

Appendix 1.1 Suggested answers | 99

(c) Cash budget for April 20Y1

Cash budget April 20Y1

Starting cash balance (1 April) $75 000

Cash flows from operations

Receipts from customers (from cash receipts schedule) $526 200

Payments to suppliers and employees

Raw material purchases (from purchases schedule) –$116 500

Direct labour –$50 000

Variable and fixed overheads –$100 000

Total budgeted monthly operating expenses or overheads are
$125 000
• Less: Depreciation of $22 000 (as this is a non-cash item)
• Less: Prepaid rent of $3000 (as this was paid in January,
so it is a non-cash item for April)

Selling and administration –$25 000

$234 700

Cash flows from investing

Sales of non-current assets $13 000

Purchases of non-current assets –$10 000

$3 000

Cash flows from financing

Interest payments –$15 000

Closing cash balance (30 April) $297 700

Question A1.5
Some items to note when answering Question A1.5:
• Capital is part of equity.
• Net cash from operations is from the statement of cash flows. It represents the sum of all
operating cash inflows (e.g. sales revenue) and all operating cash outflows (e.g. payments
to employees and suppliers).

(a) (i) Total current assets

Cash $40 000

Accounts receivable $130 000

Inventory $120 000

Total current assets $290 000

(ii) Total current liabilities

Accounts payable $100 000

Total current liabilities $100 000


(iii) Working capital

Current assets $290 000

Less current liabilities ($100 000)

Working capital $190 000


(iv) Working capital ratio

Current assets / Current liabilities $290 000 / $100 000 2.9

(v) Quick asset ratio

(Current assets – Inventory) / ($290 000 – $120 000) / 1.7
(Current liabilities – Bank overdraft) ($100 000 – $0)

Efficiency ratios

Receivables turnover 6.46 times $840 000 / $130 000

Receivable days 57 days 365 / 6.46

Payables turnover 3.96 times $396 000 / $100 000

Payable days 92 days 365 / 3.96

Inventory turnover 3.30 times $396 000 / $120 000

Inventory days 111 days 365 / 3.3

(c) The company appears to be falling short in its working capital management in several areas.
Sportz Watch’s inventory and accounts receivable are relatively high and are contributing to
the high working capital ratio result. Its inventory levels may be too high, as they are being
held for too long (111 days). Issues that may arise from this delay are obsolete and damaged
stock and increased holding costs. Without further information, it is difficult to determine
whether accounts receivable turnover is too slow (i.e. if normal credit terms with customers
are 30 days) or if turnover is good (i.e. if credit terms are 60 days).

The business cycle is taking approximately 168 days from purchase of inventory (day 0) to
payment (92 days), to sale of goods (111 days—an additional 19 days) to cash collections
(57 days after sale). The cash cycle is taking approximately 76 days (111 days—92 days +
57 days) from payment of credit purchases to collection of credit sales. This shows that there
is scope for improvement to reduce this length and reduce the need for additional cash to
support the business through this period.

Sportz Watch has a working capital ratio of 2.9, which indicates a very strong or even excessive
short-term liquidity position. This means for every dollar of current liabilities, the company
has almost three times as much in current assets. This could indicate the company has too
many liquid assets that do not generate a sufficient return. Another way of describing this is
that Sportz Watch has too much working capital tied up in inventory and accounts receivable.
Appendix 1.1 Suggested answers | 101

An assessment of Sportz Watch’s ability to immediately pay off short-term debts shows a
quick asset ratio of 1.7. This means that it has a sufficient amount of liquid current assets to
pay off its current liabilities, so this is a reasonably strong position.

Accounts payable present another set of issues. Although late payments (averaging 92 days)
may help a company’s cash position, delaying payment over 60 days may affect relationships
with suppliers, who may refuse to continue supplying, increase prices or demand shorter
credit terms before supplying in the future. This is a strong indicator that the company has

efficiency issues that need to be carefully managed.
Suggested answers | 103

Suggested answers
Suggested answers

Question 1.1
The not-for-profit sector often provides services for less than they cost. Funding to provide these
services is often difficult to obtain and can come from the government, grants, donations or
membership subscriptions. It is essential that these organisations demonstrate accountability
for resources employed and the successful attainment of objectives for their operations to
remain sustainable in the long term. Strategic management accounting supports this through
developing effective performance measures, as well as detailed accounting of resource
allocation, consumption and outcomes.

The public sector has a responsibility to provide services and be accountable to citizens
(taxpayers). This requires the allocation of resources (billions of dollars annually for the public
sector and hundreds of thousands of employees), which need to be measured, controlled and
allocated. Both cost and effectiveness must be considered, and it is essential that detailed
performance measurement systems are in place to ensure plans are implemented successfully.

The information required to support strategic management and operational processes is

similar across most sectors. Examples of this include the traditional tasks of implementing and
monitoring internal controls, as well as working capital management (e.g. cash flows, receivables,
payables). These are essential in any organisation to enable both accountability and effective

The public and not-for-profit sectors often have a broader role as a result of their service
objectives, which are often difficult to quantify in financial terms. For management accountants,
this requires an even greater level of effort to effectively combine non-financial information and
performance measures.

Strategic management accounting is much more than just product costing and overhead
allocation. For organisations to be successful (i.e. meet their goals and objectives), they require
resources, strategies, action and control. Strategic management accounting provides useful
information in each of these areas to enable organisations to achieve their goals and objectives.
Even though they are not focused on making profits, the public sector and not-for-profit sectors
must still work hard to achieve their strategic outcomes with the resources they have available.
This requires financial discipline and clever and sound decision-making.

Services also need to be costed to ensure resources are being allocated and used appropriately.
Often, it is more difficult to cost services because they are intangible compared to physical
products made from combinations of raw materials.

Question 1.2

There is a wide range of competitor-related issues to consider as a result of changing foreign

currency levels. This answer provides some examples based on a scenario where the local
currency becomes stronger.

1. An organisation will be able to purchase imported raw materials, or manufacturing parts at

a lower cost, because its currency is able to purchase more foreign currency than before.
Having lower costs may enable the organisation to pass on price cuts that solely domestic
competitors might not be able to match. If the price cuts are not passed on to customers,
then profits will increase.

2. If an organisation exports products or services, the price for foreign-based buyers will
be higher than it was previously. This may make prices higher relative to foreign-based
competitors, which may make it difficult to remain competitive.

3. Some organisations believe they are not affected by changes in currency rates because they
do not import or export their products or services. This is not always correct, because even
in this situation problems may arise. Costs or prices may not change, but the local prices of
foreign competitors’ imported products will be lower than they were previously. This might
also encourage new foreign competitors to enter the marketplace.

The opposite is typically true if the local currency becomes weaker. Note that other issues may
also exist.

Question 1.3
The answer to this question will depend on the organisation chosen.

To provide a simple example of the impact of globalisation, imagine a manufacturer of packaged

soup noodles, with a good standing in its national market. Perhaps growth has now slowed
because the local market is becoming full of low-priced competitors. Meanwhile, its customers
are becoming attracted to new imported brands of soup noodles from another country.
Restrictions on trade and transport costs are no longer an impediment, as both road and air
freight have improved considerably.

In addition, just as the company’s customers are becoming interested in foreign brands,
the resistance of overseas customers to the company’s brand of soup noodles is likely to be
replaced with receptiveness, as television and online advertising conveys the brand’s distinctive
qualities. People in neighbouring countries may have more disposable income to try out
new products and are developing the curiosity to do this. As international competition is
consolidating in the region, the choice is to join this regional competition or remain a smaller
domestic brand facing erosion of local market share by overseas competitors.
Suggested answers | 105

Question 1.4
Some examples of changes to management accounting as a result of technological
developments include the following:
• Capital intensive. Investment in technology often requires significant amounts of cash.
As a result, accurate cash flow planning and management is essential to ensure stability.
• Shorter product life cycles. Products exist for a much shorter period than in the past, as they
are superseded by technological developments. At the same time, greater investments

in technology are required to keep up with the competition and ensure that returns on
investment are recouped in the shortest time possible. Appropriate pricing, product
characteristics and life cycle costing are essential to ensure an appropriate return.
• Automated sales, production and farming methods. Technologies are reducing the
amount of manual labour required, which changes the nature of costs from variable to fixed.
This is because labour is usually a variable cost that is linked to sales volume or production
levels. Automating a process by implementing new technology (e.g. self-scanning of
shopping by customers in supermarkets) or purchasing a large piece of machinery at a fixed
price and removing the manual labour element shifts a greater proportion of a business’s
costs to fixed costs. It also changes when costs are committed to and incurred very early
in the development stages as opposed to during production. Project estimations and
evaluations must be more accurate, and effective allocation of overhead is essential.
• Information. Vast amounts of information may now be stored, tracked, analysed and
communicated across multiple locations in a short time. Management accountants have
had to give up their role as information gatekeepers and transfer the power to access this
information to other employees throughout the organisation.

Question 1.5
Possible advantages of outsourcing business operations include the following:
1. risks may be shared with, or transferred to, another organisation;
2. using outside specialists may be more efficient and more cost-effective; and
3. managers no longer have to spend time directly managing the parts of the organisation that
have been outsourced—this will give them more time to focus on generating value in the
areas where they are most competent and comfortable.

Possible disadvantages of outsourcing business operations include the following:

1. anticipated cost savings are often not realised—this can occur because of the extra time and
cost required to manage the outsourcing relationship and because of inaccurate estimates;
2. the organisation that the operations have been outsourced to may not be able to provide an
acceptable level of service or performance; and
3. the organisation may lose core business knowledge, intellectual capital or property or control
of its value-generating activities.

Question 1.6
While this list is not exhaustive, additional factors that have affected organisations and driven
change include the following:
• Quality. In today’s environment, quality is no longer an extra to help attain a premium price
for your product. It is an essential characteristic of not only the outputs of an organisation,
but of the individual processes that link together to produce the final product.
• Customer focus. The power of today’s customers is growing as strong competition provides

them with choice and lower prices. The need to make products and deliver services that
customers desire is essential. Instead of pushing products towards them, organisations are
now expected to understand customers’ needs and then develop and sell solutions for those
needs. This has led to a major reorientation within organisations.
• Changing political structures around the world. Wars, shifts towards Western-style
capitalism and the development of new major economic powers, including China and India,
may all affect organisations.

Question 1.7
The overall role of strategic management accounting is to support management with useful
information, so at a broad level, it is doubtful that this role will change. Even if the basic functions
(e.g. planning and controlling) of management do change over time, or managers pursue new
and innovative responses to address contemporary challenges, it is unlikely that this support role
will change.

However, the way this support is provided may change. The management accounting role has
continued to expand, and the way it supports management has changed drastically over time.
From pure financial information delivery to a broader range of non-financial measures, business
support and involvement, the role continues to change and develop to stay relevant.

Question 1.8
Strategic management accounting information may be used as follows (note that this list
is not exhaustive):

• Urban growth. Establish capital budgets for new buildings and infrastructure.

• Liveability. Establish maintenance budgets to keep facilities in good working condition,

including playgrounds, community centres, parks and gardens.

• Economic prosperity. Provide budgets and forecasts in relation to the availability of

resources to fund community activities and developments. Measure the actual outcomes,
compare them to the desired outcomes and identify reasons for any discrepancies. Help
develop action plans to fix any problems that have occurred. Measure the number of people
receiving training and graduating, as well as the cost of providing this training.

• Transport. Cost various traffic management systems, including new roads, traffic lights
and road infrastructure (e.g. roundabouts and bicycle lanes). Set prices for things such
as car parking that encourage pedestrians and bicycles and discourage cars in particular
areas. Calculate the cost of transport incidents, and establish benchmarks and benefits
for improving transportation options.
Suggested answers | 107

• Environmental sustainability. Establish benchmarks of acceptable levels of environmental

resource usage, pollution and contamination, and other relevant data. Develop performance
measurement systems that collect, collate and communicate performance in these areas.

• Organisational accountability. Support the organisation by providing performance

measures to ensure accountability and avoid the misuse of resources. Establish specific
controls, including limiting the amount employees may spend without authorisation,
and project reporting to ensure large capital expenditures are managed carefully.

Question 1.9
Separating tasks between employees and requiring independent verification of key activities
help to reduce internal control problems by reducing the possibility of fraud or mistakes and by
increasing the chance of detecting problems.

Appropriate measures to protect both tangible and intangible assets are essential to reduce not
only fraud, but also accidents and mishaps that cause damage to assets or injury to employees.

Documents that capture information that is both accurate and complete are essential to
organisational systems and as a point of authentication and verification of key tasks and activities.
Documents provide an audit trail of actions that allow the examination of past events.

Effective reconciliations and other cash control measures, such as requiring joint signatures
on cheques, banking all cash daily or using only cheques and electronic funds transfers (EFTs),
are essential for protecting cash resources.

Question 1.10
Several internal control issues arise with Jan’s position performing the combined roles of
receiving customer orders and processing customer payments. Jan also processes invoices,
writes cheques and mails them.

Simon appears to be in charge of both initiating the purchasing process and raising the purchase
orders. This gives Simon several opportunities to commit fraud without being detected and
enables his mistakes to go unnoticed.

It may be useful to separate the roles and spread the responsibilities more clearly between
Jan and Simon and, possibly, other workers. In addition, independent verification of orders and
receipts of payments would be essential.

Additionally documents that collect relevant data for each task (e.g. purchase requisitions,
purchase orders, customer orders, customer receipts and delivery dockets) must be created,
verified for accuracy and stored accordingly. These documents should be pre-numbered in
sequential order to account for the completeness of transactions and to check for errors or fraud.

The security of physical assets would be a high priority, as many computer parts are very small
and valuable.

Cash control measures that may be useful include: dual signatures on cheques and frequent bank
reconciliations to check for errors or fraud. Jan should not be given the task of opening the mail
as well as processing customer payments. These two tasks should be segregated. Preferably,
two staff members should be present when the mail is opened, and a listing of the customer
payments received should be made. All customer payments should be deposited into the bank
on the same day they are received as opposed to every second day.

Case Study 1.1

This table provides some examples of potential areas of value for HZ’s stakeholder groups. It may
also be possible for HZ to perform poorly in a particular area and actually reduce value for a
particular group of stakeholders.

Owners The Jones family own 95 per cent of HZ. In addition to financial returns, they are
likely to gain value from receiving employment, career opportunities and the
ability to guide the direction of the company. Owners of the other 5 per cent
would probably be focused on seeing solid returns that compensate for the risk
and the level of investment they have made.

Lenders Being able to lend appropriate levels of money that will generate interest while
ensuring the company is able to repay them over time. Things that will destroy
value include insufficient cash flows or profits to repay the interest or principal.

Customers Electrical products that comply with safety standards are of high quality and
reasonable price, with good services attached including warranty support.

Suppliers Contracts that generate sufficient revenue for the costs involved as well as strong
and reliable working relationships.

Employees Appropriate reward for the effort contributed to the company in terms of both
monetary returns and qualitative items, such as recognition and job satisfaction.
Value would be destroyed by having conflicting management requests (i.e. having
to serve two masters).

Community groups Ensuring that products are safe to use, sustainable in terms of their raw materials
and recycled at the end of their life would all be seen as valuable to different
groups within the community.
References | 109


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Australian Securities Exchange Corporate Governance Council (ASX CGC) 2014, ‘Corporate
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International Federation of Accountants (IFAC) 2005b, ‘The roles and domain of the professional
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Module 2

* The author acknowledges the use in this module of some of the content previously prepared
by Peter Robinson. Updated by Robert Cornick.

Preview 115
Teaching materials

Part A: Value creation

Introduction 117
Organisations 117
Corporate governance 120
The leadership role of the professional accountant in achieving sustainability
Creating value 125
Value drivers
Impediments to value creation
Stakeholder value
Organisation value chain 132

Industry value chain 139

Linkages in the industry value chain
Management accountants and value analysis 144

Part B: Strategic management 149

Strategic management
Strategic analysis 155
Value analysis
Strengths, weaknesses, opportunities and threats
Internal analysis
External analysis
Strategic planning 172
Strategic management framework
What should a good strategy achieve?
Business Model Generation
Cost leadership, differentiation or focus?
Strategy choice 185
Strategy implementation 187
Implementation problems
The CPA and strategic management 188

Review 190

Reading 191
Reading 2.1 191

Suggested answers 211

References 231
Optional reading
Study guide | 115

Module 2:
Creating organisational
Study guide

The ability of any organisation to thrive depends on a variety of factors, but fundamentally,
an organisation must develop and maintain a sustainable competitive advantage. Competitive
advantage is often misunderstood. According to Magretta’s analysis of Michael Porter’s influential
work, achieving a sustainable competitive advantage ‘is not about beating rivals; it’s about
creating superior customer value’ (Magretta 2011).

Another common misunderstanding is that only private sector organisations must secure
a sustainable competitive advantage. However, in the public and not-for-profit sectors,
the continued support offered by government funding, donations or membership fees is
generally conditional upon an organisation’s ability to achieve desired goals and outcomes in
an efficient and effective manner. All organisations compete for resources and customers.

Sustainable competitive advantage and the efficient and effective delivery of outcomes flow
from an organisation’s ability to develop and display its value-adding capabilities. The more an
organisation creates value for stakeholders, the greater its ability to attract ongoing investment
and support.

Understanding how an organisation creates value is important for the organisation’s managers
and other stakeholders. The contribution of CPAs to the development of this understanding
cannot be overestimated. In this module, Part A examines the concept of the value chain and
the role of the management accountant in generating information for management and other
stakeholders about value-creating activities and value chain performance. This introduction
provides the foundation for a more detailed examination, presented in Module 4, of the strategic
management accounting tools used to increase organisational value in a sustainable way.

The ability to deliver long-term value and secure a competitive position depends on how
well an organisation develops and executes its strategy. Part B of this module provides an
overview of the strategic management process. It illustrates how organisations collect and
analyse strategically relevant information to develop an achievable set of objectives centred
on stakeholder value. Having developed objectives, organisations then consider alternative
strategies and choose the best strategies for implementation. Implementation is supported by
the development of management accounting systems that monitor key performance measures
and provide feedback for timely revision of the objectives and strategic plan, thus completing the
strategic management cycle. Measuring the performance of business units and their managers,
in terms of their success in achieving strategic objectives, is discussed in Module 3.

You will recall from Module 1 that HZ Electrical Pty Ltd (HZ) is a hypothetical case study used to
illustrate strategic management accounting issues. In this module, you are required to evaluate
the strategic planning processes employed by HZ.

Figure 2.1: Subject map highlighting Module 2


n n
v v
i i
r r
o Value o
n n
m m
e Vision / Mission e
n n
t Goals and objectives t
a a
l Strategy—Creation l
a a
n Strategy—Implementation n
l l
y Strategy—Implementation y
i i
s Control and feedback systems s

After completing this module, you should be able to:
• explain and apply organisation and industry value analysis in understanding value drivers
and in reconfiguring value chains;
• apply the strategic management framework to develop and implement organisational strategy;
• apply tools for internal and external strategic analysis; and
• identify strategies that organisations can adopt to deliver value to stakeholders.

Teaching materials
• Reading
Reading 2.1
‘Strategic cost management and the value chain’
J. Shank and V. Govindarajan

• Links to resources
In this module, links to websites with podcasts and videos are provided. These are optional
supplementary resources, which are included to assist you in understanding the concepts
contained in this module. The content of these optional supplementary resources is
not examinable.
Study guide | 117

Part A: Value creation

Organisations typically have multiple stakeholder groups, including shareholders, customers,
suppliers, employees, financiers, local, state and central governments, the local community,
human rights groups, donors and others. Each stakeholder group has financial, social and
environmental goals or considerations of value. While it is not unusual for these goals to differ
between various stakeholder groups, this can make it difficult for organisations to determine
how best to provide optimal value to each stakeholder.

Organisations exist to provide value to stakeholders, and this is achieved through the process
of corporate governance. Corporate governance is the set of processes by which business
corporations are directed and controlled, and includes both a conformance element and a
performance element.

The conformance element of corporate governance refers to compliance with corporate policy
and outside regulation.

The performance aspect of corporate governance is forward-looking and focused on helping

the board of directors make strategic decisions that deliver sustainable value, which benefits all
stakeholders. This is discussed in Part A.

Two analytical tools for understanding and enhancing value creation are introduced in
Part A—the organisation value chain and the industry value chain. The organisation’s value
chain comprises the input-transformation-output processes carried out by an organisation to
provide value to customers and other recipients of the organisations’ products and/or services.
The industry value chain comprises the chain of separate organisations operating in a particular
industry. In a manufacturing setting, this would begin with raw material acquisition, followed by
the production process itself, sales to the final customer and, where appropriate, the provision
of after-sales support.

The final section of Part A discusses the impact of the value chain concept on management
accounting practice. It highlights that management accountants—by identifying and measuring
activities, their inputs and outputs, and their value drivers—can generate relevant data to achieve
and enhance organisational value creation. The importance of managing linkages with suppliers
and customers within the industry value chain is also emphasised.

Why do we have organisations? Because organisations are an efficient means of organising the
production of goods and services.

A market is a location (either virtual or real) where resources are bought and sold. The most familiar
markets are consumer markets where people buy food, clothing and services. Other markets
exist where business or government organisations purchase goods and services from each
other, and there are markets that are internal to large corporations (e.g. Shell with exploration,
refining and distribution) or to networks of organisations where related business units deal among
themselves (e.g. the One World Alliance—a group of airlines).

Economics tells us that the interaction of demand and supply in a market (i.e. the interaction
between buyers and sellers) determines the quality, quantity and price of resources exchanged.
However, this is a simplified view and market failure does occur. In fact, the concept of a
‘perfect market’ is an ideal. No real market is perfectly efficient and competitive. In real markets,
the relationship between demand and supply is affected by several factors, including monopolies,
available information, timing issues and price and demand elasticity.

The demand elasticity for some goods is low. For example, demand for consumer staples
(like milk, bread or petrol) is relatively fixed and does not respond greatly to price changes.
In contrast, demand for other goods like consumer electronics is highly elastic; demand can
fluctuate rapidly in response to consumer sentiment, virtually regardless of price.

Another drag on markets is the mismatch between the timing of production and consumption.
As the supply of most goods depends on long-term investments in manufacturing, farming
or mining capacity, markets are frequently unable to respond in a timely way to demand
fluctuations, and price bubbles or price collapses often occur. An example is the US housing
market collapse that contributed to the global financial crisis (GFC) of 2008. Housing prices

surged in the 2000s, leading to oversupply and an eventual price collapse.

So, if markets are not always efficient, how should transactions be organised? According to
Coase (1937), business organisations exist because they offer an efficient alternative way
of organising transactions.

Transaction costs
A transaction cost is a cost ‘incurred in making a bargain, over and above the benefit exchanged’
(Law 2009). In other words, it is a cost on top of the price of products or services, but that is often
needed in order to ‘do business’. Transaction costs occur in every transaction—whether within
a business, between businesses, or in consumer markets. Examples of transaction costs include
the costs of writing contracts, collecting information and negotiating. Transaction costs are not
value adding and should be minimised.

Where transactions are simple and transaction costs are low—for instance, buying an apple—
buyers and sellers will trade in the market and there will be many small businesses engaged in
this sort of trade. For example, think of the many small fruit and vegetable shops that exist.

However, when transaction costs are high and transactions can be more economically
performed within an organisation than an external market, the large business organisation
emerges. Large organisations are more efficient at organising complex transactions than are
markets because the people within the organisation are more likely to cooperate to complete
transactions, and have greater cause to trust each other.

Examples of activities normally performed within large organisations (in order to minimise the
substantial transaction costs involved) include banking, car manufacturing and power generation.
To enter these industries, a high level of investment in both tangible assets and human capital is
required. Significant economies of scale and scope, and information advantages are available to
these large organisations, and these advantages can significantly reduce transaction costs.
Study guide | 119

Example 2.1: Transaction costs—a rail line

Examples of transaction costs include:
• collecting information about competing products or services prior to a purchase;
• negotiating a purchase with the seller and writing contracts (contracting costs); and
• financing investments.

While these costs may not seem significant at first glance, consider a major project: the purchase of
a light rail system for Vancouver by the provincial government of British Columbia. This was a multi
billion dollar project and the contract document ran to several volumes (thousands of pages). In order
to negotiate and write such a contract, a team of lawyers, engineers, accountants and top level
government personnel were busy for over a year—an enormously expensive exercise. Following the
signing of the contract, teams of accountants and other professionals were involved in guiding its
implementation and ensuring that the contractor fulfilled its obligations.

Example 2.2: Transaction costs—employment related

Transaction costs include many of the costs associated with employment. While the salaries paid directly

to employees for their work are not transaction costs, there are ‘employment-related costs’ that are
necessary for the continuing operation of the organisation. These costs are not incurred as a result of
creating products and/or services, but they do add to the overall cost of employment. Examples include:
• advertising;
• interviewing and gathering information about potential employees;
• selecting employees;
• writing contracts;
• training;
• paying incentives or bonuses to employees; and
• monitoring the performance of employees.

Such costs should be minimised to ensure efficient operation of the organisation.

Professional associations (like CPA Australia) and unions exist to reduce transaction costs for members
and employers by providing assurance about the competence and trustworthiness of current and
potential employees. This assurance reduces transaction costs for all labour market participants.

Transaction costs are important because they form a very significant and, as the size of
organisations in our society increases, a continually increasing part of the value chain.
The increase in transaction costs raises questions for organisations and for management
accountants, including the following:
• How can transaction costs be identified, measured and managed effectively (i.e. minimised
or eliminated)?
• How are these costs to be shared within a value chain?
• Can an organisation successfully transfer some of its transaction costs to its suppliers,
customers or other stakeholders?

A typical transaction cost problem confronting many organisations is the ‘make or buy’ decision
that arises when organisations consider outsourcing some of their activities to reduce costs or
to access the expertise of other organisations. Careful analysis of the costs and benefits of each
option is a critical role for the management accountant.

Example 2.3: Outsourcing

An Australian manufacturer of children’s car seats provides a good example of the cost–benefit issues
that can arise in outsourcing. Children’s car seats have a number of parts, each requiring a different
technology. These include metal fittings, fabric and upholstery, and plastics. The manufacturer’s
factory had areas devoted to each of these technologies. The business determined that running what
amounted to three small factories was inefficient, and that outsourcing the product to an overseas
manufacturer would save money.

Unfortunately, the business failed to appreciate the complexity of managing the contractual relationship
with the overseas manufacturer. Quality was poor and all product that arrived in Australia had to be
unpacked, checked and re-packed. The additional quality-control costs exceeded the savings, and the
business came near to bankruptcy before solving its problems.

Corporate governance

Organisations are controlled through the process of corporate governance (CG). Key elements
of CG are shown in Figure 2.2.

CG is a broad concept. It includes the entire accountability framework of an organisation.

Some governance control systems (like the audit committee and the internal control system)
are internal to the organisation, while others are externally imposed and enforced by regulation
and/or legislation. Some controls (such as the accounting information system) are formal,
while others such as the organisational culture are in formal.

The two dimensions of CG shown in Figure 2.2 are conformance (which is historical in its
orientation) and performance, (which is forward-looking). The conformance element is achieved
through codes and standards imposed and monitored up by audit and assurance. The International
Federation of Accountants (IFAC) notes that the key conformance components are:
• culture and tone at the top;
• the Chief Executive Officer (CEO);
• the board of directors; and
• internal controls (IFAC 2004, p. 9).

Figure 2.2: The corporate governance framework


Conformance Performance
(accountability (strategy and
and assurance) value creation)

Source: Adapted from International Federation of Accountants (IFAC) 2004, Enterprise Governance:
Getting the Balance Right, accessed July 2015,

Please note that a discussion of corporate governance, with a specific focus on conformance,
is contained in the ‘Ethics and Governance’ subject of the CPA program.
Study guide | 121

The performance element is focused on helping the board of directors to make strategic
decisions. Strategic planning, risk management and performance measurement are fundamental
features. IFAC (2004, p. 10) notes that the performance element depends mainly on the:
• choice and clarity of strategy;
• strategy execution;
• ability to respond to changes; and
• ability to undertake successful mergers and acquisitions (according to IFAC, this is the most
common cause of strategy-related failure).

The purpose of CG is to control organisations, but to what end? According to IFAC (2011),
organisations should achieve financial, social and environmental goals—a ‘triple bottom line’.
Together, the triple bottom line goals define sustainable practice. In short, the purpose of
organisations and of CG is sustainability.

In order to achieve sustainability:

Economic and technological developments must be simultaneously people centred and nature
based … [with respect to nature] … Damage to ecosystems is prevented, biological diversity

and productivity are conserved, the flow of energy and matter is moderated, and the economy is
converted to rely on renewable resources and resilient technologies … [with respect to people]
… A sustainable society democratises its political and workplace environments, humanises capital
creation and work, and vitalises human need fulfilment, ensuring sufficiency in meeting basic needs.

Source: Gladwin, T. N. 2000, ‘A call for sustainable development’, in T. Dickinson (ed.),
Mastering Strategy, Financial Times, Prentice Hall, Harlow, p. 97.

Friedman (1970) was an influential economist who is often cited because he argued that the sole
responsibility of a business’s management is to ‘increase profits and maximise the value provided
to shareholders’. Some people interpret this statement to mean that business managers need
not concern themselves with ethical, social or environmental matters outside of what is required
by the law, or with any stakeholder other than the shareholder. This is an incorrect interpretation.

In order to increase profit and maximise shareholder value in a sustainable way, managers must
act ethically and responsibly. If they do not, the organisation is put at risk. Breaking the law
through fraud or anti-competitive actions is one obvious source of risk, but reputation effects are
also critically important. Development of a culture of ethical and responsible behaviour is one
of the most important risk management practices that can be introduced by a board of directors
to ensure an organisation’s success.

Responsibilities to ‘other’ stakeholders are increasingly being defined more broadly in our
society. They include responsibilities to the:
• workforce, including the employees of suppliers and customers (see Example 2.5);
• community, including both the local community where the business operates, and the
global community (community values address health, education, poverty, recreational,
and spiritual and aesthetic values); and
• environment, both local and global environmental values include values relating
to air and water quality, climate stability, prevention of erosion, animal and plant
species conservation, preservation of genetic resources and control of biochemicals
(e.g. carcinogens like diesel exhaust).

These responsibilities are broadly termed corporate social responsibility (CSR), or alternatively,
corporate citizenship.

CSR can be defined as the extent to which an organisation accepts the economic, legal,
ethical and discretionary responsibilities expected by stakeholders. Discretionary responsibilities
are those that extend beyond economic, legal and ethical responsibilities, and that exist
for the betterment of society. For example, a discretionary responsibility might arise when a
corporation provides support for a community health facility or a sporting club.

Increasingly, there is a strong business case for an organisation to act in a socially

responsible way. A number of studies have shown CSR to be a significant source of
competitive advantage (see Black 2004 or Oketch 2004). Some investors will only invest in
socially responsible organisations. Accordingly, such organisations may achieve a lower cost
of capital. Some customers will only buy from socially responsible organisations, so these
organisations can expect to increase their market share in relation to less socially responsible
competitors. Organisations whose brand is associated with CSR are differentiated from their
competitors and this can be a source of competitive advantage. Additionally, CSR has been
shown to be a leading indicator of performance. These are several powerful arguments for
adopting higher levels of CSR to achieve higher levels of profitability.

Actions a business might take in relation to CSR include:

• ethical sourcing, which is a type of activism practised through positive buying of ‘ethical’
products, or a boycott of ‘unethical’ products. Many criteria-based ratings tables provide
information on the social and environmental performance of companies. Issues like animal
rights, human rights and pollution are addressed, empowering both consumers and
businesses to make informed choices about their purchases; and

• socially responsible investing, which is similar to ethical sourcing and is increasingly

common among consumers and businesses. Socially responsible investors can encourage
corporate practices that promote environmental stewardship, consumer protection,
human rights and diversity, or avoid businesses involved in, for example, alcohol, tobacco,
gambling or weapons. Large ratings agencies like Bloomberg and Reuters provide
environmental, social and governance information directly to stock market traders.
In addition, the London Stock Exchange publishes information on the ‘FTSE4Good’
Environmental Leaders Europe 40 Index (2014), which tracks the performance of the 40
largest European companies with high CSR ratings.

Along with the business case for CSR, it can be argued that CSR is important because it links CG
with business ethics. Ethics are the belief systems that people use to judge behaviour; they deal
with what is ‘right’ and ‘wrong’ and how people ought to act when faced with a particular
situation. Systematic support or structured approaches to making ethical decisions are important
for good governance. A business actively pursuing a heightened CSR strategy will be more likely
to have these supports and approaches in place, increasing the likelihood that the business
and its employees will operate in an ethical manner. Organisations that are socially responsible
typically show a high level of awareness of legitimate stakeholder demands, and are responsive
to these demands.

Example 2.4: Amcor Limited Sustainability Report

Amcor is a global leader in packaging solutions. The company operates more than 180 sites in
43 countries, has annual revenues of USD 9.5b and employs more than 27 000 people. The company
believes that its sustainability performance is not only valued by its stakeholders, but also provides
a competitive advantage. Because of this, a clear commitment to sustainability is embedded as part
of its overall strategy, articulated through its Belief Statement, Amcor Way Operating Model and
statement of ‘Core Values’, which are:
• Safety;
• Integrity;
• Teamwork;
• Innovation; and
• Social responsibility.

“… We respond to the needs of our communities and the environment …”

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The commitment and approach to Social Responsibility is further demonstrated in the company’s
2014 comprehensive (36 page) Sustainability Review, which details how the sustainability strategy is
delivered through the following five broad domains:
1. Environment;
2. Community;
3. Workplace;
4. Market place; and
5. Economy.

To ensure that information allows for benchmarking against various international standards and
corporate peers, reporting is in accordance with the Global Reporting Initiative (GRI) Sustainability
Reporting G4 Guidelines, AccountAbility’s AA1000 Assurance Standard (2008) and the Australian
Standard on Assurance Engagements ASAE3000.

Highlights from the 2014 Sustainability Report included reductions of:

• 19 per cent in greenhouse gas (GHG) emissions intensity (cumulative reduction target of 60% from
base year 2005/06 to be achieved by 2030);
• 53 per cent in waste to landfill intensity (target of 50% from 2010/11 to 2015/16, with a long-term
objective of zero waste to landfill); and

• 16 per cent in water use intensity.

Source: Adapted from Amcor 2014, Amcor Sustainability Review 2014, accessed September 2015,

An increasing number of organisations publish environmental measures based on revenue

in their sustainability reports (e.g. grams of carbon dioxide emitted per dollar of revenue
earned). Such measures can be useful because they allow comparisons from year to year,
as the organisation grows. However, because of inflation, revenue-based measures can
be expected to improve whether or not any reduction in emissions intensity takes place.
For example, if inflation is 3 per cent the measure will automatically improve by 3 per cent—
so such measures, if unadjusted for inflation, are inherently unreliable.

Management accountants need to develop high-quality CSR systems. Such systems identify
stakeholder groups and the financial, social and environmental requirements of these stakeholders.
CSR systems then contribute to the formation of goals and objectives, and report on progress
towards achievement of these objectives.

Example 2.5 highlights the importance of CSR and what can occur when there is a negative
perception of an organisation.

Example 2.5: Apple Inc. and CSR

Following the enormous success of the iPhone and iPad, by the early 2000s Apple’s products were
being manufactured in more than 700 locations around the world (Supplier List 2013 – Apple Inc.).
One of Apple’s major suppliers is a Chinese company, Foxconn. In late 2012, Foxconn admitted to the
use of child labour at one of its manufacturing facilities (China Labour Watch October 2012).

The US Constitution states that child labour is an illegal and inhumane practice, and any US organisation
found guilty of practising or encouraging it will be prosecuted.

Although Apple did not directly control production in China, the adverse media attention generated
by these events resulted in significant protests by human rights activists across North America and

As a result of this and other incidents of unsatisfactory work practices at some its subcontracted
manufacturers, Apple has subsequently vowed to completely eliminate child labour from its supply
chain. While Apple’s audit reports show improved conditions, there are still some problematic issues
in this regard within Apple’s supply chain. This highlights the complexity of effectively dealing with
these matters in an increasingly global business environment.

Stakeholder groups identified in this example include:

• Apple shareholders, management and employees who want to improve Apple’s reputation and
protect their incomes;
• Apple’s customers who want to be associated with an ethical brand;
• US regulatory authorities, the media and human rights activists who want to ensure that child
labour is prevented and the laws are upheld;
• Apple’s suppliers who want to minimise their costs and retain their contracts; and
• the children who want food, shelter and education.

If Apple had an appropriate CSR management system in place earlier, these problems might have
been identified and avoided. Unfortunately CSR issues persist and Apple is still in the public eye
(Meyers 2014).

➤➤Question 2.1
Examine your own organisation, or one with which you are familiar (such as the university you
attended). Identify the key stakeholder groups who have an interest in the organisation, and the
corporate social responsibilities (environmental and social goals) that are demanded of the
organisation by the stakeholder groups. Use the following table to organise your answer.


Stakeholder Corporate social responsibilities

The leadership role of the professional accountant in achieving

According to IFAC (2009), the role of professional accountants has expanded beyond the
preparation and assurance of financial and sustainability reports (compliance work). Specifically,
the IFAC Sustainability Framework was issued to help accountants grasp their responsibilities
regarding sustainability. The framework states that the professional accountant should take a
leadership role in all types of organisations to:
• challenge conventional assumptions;
• redefine success in accordance with sustainability;
• establish appropriate performance targets;
• encourage and reward the right behaviours; and
• ensure that information flows to support decisions that go beyond traditional ways of thinking
about economic success.

The IFAC framework makes it clear that sustainability requires an organisation to take full account
of its impact on the planet and its people. This means:
• promoting ethical responsibility and sound corporate governance;
• providing a safe working environment;
• promoting cultural diversity and equity;
• minimising adverse environmental impacts; and
• providing opportunities for social and economic development of communities.

The IFAC framework requires leadership responsibility to be assumed by management

accountants in relation to sustainability. Taking a leadership role in relation to reporting on
sustainability and social impacts is one way that management accountants can contribute to an
organisation’s obligations in this area.
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Example 2.6: Social and environmental impact assessments

An example of where the leadership skills of management accountants (discussed above) would be
useful is in preparing social and environmental impact assessment reports. These types of reports
are increasingly required by regulators and other stakeholders. They aim to bring about a more
sustainable and equitable biophysical and human environment through assessing the effects on
society of development projects (e.g. roads, factories, mines, dams and airports) before, during and
after implementation.

You can see an example of the requirements and guidelines for social impact assessments from
the Department of State Development, Infrastructure and Planning (in Queensland, Australia) at:

Creating value
What do organisations do? Organisations create value in a sustainable way.

Porter (1985) focuses on the importance of customer value:
Value is what buyers are willing to pay, and superior value stems from offering lower prices than
competitors for equivalent benefits, or providing unique benefits that more than offset a higher
price (Porter 1985, p. 3).

Kaplan and Norton (1992) focus on customer value as a leading indicator of shareholder value:
A company’s ability to innovate, improve, and learn ties directly to the company’s value. That is,
only through the ability to launch new products, create more value for customers, and improve
operating efficiencies continually can a company penetrate new markets and increase revenues
and margins—in short, grow and thereby increase shareholder value (Kaplan & Norton 1992, p. 76).

Thakor (2000) suggests that it is most important to focus on shareholder value because
shareholders are the residual claimants on the organisation’s resources. That is, other stakeholders,
like suppliers, customers and employees, will receive their share of organisational value before
shareholders receive theirs.

Albouy (2000) supports a comprehensive stakeholder focus:

Shareholder value creation makes it necessary to have ever more satisfied customers, with good
products, developed by motivated and skilled personnel, in relationship with the best possible
suppliers and subcontractors, while respecting public regulation (Albouy 2000, p. 374).

An organisation creates value for stakeholders when the revenue it receives for the products or
services it supplies to customers is greater than the direct costs and opportunity costs of the
resources used. For any production process or activity:

Value created = Value of benefits obtained

less Direct costs
less Opportunity costs of capital resources used

If you are familiar with the calculation of Economic Value Added or Residual Income you should
recognise this formula. In the residual income calculation, the opportunity cost is represented by
a ‘notional’ capital charge. Clearly, value can be increased by increasing benefits or by decreasing
direct costs or opportunity costs. Table 2.1 illustrates in a simple way how value can be measured
at different levels.

Table 2.1: Measuring value

Level of analysis Benefits Direct costs Opportunity costs

Business unit (BU) Total BU revenue Costs traceable to the Cost of capital employed
BU by the BU

Product line Product revenue Costs traceable to the Cost of capital assets
product traceable to the product

Activity—e.g. quality Reduced failure costs— Costs traceable to QC Cost of capital assets
control (QC) spoilage and warranty activity—prevention traceable to QC activity;
cost and monitoring cost of lost business

Many types of organisations exist in agriculture, manufacturing, mining, financial services,

defence, education, health care and other industry sectors. Some organisations make a profit
(and create value) by providing a product or service while others achieve social goals by serving
the community. A wide range of organisational goals exists, and many different approaches are

taken to achieve these goals.

While there are many differences between organisations, all successful organisations create
value by:
• competing for resources;
• processing or transforming the resources in a value chain; and
• supplying a product or service that meets the needs of their customers.

Understanding, measuring and managing the value creation process are critical strategic
management accounting activities. The value creation process is shown in Figure 2.3 and
illustrated in Example 2.7.

Figure 2.3: The input-transformation-output-outcomes model

Inputs Transformation Outputs Outcomes

Resources used as inputs may be in many forms:

• Raw materials—for example, agricultural products, timber or minerals.
• Physical—for example, property, plant and equipment.
• Human—for example, labour and managerial skills.
• Legal property rights—for example, patents, trademarks and brand names.
• Intangible—for example, intellectual capital or knowledge.

The activities that transform inputs into outputs create customer value. In order to maximise
value creation, the management accountant must answer three questions:
What are the key value drivers of the activity?
How do these value drivers affect some measure of value?
What innovations in the management of these drivers can be introduced?

The model described in Figure 2.3 can also be applied to the not-for-profit sector.
Example 2.7 shows how the model can be applied to a not-for-profit organisation that
is a charity for the homeless.
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Example 2.7: Not-for-profit (homeless charity), input–

transformation–output–outcomes model
Inputs Activities Outputs Outcomes

Donations Feeding the hungry Meals served Health

Staff Sheltering the Rooms provided Quality of life
Volunteers homeless Classes taught Employment
Facilities Job training and economic
Equipment independence

Value drivers
It is the management accountant’s job to identify and measure value drivers as well as measure
the inputs and outputs of value-creating activities in order to plan for, control, and maximise
value creation.

According to Thakor and DeGraff et al. (2001), for example, there are four main types of strategic
value drivers:
• collaboration;
• innovation;
• efficiency; and
• market awareness.

These four value drivers sometimes require trade-offs to be made, especially between efficiency
and the other three, and each organisation will be positioned differently with respect to the four
value drivers.

The chosen value drivers, or the organisation’s value proposition, have a determining effect on
the organisation in:
• the way that resources are allocated;
• the way performance is measured and rewarded; and
• the organisational culture and leadership style.

For example, in a factory, the main value drivers might relate to efficiency and include employee
training, employee talent, the factory layout and the complexity of the manufacturing process.
Innovations in these value drivers should lead to outcomes like shorter cycle times or reduced
waste, which lead in turn to a lower product cost and increased value.

➤➤Question 2.2
Examine your own organisation or choose a familiar organisation like McDonald’s or Toyota.
Describe the goals and the input-transformation-output-outcomes model (i.e. the value chain)
of the organisation.

Impediments to value creation

Thakor (2000) identifies three main impediments to value creation:
1. Lack of understanding of value. Managers and employees must understand, for their area
of responsibility at a minimum, the main value drivers and how these drivers create value.
2. Self-interested behaviour. In order to discourage self-interested behaviour, employees
should be rewarded for creating organisational value and for cross-functional collaboration.
3. Negative competition and functional orientation. In many organisations, power and
rewards are associated with the control of resources; managers of departments or
business units who have the most employees and the biggest budgets are paid the
most. This type of compensation structure rewards empire building and value destruction
because managers compete for resources without regard for their value creation potential,
or the organisation’s objectives.

Consider the following questions about your organisation or an organisation you are familiar with.
Does the organisation:
• reward employees for under-spending their budget and decreasing the use of resources in
order to create additional value?

• seek out and eliminate competitive activities within the organisation that destroy value?
• reward cross-functional collaboration?
• reward employees for identifying activities that could be performed more efficiently outside
their own functional area, whether by another functional area, or by outsourcing?
• encourage job rotation to ensure that employees understand the capabilities and
requirements of other functional areas?

Stakeholder value
As noted earlier, the goal of all organisations is sustainable value creation. In order to understand
the nature of the value that is to be created, and how this can be achieved, the management
accountant must understand the organisation’s stakeholders.

A useful way to think about an organisation is as a coalition of stakeholder groups who are
simultaneously competing for resources and collaborating to make the organisation successful.
In order for the organisation to survive and prosper, each stakeholder must make a contribution
to the organisation, and each stakeholder must get something they value in return for their
contribution. Table 2.2 shows how different organisations offer different value propositions
to stakeholders.

Table 2.2: Stakeholder value propositions

Stakeholder Provides Value propositions

Shareholder Equity Dividends and capital growth

Financiers Loans Interest and capital payments

Customer Revenue Quality products at a competitive price

Supplier Materials A fair price and regular orders

Managers Planning and control Salary, bonus and promotion

Workers Labour Training, wages, safety and job security

Government Infrastructure Taxes and compliance with the law

Community Land and workers Employment opportunities, taxes, clean air and water
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As can be seen from Table 2.2, delivering value to stakeholders requires organisational
resources. Because all value delivery requires some economic outlay, all stakeholder groups
are in competition for scarce resources. No stakeholder group will ever get everything that
they want, yet they must all get enough to ensure their continuing cooperation, and so ensure
the sustainability of the organisation. Finding an acceptable balance for all of the competing
claims of stakeholders is a key responsibility of top management and is an essential part of
strategic thinking.

Example 2.8 shows Origin Energy’s Value Distribution schedule from their 2014 GRI Disclosures.

Example 2.8: Origin Energy Value Distribution

Stakeholder $m %

Employees 783 36.0

Investors 1087 50.0

Community 7 0.3

Government (Tax) 299 13.7

Value added 2176 100

Source: Adapted from Origin Energy 2014b, GRI: Economic, p. 1, accessed October 2015, http://www.

Understanding and balancing the claims of stakeholders is a particularly challenging task for
not-for-profit organisations. Donors are the main source of revenue for many not-for-profit
organisations, yet donors do not receive a product or service for their contribution. The value
donors receive is intangible, and largely invisible. People must be convinced that a real need
exists and the not-for-profit organisation, as opposed to a competing charity or a government
service, is the best hope for addressing the need. The not-for-profit organisation needs to
demonstrate that what donors value is consistent with its mission and accomplishments.

Threats to stakeholder value

One major threat to stakeholder relationships and organisational sustainability is corporate tax
avoidance via the use of tax havens. For example, the following quote highlights Apple’s situation:
Even as Apple became the United States’ most profitable technology company, it legally avoided
billions in taxes in the US and around the world through a web of subsidiaries so complex it
spanned continents and went beyond anything most experts had ever seen, congressional
investigators disclosed on Monday (Schwartz & Duhigg 2013).

When organisations fail to satisfy the needs of their stakeholders, in this case the governments/
communities of the countries where Apple operates, then the coalition of stakeholders breaks
down and the organisation risks large penalties or even failure. Similarly, when governments
are unable to collect taxes, they cannot provide the physical and administrative infrastructure
necessary to support a modern economy, and the sustainability of the national economy is
brought into question. Professional accounting associations like CPA Australia contribute to
the sustainability of organisations and of national economies by developing and enforcing the
Code of Ethics for Professional Accountants.

Short-term and long-term stakeholder value

In the short term, value provided to one stakeholder group always reduces the value available
to other stakeholders. For example, if an organisation wishes to deliver greater customer value,
it may do this by providing higher quality items at a lower price. This provides customer value,
but at the expense of shareholder value (lower profit and dividends). However, an increase in
customer value may create long-term benefits for shareholder value, such as customer loyalty,
repeat business, and increased market share.

In the longer term, the relationship between employee, customer, supplier and shareholder value
is not one where benefits and costs completely offset each other. There are always opportunities to
create additional value throughout the organisation’s value chain by effective employment of the
value drivers noted above; that is, collaboration among stakeholders, innovation, efficiency and
market awareness. Good strategic planning and execution can deliver this overall increase in value.

Example 2.9 demonstrates the approach taken by Shell to ensure that strategic initiatives are
aligned with the overall objective of value creation.

Example 2.9: Strategic initiatives and value creation at Shell

Shell is a global group of energy and petrochemical companies, headquartered in The Hague, in the
Netherlands. The group operates in more than 70 countries, employs 94 000 employees and in 2014
had total revenue of USD 421b.

The company was early to recognise the benefits of incorporating sustainability as an integral element
of its value creation strategy—the 1998 Shell Annual Report introduced a number of new terms linked to
sustainable development, including the (then) relatively new concept of the ‘triple bottom line’ (TBL)†.

This term was first coined in 1994 by John Elkington, the founder of a British consultancy called SustainAbility
who argued that companies should be preparing three different (and quite separate) bottom lines. One is
the traditional measure of corporate profit—the ‘bottom line’ of the profit and loss account. The second is
the bottom line of a company’s ‘people account’—a measure of how socially responsible an organisation has
been throughout its operations. The third is the bottom line of the company’s ‘planet’ account—a measure
of how environmentally responsible it has been.

The TBL thus consists of three Ps: profit, people and planet. It aims to measure the financial, social and
environmental performance of the corporation over a period of time.

Nearly 20 years later, Shell continues to remain true to this philosophy, as evidenced by the following
statements from the 2014 Annual Report:
… The company strives to create competitive returns for shareholders by continually reinforcing
its position as a leader in the oil and gas industry while helping to meet global energy demand
in a responsible way. Safety, environmental and social responsibility have long been at the
heart of the company’s activities …
… Our approach to sustainability starts with running a safe, efficient, responsible and profitable
business. We also work to share benefits with the communities where we operate. And we’re
helping to shape a more sustainable energy future, by investing in low-carbon technologies
and collaborating with others on global energy challenges …

Highlights of the company’s achievement of these objectives in 2014 were:

• $14 billion spent in lower income countries.
• 1074 assessments of suppliers against the Shell Supplier Principles.
• $160 million spent on voluntary social investment worldwide.

Sources: Shell Global 2015a, ‘Shell global homepage’, accessed October 2015,
Shell Global 2015b, ‘Environment & society’, accessed October 2015,
Shell 2014, Sustainability Report, Royal Dutch Shell plc, accessed October 2015,
Study guide | 131

Since the value an organisation creates is not endless, the share of the value given to some
stakeholders (e.g. customers in the form of lower prices) cannot also be given to others
(e.g. better pay for employees). It is possible that Coles delivered superior value to customers
and shareholders at the expense of employees and suppliers. Downsizing the workforce or
using market power to pressure suppliers (for lower prices) are strategies commonly employed
by large and powerful organisations. One has to question, however, whether an aggressive
approach to extracting value from some stakeholders is sustainable. A collaborative approach to
value creation and organisational sustainability implies a sharing of the gains from value creation
initiatives amongst stakeholders. It also implies increasing available organisational value through
effective strategic management.

➤➤Question 2.3
In your own words provide a definition and a relevant performance measure† for:
(a) organisation value;
(b) shareholder value;

(c) customer value;
(d) employee value;
(e) community value; and
(f) supplier value.

For example, a relevant measure for shareholder value is return on investment (ROI).

➤➤Question 2.4
BikeCo is a family-owned company that has been manufacturing bicycles in Australia for 40 years.
The company manufactures eight models including children’s bikes, road racers and mountain
bikes, and has an above-average quality reputation. BikeCo distributes its products through 500
independent bicycle shops and has a 10 per cent market share. BikeCo’s most recent income
statement is shown below.
Income statement for the year ended 30 June 20Y1
Sales (100 000 bicycles × $200) 20 000
Variable cost 12 000
Contribution margin 8 000
Fixed manufacturing costs 4 000
Fixed selling and administration expenses 4 000
Net profit 0
Recently, BayMart (a discount department store chain) offered BikeCo an exclusive three-year
contract for 40 000 bicycles per year. BayMart wants BikeCo to provide private label (house-
brand) bicycles to be sold as the BayMart ‘Charger’ brand. Under the terms of the contract,
BayMart would require BikeCo to hold a two-month inventory of bicycles and would pay BikeCo
an average of $180 per unit, which is 10 per cent less than BikeCo’s current average unit selling
price of $200.
The Australian bicycle market has grown steadily over the past decade and many Australians
prefer to purchase locally manufactured products. However, due to a strong Australian dollar
and high local labour costs, most bicycles sold in Australia are now imported. Automation of
BikeCo’s production process would reduce unit cost, but retooling the factory would be expensive.
Currently, BikeCo is operating its factory at 80 per cent capacity.

(a) Calculate the factory’s unused capacity and contribution margin per unit.
(b) Using the figures calculated in (a), calculate the total contribution available, and the increase
to BikeCo’s profit, if the full capacity of the factory were to be achieved and sold.
(c) Based on the case facts provided above, identify the value proposition that the company
offers to five stakeholder groups.

Stakeholder Value proposition



Bicycle shops

BayMart/Department stores


Note: The BikeCo case continues in Questions 2.12 and 2.15.


Organisation value chain

Porter (1985) describes the sequence or network of activities that comprise an organisation’s
input-transformation-output process as a value chain. An organisation that can successfully
supply to its customers or other stakeholders does so because it is able to transform resources
from a less desirable state or location into a more valuable state or location.

Activities are the means by which an organisation creates value in its products or services.
An activity is any task that an organisation engages in with the intention of achieving a specified
goal. A simple way of understanding activities is that they are ‘what people do’. An accountant,
for example, might engage in activities like bookkeeping, reporting, training, communicating
with clients, and advising. Activities use resources and so incur costs. In combination with other
activities in a value chain, activities provide a product or service that can earn revenue from
customers. In a not-for-profit organisation, activities provide products or services, but these
are focused on providing stakeholder value in less-tangible forms (like the satisfaction a donor
receives when giving to a worthy cause, or the improved health of a hospital patient).

➤➤Question 2.5
Prepare a list of activities for a restaurant and identify the different ways these activities can
create value for customers.

Remember that activities are what people do, so start by identifying the restaurant employees and
their roles. Do not forget the support activities.

Porter (1985) studied the activities of several organisations and developed a generic model of
an organisation value chain (Figure 2.4).
Study guide | 133

Porter’s model shown below depicts how a typical ‘push based’ organisation might organise
primary and support activities to procure inputs, add value to the inputs by processing them,
and generate outputs of value to its customers. Primary activities transform resources into
finished products that are then sold to the customer, but primary activities cannot be successfully
undertaken without support activities.

Tables 2.3 and 2.5 provide examples of activities associated with each part of the value chain.

Figure 2.4: Organisation value chain









Source: Porter, M. E. 1985, Competitive Advantage: Creating and Sustaining Superior Performance,
The Free Press, New York, p. 37. Reprinted with the permission of The Free Press,
a division of Simon & Schuster, Inc. Copyright © 1985, 1998 by Michael E. Porter.

In Figure 2.4 the primary activities, which are shown sequentially at the bottom of the diagram,
are the activities that transform raw materials or resources into finished product. Support
activities, which are shown at the top of the diagram, are indirect activities and––although they
are not directly related to ‘transformation’––without them, the direct transformation process
may not occur.

As mentioned previously, the value chain of an organisation reflects that organisation’s

uniqueness. An organisation’s value chain might look quite different to the generic value chain
presented in Figure 2.4, and the classification of activities as ‘primary’ or ‘support’ might also be
different. Consider, for example, ‘accounting’ as an activity. In most organisations it is a support
activity but, in an accounting firm, it would also be a primary activity (i.e. operations). This is
discussed further a little later.

You should study Table 2.3 to ensure you fully understand that the value chain is a series of linked
and strategically relevant activities providing a competitive advantage to the organisation.

Table 2.3: Primary activities in the value chain of a manufacturing organisation


Primary activities Associated activities

Inbound logistics Locating, ordering, receiving, handling, storing and controlling the inputs to
the production system.

Operations Operations convert resources into a final product. In a manufacturing

organisation, operating activities are undertaken in the factory. Activities include
testing, quality control, scheduling, cost control and fixed asset management.

Outbound logistics Activities include packaging, warehousing and delivering.

Marketing and sales Marketing and sales are those activities that inform customers about the
product, persuade them to buy it, and enable them to do so. Activities include
brand development, advertising, promotion, sales order processing and
customer account management.

Service After-sale service augments the value of the product in the hands of the

customer through activities like product installation, product upgrades, repair,

maintenance and spare parts supply.

Source: Adapted from Viljoen, J. & Dann, S. 2000, Strategic Management: Planning and Implementing
Successful Corporate Strategies, 3rd edn, Longman, Melbourne, pp. 268–9.

You should also consider how value is created and destroyed in the primary activities in your
organisation, or an organisation with which you are familiar.

Table 2.4 provides some examples of how value is created and destroyed in primary activities.

Table 2.4: Creating and destroying value in primary activities


Primary activity Create value by Destroy value by

Inbound logistics Lowering material costs Aggressive negotiations with suppliers

that are in conflict with innovation goals
Delivering quality improvements and relationship goals
through sampling and statistical
analysis techniques Failing to hedge resource prices

Creating new features in components

provided by suppliers

Operations Lowering cycle time Poor quality products

Reducing headcount Cost overruns

Increasing manufacturing capacity Over-investment in working capital

Improving fixed asset utilisation Failure to outsource appropriately

Reducing working capital levels Over-engineered products with

unwanted features

Outbound logistics On-time and frequent delivery Late or infrequent delivery

Low-cost and environmentally friendly Back orders

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Primary activity Create value by Destroy value by

Marketing and sales Brand development Continuing with sales of unprofitable

Market development
Pricing products on the basis of
Increasing customer satisfaction resources used rather than market

Service Training of technical and other Failure to respond to customer needs in

customer support personnel a timely manner.

Source: Adapted from Thakor, A. V. 2000, Becoming a Better Value Creator, Jossey-Bass, San Francisco.

Table 2.5 provides examples of support activities.

Table 2.5: Support activities in the value chain of a manufacturing organisation


Support activities Associated activities

Procurement Acquiring the inputs required for production. Procurement activities include
the purchase of plant, parts and equipment.

Technology Technology development activities include research and development†,

development product design and manufacturing process improvement.

Human resource Human resource management activities ensure that the right people,
management with the right skills, abilities and motivation are made available to each activity.
Human resource management activities include the recruitment, training,
development and rewarding of people.

Firm infrastructure Systems. Systems activities ensure that efficient and effective information
management, reporting, planning and control systems operate within and
between each activity. Planning, finance and quality control activities are crucially
important to the performance of an organisation’s activities.

Marketing. Marketing, as a support activity, differs from marketing and sales

as a primary activity because it takes a longer-term perspective. For example,
if a pharmaceutical organisation provides samples of drugs to doctors, that is
a primary marketing activity. If the organisation gathers a group of prominent
doctors to suggest ways that products might be improved to better meet the
needs of patients, that would constitute a support marketing activity.

Research and development activities might sometimes be considered to be primary activities in
organisations where product upgrades are an important part of the business strategy—like the car
manufacturing or telecommunications industries.

Source: Adapted from Viljoen, J. & Dann, S. 2000, Strategic Management: Planning and Implementing
Successful Corporate Strategies, 3rd edn, Longman, Melbourne, pp. 268–9.

You should also consider how value is created and destroyed in the support activities in your
organisation, or an organisation with which you are familiar.

Table 2.6 provides some examples of how value is created and destroyed in support activities.

Table 2.6: Creating and destroying value in support activities


Support activities Create value by Destroy value by

Procurement Purchasing equipment that provides Purchasing flexible robotic equipment

world class cost performance and when the business strategy demands
efficiency efficiency

Technology Reducing wait time and move time in Incrementally improving out-of-date
development manufacturing processes systems

Developing new e-commerce Developing products that do not meet

products market needs

Human resources Attracting talented personnel Hiring the wrong people

Effective training Engaging in excessive litigation

Linking compensation to performance Linking compensation to the control of

resources and headcount

Firm infrastructure Reducing working capital as a Failing to report on and manage

percentage of sales significant risks

Identifying and divesting non-value Poor data reliability

adding assets
Maintaining multiple systems
Reducing interest costs
Providing excessive routine reporting
Providing in-depth market research to
support product development Developing products on the basis
of the technological expertise of the
organisation rather than the needs of

Source: Adapted from Thakor, A. V. 2000, Becoming a Better Value Creator, Jossey-Bass, San Francisco.

Example 2.10: Support activities

Consider the relationship between the human resources support activity and the operations primary
activity at Woolworths, one of Australia’s two largest chains of supermarkets.

At Woolworths, despite the growing use of self-service checkout facilities, a large number of staff
members still operate the checkout counters. It is important that these personnel understand how
to operate their terminals, deal with the pricing and other exceptions that often arise, and deal with
customers in a positive fashion. Woolworths’ human resources activity therefore has a critical role in
selecting personnel who have the ability to carry out these primary activities, and in training them to
operate in accordance with the Woolworths system. In fact, human resources has a role in supporting
every one of Woolworths’ primary and support activities.

Value chains will differ

Depending on the organisation, the position of activities in the value chain might differ from that
in Porter’s generic model. Some organisations ‘push’ their products; that is, they manufacture
their products and then attempt to sell them. For such organisations, marketing and sales
are near the end of the value chain. Other organisations have their products ‘pulled’; that is,
they produce to order. In such a case, the marketing and sales activity would be located near the
start of the value chain.
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In addition, some of the activities that appear in Porter’s value chain might not appear in the
value chain of a business.

For example, consider the value chain of a bakery. The primary activities include:
• purchasing raw materials; and
• transforming these into bread through
–– mixing and cooking;
–– packing;
–– storage; and
–– shipment.

For the primary activities to occur effectively and efficiently, the bakery requires support
activities including:
• hiring and training people to bake;
• purchase of plant, equipment and other infrastructure (ovens, mixing machines,
warehouses); and
• information technology (IT) to track products through the system, provide quality control

and process customer orders.

Drawing a value chain

Value chains are made up of activities. Activities are what people do. So the first step in drawing
a value chain is to list the organisation’s personnel and what they do. The activities of a restaurant
were identified in Question 2.5.

When drawing value chains, we focus on the activities that create or maintain value along the
input–transformation–output pathway; that is, activities that customers will be willing to pay for.
Note that, as previously mentioned, there may be several ways of presenting a value chain diagram.
The key is to ensure that it reflects the main activities in the value chain of the organisation.

In order to draw the restaurant value chain, primary activities are sequentially presented, from left
to right, according to their place in the input–transformation–output chain. Support activities
are presented in parallel with the chain of primary activities. Figure 2.4 provides an illustration
for a generic manufacturing company and Figure 2.5 below illustrates the restaurant value chain
constructed on the basis of information collected in Question 2.5.

Figure 2.5: Restaurant value chain

Primary activities

Sell Serve food/
food and Cook
food/drinks drinks

Procurement, Human resources, Accounting, Marketing, Maintenance

Support activities

Source: CPA Australia 2015.


Activities and their relationship to functions or departments

Porter (1985) clearly differentiates between activities and functions or departments. Functions
or departments (e.g. finance, human resources or production) reflect the formal structure of
an organisation, the organisation of labour and hierarchical reporting relationships. Activities,
in contrast, are simply the work that is undertaken—the things that people do.

An activity can be performed in a number of different departments. For example, a manufacturing

organisation needs to acquire many different types of resource inputs. The activity of acquiring
these resources is called procurement. Procurement is carried out by many individuals in many
different departments, because resources are best acquired by those most competent for the task.
For example:
• raw materials are procured by the purchasing department;
• IT software and hardware are procured by the IT department; and
• machinery is procured by production managers.

The procurement activity therefore crosses the boundaries of functional departments

(purchasing, IT and manufacturing). In order to maximise organisational value, organisations

should consider whether to focus on managing procurement at the business level rather than at
a departmental level. Taking a whole-of-business approach to procurement is likely to increase
its efficiency and effectiveness. The same can be said of other activities like quality control and
systems development.

An activity-based managerial approach is often called a horizontal management structure.

This can be contrasted with a traditional departmental and hierarchical approach to
management, which is called a vertical management structure.

In addition to the primary and support activities shown in Figure 2.4, Porter (1985) identifies
quality assurance activities as important. Quality assurance activities ensure that other activities
are performed appropriately. Examples of quality assurance activities include:
• the inspection of work in progress or fully finished inventories;
• the review of an activity (e.g. procurement) or business function (e.g. administration); and
• auditing (e.g. the quality of the accounting records and managerial reports).

Information technology and the value chain

IT has had a dramatic effect on the form of organisations’ value chains, and on their transaction
costs. Five features of IT are critical:
1. exponential increases in processing speed (computer chips, solid state mass storage);
2. optic fibre and wireless networks;
3. digitisation of products (TV, radio, books, music, video);
4. convergence of standards, protocols and supporting technologies (low-cost storage,
IP addresses, cloud computing); and
5. software development.

For example, many banks have made large investments in IT and automation, and simultaneously
reduced the scale of their branch networks. The value chain of personal banking is steadily
moving from being based on personal service and tangible assets to a virtual space where
self‑service is the norm. Arguably, a bank’s use of IT should result in lower fees and charges—
hence a more attractive price to customers—than if the bank were to provide its financial services
through a physical branch network. Larger banks will be the best positioned to exploit the scale
of their technology investments and so achieve the lowest unit costs.

In Reading 2.1, Exhibits 6 and 7, Shank and Govindarajan (1992) describe the value chains for a low
cost and a full-service airline. You should read Reading 2.1 now.
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➤➤Question 2.6
Describe the value chain, including both primary and support activities, using a format like
Tables 2.3 and 2.5, for a:
(a) manufacturing organisation;
(b) financial services organisation;
(c) charity organisation (e.g. Oxfam:; and
(d) public hospital.

Example 2.11: Reconfiguring Sara Lee’s value chain

Sara Lee Corp was the descendant of a Chicago grocery store called Sprague, Warner & Co, that was
founded during the American Civil War by Albert A. Sprague and Ezra J. Warner. Over the years,
the company evolved into a vertically integrated packaged food manufacturer.

By the early 2000s the management of Sara Lee had formed the view that the company really only

had one core competency that created competitive advantage, namely managing the Sara Lee brand.
Essentially, this competency was built on marketing expertise and a good understanding of customer
needs. Operationally, however, it was evident that the company had no particular advantage in actually
producing and distributing their products.

Because of this Sara Lee adopted a strategy of outsourcing the preparation and distribution of its
products through entering into manufacturing and distribution contracts with various external suppliers.
As long as Sara Lee could ensure the quality of its product through effective and efficient management
of the contracts with its suppliers, the company was able to focus on its key competency—increasing
the value of its brand.

Coca-Cola has adopted a similar strategy. Production and distribution of its soft drinks are licensed
to independent bottlers who purchase the flavouring syrup from Coca-Cola. The business strategy is
focused on the brand.

Sources: Adapted from ‘Sara Lee: Playing with the recipes’ and Reich, R. ‘Brand name knowledge’,
both cited in Hilton, R. and Maher, M. et al. 2000, Cost Management Strategies for Business
Decisions, Irwin, Toronto, p. 14. Encyclopedia of Chicago, accessed September 2015,

➤➤Question 2.7
Consider Sara Lee’s value chain before and after the outsourcing strategy:
(a) Draw a diagram of Sara Lee’s value chain before and after it outsourced its activities.
(b) What changes are there between the two value chains?
(c) What problems might you see for an organisation that has outsourced most of its value chain?

Industry value chain

The organisation value chain introduced above highlighted how an organisation can be
modelled as a network of primary and support activities designed to deliver value to its
stakeholders. However, the value chain concept is not limited to the analysis of organisational
value. It is also used in analysing industry value—the way an industry delivers value to its
participants. Some industry value chains are relatively simple, and others complex. For example,
the petroleum industry is relatively simple, involving oil exploration, drilling and production,
transportation, refining and petrol retailing. In contrast, the automobile industry is complex
because its supply chain sources inputs from the petroleum industry (plastics), the mining
industry (metals), the rubber industry (tyres) and the electronics industry.

The industry value chain begins with the production of raw materials and ends with the retail
distribution of products and services. Whether or not an organisation can develop a successful
strategy depends on how it manages its value chain relative to that of its competitors. To do this
well, the organisation must understand the entire value delivery system of its industry, not just the
portion of the value chain in which it participates.

The industry value chain is like a river. Upstream activities occur at the start and flow downstream.

Consider the bread industry. At the start, wheat and other grains are grown. Once the wheat is
planted, grown and harvested, it moves through the industry value chain (flows downstream)
for further processing into flour. Next, the flour is packaged, sold and distributed to bakers who
produce the bread. Once baked, the bread is packaged and distributed to retailers and finally
sold to the end consumer. Also note the importance of the various interlinking activities including
baking, packaging, transportation and retailing, which are all parts of the industry value chain.

Figure 2.6 presents an industry value chain for a manufactured product that identifies six
discrete roles. While larger more complex organisations can sometimes fulfil a number of

roles with an industry value chain, for the purpose of analysis it is common for each step to
be separately identified.

Figure 2.6: The industry value chain†

Retailer materials
6 1

Primary manufacturing
Distributor 5

Product producer

Note that in this simple industry value chain, the activities flow in a circle. Other representations of
industry value chains might show a vertical flow or a horizontal flow of activities. There is no ‘correct’
format. A format should be chosen that is most appropriate to the level of detail that needs to be shown.

Source: CPA Australia 2015.

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In order to better understand Figure 2.6, consider the automotive industry.

Role 1: Production of raw materials. An important material in the automotive industry is steel,
so a mining company that extracts iron ore from a mineral deposit could fill this role.
Role 2: Primary-level manufacturing, where the iron ore is processed into steel.
Role 3: Fabrication of automotive parts, such as car body panels, from the steel.
Role 4: Assembly of cars.
Role 5: Distribution of the cars to dealers.
Role 6: Retail sales.

A seventh role in the automotive industry might be after-sales service, where extended warranties
and servicing are provided by other companies.

It should be clear that industry value chains often overlap. In the auto industry value chain just
described, Role 1 is the production of raw materials. This role would encompass the steel making
industry, the plastics (petroleum) industry and others. The extent to which an organisation needs
to understand the full complexity of its industry value chain depends on its size and place in

the chain. For example, a steel manufacturer would have little interest in a rubber manufacturer.
On the other hand, a plastics manufacturer would be very interested in the rubber manufacturer as
the two industries often compete with substitute products (natural rubber versus synthetic rubber).

Vertical integration within an industry value chain occurs when one organisation expands to
take on multiple roles within an industry. The purposes of vertical integration are to eliminate
inter-organisational transaction costs (with suppliers or customers) and to enter profitable
segments of the industry value chain. Vertical integration within an industry value chain can flow
upstream or downstream. Upstream (or backwards) integration is movement towards the raw
materials end of the industry value chain. Downstream (or forwards) integration is movement
closer to the end-use customer.

Horizontal integration is also possible. This involves acquiring competitors that occupy the
same role in the value chain. The objective of horizontal integration is to create value through
economies of scale and, of course, through the removal of a competitor from the industry.

Example 2.12: Vertical integration in the automotive industry

In the automotive industry, where we find some of the largest corporations in the world, the largest
and most profitable organisations (e.g. Toyota or Mercedes) are assemblers and distributors. Very few
automotive organisations own an iron ore mine, a steel mill or an oil well. Automotive organisations
do manufacture some critical parts, such as engines and transmissions, but in general they rely on
independent suppliers for about 80 per cent of their parts. Additionally, few automotive organisations
directly own retail outlets (although they can control retailers through dealer licensing).

If Mercedes was to move to fabricate all its parts, that would be upstream integration. If the company
established its own retail distribution network, that would be downstream integration.

In Reading 2.1, Shank and Govindarajan (1992) describe the paper products industry value chain.
You should review Reading 2.1 now.

As shown by Shank and Govindarajan (1992), in the paper products industry, six roles are
carried out before the main product, newsprint, is sold to the final customer (the publisher of a
newspaper). The six roles are:
1. growing timber;
2. logging and wood chipping;
3. manufacturing pulp;
4. manufacturing paper;
5. processing paper products; and
6. distributing them to end-use customers.

Figure 2.7 shows how different organisations take on differing roles in an industry value
chain. A fully integrated organisation, Competitor A, competes with six other organisations
(B through G) that occupy one, two, three or four roles within the industry value chain.

Figure 2.7: The value chain in the paper products industry


Forestry and

Logging and
Competitor B

Competitor C

Competitor D

Competitor A

Competitor G

Competitor F
Competitor E


End-use customer

Source: Shank, J. K. & Govindarajan, V. 1992, ‘Strategic cost management and the value chain’,
Journal of Cost Management, vol. 5, no. 4, p. 6.
Study guide | 143

Linkages in the industry value chain

Strategists originally assumed that the industry value chain would operate at maximum efficiency
and produce optimum value if each industry participant maximised its own efficiency and value.
Subsequent analysis has shown this to be false. Competition between value chain participants
often leads to dysfunctional outcomes and reduces overall value.

Industry value chains are most efficient and effective when the organisations that make up the
value chain collaborate (Manzoni & Islam 2009). Trust, shared values and aligned goals are
critical factors in collaboration. Of course, obstacles exist to effective collaboration. Managing
collaborative relationships is a high-level skill that is most effective within long-term relationships.
Sharing risks and rewards, and determining the best way to measure performance, are important
and challenging aspects of this management role. Measurement is particularly challenging,
as management accountants must learn to measure performance across organisational
boundaries and, at the same time, assess and reward the contribution of each participant
to the joint outcome.

Collaboration enables organisations to more effectively plan their operations, minimise waste,

and generally reduce transaction costs. In the past, decoupled organisations had to forecast and
then plan operations around these forecasts. Forecast errors led to waste and inventory build-up.
In contrast, the modern organisation, by working collaboratively with suppliers and customers in
the industry value chain, can coordinate activities by sharing information. Waste, inventories and
transaction costs are minimised, and supply chain management can be significantly improved.

As a result of increasingly competitive global markets and the perceived benefits of vertical
and horizontal integration within industry value chains, organisations have found it beneficial to
adopt new organisational forms, such as strategic alliances and joint ventures. Alliances and joint
ventures are types of integration that, unlike mergers and acquisitions, do not involve a transfer
of ownership rights. An alliance can be defined as:
a co-operative arrangement between two or more organisations that forms part of, and is
consistent with, their overall strategy, and contributes to the achievement of their major goals
and objectives (Howarth, Gillin & Bailey 1995, p. 2).

Strategic alliances can be based on:

• service-level agreements;
• customer affinity programs (e.g. frequent flyer programs);
• purchaser–supplier collaborations; or
• joint ventures (e.g. between power generators and retailers).

An effective alliance is designed to reduce overall transaction costs (the costs of negotiating and
enforcing the terms and conditions of various contracts) and to create extra value for the members
of the alliance by providing members with access to broader markets and new resources.

Example 2.13: Star Alliance

Established in 1997, Star Alliance is a group of 27 airlines including Air New Zealand, Singapore
and United. The 27 airlines operate 4551 aircraft, collectively make 18 521 departures each day and
employ 410 274 staff. The participating airlines share the expensive infrastructure required for ticketing,
airport lounges and fleet logistics. The alliance allows the airlines to provide their customers with the
opportunity to fly to 1321 airports in 193 countries with just one air ticket, and provides access to a
single frequent flyer program honoured by all alliance participants. Star Alliance carried 654 million
passengers and generated $177 billion of revenue in 2014.

You will recall that, earlier in this module, the shortcomings of markets were noted, and the
organisation was proposed as a viable alternative for carrying out transactions. The term ‘mode
of control’ refers to how an organisation is owned, structured and controlled, and how it engages
with the industry value chain (i.e. whether it focuses on one area, or across the whole chain).
The market is at one end of the ‘mode of control’ continuum (see Figure 2.8), reflecting an
organisation’s need to frequently transact with other market participants. Hierarchical organisations
are at the other end of the continuum, reflecting their ability to conduct operations (e.g. product
design, marketing, manufacturing, transportation and accounting) internally. Alliances and joint
ventures are a third mode of control, sitting between the market and the hierarchical organisation.
An alliance is therefore a useful way for an organisation to manage transaction costs without
becoming a completely hierarchical organisation (i.e. doing everything internally).

Figure 2.8: Forms of business organisations

Hierarchy Global organisation

Mode of control

Stand-alone business
Market demand
Per cent of market-based transactions

Source: CPA Australia 2015.

As ‘stand-alone’ airlines are not part of an alliance, they have to compete with each other in the
marketplace. They have to develop their own systems, and can offer customers relatively limited
travel options. At the other extreme one airline could horizontally integrate, taking over a number
of regional airlines in order to develop a global presence and benefit from the efficiencies
inherent in major IT systems and large-scale operations. While this latter approach may be
attractive, the airline industry is similar to many others in that national governments frequently
restrict foreign ownership. Alliances are, for this reason, an attractive approach to organisational
design in this and many other industries.

Management accountants and value analysis

Organisation and industry value chains exist to deliver stakeholder value. They do this through a
network of interconnected primary and support activities. Value analysis involves examining the
parts of the value chain—the activities, and the value chains themselves—in order to optimise the
value produced for stakeholders. To do this, the management accountant must take a strategic
view of the organisation.

The value chain has significant implications for management accounting systems (MAS).
In the past, MAS delivered accounting information that met the decision-making needs of the
managers of vertically controlled (hierarchical) organisational units. The main focus of the MAS
was on internal cost centres (i.e. departmental budgets, standard costs and variance analysis).
These MAS limited the competitive effectiveness of organisations and potentially destroyed
value (e.g. when managers spent time and resources attempting to achieve out-of-date or
inaccurate budgets, and uncompetitive standard costs).
Study guide | 145

As modern-day organisations are increasingly organised and managed with reference to activities
that cut horizontally across departmental boundaries, and even across organisation boundaries,
MAS have also been reorganised around activities to enhance the value creation process.
These new MAS focus on product- and market-oriented information flowing horizontally from
supplier to customer—not on internal cost centres.

Horizontally oriented and product-oriented information systems should provide management

accountants and managers with information about the value drivers that contribute to value
creation and competitive advantage. These value drivers are:
• strategy;
• collaboration;
• customer satisfaction;
• quality;
• innovation; and
• time.
The strategic importance of value chain management demands that management accountants
become familiar with the concept and provide information so an organisation can understand

and manage its value chain and that of its industry, and hence establish a coherent strategy
(Porter 1985).

Shank and Govindarajan (1992) suggest that value analysis must focus on how organisations
create value and, particularly, how they can exploit linkages with suppliers and customers up
and down the industry value chain. Similarly, Munday (1992) says that management accountants
must consider how cost reductions can be achieved and value created in both the organisational
and the industry value chains.

While value analysis can be done as a special project to enhance stakeholder value in the
short term, in reality it is a holistic approach to visualising and managing an organisation.
Organisations, and the industries in which they operate, are dynamic. For example:
• stakeholder needs change over time; and
• organisational and industry value chains change in response to:
–– innovation;
–– economic conditions; and
–– competitive pressures.

Value analysis is best approached as an ongoing cycle designed to support the continuous
development of organisational strategy.

Value analysis creates a view of the organisation and its industry as a complex web of interrelated
activities. Effective management of the organisation entails extracting the most value from each
activity, and organising the value chains of each product and market in the most effective way.
This requires:
• reconfiguring existing value chains;
• eliminating non-value adding activities;
• introducing new activities; and
• enhancing the efficiency of existing activities.

To do this, value analysis requires the management accountant to identify:

• significant activities;
• inputs (costs/resources) and outputs of activities in both financial and non-financial terms;
• value created by an activity;
• the value driver of an activity;
• linkages between value-creating activities within the organisation; and
• linkages between value-creating activities that cross organisational boundaries (with suppliers
and customers, e.g. quality control).

Having collected this basic data, the management accountant is in a position to provide
management with performance measures and advice to aid in the management of strategically
important activities, value drivers and linkages.

Example 2.14: Open book approach

In many modern purchaser–supplier relationships, the accounting books of the supplier are opened to the
purchaser. While an open-book approach might provide the purchaser with information to use against the
supplier in price negotiations, it also makes it possible for the purchaser and the supplier to cooperate
on initiatives to reduce overall value chain costs, and then share the benefits of the cost reductions.

Such a cooperative approach is commonly used in the automotive industry. For example, it is common
for engineers from Toyota or Ford to spend much of their time working with supplier organisations to
improve their manufacturing processes, and so better integrate the supplier into the buyer’s value chain.

Performance measures and investment decisions


As value analysis emphasises the importance of building sustainable partnerships to improve

the competitive position of the organisation, relevant non-financial and team-based measures of
performance must be adopted. Changes in the nature of performance measures, and a growing
appreciation of the linkages between them, suggest that management accountants must
develop more comprehensive performance measurement frameworks. The balanced scorecard
is the best known and most widely used of these frameworks, and is discussed in Module 3.

The value chain also has implications for the type of investments that organisations make,
and how investment decisions are made. Investments in new technology have strategic and
economic implications for organisations, as well as for an organisation’s suppliers and customers.
Investment decisions must take into account the impact on the industry rather than just the
organisation. Module 5 discusses the capital investment decision.

The management accountant’s role must focus on the value chain. Table 2.7 summarises the
differences between traditional and strategic management accounting views. The traditional
view of the value chain has a short-term, internal and functional focus, where improving the
cost performance of parts of the organisation is seen as the key to improving profitability and
return on investment. In contrast, the strategic view of the value chain is focused on internal and
external linkages. It encourages the creation of value through the development of partnerships
that cross departmental or organisational boundaries. This requires a broad view of what creates
organisational value, and it requires a long-term view of what constitutes a successful and
sustainable organisation.
Study guide | 147

Table 2.7: Traditional and strategic views of the value chain

Points of difference Traditional Strategic

Focus • Internal—mainly • External supplier–customer

manufacturing operations linkages
• Short-term profit • Industry value
• Sustainable value creation

Cost objects • Products • Activities

• Functions • Product attributes
• Departments • Markets

Organisational • Departmental • Strategic business units

• Cost, revenue, profit and • Value chains
investment centres

Linkages • Largely ignored • Shared aim of value creation

• Cost allocations and transfer • Linkages recognised and
prices used to reflect managed cooperatively

interdependencies • Alliances
• Win/lose relationship with • Collaboration
suppliers and customers and
other departments

Cost drivers • Volume-based allocation of • Multiple value drivers

costs—often unrelated to • Cost drivers directly affect
economic value economic value
• Arbitrarily chosen

Accuracy • High apparent precision • Low precision

• Lack of economic substance • Future orientation
• Economic substance

Cost containment philosophy • An across-the-board cost • Cost containment is achieved

reduction approach by managing the cost drivers of
• A focus on improving the activities
existing situation • Cost improvement is achieved
through reconfiguring value
chains and improving linkages
with suppliers and customers

➤➤Question 2.8
Debits and Credits Ltd (DCL) develops and sells accounting software packages. Figure 2.9 shows
the value chain of DCL.

Figure 2.9: Organisational value chain of DCL

Executive governing structure of DCL

Including the board of directors and the senior executive management team

New 2 4 6
Procurement 3 5
product Production Marketing Distribution After-sales
research of resources and sales service
and design

Organisational enabling structure of DCL

Including legal, accounting and finance, human resources and information technology

(a) Assign each of the costs listed below to the appropriate section of DCL’s organisational value

In the year ending 30 June 20X0, DCL incurred the following costs:
1. Purchase of blank DVDs to be used for burning accounting software packages for sale
to DCL’s customers.
2. Payments made to an internet service provider for bandwidth for the delivery of software
packages to licence holders.
3. Costs of developing new user-friendly screen layouts for existing accounting software
4. Fees paid to graphic designers for the design and construction of display units to be
used in major retail stores that sell computer software.
5. Costs of development and delivery of sales training packages to the staff of customers
that stock and sell DCL software.
6. Legal and related consulting costs incurred in the purchase of a new subsidiary, Payroll
Software Ltd (PSL). PSL has developed software that DCL believes will improve the payroll
functionality in its top-selling accounting software package.
7. The costs of staff employed to operate DCL’s customer help desk.
8. The cost of the feasibility study for the development of a new e-store for DCL’s software
9. Burning software onto DVDs and packing for sale.
(b) Construct an industry value chain for DCL modelled on Figure 2.7, the paper products industry
value chain. As DCL is a service business, the value chain will be significantly different. Consider
the industry DCL operates in, its suppliers (upstream) and its customers (downstream).
Study guide | 149

Part B: Strategic management

Part B begins by defining strategy and discussing the nature of strategic management and some
of its important limiting assumptions. We then move on to develop an understanding of each of
the four aspects of strategic management:
1. strategic analysis (analysis of an organisations’ internal and external environments);
2. strategic planning;
3. strategy choice; and
4. strategy implementation.

Strategy implementation is the major theme of Modules 3, 4 and 5. It is important to appreciate

that strategic management is an ongoing and repetitive process with many feedback loops.

A strategy is a road map for getting to a goal. It shows how resources will be allocated and

provides guidance on which activities to undertake. A good strategy provides a match between
the internal capabilities of an organisation and its external environment, and meets the goals of
the organisation’s stakeholders. Strategy is focused on the future; it is goal-oriented, long-term
and outward-looking.

Porter (1980) states that business strategy is a set of:

… Offensive or defensive actions to create a defensible position in an industry, to cope successfully
with … competitive forces and thereby yield a superior return on investment for the organisation …
(Porter 1980, p. 34).

Porter makes some key observations:

• The best strategy for a given organisation is ultimately a unique construction reflecting its
particular circumstances.
• A meaningful strategy makes it clear what the organisation will not do. Trade-offs make
competitive advantage possible.
• The sign of a good strategy is that it deliberately makes some customers unhappy
(Magretta 2011, p. 184).

The last observation requires some explanation. As an example, low cost may be very important
to some customers. If an organisation has successfully differentiated its product, it should be
able to charge a premium price and so will choose not to satisfy price-sensitive customers.
Dropping the price would mean abandoning the strategy.

Example 2.15: Qantas’ strategy

Corporations sometimes seek to adopt more than one strategic position to create value. This is
appropriate because corporate strategy is often about acquiring a portfolio of businesses. Having
selected a number of business units in one or more industries, a strategy is chosen for each business
to establish and enhance its competitive position in its industry.

Qantas has a corporate strategy of focusing on the airline industry. Within this corporate strategy,
Qantas pursues two main lines of business—air travel and airfreight. Within the air travel business,
Qantas has developed three strategic business units: the frequent flyer program, Jetstar and Qantas.
The Jetstar business unit offers relatively minimal service and pursues an essentially low-cost strategy,
while the Qantas business unit pursues a full-service and high-price strategy. Qantas has been careful
in identifying the routes, flight times and market segments that each business unit serves to ensure
that they do not compete with each other, and that both compete effectively with other carriers.

Qantas has also separated its profitable domestic business from its loss-making international business.
In 2013, Qantas’ international business unit entered into a partnership agreement with another
international carrier in order to direct passengers into their domestic business.

You will recall the comparison of the People Express and United Airlines value chains in Reading 2.1.
These value chains clearly show the differences between a budget and a full service airline.

Strategic management
The goal of strategic management is to achieve a sustainable competitive advantage evidenced
by a superior return on invested capital (ROIC). Emerging competitive forces (e.g. new competitors
or substitute products) continually challenge the commercial viability of an organisation’s existing
product range and marketing strategies. If an organisation focuses solely on existing products and
markets, it is likely to lose market share and profitability. To remain competitive, organisations must
defend their products and markets, but also continually reinvent themselves. This is the essence of
the strategic management process.

Competitive advantage can be defined as anything that gives an organisation an edge over
its industry rivals in the products it sells or the services it offers. Ideally, organisations seek to
achieve and maintain sustainable competitive advantage (Porter 1985). Unless advantage can
be sustained, profitability will, over time, be eroded as competitors seek to share in the benefits.
Strategic management is therefore about creating unique and superior customer value.

Practically speaking, strategic management is a set of techniques for understanding, and therefore
influencing, an organisation’s strategic position in existing and future markets. While differing views
exist about the functions that comprise strategic management, as mentioned previously, most
suggest that a strategic management framework includes:
• strategic analysis;
• strategic planning;
• strategy choice; and
• strategy implementation.

Johnson and Scholes (2002, pp. 4–9) suggest that strategic management should:
• establish the scope of the organisation’s activities (draw boundaries);
• match the organisation’s activities to its capabilities (strengths);
• allocate resources;
• facilitate strategy implementation by setting a framework for operational decisions;
• reflect the values and expectations of senior managers and other key stakeholders;
and affect the long-term direction of the organisation.
Study guide | 151

Strategic management processes are undertaken by the board of directors and senior
executives when they:
• set goals and objectives for the organisation.
• formulate and implement strategies that
–– are consistent with the organisation’s environment;
–– aim to achieve the organisation’s goals; and
–– reinforce one another (strategic fit).
• Implement appropriate strategic management accounting control systems to
–– identify and manage risks;
–– formulate and evaluate strategies; and
–– control strategy implementation.

Management accounting systems collect strategically relevant information about the organisation
and its environment, establish performance measures and targets for organisational objectives,
and monitor performance through variance analysis and other methods of performance evaluation.
Figure 2.10 highlights the key elements of the strategic management framework described above.

Figure 2.10: Strategic management framework

Vision, mission, goals

Strategic analysis

and objectives

Industry, national Value analysis Organisational

and global factors SWOT analysis capabilities

Strategic plan/Choice


Source: CPA Australia 2015.

Strategic management is not the same as operational management. Operational management

ensures the efficient deployment of resources in the pursuit of an agreed strategy. It is mainly
short-term and internal in its orientation. Like strategic management, accounting for operations
involves target setting, performance measurement and variance analysis.

When examining strategic management, it is important to be aware that it is based on three
1. the environment is predictable;
2. organisations and people are controllable; and
3. decision-makers act rationally.

Each of these assumptions can be questioned.


First, it is obvious that it is not usually possible to reliably predict the future. Predictions about
asset lives, the productivity of assets and employees, market demand, interest rates, exchange
rates, future revenue streams and future resource costs all require the use of subjective judgment.
In order to cope with the unreliability of predictions, techniques such as scenario analysis and
sensitivity analysis have been developed to minimise the level of uncertainty.

Sensitivity analysis involves exploring ranges, rather than point estimates, for key variables
such as interest rates, prices, demand, etc. Scenario analysis involves exploring a range of
scenarios such as ‘pessimistic’, ‘most likely’ and ‘optimistic’. For example, in an optimistic
scenario, financing costs would be low, prices would be high and demand would grow strongly.
Both scenario analysis and sensitivity analysis are important tools of risk management.

Sensitivity analysis and scenario analysis are discussed further in Module 5. Sensitivity analysis
and scenario analysis do not have universal acceptance because of the subjectivity of the analysis
and the range of results that are obtained. However, as it is not possible to accurately predict the
future, understanding the range of possible outcomes is far more useful than any point estimate
is likely to be. The process of analysis, and the learning that arises from this, is likely to be more

valuable in improving decision-making than the use of a so-called ‘accurate’ estimate. In fact, it is
important to remember that any estimate of future outcomes may be wrong, and that the extent
of the error, and as a consequence its effect on organisational performance, is unknowable.

Second, control systems, and particularly remuneration systems, may be unreliable because they
often encourage unintended or dysfunctional behaviours, such as fraudulent financial reporting
or the maximisation of short-term profits at the expense of long-term return on investment.
Accounting control systems can be highly motivational, and this is both a great strength and a
great weakness. People will often focus on target achievement regardless of any detrimental
effect on themselves or their organisations (the behavioural consequences of performance
measures and performance targets are discussed in Module 3).

Another factor contributing to the unreliability of accounting control systems is the proxy
nature of most performance measures (see Module 3 ‘Performance indicators’). For example,
profit is said to measure the economic performance of a business unit, but profit is affected
by depreciation charges and other accruals, some of which are necessarily quite arbitrary.
Similarly, net asset value is said to provide a measure of the economic value of an organisation,
but frequently the market value of an organisation is a multiple of net asset value. Net profit and
net assets are therefore problematic indicators of true economic value.

Third, psychologists have for many years studied human decision-making and have identified a
multitude of common and persistent factors that compromise the process. Decision-makers are
subject to poorly understood biases, and are able to reason only imperfectly. People are said
to be ‘creatures of habit’. They seldom question common assumptions or the way that things
have been done in the past. As recommended by IFAC, it is very important that management
accountants question common assumptions, accepted practices and their own biases.

We can therefore conclude that strategic management is inherently uncertain. Organisational

and managerial control can be highly effective in the short term and in stable environments,
but in the longer term, environmental complexity and instability make any notion of rational
control questionable.
Study guide | 153

So why invest resources in strategic management? Because some long-term and external analysis
is better than none, and executive teams that engage in strategic management have been shown
to outperform those who do not. In a study of larger Australian organisations, Bedford and
Malmi (2009) reported that greater formality in strategic planning enhances organisational
performance. Performance is improved when:
• strategic goals are specific, detailed and quantified;
• strategic plans are highly detailed;
• strategic plans are tightly followed; and
• strategy is developed through formalised processes.

Formalised strategic planning processes provide greater focus, clarity and consensus on strategic
objectives, and on the actions required to realise these objectives.

Managers and management accountants can help to overcome the shortcomings of their
systems and the nature of human biases by doing their best to understand them. Ultimately,
organisational success is not measured in absolute terms, but is defined in relation to competitors
who are faced with similar difficulties with their own strategic management processes.

Organisations exist in the for-profit and the not-for-profit sectors, the private and public
sectors, and in many different industries. All organisations are defined by their value chains,
their stakeholders, and the strategies they employ to fulfil their goals. While the discussion of
strategic management in this module makes reference mainly to profit-making organisations,
all of the concepts introduced are also broadly applicable because all organisations engage in
competition. For example:
• In the public sector, competitive rivalry exists between political parties, government
departments and levels of government.
• In the not-for-profit sector, charities compete for donations, and sporting clubs for members.
• In health care and education, public and private providers (e.g. hospitals and schools) are in
direct competition. Additionally, components of public institutions’ value chains (e.g. support
activities like catering and cleaning) are often outsourced to private-sector providers.
• A public transport authority must plan for the competition that its trains and buses receive
from privately owned cars and taxis.

Case Study 2.1

Creating organisational value: Evaluating the strategic planning process
We now return to the HZ Electrical Pty Ltd (HZ) case study introduced in Module 1.

You will recall that Bronwyn Jones’ eldest son Stephen had championed HZ’s development of its own
product range and established connections with a Chinese joint venture partner. While the initiative
had been reasonably successful in terms of revenue, the profit margins on these sales were lower than
that realised on the sale of licensed products because the products did not have a well-known brand
name. Nevertheless, Stephen was recommending to the board of directors that they make a greater
investment in the China joint venture.

HZ’s focus on the development, manufacture and sale of its own product range meant that the
licensed products were neglected and sales were stagnating. Some suppliers of licensed products
were concerned about the decline in their sales, and also the competition provided by HZ’s own line
of electrical appliances.

Another strategy adopted by HZ was the opening of factory outlet stores in a number of capital
cities in Australia for the clearance of outdated products. The factory outlet stores had added to the
organisation’s bottom line by increasing the margins generated from these sales. However, two of
HZ’s customers had expressed concern about the competitive impact of the factory outlet stores on
their retail stores.

Bronwyn Jones’ other son, John, thought HZ should expand its retail offering by opening a chain of
retail stores to sell the entire product range.

Cynthia Grey, the CEO of HZ, was recently appointed to her position. She was surprised to find that
HZ had little in the way of a formal strategic plan. She arranged for the senior management team and
the board of directors to spend two days at a resort to plan the organisation’s future. The meeting
was a disaster.

While Cynthia had developed a well-structured agenda and her management team presented
comprehensive and thorough reviews of the various operations of HZ, the directors continually
argued among themselves about what direction the organisation should take. Cynthia was dismayed
by the tone of the planning meeting and by the fact that two directors criticised every proposal the
executives put forward.

Other senior managers were not as dismayed as Cynthia, as the planning meeting simply confirmed
their long-held belief that the directors were in conflict about the direction of the organisation. It was
believed that the former CEO had been fired because he had continually challenged the board of
directors about the lack of a coherent organisational strategy.

The strategy planning meeting did, however, result in a plan being prepared by the board, which was
passed to Cynthia Grey for implementation. The plan did not incorporate any of the senior management
team’s proposals. Since the planning meeting, a number of strategic proposals had been submitted
to the Jones family board members by management, but only one had been approved. All other
proposals were put aside by the Jones family without any explanation. It appeared that the Jones
family had decided to keep private any debate about the direction of the organisation. At the monthly
board meetings, the Jones family’s attention was focused primarily on financial performance and the
20 per cent return on investment target.

After reviewing the above background information, consider each of the evaluation statements
presented in Table 2.8 below. Using the table, rate the quality of the strategic planning process
followed by HZ.

Table 2.8: Evaluating strategic planning at HZ

Evaluating statements Poor Fair Good

1. The directors and senior management understand and agree on:

– mission and vision
– goals and objectives
– strategic issues
– core strategies
– major initiatives to implement these strategies.

2. Strategic planning tools and frameworks are effectively employed.

3. The board has high-level strategic skills.

4. The board and senior management are actively involved in

strategy development.

5. An appropriate balance in strategy development is maintained

between the board and senior management.

6. The board is always involved early in the strategy development


7. Strategic planning meetings are always supplied with detailed

environmental and organisational data.

8. Sufficient board time and resources are made available for strategic
planning and review.
Study guide | 155

Evaluating statements Poor Fair Good

9. Reports of senior management to the board are strongly linked

to strategy.

10. Strategic planning is built into the board’s meeting agenda.

11. Strategic issues and updates receive strong coverage at board

meetings and meetings of the board with management.

12. Proposals considered by the board and senior management are

linked back to an agreed mission, goals and objectives.

13. The board and senior management monitor a broad range of

financial and non-financial key performance indicators (KPIs) relevant
to the strategy.

14. Evaluation of senior management is strongly linked to strategy.

15. Risk assessment is carried out for every strategic proposal

considered by the board.

16. Directors and managers routinely engage in informal dialogue
about strategic issues.

Source: CPA Australia 2015.

A suggested answer to the Case Study 2.1 task is provided at the end of the ‘Suggested answers’
for Module 2.

Strategic analysis
Strategic analysis underpins the strategic management framework. Strategic analysis is
concerned with understanding the internal and external environments of an organisation.
Two common approaches to strategic analysis are discussed below:
• value analysis; and
• strengths, weaknesses, opportunities and threats (SWOT) analysis.

The concepts of internal and external analysis are expanded on in the ‘Global Strategy and
Leadership’ subject of the CPA Program.

Value analysis
Value and the value chain were introduced in Part A of this module. A value chain is a network
of interrelated activities that provides value to customers and other stakeholders.

Organisations exist to create value. Organisational objectives identify each stakeholder group
and how to create and deliver value to that group. Strategies are plans for delivering this value
through value chains. Value chains achieve the strategic objectives through their activities.

Activities and value chains must be continually analysed to optimise the design of the activities,
and of the value chain itself. The organisation and its environment are dynamic and optimisation
is a moving target.

In analysing the contribution of activities to value creation, it is important to understand the

value propositions of all stakeholders. For example, preparing the organisation’s tax return is an
activity that contributes nothing directly to customers or shareholders, but is important to the
government, another key stakeholder. In an indirect way, therefore, the activity provides both
customer and shareholder value because taxation provides the transport and legal infrastructures
that makes business activity possible.

Organisation value chains

Porter (1985) argues that competitive advantage arises from the way an organisation organises
and performs the activities that comprise its value chain. Value analysis focuses on the ‘chain’
because activities are interrelated and, while individual activities can be improved to provide
greater value, it is the linkages between activities that are critical in creating value. Thus,
an organisation may improve its competitive advantage by:
• identifying primary or support activities that either do not add value or actually destroy
value. Such non value adding activities should be minimised or, if possible, eliminated;
• using substitute (less costly) inputs for activities;
• conceiving new ways to conduct activities, like designing new processes or implementing
new technologies; or
• linking the activities within its value chain in a more effective way than competitors.

A ‘non-value adding activity’ means that customers do not compensate the organisation for
the costs incurred in carrying it out (e.g. storage of inventory). Organisations can reduce the
total cost of their value chains by eliminating or reducing activities that customers do not value.
This may also help them to shorten the duration of innovation and production cycles, reduce the

time it takes to bring new products to market or fill customer orders and, in turn, lead to improved
competitive advantage.

Industry value chains

Activities that add value are not constrained by an organisation’s boundaries. Each role in the
industry value chain contributes value to the industry’s end product. For example, a restaurant
chef plays an important role in choosing quality ingredients, but the quality is also determined
by the farmer. The activities of the farmer add value for the restaurant’s customers.

Understanding an organisation’s competitive position in its industry value chain has significant
strategic implications. If some value chain roles in an industry are relatively unprofitable,
it may be wise for an organisation that operates across the entire industry value chain to
outsource or divest less profitable activities. Alternatively, an organisation may secure a
competitive advantage by better managing the linkages it has with its suppliers (and customers)
up and down the industry value chain. As mentioned earlier, linkages can take the form of,
for example, outsourcing, joint ventures or alliances. An alternative to increasing upstream
and downstream linkages in the value chain is vertical integration—i.e. acquisition of suppliers
(upstream or backward integration) or customers (downstream or forward integration).

An organisation must carefully consider the value chains of its suppliers and customers before
introducing any performance-improvement initiative targeted at its own value chain. Simply
shifting costs to suppliers or customers will not change the overall value created in the industry
value chain, and customers will have an incentive to shift their business to lower-cost (higher-
value) supply chains.

Shank and Govindarajan (1992, p. 3) describe a US automobile manufacturer that, for every dollar
of manufacturing cost saved as a result of introducing a just-in-time (JIT) inventory control system,
increased its suppliers’ manufacturing costs by more than a dollar. Not surprisingly, the suppliers
demanded price increases that more than offset the savings that had been achieved from the
JIT initiative, and the overall value produced by the industry decreased.

One other factor important to competitive advantage is the ability of an organisation to develop
and display its value-adding capabilities through reputation and branding. The greater and more
unique the organisation’s value-adding activities, the greater the reliance other parties are likely
to place on the organisation, and the stronger the organisation’s position becomes in the value
chain (Pfeffer & Salancik 1978).
Study guide | 157

Example 2.16: Sustainable competitive advantage at Microsoft

Microsoft developed a popular operating system for computers (Windows) and now most manufacturers
of PC-based (as opposed to Apple) computers supply their machines with Windows installed. This has
led to further opportunities for the organisation. Microsoft has thus long enjoyed a sustainable
competitive advantage. This is evidenced by the fact that the company has been the subject of anti-
monopoly lawsuits brought by the US government (in which Microsoft was successful).

The main lesson for management accountants is that knowledge of both organisational and
industry value chains is essential to strategic analysis. If an organisation does not know how it
provides value to its customers, and does not understand its role in the industry value chain,
it cannot develop a meaningful strategy.

Example 2.17: Value analysis

The introduction of a Just in Time (JIT) system provides an example of how competitive advantage
can be gained from the development of close linkages between an organisation and its suppliers
and customers. A JIT system is an inventory strategy that aims to reduce the stockpiling of goods by

supplying them only when required for use.

In order for a JIT system to be successful, customers must cooperate by providing reliable long-
term purchase orders for the organisation’s products, and suppliers must be able to reliably deliver
required quantities of high-quality inputs at regular intervals. The successful linking of an organisation’s
operations with those of its suppliers and customers through adoption of JIT throughout the supply
chain should reduce the cost of raw materials, work-in-progress and finished goods inventories for all
supply chain participants and increase total industry value.

Consider a car manufacturer who wants to increase customer value by cutting inbound logistics costs.
A value analysis of activities suggests that inventory carrying costs are significant and the cost of this
activity would be reduced by the introduction of a JIT system for the delivery of parts.

Inbound logistics activities must be improved to accommodate the JIT system:

• reliability of the scheduling activity must be improved;
• set-up activities that determine the time between production runs must be shortened;
• suppliers will have to deliver more frequently in smaller lot sizes; and
• improved coordination and communication in the supply chain will be essential.

This example illustrates how value analysis within an organisation is complemented by value
analysis of the linkages between organisations in the supply chain.

View the mini-lecture presented by Eugene O’Loughlin on value analysis, where O’Loughlin shows
how to analyse the value provided by a simple product. As he notes, however, this value analysis
process can be applied to any unit of analysis: a business, a product, an activity or an individual: For quick access, copy TT6tVH6cDMM
(case sensitive) into the YouTube search box.

Strengths, weaknesses, opportunities and threats

SWOT analysis is a well-established approach to strategic analysis. It involves analysis of
the organisation’s internal environment (strengths and weaknesses—SW) and its external
environment (opportunities and threats—OT). The organisation’s strategy should be developed
by using the results of the SWOT analysis; that is, by using its strengths to exploit opportunities,
while simultaneously managing the risks arising from internal weaknesses and external threats.
Classifying strategic issues as internal/external (SW/OT) is sometimes difficult (e.g. products
are normally part of the internal analysis, but clearly have market or external implications),
but nonetheless the SWOT approach has proved to be a useful tool as part of the strategic
management process.

Figure 2.11 illustrates how an organisation’s strategy should be framed by factors present in the
organisation’s external and internal environments.

Figure 2.11: SWOT analysis

National and global

• Political and legal
• Economic
• Social environment
• Technological

Internal environment
• Assets and resources
Strategy • Customers
• People and management
• Competitors
• Systems and processes
• Suppliers
• Capabilities

Strategic framework

Internal • Vision
environment • Mission
• Values
• Goals and objectives

Source: CPA Australia 2015.

In the following two sections, we present four tools that support SWOT analysis:
1. product life cycle analysis;
2. the Boston Consulting Group (BCG) matrix;
3. Porter’s five forces model; and
4. ‘PEST’ analysis.

The first two are tools for analysing an organisation’s product portfolio, the five forces model is
a tool for industry analysis, and PEST analysis addresses the external environment in its broadest

View the video on SWOT analysis by Erica Olsen (2008a) on YouTube: ‘SWOT Analysis: How to
perform one for your organization’. Olsen summarises the basic parts of a SWOT analysis and
provides practical illustrations: For quick access,
copy GNXYI10Po6A (case sensitive) into the YouTube search box.

Internal analysis
The purpose of the internal part of a SWOT analysis is to identify the organisation’s strategically
relevant strengths and weaknesses. As each organisation is unique, what is relevant for any one
organisation cannot be generalised.

An accepted approach to understanding how organisations can draw on their inner strengths
to create a sustainable competitive advantage is generically referred to as resource-based
theory. In this approach, each organisation is seen as having a set of distinctive capabilities and
reproducible capabilities. Only distinctive capabilities can lead to a sustainable competitive
advantage; examples of distinctive capabilities include patents, strong brands, supplier
relationships and government licences. Reproducible capabilities can be copied by other
organisations; most technical capabilities are reproducible.
Study guide | 159

Prahalad and Hamel (1990) introduced a similar idea of the ‘core competency’. They showed the
importance of understanding the core competencies that an organisation has—those things that
the organisation is able to do better than the competition.

Figure 2.11 identified some general categories that should be considered in an internal
strategic analysis:
• Assets—include working capital, plant and equipment, and intangible assets.
• Resources—unique sources of supply or special relationships with suppliers.
• People and management—the human capital of the organisation.
• Systems and processes—support systems like core manufacturing systems and IT systems,
value analysis systems, or the MAS.

Much of the focus of business-level strategy is on products and markets, so understanding

existing and potential products is an important part of a strategic analysis. Product analysis is
discussed in the following section. Two complementary approaches to understanding products
are discussed—product life cycle analysis and the BCG market growth/share matrix.

You should note that the product life cycle is also discussed in Module 4.

Portfolio theory and product life cycles

In the stock market, investors frequently purchase a portfolio of shares in order to reduce
risk. A well-constructed portfolio includes shares that perform well in periods of economic
growth (e.g. mining companies), and other shares that perform well in periods of little growth
(e.g. supermarkets). In the same way, organisations invest in a portfolio of products to reduce
the risk associated with relying on a single product. Product life cycle theory and the BCG matrix
are tools used to understand and manage product portfolios.

Product-related risks arise from uncertainties about:

• demand;
• sales volumes;
• prices;
• investment requirements;
• competitor offerings (direct competition or substitute products); and
• obsolescence.

Product life cycle analysis helps managers to improve their understanding of and ability to manage
these product-specific risks. Product life cycle theory is particularly useful for understanding the
dynamics of consumer-product industries like electronics and cars, which typically have relatively
short–medium life cycles. It is less useful for commodity-based industries. For example, iron ore
and oil are two commodity products for which product life cycle analysis may not be as useful,
or perhaps only useful over the longer term.

A product’s life cycle can be divided into four distinct stages:

1. Introduction.
2. Growth.
3. Maturity.
4. Decline.

Product life cycle theory holds that each stage of a product’s life cycle has different cash
flow and profit implications. Products in the early stages of their life cycle, introduction and
growth, require high levels of cash investments in design, and for new manufacturing plant and
marketing. In the maturity stage of the product life cycle, little investment is required and cash
inflows increase dramatically. In the decline stage, revenues are reduced while service obligations
must be met.

A strategically balanced product portfolio is one that contains both new and old products.
Mature products provide cash inflow for investment in the development of new products,
which will in turn provide cash flow for the next generation of products.

The ‘Introduction’ phase is when a new product is introduced to the market by the organisation.
This is a risky stage when prices tend to be high and demand low. There is no guarantee that
the marketplace will accept the new product. In the case of a novel product, if the product and
marketing strategies are inadequate, the new product may fail.

At the introduction stage, the organisation may be able to take advantage of barriers that
restrict immediate entry by competitors to the new product market—a ‘first mover’ advantage.
This temporary monopoly position may enable the organisation to charge a high price before
rivals enter the marketplace. Such a pricing policy can recoup the costs of product research and
development quickly. Alternatively, the organisation may opt for a low-price strategy to build a
dominant market position. This latter form of pricing is known as penetration pricing. As market

dominance is established, the organisation can then increase its prices.

In the growth stage, the market has accepted the new product. A rapid increase in market size
is expected. Seeing the success of the product, competitors enter the market. A consequence
of increasing competition is that prices drop. This is caused partly by organisations engaging in
price competition to gain market share, and partly by the cost savings manufacturers achieve
through economies of scale and learning. If entry to the market is expensive, the growth stage
might see a strengthening of an organisation’s competitive position.

To meet demand at this stage, the organisation will need to invest in new manufacturing capacity
and new marketing, promotion and distribution capacity. However, this stage can generate the
highest level of profits in the product life cycle.

Although sales volumes might still increase in the maturity phase, they increase at a lower rate.
New investment is low and cash flows increase while profits start to decline. Product promotion
activity may fall as consumers adopt a brand. The number of suppliers is reduced as some
leave the market or merge to obtain greater economies of scale in production, marketing or
distribution. As growth slows, competition increases and competitors seek to maintain market
share through price reductions.

The market is saturated and sales volumes decline due to technological obsolescence and
substitute products. Intense competition takes place, with price promotion and advertising
forcing unsuccessful suppliers to exit the market. Cash flows might be negative at this stage
due to warranty, parts supply or other ongoing service commitments.
Study guide | 161

Example 2.18: Product life cycle

The product life cycle can be seen in the television industry. When plasma, LCD and LED televisions
were introduced, they were very expensive and the market was small, comprising mainly ‘early adopters’.
Over time, product acceptance led to rapid market growth, resulting in many manufacturers entering
the market with volumes increasing and prices falling. Prices will, no doubt, continue to decline and
in the future we can expect consolidation in the industry and replacement of this product with some
new technology.

Another example is the ‘tablet’ device first popularised by Apple’s iPad. Following Apple’s introduction
of a high-priced tablet, several manufacturers rushed new products to market and a strong growth
phase began. Subsequently, prices fell dramatically. Apple is now challenged to introduce new models/
features and stimulate further market growth. If this is not possible, the product will become mature
and some manufacturers will inevitably drop the product from their portfolio.

BCG market growth/share matrix

The Boston Consulting Group (BCG) developed a 2×2 matrix for the analysis of product

portfolios. The matrix has an external (market growth) and an internal (market share) dimension,
and so contributes to both the internal and external aspects of strategic analysis. Figure 2.12
shows the four quadrants of the BCG matrix.

Figure 2.12: BCG growth/share matrix

Relative market share

High Low
Rate of market growth

Star Question mark


Cash cow Dog

Source: Adapted from Smith, M. 1997, Strategic Management Accounting Issues and Cases, 2nd edn,
Butterworths, Sydney, p. 119. Reproduced and adapted with permission of LexisNexis.

Market growth is important. Even though high-growth markets require significant investments
of cash, it is easier and less costly for products to gain market share in growth markets than
in mature markets. An organisation’s competitive position, as measured by market share,
is indicative of the profitability and cash-generating ability of the product. The stronger the
organisation’s market share, the more likely it is able to control its profit through reducing input
costs, low-cost production through economies of scale, and control of prices.

The BCG market growth/share matrix identifies four types of products:

1. Stars—products that are sold into high-growth markets and hold a high market share.
Although these products generate large cash inflows, due to the pace of growth in the
market, the organisation needs to continue to invest heavily in the product to maintain
its position.
2. Cash cows—as stars enter the maturity phase of their product life cycle, the need for finance
slows and they become cash cows, generating large cash inflows. Cash cows are products
that hold a high-market share in a low-growth market. Due to the low market growth,
the organisation does not need to continue investing in the product and the cash flows it
produces support the development of other products.
3. Question marks—products that hold a low market share in a high-growth market. Due to the
low market share, the organisation may to need to continue a high level of investment in the
product to maintain or increase its market share and cash inflows. The organisation needs
to decide whether ‘question mark’ products are worth continuing (in the hope that they will
make the transition to stars) or should be withdrawn from the market.
4. Dogs—products that hold a low market share in a low-growth market producing low cash
inflows. The organisation should probably eliminate these products from its portfolio,

as ‘dogs’ are unlikely to generate enough cash to support investment in other products.

The BCG approach to product analysis differs from product life cycle analysis because it
disregards the time element and it does not assume that all products will grow and mature.
Some products will never enter the growth phase (dogs). Others will grow but never achieve
market dominance (question marks). However, the two techniques together provide a good
understanding of an organisation’s product portfolio, and form an important part of an
organisation’s internal analysis.

Example 2.19: BCG matrix

June 8 2015

In his keynote address at the World Wide Developers Conference held in San Francisco in June 2015,
CEO Tim Cook announced some staggering statistics. For example:
• 100 billion apps have been downloaded from the App Store.
• 850 apps are downloaded every second.
• 600 million iOS† devices have been sold to date.
• There are more than 1.5 million apps now available in the App Store.

July 22 2015

Apple Inc.’s Q3 financial results

Apple’s main physical products are the iPhone, iPad and MacBook. The iPod, once a star performer,
is in decline. Apple TV and, more recently, the Apple Watch are emerging products. Non-physical
products such as digital download and streaming services, particularly of music and apps, are also
increasingly important. The following statistics from Apple’s Q3 financial results website illustrate that
the company’s star products are iPhones and iPads, which is where market growth remains significant.
Apple’s market share is high.

• Revenue: $49.6 billion

• Net profit: $10.7 billion GBP
• iPhones sold: 47.5 million
• iPads sold: 10.9 million
• Macs sold: 4.8 million
Study guide | 163

Application of the BCC matrix suggests that iPhones, IPads and iMacs are probably cash cows. The iPod
would still likely be considered a cash cow by applying the definitions in the BCG matrix, but this may
change in the near future. Apple TV and the Apple Watch are question marks at this relatively early
stage of their life cycle.

Apple’s mobile operating system.

Sources: Allsop, A. (2015) ‘Apple Q3 2015 financial results: 47.5 million iPhones, 10.9 million iPads,
4.8 million Macs’, Macworld, accessed October 2015,
Viticci, F. (2015) ‘The Numbers from Apple’s WWDC 2015 Keynote’, MacStories, accessed October 2015,

Please note that while product portfolio analysis is an important aspect of an organisation’s internal
analysis, there are other aspects of an internal analysis designed to identify an organisation’s
strengths and weaknesses that are not discussed here. Strategically important internal capabilities
that should be analysed include the workforce, management, technology, access to resources,
intangible assets, access to finance, and governance structures. Some of these issues are noted by
Erica Olsen in the SWOT Analysis video mentioned earlier. If you have not viewed this video yet,

go to

➤➤Question 2.9
Consider your own organisation, or one with which you are familiar. Examine the products or
services of this organisation.
(a) Where are these products or services positioned within the product life cycle and within the
BCG growth/share matrix?
(b) Is the organisation’s product portfolio high or low risk? What changes would you recommend?

External analysis
The business environment is dynamic and, to succeed, organisations must be dynamic and
responsive. Prahalad (2001) argued that the strategic space available to organisations is
expanding and provides unlimited opportunities to the strategist. Opportunities arise from
many sources, including:
• changes in the national and international regulatory environments;
• the emergence of new products, markets, industries and economies;
• new technologies (e.g. new distribution channels made possible by the digitisation of
products like music, film, TV and education); and
• the convergence of technologies (e.g. cameras, phones, computers and navigation systems).

Traditional management accounting is focused on providing internal information to support

strategic analysis as well as day-to-day operational activities. In contrast, strategic management
accounting has a strongly external focus that identifies and captures information from outside
the organisation. Relevant information is very broad and includes an understanding of the
organisation’s industry and its local, national and global economic and social environments.
The SWOT diagram in Figure 2.11 identified some general categories relevant to an
external analysis.

The purpose of the external part of a SWOT analysis is to identify opportunities and threats.
First, organisations need to understand where they are situated within their industry. For example,
a profit-making organisation must be aware of its competitors’ strengths and weaknesses so as
to identify threats to its own position, and opportunities for growth and profitability. Without an
understanding of the competitive environment, an organisation is unable to plan effectively or
develop a meaningful strategic position.

The aim of industry analysis is to understand how competitive forces create the profitability
(the prices, costs, and investments) of the industry. One approach to industry analysis introduced
previously is industry value chain analysis. An understanding of competitive forces can help to
identify new strategies that shift competitive forces and create a higher return on investment.
For example, if industry profitability is driven by price competition, it might be possible to shift
the basis of competition by introducing a new customer value proposition based on provision of
additional services like stock management or fast delivery.

Industry analysis should start by defining the industry. Errors can arise from a focus on the wrong
industry, or from defining the industry too broadly or narrowly. A narrow viewpoint might overlook
potential linkages across products and markets. A broad viewpoint might miss important
distinctions between products and markets. For example, does the local market for petroleum
have unique and important characteristics, or is the industry global in its scope? As a second
example, are cars and motorcycles in the same industry, or in two separate industries?

To answer these questions in a way that is useful for strategic analysis, we need to look at the
industry’s suppliers, buyers, competitors, barriers to entry, and so on. In the petroleum industry

example, if the local industry is the appropriate unit of analysis, a local strategy is needed. If not,
then a national or global strategy is required. In the second example, if we conclude that cars
and motorcycles are in different industries, then an organisation will need a separate strategy for
competing in each product category. Porter (2008) explains that, if differences between products
or between geographic markets are large, then different industries might be present.

A second important factor in industry analysis is the chosen timeframe. Strategic analysis should
not be overly concerned with temporary fluctuations in prices or demand, but should focus on
the industry’s business cycle, whether short (e.g. mobile phones) or long (e.g. mining).

Industry analysis should be quantified, and this is a key responsibility for the management
accountant. For example, in assessing buyer power, it is important to determine how many buyers
exist, and the market share of each buyer. For example, if you are a supplier to the Australian retail
food industry, buyer power is high because just two large organisations, Coles and Woolworths,
sell between 60 and 70 per cent of Australian groceries between them.

Five forces
According to Porter (1985, 2006), the strategic environment of an industry is shaped by five forces
(see Figure 2.13). Porter’s five forces are the:
1. threat of new entrants to the industry;
2. threat of substitute products;
3. power of customers;
4. power of suppliers; and
5. intensity of competition.

View the video on YouTube by Michael Porter: ‘The five competitive forces that shape strategy’.
In this video, Porter explains his model and provides practical examples of the five forces: For quick access, type mYF2_FBCvXw
(case sensitive) in the YouTube search box.
Study guide | 165

Figure 2.13: Porter’s five forces

Political and legal Economic (macro)
environment environment
New entrants
Identifying some new
form of competitive

Suppliers Customers
Existing competitor
Threat of forward Threat of backward
integration integration

Alternative products
New ways of
satisfying the same
Physical customer

environment environment

Reprinted with the permission of The Free Press, a Division of Simon & Schuster Inc.,
from Competitive Advantage: Creating and Sustaining Superior Performance.
Copyright © 1985 by Michael E. Porter. All rights reserved.

Force 1: New entrants

The globalisation of business and the reduction of trade barriers between countries have
provided many opportunities for organisations to expand their operations to new locations.
The emergence of a new entrant in an industry may result in significant realignment of the
competitive positions of existing organisations. For example:
• More production capacity and product volume will be added. Economics tells us that when
supply increases, prices will fall.
• New entrants often seek to build market share by setting their price below the prevailing
market price.
• The cost-of-production inputs will rise as the new entrant seeks to secure access to scarce
resources (e.g. skilled manufacturing labour may become more expensive).

Not all industries are susceptible to the threat of new entrants. Significant economic disincentives
may act as barriers to entry. These could include:
• legal constraints in the form of limited licences (e.g. the television, radio or
telecommunication industries) or patents;
• technological barriers in the form of secret or innovative production processes or product
formulations that cannot be readily copied (e.g. pharmaceuticals);
• availability of financial resources for investment in the industry;
• economies of scale that enable existing industry members to decrease unit costs to a level
that a competitor cannot match in the short term; and
• brand reputation barriers give established industry members a strong reputation in the
market and high customer loyalty.

With the ongoing deregulation of many industries (e.g. banking, telecommunications, civil aviation,
and power generation and distribution) and the elimination of global trade barriers, the threat of
new entrants arises from both domestic and international sources. Many local markets have been
overtaken by global markets.

Example 2.20: F
 ree trade agreements between Australia and
other countries
The free trade agreements established between Australia and other countries—including the United
States, South Korea, Japan and China—make it easier for organisations in each of those countries to
compete in some Australian markets, and vice versa. As an example, in the Australian pharmaceutical
industry, the competitive position of Australian manufacturers and suppliers of generic drugs has
been weakened as a result of the free trade agreement with the United States. On the positive
side, an Australian pharmaceutical distributor may enter into an alliance with a US pharmaceutical
manufacturer who is able to supply products to its Australian partner at low cost because of the large
scale of its operations or the access it has to cheaper inputs (e.g. materials and labour).

Force 2: Alternative or substitute products

An alternative product is one that performs a similar function to that produced by the
organisation. The presence of alternatives reduces the demand for an organisation’s products
and drives down prices.

Example 2.21: Substitute products

Margarine, a product of the edible oils industry, competes with butter, a product of the dairy industry.
Another example is the substitution that occurs between private and public transport (cars and trains).
Automobile manufacturers must consider their direct competitors (i.e. other car manufacturers) and
the competition that arises from other forms of transport.

Force 3: Customers
When an organisation has powerful customers, its strategic position is weakened. Alternatively,
when the organisation has power over its customers, this is a source of strategic advantage.
A customer may have some power over the prices at which sales are made because the customer:
• purchases large quantities, so is an important customer;
• might attempt to take over the organisation (backward, or upstream, integration); or
• can switch to alternative products or suppliers at little incremental cost.

Example 2.22: Buyer power

A powerful buyer is the huge American retailer Walmart. Suppliers to Walmart frequently complain
about the continual price reductions forced on them, and many of Walmart’s suppliers have been
driven into bankruptcy. In Australia, Coles and Woolworths, who dominate the supermarket industry,
are increasingly being subjected to similar criticism.

Toyota is another powerful organisation that has sought to control the price and quality of the
components and parts it purchases by holding an equity stake in its suppliers.

Force 4: Suppliers
Supplier power is the opposite side of customer power. Powerful suppliers have a strong impact
on an organisation’s sustainable competitive advantage because they can drive up the price of
business inputs. To understand the importance of supplier power, simply reverse the arguments
made above about buyer power. A supplier may have power because:
• the supplier is significantly larger than the organisation it is selling to;
• the supplier might attempt to take over the organisation (forward or downstream integration);
• alternative products or suppliers are not available to the buyer; or
• the product provided by the supplier is important to the organisation in terms of the value of
its own products.
Study guide | 167

Force 5: Existing competitors

The type of business strategy an organisation adopts must be developed in relation to the
competitive strategies adopted by rivals. Understanding a competitor’s strategies has critical
implications for the design of the organisation’s value chain activities, such as product design,
quality, pricing and advertising.

Knowledge of competitors’ product/market portfolios assists managers to predict the reaction

of a competitor to their own strategic moves. For example:
• If the competitor has a very narrow market portfolio, the competitor’s response to a threat to
its market will be both prompt and aggressive.
• If the competitor has a broad market portfolio, the competitor’s response to the threat may
be less aggressive.

Intense competition through price discounting in the airline industry provides a good example
of the marginal profitability that competitors in this industry will accept in their efforts to protect
market share.

➤➤Question 2.10
Porter’s five forces model is focused on organisations operating in the for-profit private sector.
However, a five forces analysis is equally applicable to not-for-profit and public sector entities.
Consider the Australian higher education industry. The industry has been very profitable, but more
recently profitability has declined. Each of the five forces is relevant:
• ‘new entrants’ in the form of private education providers;
• ‘substitute’ job training programs like apprenticeships;
• ‘customer power’ from international and local student groups;
• ‘supplier power’ from academics and governments; and
• ‘competition’ among existing universities and TAFEs, both locally and internationally.
Using the five forces model, analyse the Australian higher education industry and assess its
strategic environment. Aspects you should consider in your response are:
• stakeholders; and
• the level of power held.

While industry factors are important to strategic analysis, the external environment is much
broader in scope than the industry. PEST analysis offers a tool for examination of these additional
factors. PEST stands for:
• Political.
• Economic.
• Socio-cultural.
• Technological.

Other versions of PEST exist that further broaden the frame of analysis:
• SLEPT (adds ‘Legal’ to PEST).
• PESTEL (adds ‘Environmental’ to SLEPT).
• STEEPLED (adds ‘Education and Demographics’ to PESTEL).

While a multitude of issues arise in a PEST analysis, three that are commonly included are
discussed below:
1. Regulation is an important aspect of the political and legal dimensions.
2. Corporate social responsibility (CSR) is an important aspect of the socio-cultural dimension.
3. The business cycle is an important aspect of the economic dimension.

National regulatory frameworks and international treaties and trade agreements can affect an
organisation’s strategic position. Regulatory constraints may limit the type of products that
can be offered to consumers and can reduce or increase the level of competition or prices.
For example, tobacco and alcohol cannot be sold to minors.

In a similar vein, the loosening of regulatory constraints in the insurance, telecommunication

and civil aviation industries has changed the competitive positions of many organisations in
these industries. Prior to airline market deregulation, a profitable duopoly existed in Australia—
Ansett Airlines and Qantas. After deregulation, Ansett ultimately failed and several new entrants

attempted to enter the industry to compete with Qantas. Some have done so successfully
(e.g. Virgin Australia and Tiger Airlines), while others have failed (e.g. Compass Mark I and II,
and Strategic Airlines).

The progressive reduction of interstate and international trade barriers, and the adoption of
international (e.g. the General Agreement on Tariffs and Trade) and bilateral (e.g. Australia/US)
trade agreements have had a strong influence on the globalisation of business opportunities and
competitive threats.

Corporate social responsibility

Porter and Kramer (2006) pointed out the importance of CSR to an organisation’s competitive
position. They introduced a framework that organisations can use to:
• identify the social and environmental consequences of their actions;
• discover opportunities to benefit both society and themselves (e.g. strategic linkages with
stakeholders); and
• determine the CSR initiatives they should address.

In a similar vein, Smith (2007) argued the importance of strategically leveraging social responsibility
in a way that provides a sustainable competitive advantage. This is achieved by developing a
culture capable of simultaneously executing a combination of relevant activities successfully.

Governments, activists, the media, shareholder associations and other stakeholders have
become adept at holding organisations to account for the social consequences of their actions.
In response, CSR has emerged as a priority for business leaders. Perceiving social responsibility
as a strategic opportunity, rather than as damage control or a public relations matter, requires a
mindset that is increasingly important for competitive success (Porter & Kramer 2006, p. 78).
Study guide | 169

Moulang and Ferreira (2009) investigated the environmental awareness of Australian businesses.
They found only one organisation in eight had environmental strategies within their overall
business strategy, and that there was a very low level of integration of environmental management
systems with business management systems. Existing environmental management systems
were mainly compliance oriented rather than strategically oriented. Management accountants
should grasp this opportunity to enhance the CSR information provided into the strategic
management process.

In a review paper, Carroll and Sharbana (2010) summarise the arguments that provide rational
justification for CSR initiatives from a primarily economic and financial perspective, concluding that
firms that engage in CSR activities will be rewarded by the market in economic and financial terms.
CSR is discussed in Part A of this module.

View the following video, which is about an IBM study that addressed the importance of CSR to
the leaders of 250 businesses: For quick access,
type PdkYieDuVvY (case sensitive) in the YouTube search box.

Business cycle
A third important aspect of the external environment discussed here is the business cycle.
Business cycles are fluctuations in local, national or international economic activity evidenced
by changes in gross domestic product (GDP), inflation, interest rates, unemployment rates and
other macroeconomic variables.

A business cycle generally comprises four phases: boom, recession, depression and recovery:
1. A boom is a rise in economic activity that lasts until a peak is reached.
2. A recession is the fall from the peak of economic activity back to the mean (normally
a recession is defined by two quarters of negative GDP growth).
3. A depression is the slide from the mean down to a prolonged and low level of
economic activity.
4. A recovery is the rise from the trough of economic activity back to the mean.

Predicting the turning points in the business cycle is difficult, as is predicting the extent of the
rises and falls, and the differential effects of the business cycle on different countries. All that is
known with certainty is that business cycles recur.

Example 2.23: Triggering event—9/11

The attack on the World Trade Center in New York on 11 September 2001 (9/11) has been identified
by some economists as the cause of the 2001 recession in the US economy. However, others have
argued that an examination of US economic data reveals that the 2001 recession started six months
before 9/11. Triggering events that affect consumer or business confidence can have profound effects.
It is likely that 9/11 increased the speed and the severity of the 2001 recession.

Example 2.24: Business cycle

The Western world was in a boom period from 2002 to 2007. Low interest rates and a large money
supply led many American consumers to take out loans to purchase real estate. In addition, merchant
banks and hedge funds borrowed money for speculation in mortgage, equity and bond markets.
An asset ‘price bubble’ arose in these markets.

In 2007, the global financial crisis (GFC) was triggered by the collapse of Lehman Brothers, a large US
merchant bank and, as the bubble burst and prices declined, many banks holding devalued assets failed.
This led in turn to a significant reduction in the availability of credit, which caused many organisations
to become insolvent when they were unable to refinance their debts.

A recovery appeared underway in 2010–11, but in 2011 some countries in the eurozone were unable
to refinance their debts and fund their budgets, leading to a European recession.

By 2014, evidence of a US recovery was continuing (with the US stock market hitting all-time highs),
though US interest rates were at very low levels. European countries varied widely, with some in
depression and others in recovery. Throughout, China’s economic growth continued to be strong.
However, in mid-2015 two events occurred which could potentially impact global growth. Firstly,

the Shanghai stock market (which had risen by more than 30 per cent in the previous 12 months)
suffered a correction. Secondly, Greece defaulted on a loan repayment to its European creditors,
mainly German and French banks. While it is too early to assess the long-term impact of these events,
it is evident that global markets have become more volatile as a result.

Many business decisions have long-term implications. One example is Woodside Petroleum’s
$43 billion investment in liquefied gas processing in north-western Australia, a project which is
expected to last for decades. Management accountants should use their understanding of the
business cycle to ensure that unreasonable assumptions are challenged (e.g. constant growth
in the world economy is frequently, and inaccurately, assumed). Those organisations that ignore
the business cycle, and who base their business strategies and value chain configurations
on an assumption of continuous growth, are less likely to survive the onset of a recession.
An understanding of the business cycle allows an organisation to better manage risks and to
explore a range of different investment scenarios. Organisations that are successful in the long
run consider both positive and negative scenarios (e.g. negative, zero, low and high growth).

The management accountant must try to understand the existing industry and economic
situation, and how the economic situation and the structure of the industry are likely to change
over the strategic horizon. An understanding of economic history is useful in this regard.

This section introduced two tools for carrying out the external (opportunities and threats)
aspect of a SWOT analysis. Porter’s (1985) five forces model identifies the main competitive
forces that determine an organisation’s strategic position in its industry. The performance
of an organisation’s value chain is influenced by the challenges or threats posed by existing
competitors, new competitors, substitute products, suppliers and customers. PEST analysis is
a framework for carrying out a broader environmental analysis. Political, economic, socio-cultural
and technological factors have a significant effect on an industry and the competitive position
of an organisation.

Content of a SWOT analysis

Table 2.9 contains a sample of the many questions that should be considered in a SWOT analysis.
It is important for the management accountant to appreciate that answers to all these questions
should be detailed, and especially quantified, to the greatest extent possible.
Study guide | 171

Table 2.9: Questions for a SWOT analysis

SWOT Financial questions Value chain questions

Strengths and • Are margins strong? • Are value propositions clearly stated and
weaknesses • Are revenues reliable? aligned with stakeholder needs?
• Are revenue streams • Are brands strong?
diversified? • Are customer relationships strong?
• Are costs predictable? • Are channels for value delivery efficient
and effective?
• Do channels match customer segments?
• Are operations efficient?
• Do we achieve economies of scale?
• Do unused intellectual property or other
valuable assets exist?
• Do synergies exist between products?

Opportunities • Do prices reflect what • Do unsatisfied customer needs exist?

and threats customers are willing to pay • Can we identify new customer segments?

for the product or service? • Are customers clearly segmented?
• Can we replace one off • Would finer segmentation clarify the value
transactions with a revenue proposition?
stream (e.g. rental or • Do customers have high switching costs?
licensing)? • How can switching costs be increased?
• Which costs are growing • Are substitute products threats?
fastest? • Are our important resources or partnerships
available to competitors?
• Are partnership linkages reliable and
• Should additional activities be outsourced?
• Are our main activities easy to imitate?
• Do competitors threaten our market share?

➤➤Question 2.11
Consider your own organisation, or one with which you are familiar (like your supermarket or your
bank). Examine the competitive forces at work in the industry. What is the competitive position
of your selected organisation? Is it strong? Is it sustainable?

➤➤Question 2.12
(a) Refer to the information provided about BikeCo in Question 2.4. Prepare a SWOT analysis
for BikeCo. Clearly differentiate the strengths, weaknesses, opportunities and threats you
identify (i.e. do not include any item in more than one category).
(b) In relation to BikeCo’s existing strategy of differentiation on the basis of manufacturing a
quality Australian-made bicycle, how do BikeCo’s strengths, weaknesses, opportunities and
threats affect its ability to achieve a sustainable strategic position? Provide numerical analysis
where appropriate.
(c) Assume that BikeCo accepts the BayMart contract and decides to follow a new strategy
of manufacturing low-cost generic bicycles. How do BikeCo’s strengths, weaknesses,
opportunities and threats impact on its ability to achieve a sustainable strategic position?
Provide numerical analysis where appropriate.

Note: The BikeCo case continues in Question 2.15.


Strategic planning
After managers have obtained a thorough understanding of the organisation’s internal
and external environments through strategic analysis, they are in a position to reassess the
organisation’s existing strategic management framework and strategic plan, and to revise them
as necessary. Strategic planners aim to improve existing organisational objectives or identify
new organisational objectives, then improve on existing strategies or invent new strategies to
achieve those objectives.

Strategic planning is discussed in greater depth in the ‘Global Strategy and Leadership’ subject of the
CPA Program.

Strategic management framework

Strategy is developed within a strategic management framework that includes vision, mission,
goals and objectives. A clearly articulated framework helps ensure that an organisation’s strategy
will deliver appropriate value to stakeholder groups.

The vision states why society is better off due to the existence of the organisation. The vision is a
guiding principle or the core value of the organisation.

For example, Amazon’s vision is ‘to be Earth’s most customer-centric company for four primary
customer sets: consumers, sellers, enterprises, and content creators’ (Amazon 2013).

The mission identifies the organisation’s stakeholders, commercial rationale and target market.
Ideally, mission statements should refer to the:
• identity of key stakeholders (e.g. shareholders, customers and employees);
• stakeholder value to be delivered;
• nature of the organisation’s business (e.g. its outputs and the markets it services);
• competencies and competitive advantages by which the organisation will prosper;
• ways the organisation will compete (e.g. reliance on quality, innovation or low prices;
commitment to customer care; policies on acquisition versus organic growth and the
geographical spread of operations); and
• CSR principles (e.g. commitment to maintaining good working relationships with suppliers
and employees; social policies such as equal opportunity or energy conservation; and
commitment to after-sales service and customer satisfaction).

In practice, however, many companies tend to release shorter and less specific statements in their
annual reports.

Example 2.25 highlights extracts from the 2014 annual reports of three well-known and highly
regarded companies. Each includes some, but not all, of the points listed above in their reported
mission statements.
Study guide | 173

Example 2.25: Extracts from three annual reports

Wesfarmers Limited:
Wesfarmers’ long standing objective is to deliver a satisfactory return to shareholders. Guided
by this principle, the company has developed a unique, highly-focused and disciplined
business culture. Underlying this, Wesfarmers adheres to four core values: integrity; openness;
accountability; and boldness. (Wesfarmers 2014)

Amcor Limited:
By being dynamic and seeking innovation, Amcor will globally offer cost effective, differentiated
products for environmental purposes that have high quality and added value to customers
(Amcor Limited 2014).

Apple Inc:
Apple designs Macs, the best personal computers in the world. Apple leads the digital music
revolution with its iPods and iTunes online store. Apple has reinvented the mobile phone
with its revolutionary iPhone and App Store, and is defining the future of mobile media and

computing devices with iPad (Apple 2015).

Goals and objectives

Further detail is, however, sometimes provided in other sections of the report under headings
such as ‘Our Values’ or ‘Goals and Objectives’ or similar.

Goals should express the organisation’s mission in detail—the ‘what’, ‘how’ and ‘when’ of
delivering value to stakeholders. Objectives are similar in content to goals, but offer quantitative
measures of the goals against which performance can be assessed. Performance measures
should include time-based measures.

For goals and objectives to be effective, they must be consistent. That is, objectives set for
different parts and levels of the organisation should not be in conflict. The organisational goals
and objectives provide the framework for strategy development.

The key aspect of an effective strategic framework is that it provides guidance for the
development of strategy and a way to judge whether a strategy is appropriate. In developing
strategy, each goal should be addressed. Strategies that do not address specific organisational
goals are probably counterproductive.

The following example illustrates the corporate mission and goals of Wesfarmers, a prominent
Australian organisation (owner of Coles, Bunnings and other businesses).

Example 2.26: Wesfarmers’ goals

From its origins in 1914 as a Western Australian farmers’ cooperative, Wesfarmers has grown into one of
Australia’s largest listed companies and employers. Its diverse business operations cover: supermarkets,
department stores, home improvement and office supplies; coal mining; insurance; chemicals,
energy and fertilisers; and industrial and safety products. The primary objective of Wesfarmers is to
provide a satisfactory return to shareholders.

The company aims to achieve this by:

• satisfying the needs of customers through the provision of goods and services on a competitive
and professional basis;
• providing a safe and fulfilling working environment for employees, rewarding good performance
and providing opportunities for advancement;
• contributing to the growth and prosperity of the countries in which it operates by conducting
existing operations in an efficient manner and by seeking out opportunities for expansion;
• responding to the attitudes and expectations of the communities in which the company operates;
• placing a strong emphasis on protection of the environment; and
• acting with integrity and honesty in dealings both inside and outside the company.

(Note how this expands on the mission statement shown above, and covers most of the points listed.)

Source: Wesfarmers 2015, ‘About us’, accessed July 2015,

➤➤Question 2.13
(a) Review CPA Australia’s vision and mission.
(Go to and click on ‘About us’.)
How does CPA Australia contribute to society?
(b) Consider your own organisation or another one with which you are familiar (like the university
you attended). What is its vision and mission? If your organisation does not have a stated
vision and mission, consider how it contributes to society and work out what its vision and
mission could be.

What should a good strategy achieve?

A good strategy should:
• reflect the values of top management and the board;
• identify how the organisation competes (e.g. cost leadership or differentiation);
• identify which product and market strategies the organisation intends to pursue;
• identify institutional strategies (linkages with other organisations) that determine the method
of growth (e.g. vertical integration or alliances);
• provide inspiration in the form of worthwhile and relevant goals;
• help individual managers see the linkages between their own tasks and initiatives, and those
being taken elsewhere in the organisation;
• provide guidance to managers and enable them to fully evaluate the trade-offs and priorities
of everyday work;
• create discretion for the individual manager to manoeuvre by loosening some existing
constraints and generating new options;
• facilitate communication by establishing a common vocabulary that every manager in the
organisation understands and is fluent in using;
• make full use of the organisation’s existing strengths;
• remedy or avoid the organisation’s existing weaknesses;
• complement the organisation’s existing strategic position;
• satisfy the organisation’s stakeholders; and
• provide the organisation with a sustainable competitive advantage.
Study guide | 175

Hambrick and Fredrickson (2001) suggest that the following SWOT-oriented questions should be
answered in order to test the quality of an organisation’s existing strategy. Obviously, the answers
depend on completing a thorough strategic analysis:
1. Strengths. Does the organisation’s strategy exploit its resources and capabilities?
Given the organisation’s particular mix of resources and capabilities, does its strategy offer it an
advantage over its competitors? Can the organisation pursue its strategy more economically
than its competitors?
2. Weaknesses. Does the organisation have sufficient resources to pursue its strategy?
Does the organisation have the money, managerial time and talent, and other essential
capabilities required to achieve what it envisages? Is the organisation spreading its resources
too thinly, which means that its competitive position is under-resourced and feeble?
3. Opportunities. Is the organisation’s strategy consistent with its environment?
Does the organisation’s strategy align with the key success factors of the chosen environment?
Are there healthy value-creating opportunities in the direction the organisation wishes to head?
4. Threats. Will the organisation’s differentiators be sustainable?

Will the organisation’s competitors have difficulty in matching the organisation’s capacities?
If not, does the organisation have a strategy that explicitly requires a ceaseless regimen of
innovation and opportunity creation?
5. Fit. Are the elements of the organisation’s strategy internally consistent?
Has the organisation made a choice of arenas, vehicles, differentiators, staging and economic
logic? Do these elements fit and mutually reinforce each other?
6. Reality check. Is the organisation’s strategy capable of being implemented?
(Hambrick & Fredickson 2001, p. 59.)

Because of the dynamic business environment and the five forces of industry competition,
an organisation’s existing strategy is unlikely to satisfy all of its goals and objectives, and provide
sustainable competitive advantage in the long term. Even where an existing strategy is successful,
it is still important for the organisation to seek new strategies that can achieve these outcomes
in ways that provide greater value now and in the future.

Consider your own organisation, or one with which you are familiar. Identify the organisation’s
strategy or strategies. (Strategy documents are often available on an organisation’s website.)

➤➤Question 2.14
Refer to Case Study 2.1 on HZ. For each of the six strategy evaluation questions proposed
by Hambrick and Fredrickson shown above, provide an answer for HZ. How would you rate
HZ’s strategy?

While it is difficult to generalise about strategies that an organisation might adopt, the following
are characteristics of strategies formulated by many innovative organisations.
• Focus on core competencies.
• Use joint ventures, alliances and acquisitions to access resources and competencies.
• Acquire other organisations to achieve horizontal or vertical integration.
• Reduce layers of management to enhance organisational responsiveness.
• Increase the use of project- and team-based forms of organising to increase horizontal
knowledge and resource-sharing.
• Invest in team building, mission building and training to provide the skills to make flatter
structures work.
• Invest in new forms of IT.
• Increase market share through the introduction of new or improved products or services.
• Develop new export markets to improve economies of scale.
• Focus on those activities that generate the greatest value by disposing of, or outsourcing,
non-core or lower value-adding competencies.

Frigo (2002) provides the following guidance on planning a successful strategy.

Identify needs-based market segments

It is not enough for an organisation to define its target markets broadly. For example, the
automotive market comprises many needs-based segments, such as families who need a seven-
seat people mover or small businesses that need delivery vans. Only by concentrating strategy
on a needs-based segment can strategic plans be clarified.

Partner strategically
The organisation chooses from a number of options for collaborating with others to achieve
strategic goals. The spectrum of collaboration ranges from the minimalist level of partnering,
where the partnering organisations simply exchange information, to the extreme level where
the organisations formally integrate their activities through acquisition. Partnering options also
include such avenues as market transactions, outsourcing, co-branding ventures, alliances and
joint ventures, all of which allow the organisation to focus on its own core competencies, while at

the same time accessing the capabilities of the partner organisations.

Use portfolio theory

In certain industries, new product development can be a highly risky strategic initiative.
For example, in the pharmaceutical industry, not all new drugs will be effective, and the risk of
product failure might discourage an organisation from investing in new product development.
However, organisations that fail to invest in innovation relegate themselves to predictable
offerings and the eventual commodification of their products. Successful organisations are able
to balance risky strategic initiatives with conservative incremental-return strategies, using product
life cycle analysis and other product portfolio analysis tools.

Engage with employees

For the organisation to fully engage with its employees, it must not only offer the right
incentives so as to align their interests with those of the organisation, but also ensure that
they receive quality leadership and have a sense of purpose and a supportive organisational
culture. Employee engagement, and the commitment that comes from this emotional link to
the organisation, is strongly linked to customer satisfaction. For example, the Ritz-Carlton hotel
chain secured a strong competitive position through:
• use of a personnel assessment system that focused on personal qualities and attitudes
crucial to the organisation’s success;
• careful selection of the right employees;
• rigorous training in the Ritz-Carlton principles of customer service and process focus;
• use of a guest-recognition database; and
• empowerment of employees to take action to promptly resolve customer complaints.
Study guide | 177

Re-engineer the industry value chain

Re-engineering the industry value chain means more than focusing on the value chain activities
of the organisation itself. For example, by adopting an internet-based direct-to-consumer
marketing strategy, Dell computers integrated the downstream industry value chain and captured
the value previously achieved by computer retailers.

Communicate strategically
An organisation’s strategy cannot be successful if it is not communicated. Organisational
communications must ensure that all stakeholders, internal and external, are aware of the
organisation’s business strategy. For example, effective strategic communication should build
employee engagement and direct their attention to activities that help realise the overall
organisational strategy.

Business Model Generation

Osterwalder and Pigneur (2010) present a structured and graphic approach to strategic planning

called the Business Model canvas (see Figure 2.14). They recommend that, as a first step
in business design, strategists should carry out a strategic analysis including a SWOT analysis.
Only after developing a thorough understanding of the internal and external environments can
the Business Model canvas be employed for strategic planning.

8. Key partners 7. Key activities 2. Value 4. Customer 3. Channels

Who are our key partners? What key activities do our value propositions relationships Through which channels do our
propositions require? customer segments want to
Who are our key suppliers? be reached?
What value do we deliver to the customer? What type of relationship does each of our
Our distribution channels?
Which key resources are we acquiring customer segments expect us to establish How are we reaching them now?
Which one of our customer’s problems are
from partners? Customer relationships? and maintain with them?
we helping to solve? How are our channels integrated?
Which key activities do partners perform? Revenue streams? Which ones have we established?
What bundles of products and services are Which ones work best?
we offering to each Customer Segment? How are they integrated with the rest of
Categories our business model? Which ones are most cost-efficient?
Motivations for partnerships Which customer needs are we satisfying?
• Production How costly are they? How are we integrating them with
• Optimisation and economy
customer routines?
• Reduction of risk and uncertainty • Problem solving Characteristics
• Acquisition of particular resources • Platform/network Examples
• Newness Channel phases
and activities

• Performance • Personal assistance

1. Awareness—How do we raise
• Customisation • Dedicated personal assistance
awareness about our company’s
6. Key resources • “Getting the job done” • Self-service products and services?
• Design • Automated services 2. Evaluation—How do we help
What key resources do our • Communities
• Brand/status customers evaluate our
value propositions require?
• Price • Co-creation organisation’s value proposition?
Our distribution channels? 3. Purchase—How do we allow
• Cost reduction
Customer relationships? customers to purchase specific
• Risk reduction
Revenue streams? products and services?
• Accessibility
Figure 2.14: The Business Model canvas

4. Delivery—How do we deliver a
• Convenience/usability value proposition to customers?
Types of resources 5. After sales—How do we provide
• Physical post-purchase customer support?
• Intellectual (brand patents, copyrights, data)
• Human
• Financial

9. Cost structure 5. Revenue streams 1. Customer

What are the most important costs inherent in our business model? For what value are our customers really willing to pay? segments
Which key resources are most expensive? For what do they currently pay?
For whom are we creating value?
Which key activities are most expensive? How are they currently paying?
Who are our most important customers?
How would they prefer to pay?
Is your business more How much does each revenue stream contribute to overall revenues?
• Mass market
• Cost driven (leanest cost structure, low price value proposition, maximum automation,
• Niche market
extensive outsourcing)
Types Fixed pricing Dynamic pricing • Segmented
• Value Driven (focused on value creation, premium value proposition)
• Asset sale • List price • Negotiation • Diversified
• Usage fee • Product feature dependent (bargaining) • Multi-sided platform
Sample characteristics
• Subscription fees • Customer segment dependent • Yield management
• Fixed costs (salaries, rents, utilities) • Real-time-market
• Lending/renting/leasing • Volume dependent
• Variable costs
• Licensing
• Economies of scale
• Brokerage fees
• Economies of scope
• Advertising

is adapted from the original version available online.

Please note: The layout of the Business Model canvas in Figure 2.14
Licensed and available under a CCBYSA 3.0 license
Source: Adapted from Business Model Foundry 2015, ‘The Business Model canvas’, accessed July 2015,
Study guide | 179

In their book, Business Model Generation, Osterwalder and Pigneur (2010) identify the nine
building blocks of a business model, and illustrate the business models of a number of innovative
modern organisations (e.g. Lego, Wii, Apple, Skype, Gillette).

The nine building blocks of the Business Model canvas are:

1. customer segments
2. value propositions to satisfy the customer segments
3. channels that deliver the value propositions to customers (e.g. distribution, information, sales)
4. customer relationships
5. revenue streams resulting from delivered value propositions
6. key resources—the assets required to deliver the value propositions
7. key activities—the activities required to deliver the value propositions
8. key partnerships—providers of outsourced resources and activities
9. cost structure.

The Business Model canvas has a value side (right-hand side: building blocks 1–5) and a cost side
(left-hand side: building blocks 6–9). The interaction between these two sides (cost and value)

is the primary determinant of a business model’s success. Business model value is maximised
when customer value is maximised and cost is minimised.

Several types of business models are presented in Business Model Generation:

• the long tail;
• multi-sided platforms;
• open business models; and

In the FREE business model, one customer segment receives their value proposition free of
charge (e.g. Google, Skype, or free-to-air television and radio). Unsurprisingly, a free value
proposition is popular and attracts high customer numbers. Other customer segments
(advertisers) provide a revenue stream for access to this group. Not-for-profit organisations use
the FREE model too. For example, the Fred Hollows Foundation provides free eye cataract
surgery to the poor. Another customer segment (donors) is attracted to this free service and
provides a revenue stream to the foundation.

View the following video which provides a brief introduction to the Business Model canvas: For quick access, type QoAOzMTLP5s
(case sensitive) into the YouTube search box.

➤➤Question 2.15
Refer to the information in Question 2.4 about BikeCo.
Using the Business Model canvas in Figure 2.14 as a guide, construct a canvas for BikeCo, assuming
that BikeCo accepted the BayMart contract. You will need to identify key elements of each of
the nine building blocks. Start with building block 1, ‘Customer Segments’.

Cost leadership, differentiation or focus?

Among the many strategists who have proposed frameworks for understanding strategic planning
and strategy choice, Michael Porter’s work is probably the best known. Porter (1980) identified
three generic business strategies that can deliver competitive advantage. Two strategies—
cost leadership and differentiation—are broad, industry-wide strategies. The third, called a focus
strategy, is narrowly focused on a market niche and involves pursuing a strategy of cost leadership
or differentiation within that market niche. These generic strategies are shown in Figure 2.15,
and described in Table 2.10.

Figure 2.15: Competitive strategies

Competitive advantage

Broad target Cost leadership Differentiation

Competitive scope FOCUS

Narrow target
Cost focus Differentiation focus

Source: Porter, M. E. 1985, Competitive Advantage: Creating and Sustaining Superior Performance,
The Free Press, New York, p. 12. Reprinted and adapted with the permission of The Free Press,
a division of Simon & Schuster Inc. Copyright © 1985, 1998 by Michael E. Porter.

Table 2.10: Porter’s three competitive strategies


1. Cost leadership When an organisation pursues an industry-wide cost-leadership strategy, the

organisation aims to be the lowest-cost producer in its industry. Cost leadership
is associated with a high market share and economies of scale in operations or in
other primary activities. By producing at the lowest cost, an organisation is able to
compete on price with every other producer in the industry and earn the highest
profit per unit sold.

Target is an example of an organisation in the retail clothing industry pursuing

a broad cost-leadership strategy. Target’s strategy is focused mainly on cost
minimisation of inbound logistics activities.

2. Differentiation When an organisation pursues an industry-wide differentiation strategy, the

organisation offers a product or service that is unique in the market. Differentiated
products command a price premium.

Microsoft is an example of an organisation that successfully pursued a broad

differentiation strategy in the computer industry. Microsoft’s strategy is focused on
product design and marketing.

3. Focus When an organisation pursues a focus strategy, the organisation restricts its
activities to a market niche (or market segment) by providing products or services:
• at the lowest cost to that segment (cost-focus); or
• that are differentiated for that segment (differentiation-focus).

A market niche can be defined in many ways—for instance, as a geographical

location (e.g. Melbourne) or as a consumer demographic (e.g. teenage girls).

For the global airline industry, consider a small domestic-only operator (focus) that
aims to achieve the lowest cost.

In adopting a differentiation strategy, the organisation offers a unique product or service to the
whole industry or market. In adopting a differentiation-focus strategy, the organisation offers a
unique product or service in a particular market niche or segment, rather than the whole industry.
So, both involve a unique product or service and the difference between the two lies in their
target market—broad or narrow.
Study guide | 181

Example 2.27: The automotive industry

BMW, Mercedes and Audi provide a differentiated product (i.e. higher quality, safety, brand-name).
Although priced at a premium, the price difference between these vehicles and other competitors in
the motor vehicle industry is not extreme, and has reduced over the last few years. As such, the vehicles
from BMW, Mercedes and Audi are available to a wide range of customers, and are commonly seen
throughout the community.

Ferrari, Rolls Royce and Lamborghini are also examples of unique or differentiated products. However,
they are priced at the very high end of the market, often at several hundred thousand dollars each.
There are also very few of them made or available for purchase. As such, there is only a very small
customer group that can afford these vehicles. They have a differentiation-focus strategy on a very
narrow or niche segment of the market within the industry.

Cost leadership (broad target)

Achieving cost leadership is effected by:
• The scale of manufacturing facilities.

• The use of the latest manufacturing technology. Organisations using the most efficient
methods of production should be able to secure improved cost performance and
product quality.
• Learning. All activities are associated with learning effects. By producing more items than
any other competitor, an organisation maximises its learning and achieves the lowest costs.
• Access to economical resources. If the organisation can gain favourable access to the
sources of its raw materials or labour because of the scale of its purchasing, its location,
or through vertical integration, the lower prices paid for these inputs can contribute towards
overall cost leadership.
• Focus on operational productivity. If the organisation seeks out productivity improvements
and cost reductions, lower product cost will result.
• Ensure value is created by support activities. Unless continually examined and subjected
to suitable cost-minimisation strategies, indirect activities (e.g. research and development,
sales force administration, promotion and distribution) can add significant costs to an
organisation’s value chain without delivering commensurate benefits. Leveraging greater
value per dollar spent on support activities reduces the organisation’s value chain costs.

A cost-leadership strategy has the following implications:

• Pricing. To achieve high volumes of sales, organisations must carefully monitor competitors’
prices and be prepared for aggressive price-based competition.
• Product quality. A cost-leadership strategy is well suited to commodity-type products where
products are very similar, or consumers can readily compare the attributes of competing
products. With such products, organisations must be able to match the product quality of rivals.
• Advertising. Advertising may be used to boost sales volume, especially where advertising
emphasises price discounts or unbeatable prices. Non-price advertising is unlikely to have
much effect on demand. Organisations must carefully monitor the relationship between
pricing, demand, advertising expenditure and profits.

Example 2.28: Strategy evolution

A cost leader does not always have to compete on price, as their product or service characteristics
(e.g. brand) might also allow the organisation to differentiate themselves from their rivals. This is a
common evolutionary path for organisations. They enter a market as a cost leader and expand through

In the 1960s, Toyota and other Japanese automobile makers entered the North American market with
small, inexpensive cars—a cost-leadership strategy. Over time these organisations grew to dominate
the North American automotive industry, producing a full range of cars known for their high quality.

Differentiation (broad target)

Organisations pursuing a differentiation strategy must continually seek to innovate in order to
stay ahead of rivals in image, quality or other key differentiating characteristics. If rivals innovate,
the organisation must invent a superior innovation. Consequently, a differentiating organisation
will have large budgets for research and development, and advertising.

Example 2.29: Brand differentiation

A brand-differentiated product is Coca-Cola. While the product is largely identical to many lower-
priced products, it has been differentiated by its brand, and brand loyalty allows the organisation to
charge a premium for the product. The brand is supported by a significant investment in advertising
and other marketing activities.

Sources of differentiation
Porter (1996) explained that unique strategic positions emerge from three sources: variety,
needs and access.

Strategic position can be based on producing a subset of an industry’s products or services.
This is variety-based positioning because it is based on the choice of product or service
varieties, rather than customer segments (Porter 1996, pp. 65–6). Examples of variety-based
organisations include those automobile manufacturers who concentrate on luxury cars, like BMW,
Mercedes or Audi.

Needs-based positioning is based on serving most or all the needs of a particular group of
customers. It arises when there are groups of customers with differing needs, and when a tailored
set of activities can serve those needs best. IKEA’s customers are a good example of such a
group. IKEA seeks to meet all the home-furnishing needs of its target customers.

The third basis for positioning is that of segmenting customers who are accessible in different
ways. Access can be a function of customer geography or customer scale—or of anything that
requires a different set of activities to reach customers in the best way. For example, fast food
restaurants must have an excellent location in relation to their customers. An increasingly
important customer group to access is smartphone owners who engage with social media like
Twitter and Instagram.

The following table highlights some advantages and disadvantages of cost leadership and
differentiation strategies.
Study guide | 183

Table 2.11: Advantages and disadvantages of cost leadership and differentiation

Advantage Cost leadership Differentiation

Barriers to new entrants Economies of scale raise barriers Brand loyalty and perceived
to entry. uniqueness are barriers to entry.

Substitutes Organisation is less vulnerable than Customer loyalty is a barrier against

its less cost-effective competitors to substitutes.
the threat of substitutes.

Customers Customers cannot drive down prices Customers have no comparable

any further than the next most alternative, as the product is
efficient competitor. perceived as unique.

Suppliers Flexibility to deal with cost increases High margins can offset vulnerability
from suppliers, given the greater to price rises.
value-added margin. Large scale
may increase power over suppliers

Industry rivalry Organisation remains profitable Brand loyalty lowers buyer price
when rivals fail through excessive sensitivity.
price competition.

Profitability A cost leader can choose to achieve High margins can be achieved as long
higher margins by matching the as the product is clearly differentiated
prices of its competitors. and provides value.

Disadvantage Cost leadership Differentiation

Technology Technological change requires Technology provides competitors

additional capital investment. scope for new sources of

Competitors Competitors can learn by imitation. Imitation eliminates the source of

Technological capabilities are differentiation.

Offshore competitors with low

labour costs are a threat.

Product characteristics Cost concerns ignore product Customers may no longer require the
feature and marketing issues. differentiating factor.

Branding is essential.

Price Increase in input costs can reduce Eventually customers become price
price advantages. sensitive.

Fluctuations in foreign exchange Demand may be increasingly elastic

rates may affect input costs or with respect to price.
selling prices.

Demand depends on the price

sensitivity of customers.

Globalisation In a global industry, only one In a global industry, many

organisation can achieve cost organisations are looking for
leadership. differentiating value propositions.

Example 2.30: Value chains of discount and high-end retailers.

Tables 2.12 and 2.13 illustrate the value chains of two retailers.
1. The value chain presented in Table 2.12 is similar to those of discount supermarket chains such
as Costco and Aldi. These retailers sell on price and pursue a cost-leadership strategy. This can
be seen in the limited product range and low-cost locations of these retailers.
2. The value chain in Table 2.13 is based on a high-end department store such as David Jones,
where  the retailer seeks to differentiate on quality and service, hence the promotion of
‘no argument’ refunds, the use of prime retail locations like major malls, exclusive access to certain
designers’ products, and customer-care training for staff.

Table 2.12: Organisational value chain of a retailer adopting a cost-leadership


infrastructure Minimal corporate headquarters and decentralised store management

Inbound Outbound Marketing


logistics Operations logistics and sales Service

Human resource Consider Dismissal No floor staff Consider

management outsourcing for checkout outsourcing

Technology Computer- Simple

based checkouts with
warehousing high-volume
and delivery throughput

Procurement Brand Restricted Customer Low price

purchases with product range access routes promotion
big discounts and parking
Price points Price
House brands guarantees
Basic store
Bulk design

Table 2.13: Organisational value chain of a retailer adopting a differentiation


infrastructure Central control of operations and credit control

Inbound Outbound Marketing

logistics Operations logistics and sales Service

Human resource Recruitment of Customer care Flexible staff Experienced Handled by

management mature staff training to help with and well-paid store
packing staff with
High staff-to- good product
customer ratio knowledge

Technology Product Consumer Store credit

development research research and cards
Study guide | 185

infrastructure Central control of operations and credit control

Inbound Outbound Marketing

logistics Operations logistics and sales Service

Procurement Own-label Prime retail Collect-by-car Advertising Refunds

products positions service in quality given without
magazines question
High-end In-store Home delivery
branded upmarket food No discounts
products halls on food past
sell-by dates
store design

Source: CPA Australia 2015.

Focus (narrow target)
The third type of competitive strategy identified by Porter (1980) is a focus strategy where
an organisation concentrates its attention on one or more market niches or segments.
An organisation pursuing a focus strategy will not sell its products industry wide but focuses its
value chain on a particular customer demographic, geographical area or a limited product range.
There are two forms of focus strategy.

A cost-focus strategy is like a cost-leadership strategy but is focused on a particular customer

demographic, geographical area or a limited product range. This type of strategy is often found
in the printing, clothes-manufacture and automotive-repair industries, or any industry that
requires a small initial investment and offers little in the way of economies of scale.

A differentiation-focus strategy involves selecting a market segment and competing on the

basis of product differentiation for that segment. Organisations selling luxury goods and high
fashion clothing often adopt this strategy.

The drawbacks of a focus strategy are:

• The market segment or niche may not be big enough to provide the organisation with a
profitable base for operations or opportunities for growth.
• The segment’s needs may become less distinct from the main market, and industry-wide
competitors may meet the needs of the segment.

Strategy choice
As mentioned above in the introduction to Part B, strategic management is an iterative process
with many feedback loops. Accordingly, strategy choice does not follow strategic analysis and
strategic planning in a linear fashion as might be thought. Rather, strategies evolve in the process
of strategic analysis and strategic planning.

The notion of strategic choice might be thought to imply that one best strategy should be
(or can be) determined. This is incorrect. As noted, strategic management is inherently uncertain.
A risk-based management approach means that a number of potentially successful strategies
are developed, and one (or more) preferred strategies are implemented. This is done with the
understanding that alternative strategies might then be adopted on the basis of new information,
or changes in the external environment.

A strategic business unit (SBU) is a unit within a corporation that serves a defined external market
with a distinct family of products. An SBU has unique stakeholders, unique objectives relating to
providing stakeholder value, and unique strategies to achieve these objectives.

Porter (1980) argues that a strategic business unit must pursue only one of the three generic
strategies. Organisations that fail to select a single strategy for a business unit will be ‘stuck in
the middle’ and will be unprofitable. According to Porter (1980), an organisation pursuing a stuck
in-the-middle strategy:
lacks the market share, capital investment and resolve to play the low-cost game; the industry-
wide differentiation necessary to obviate the need for a low-cost position, or the focus to create
differentiation or low cost in a more limited sphere

Source: Porter, M. E. 1980, Competitive Strategy: Techniques for Analyzing Industries and Competitors,
The Free Press, New York. p. 41.

In practice, it is not easy to draw hard and fast distinctions between generic strategies, or for
an organisation to choose to follow one strategy exclusively. Today, technology such as flexible

manufacturing systems (i.e. robots) enable mass customisation. Organisations adopting such
technology can offer customers differentiation and low cost (although robotic machinery is very
expensive). Many organisations have successfully pursued strategies involving elements of cost
leadership and differentiation.

Business Model Generation, by Osterwalder and Pigneur (2010), recommends that an effective
strategy is one that increases customer value at the same time as it reduces costs. This idea
does not contradict Porter’s approach, but provides alternative criteria for evaluating a
strategy’s effectiveness.

Organisations encounter difficulties when they fail to develop any strategy at all, when their
strategy is based on inadequate strategic analysis, or when their strategy is poorly designed or
incoherent. A business unit might pursue multiple strategies, as long as there are no inherent
conflicts and the strategies are clearly articulated.

While management’s commitment to, and accountability for, strategy implementation is critical,
over-commitment to any one strategy is highly risky. On the other hand, Porter warns that too
much flexibility means you will never stand for anything or become good at anything, and that
too much change can be just as disastrous for strategy as too little (Magretta 2011).

In choosing a strategy, those criteria for a good strategy noted at the beginning of the Strategic
Planning section of Part B should be considered. Briefly, these criteria suggest that a good strategy:
• promotes organisational values;
• shows how to compete;
• incorporates product and market strategies;
• creates linkages, both internal and external;
• creates inspiration and guidance for managers;
• provides discretion for management action;
• provides a common language;
• exploits strengths and opportunities;
• manages weaknesses and threats;
• complements existing strategies;
• meets stakeholders expectations; and
• provides sustainable competitive advantage.
Study guide | 187

If a strategy ‘ticks all of these boxes’, it is probably a good strategy. These questions cannot,
however, be asked after a strategy has been developed. They are fundamental guidelines to be
applied during the strategic planning process. When the planning process is complete, all of
these questions should have been discussed, and a consensus achieved.

Strategy selection is discussed in detail in the ‘Global Strategy and Leadership’ subject of the
CPA Program.

Strategy implementation
The aim of strategy implementation is to achieve the organisation’s strategic objectives.
Implementation demands action and requires the creation of tangible outputs. Strategy
implementation seeks to:
• unite the organisation behind its agreed strategy;
• ensure that organisational activities lead to realisation of the strategic objectives;

• generate a commitment from all levels of the organisation to implement the strategy;
• hold managers accountable for, and reward them for, successful implementation; and
• provide regular feedback on the practicality and success of strategic plans so that those
plans can be reconfigured as required.

The next three modules (3, 4 and 5) focus on aspects of strategy implementation.

Two well-known tools used to control the implementation of strategic plans are the strategy
map and the balanced scorecard (BSC). These tools focus the organisation on its strategy,
ensure strategic objectives are realised, generate strategic commitment, provide for accountability
and reward, and provide feedback to the strategic planning process. These tools are discussed
further in Module 3.

Module 4 is also concerned with issues of strategy implementation. The main topics addressed
are activity analysis, activity-based costing, activity-based management and customer profitability
analysis. At a detailed level, these tools are focused on the control of costs and revenues, and on
the delivery of value.

Module 5 addresses project management with a particular focus on long-term and large-scale
projects. Strategies are projects. They are unique, future-oriented and large scale. All of the
recommendations in Module 5 about project management, including organisational structure,
project teams, scheduling, budgeting and monitoring of results, are relevant to strategy

➤➤Question 2.16
Consider your own organisation, or one with which you are familiar (like the HZ case study).
Examine the approach that the organisation employs in implementing its strategy. Does the
approach achieve the five objectives of strategy implementation noted in this section? What
particular weaknesses can you identify in your organisation’s strategy implementation process?

View Erica Olsen’s video (2008b) on strategy implementation on YouTube: ‘The Secret to
Strategic Implementation’. Olsen stresses the importance of a) appointing a strategic manager,
b) communications, c) accountability and d) frequent reporting:
watch?v=ndCexCPLNdA. For quick access, type ndCexCPLNdA (case sensitive) in the YouTube
search box.

Implementation problems
Many organisations fail to successfully implement strategic change. Understanding how
new systems work takes time, and the learning process is often unexpectedly drawn out and
expensive. This is especially a problem when the training needs of employees are improperly
assessed. Research has shown that as much as 50 per cent of the cost of new systems is required
for training, and that these costs are often significantly underestimated, or it is assumed that
employees will learn how to use new systems on their own, and in their own time.

Due to the complexity of strategic change, it is difficult for managers to envisage how changes
in strategy should be supported by changes in organisational structure, processes and systems.
Often there is a significant time lag before appropriate structures and processes can be worked
out and implemented. It is always easier for organisations to remain with a suboptimal system,
as any change is likely to result in short-term performance declines and confusion. Old systems
possess inertia because people have become used to them and have learned to operate them
relatively efficiently in spite of their inadequacies.

The important thing to understand about strategy implementation is that implementation involves

significant learning. As learning takes place, the original strategic plan will invariably need to be
modified. Planning and implementation are not separate activities, but part of a circular process
where feedback from implementation leads to the revision of plans and fresh approaches to
implementation. Similarly, strategic planning and implementation are not one off activities,
but are ongoing. Business organisations and their environments are dynamic, and the planning
and implementation activities required to adapt to a changing environment are continuous.

Strategy implementation is also discussed in the ‘Global Strategy and Leadership’ subject of the
CPA Program.

The CPA and strategic management

CPAs, along with the management accounting systems they employ to analyse value chains
and collect other strategically relevant information about the organisation and its environment,
can make a significant contribution to achieving sustainable competitive advantage.

The CPA’s role in strategic management is not unfamiliar. Tasks like information gathering,
analysis and reporting are fundamental to CPAs. Clearly, the CPA has the professional skills to
gather and report information that is quantitative and objective, especially financial information.
This information plays an important role in determining which strategies will create the greatest
organisational value. However, financial and quantitative data can only meet part of the strategic
decision-making needs of an organisation’s managers.

During all stages of strategic management (i.e. strategy analysis, planning, choice and
implementation), much of the information gathered and reported by the CPA will be forward
looking, external and subjective rather than historical, internal and objective. For example,
information on the business cycle has these characteristics and, consequently, it will be difficult
to forecast or quantify reliably. However, the existence of such uncertainties does not reduce
the need to understand these issues—if anything, uncertainties increase the importance of
gathering, analysing and reporting relevant information.
Study guide | 189

Some forecast of the future, however uncertain, is always preferable to failing to include an
important factor in a strategic analysis. In any case, accountants have always had to deal with
uncertain future events, like estimating the expected life and salvage value of depreciable
assets or estimating doubtful debts, so long-term forecasting presents a familiar challenge.
Where point estimates are likely to be misleading, scenario analysis and sensitivity analysis
provide useful alternatives.

Sound strategic management relies on a robust analysis of:

• industry (e.g. growth, profitability and market segmentation);
• competitors (e.g. market share, pricing, cost structure and profitability);
• technological, structural and/or social change (e.g. automation of manufacturing activity
or the outsourcing of non-core activities);
• sources of risk;
• drivers of customer satisfaction; and
• stakeholder needs.

While CPAs cannot eliminate the subjectivity in strategic management, they can challenge

the assumptions underlying forward estimates (e.g. economic growth, population growth,
interest rates) and they can provide some understanding of the risks involved (e.g. the
organisational consequences if the strategy fails or sales targets are not met). By challenging
key assumptions and carrying out scenario analysis, a CPA can increase the objectivity and
substance of the strategic management process and direct their organisation to sustainability.

In this module, we examined value creation in Part A and strategic management in Part B.

In Part A we showed that organisations exist because they provide an efficient way to organise
economic activities, especially in the presence of significant transaction costs. Control of
organisations is accomplished through corporate governance. Effective corporate governance
ensures that the financial, social and environmental requirements of an organisation’s stakeholders
are met. Successful organisations achieve sustainable value creation where value is measured in
terms of stakeholder requirements.

Understanding how an organisation creates stakeholder value is critical for managers and
their advisers. Through an understanding of the organisation value chain, managers are better
able to appreciate how the organisation provides value, and how this value can be enhanced.
An understanding of the industry value chain enables managers to identify opportunities to
enhance value through linkages with other organisations in the industry value chain.

Part B of the module introduced strategic management. Strategic management is a structured

process of information gathering, strategy planning and selection, and strategy implementation.
Gathering sufficient and appropriate strategic information to inform the strategic management
process is a major task for the management accountant. Information must be provided about the:
• value required by organisational stakeholders, and how the organisation provides this value;
• internal strengths and weaknesses of the organisation; and
• external opportunities and threats provided by the industry, as well as national and global
business environments.

Having completed a strategic analysis of the business and its environment, the management
accountant must engage in strategic planning. Porter’s framework for understanding available
strategic alternatives—cost leadership, differentiation and focus—was illustrated, as was the
Business Model Generation approach. Strategy must be developed on the basis of sound
assumptions, and the testing of assumptions is a critical task for the management accountant.
Also important is the examination of an organisation’s strategy for internal consistency.

The third phase in strategic management is implementation. Some implementation guidelines

were introduced in Part B. Later modules deal more extensively with implementation issues.

Successful organisations are those that are able to develop and execute effective strategies
responsive to a dynamic environment. This strategic management activity must be supported by
accounting information systems that:
• monitor stakeholders to determine their requirements;
• analyse the inputs, outputs and value drivers of activities to build effective value chains and
create value;
• collect and communicate strategically relevant information about the organisation, the
industry, and the macro-economic environment;
• set targets for strategic initiatives; and
• measure performance and provide feedback on strategic initiatives.
Reading 2.1 | 191


Reading 2.1
Strategic cost management and the value chain
John K. Shank and Vijay Govindarajan



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Suggested answers
Suggested answers

Question 2.1
The answer to this question has been prepared for a university and an electronics retailer.
The emphasis here is on corporate social responsibilities.

Table SA2.1: Organisation—university

Stakeholder Responsibilities

Student Appropriate and interesting education

Access to a job
Fair assessment

Teacher Interesting work

Secure income stream
Safe workplace
Capable students

Government Job-ready workers

Ethical citizens

Management Career opportunities

Secure income stream
Safe workplace

Employers Job-ready workers:

• Good work ethic
• Communications skills
• Competent
• Ethical

Table SA2.2: Organisation—electronics retailer

Stakeholder Responsibilities

Customers A quality product at a reasonable price

Appropriate product warranty
Good after-sales service

Suppliers A fair return

Timely ordering

Government Payment of taxes

Conduct consistent with the law and regulations

Management Career opportunities

Interesting work
Safe workplace
Incentives for superior performance

Employees Interesting work

Safe workplace
Equitable pay
Job security

Community Employment opportunities

Environmentally sound business practice
Support for community organisations

Shareholders Dividends and capital growth

Question 2.2
This question requires you to draw on your knowledge of an organisation that you work for or
are familiar with. Your nominated organisation may be a for-profit, private-sector organisation,
a public-sector agency or a not-for-profit organisation.

As all organisations are created to realise a particular purpose, they should all have readily
identifiable goals. However, in the case of public-sector and not-for-profit organisations, the goals
may be far more complex and less precise than those of their private-sector counterparts. Thus, it
would be more difficult to have described the goals of a public-sector or not-for-profit organisation.

The concept of the value chain is one that applies to all types of organisations. In some settings,
such as a manufacturing organisation like McDonald’s or Toyota, the properties of the value
chain are tangible and fairly well defined. Here, the value chain typically has a deterministic
character, where a given amount of inputs can be transformed into a given amount of outputs
under specified manufacturing or transformation conditions. The value of many of the inputs and
outputs are easily measurable, and the calculation of value created is not difficult.

The value chains of organisations providing services rather than tangible products (e.g. professional
accounting organisations and public-sector and not-for-profit agencies) are complex and are more
difficult to describe. Furthermore, the input-transformation-output-outcome model of a service
organisation is less deterministic than its product-supplying counterpart. The following illustrates
these issues.
Suggested answers | 213

Public-sector agencies are expected, through the delivery of outputs, to realise agency-level
objectives such as:
• enhancing the quality of life and wellbeing of the community;
• creating the conditions required for the investment and growth that helps to build a strong
economy and deliver more jobs, more opportunities and greater wealth for the community; and
• ensuring that biological diversity is preserved and habitats protected through the sustainable
management, development and use of environmental resources.

For example, a public-sector or not-for-profit agency that has a goal of improving the quality
of life of severely disabled clients will perform a complex chain of activities directed at realising
this goal. Measuring the outputs of the process will be difficult because success in achieving
objectives is difficult to measure. On the input side, in some instances, extensive resources may
be required to achieve a given outcome, while in other instances the inputs might be minimal.
Given the labour intensive nature of the production process and the diversity of customer needs,
the transformation process must be flexible and, in this situation, specifying the input/output
relationship and measuring the value provided might be difficult.

An agency with responsibilities for severely disabled people will provide a range of training,
accommodation, health care and employment services for its clients. Measuring the value of
these activities to clients could be carried out with a quality-of-life survey, or from mortality
statistics that perhaps reveal an improvement in the life expectancy of the disabled. Measures—
such as the number of clients in care, the number of clients engaged in training programs or
placed into the paid workforce—provide an indication of how active the agency has been,
but do not directly address whether the agency has created value.

Question 2.3
(a) Organisational value has different meanings and these meanings depend on the context
within which the term is used. In a broader sense, organisational value is the total net value
that is created for all stakeholders, including society as a whole, and is measured as the
total benefit generated by the organisation’s activities minus the resources that have been
consumed in carrying out those activities.

The emergence of the triple bottom line (TBL) reporting framework is consistent with this
concept of organisational value creation. In TBL reporting, the organisation calculates
measures of economic value added, social value added and environmental value added to
arrive at a total organisational value.

(b) When one refers to shareholder value, it is the value that remains for shareholders after all
other legitimate claims. It might be simply measured as residual income, return on equity
(ROE) or return on investment (ROI). Shareholders ultimately receive value through dividends
and the capital growth of their investments.

(c) Customer value is the value that a customer derives from the product or service they acquire.
Customer value is a complex concept, as products are typically conceived as a bundle of
complementary features. For example, cars provide transport, but also safety, prestige,
comfort and entertainment. Many measures exist, including the percentage of customers
willing to refer your product or service to others. The ultimate measure of customer value
from the organisation’s perspective is revenue.


(d) Employee value is the benefit employees obtain from the employment contract. Value for
employees comes in the form of pay and job security, and also includes intrinsic benefits such
as interesting and challenging work. Two possible measures of employee value are employee
satisfaction and employee turnover.
(e) Community value is the benefit obtained by the local community from the presence of
the organisation. Employees and managers will be members of the local community and
their wages contribute to the wealth of the other businesses in the community, as well as
to public infrastructure and services. These individuals will also support the community in
many non-monetary ways. One possible measure might be the amount that the organisation
contributes to the community directly by providing resources to local health, educational,
or environmental programs.
(f) Supplier value is the benefit, largely economic in character, obtained from trading with the
organisation. Thus, supplier value could be measured as being the profit or revenue realised
on the sale of goods or services.

Question 2.4

(a) BikeCo is operating its factory at 80 per cent capacity with sales of 100 000 units. So full
capacity is 100 000 / 80% = 125 000 units. Unused capacity is therefore 25 000 units
(i.e. 125 000 – 100 000).

From the income statement, the contribution ratio is $8 000 000 / $20 000 000 or 40%.
The unit selling price is $200 per bike, so the unit contribution margin is 40% × $200 = $80.
This calculation is confirmed by dividing the total contribution margin by the number of
bicycles (i.e. $8 000 000 / 100 000 = $80).

(b) For the unused capacity of 25 000 bicycles, the total contribution available is therefore
$2 000 000 (i.e. 25 000 × $80). Note that this reflects the contribution of the additional sales
towards fixed costs and profits.

Assuming all selling and administration expenses are fixed as noted, the increased
contribution would improve the profit by $2 million.

Table SA2.3

Stakeholder group Value proposition

Owners Profit

Employees Secure employment

Good wages

Bike shops Quality Australian-made bicycles

BayMart/department stores Low-cost reliable product

Inventory management

Consumers Quality Australian-made bicycles

Competitive prices compared with imported bikes
Suggested answers | 215

Question 2.5
Activities are what people do. In order to understand the activities in a restaurant, we start with a
list of restaurant personnel and then identify activities performed (as shown in Table SA2.4).

Table SA2.4: Activities in a restaurant

Kitchen Activity Dining area Activity

Head cook Order, receive and inspect Maître d’ Order, receive and inspect drinks
food; cook from suppliers; greet and seat clients;
sell and serve drinks; collect money

Assistant cooks Cook Waiters Sell food; serve food; prepare bill

Dishwasher Clean kitchen Bus person Clean tables

A customer dining in the restaurant is prepared to pay for these activities. The ultimate value
an organisation creates is measured by the amount customers are willing pay for its products or
services above the cost of carrying out its activities. An organisation is profitable if the realised
value to customers exceeds the collective cost of performing the activities.

Some ways that a restaurant can create value include the following.
• It can become more efficient by automating the production of meals, for instance, a fast-
food chain. Customers value the economy, speed, convenience and consistency of the meals
served by a fast-food restaurant.
• It can develop long-term commercial relationships with suppliers so that the chef always has
access to the best quality fresh produce. Customers value the quality of the meals served by
a restaurant that uses the best fresh produce.
• It can specialise in a particular type of cuisine (e.g. Thai, Italian or Japanese). Customers value
the style of cuisine because they do not have skills to cook such food at home.
• It can be sumptuously decorated for those customers who not only value the restaurant’s
food, but also wish to dine in a venue that has ‘atmosphere’ or ‘ambience’. Customers value
the sense of occasion provided by dining in a five-star restaurant.
• It can serve a particular type of customer (e.g. celebrities). Customers value the experience of
dining with like-minded patrons.

Each of these options for a restaurant to organise the activities of buying, cooking and serving
food is a way for it to increase customer value.

Question 2.6
Table SA2.5

Value chain stage (a) Manufacturer (b) Financial services

Primary activities

Inbound logistics Locating, ordering, receiving, Securing funds from depositors or

handling, storing and controlling the other lenders
inputs to the production system

Operations Quality control and testing Processing depositors’ transactions

Scheduling Lending funds to borrowers in a variety
Cost control of forms, including:
Fixed asset management • credit cards
Manufacture (fabricate, assemble etc.) • home loans
• personal loans
Investing and trading activities

Outbound logistics Packaging Not a key value chain component


Marketing and sales Brand development Same as for manufacturing

Sales order processing
Customer account management

Service Product installation Customer portfolio review

Product upgrades Collection of overdue accounts
Repair and maintenance
Spare parts supply
Warranty service

Support activities

Procurement Purchase of manufacturing plant, parts Purchase and leasing of premises

and equipment and ATMs

Technology Product design Product design

development Manufacturing process improvement Service-delivery process improvement
Research and development Research and development

Human resource Recruitment Same as for manufacturing

management Training
Development and rewarding of people

Firm infrastructure: Systems. Might include the Systems. Might include the installation
installation and maintenance of an and maintenance of an on-line
enterprise resource planning (ERP) brokerage system

Marketing. As a support activity, Marketing. Same as for manufacturing

marketing includes long-term product
Suggested answers | 217

Value chain stage (c) Charity (Oxfam is primarily (d) Public hospital
concerned with famine relief)

Primary activities

Inbound logistics Identifying areas of need and Scheduling and assessing patients
negotiating access referred by doctors or arriving in

Operations Processing of donations Testing, monitoring, operating and


Outbound logistics Distribution of food Assessment and release

Distribution of farm equipment and
Training of farmers

Marketing and sales Brand development Medical research


Service Follow-up of training activities Return visits for follow-up of treatment.
In-home nursing visits

Support activities

Procurement Purchasing food for distribution Purchase of hospital building, medical

Equipment and livestock required for equipment and patient requirements
the establishment of farms (e.g. drugs, linen and food)

Technology Website development for accessing Medical research

development donors

Human resource Recruitment and training of staff and Recruitment and training of medical
management volunteers and support staff

Firm infrastructure: Systems. Website for donors Systems. Patient management systems
Distribution system for food and Medicare records
equipment Pharmacy management

Marketing. As a support activity, Marketing. Community relations

marketing includes long-term product

Question 2.7
(a) Prior to outsourcing production and distribution, one would expect that the primary activities
in Sara Lee’s value chain would have comprised inbound supply logistics, production,
marketing, distribution and customer service. Support activities would be similar to those
in other manufacturing organisations, and would have included company infrastructure,
human resource management, technology development and procurement (see Panel A in
Figure SA2.1 below).

Following the outsourcing decision, Sara Lee’s value chain would have been simplified
to one of contract management (of the various tasks now contracted out) and marketing.
The support activities would likely remain relatively unchanged. Research and development
would remain in-house; however, it is likely that product design would now be coordinated
between Sara Lee and an external provider.

Figure SA2.1: Sara Lee’s value chain before and after reconfiguration
Panel A: Before value chain reconfiguration

Inbound Customer
Production Marketing Distribution
supply logistics service

Source Manufacture Promote the Deliver Provide

ingredients bakery and Sara Lee Sara Lee after-sales
to the other brand within products on service,
required convenience the market, time and in ensuring the
quality and foods to set ensuring full to value of the
cost standard. strong brand distributors and Sara Lee brand
specifications. recognition. customers. is maintained.

Panel B: After value chain reconfiguration

Management of
Management of product design and distribution and

manufacturing outsourcing contracts customer service


(b) The major change in the value chain of Sara Lee was the replacement of the activities of
inbound raw materials acquisition, production, distribution and customer service with a
‘single’ value chain activity of contract management. The activity of contract management
will call on many human resource skills and competencies across the different types of
contracts that need to be managed. For example, Sara Lee employees managing contracts
with product design partners will need to take knowledge from Sara Lee’s own research
and development activities, have the skills to analyse trends and innovations in the
bakery and convenience foods industry and be able to work successfully with the external
provider to develop new products. It is important, in the context of Sara Lee retaining a
strong competitive position, that it has access to a continuing supply of new bakery and
convenience-food products that do not erode the quality (and value) of the Sara Lee brand.
On the other hand, Sara Lee employees involved in managing the organisation’s contracts
with bakeries need the skills to monitor the quality of products manufactured under the
Sara Lee brand and be able to promptly identify and offer solutions to production problems
(e.g. poor-quality output).

(c) The major threat to Sara Lee from the decision to outsource to other parties, product design,
inbound-raw-materials acquisition, production, distribution and customer service is that the
organisation loses direct managerial control over these operations. In this situation, the viability
of the outsourcing arrangements for Sara Lee depends on how well the organisation’s partners
perform. While KPIs related to factors such as product quality, time to market, delivery
performance and after-sales service will be specified in the various contracts that Sara Lee
enters into with its suppliers, these measures will be incomplete, less accurate and lagging
when compared to the observation of performance that accompanies direct managerial control.

For example, in attempting to improve the cost performance of its own manufacturing
operations, a bakery partner might be inclined to ‘shave’ product quality by using slightly
inferior and cheaper ingredients. The inability to ensure that product quality standards are
maintained in the manufacturing process may result in irreparable harm being done to the
Sara Lee brand.

Over time, as Sara Lee develops a long-term arrangement with a particular supplier,
trust may be developed. This can lead to an open and transparent relationship between
the organisations, with less concern about potentially opportunistic behaviour of a partner
(e.g. a bakery using low-cost and inferior materials in the manufacture of Sara Lee-branded
products), which would reduce Sara Lee’s risks from outsourcing some of its operations.
Suggested answers | 219

Question 2.8
(a) The costs incurred by DCL during the year ending 30 June 20X0 would be classified as follows.

Table SA2.6
Assigning DCL’s expenditures to different sections of the value chain is the first step in the analysis of how
DCL provides customer value. Value is the difference between the cost of carrying out the activities and
the revenue gained from customers. Value can be increased by reducing the costs of a single activity, or by
combining new or old activities to achieve new synergies. Value can also be improved by initiatives that
increase revenues more than they increase costs.

Costs incurred by DCL Value chain section of DCL

1. Purchase of blank DVDs Procurement of resources—the costs are for a product related
primary activity.

2. Payments to internet service Distribution—the costs are incurred specifically to enable delivery

provider of software to customers.

3. Costs of new user-friendly New product research and design—the costs are for a product-
screen related primary activity rather than general IT development.

4. Fees paid to graphic designers Marketing and sales—the costs are incurred to market and sell the
products in retail stores.

5. Customer training Marketing and sales—the costs are incurred to market and sell the
products in retail stores

6. Legal and consulting costs Organisational enabling structures—while the new subsidiary will
improve the functionality of an existing DCL, the costs relate more
so to firm infrastructure.

7. Costs of customer help desk After-sales service—the costs are specifically incurred in helping
staff customers with products.

8. Costs of feasibility study Organisational enabling structures—while an e-store would involve

all of marketing, sales, distribution and after-sales service activities,
a feasibility study is likely to involve legal, finance and IT support
activities rather than any primary (product-related) activity.

9. Burning and packing DVDs Production—the costs are for a product-related primary activity

(b) Defining the boundaries of the industry in which DCL operates depends on the detail of
analysis required. DCL is in the IT industry or the accounting industry. The industry value chain
below includes only those participants identified in the case.

The inputs purchased from upstream industry participants by DCL include media (DVDs and
broadband) and graphic design. Downstream industry participants include the retailers who
sell their software and the accountants who use it to service their clients.

Figure SA2.2: DCL’s industry value chain

• DVDs
• Broadband
Media • Graphic design

• Programming
Software • Training

• Marketing
Distributor • Sales

• Book keeping
Accountant • Tax

Question 2.9
(a) Your answer to this question requires you to analyse products in terms of their progress
through the product life cycle (i.e. introduction, growth, maturity and decline) and their
position in the BCG market growth/share matrix (i.e. stars, cash cows, question marks or
dogs). Your response will depend on the example you have used.

Consider Apple Inc., which sells desktop computers, notebook computers, iPhones, iPods,
iPads, Apple TVs, apps and watches. While the classification of these products is debatable,
and is based on the assumption that the personal computer market is saturated, at least in
Western countries the following might be appropriate.

Table SA2.7

Product Product life cycle stage BCG growth/share

Desktop (iMac) Decline Cow

Notebook (MacBook) Mature Cow

iPhone Mature Cow

iPod Mature Cow

iPad Mature Star

Apple TV Growth Question mark

App Store Growth Star

Apple watch Growth Question mark

(b) Continuing with the Apple Inc. example, Apple’s product portfolio is very low risk as it
includes many mature cash-generating products. The risk in the portfolio is the lack of new
growth products to replace the maturing products.
Suggested answers | 221

Question 2.10
Table SA2.8

Force Stakeholder Comment Power held

New entrants Private providers Private providers are willing to offer Medium
low priced products. Most have
developing reputations.

Alternative or Apprenticeship Apprenticeships are poorly funded Low

substitute products programs by both government and business.

Customers Local students Student power is low but Low

reputation effects are important in
International students
the longer term.

Suppliers Academics Academic unions are not strong Low

and student/staff ratios are flexible.

Government Government funding is dependent High
on political party policy.

Existing competitors Universities and TAFEs Local competition is well-organised Rivalry: Medium
in an oligopoly.

International International competition is Rivalry: Medium

universities dependent on exchange rate
fluctuations and reputation.

Based on the brief analysis above, the main threat to the industry is government policy. Funding
cutbacks are a significant and unpredictable threat to the number of places available to students,
the level of student fees, and to the funding of staff and facilities. Secondary threats are found in
competition from new private providers and international universities. Other industry factors are
less significant. While the industry is experiencing short-term difficulties, the long-term trend for
the industry would appear to be profitable.

Question 2.11
Your answer to this question should cover the five forces that are present in the selected
organisation’s industry, as well as regulatory and CSR factors that may be specific to the industry
chosen. As noted in this module, it is perhaps an easier task to see the competitive forces at
work in industries where a profit motive is present. Nevertheless, public-sector and not-for-profit
organisations are also confronted with similar competitive forces in their industries. For many
organisations, the future promises greater competition rather than less, and the competitive
position your selected organisation achieves over the next five years depends on how well
it is able to develop and execute the strategies that obtain superior performance from the
organisation’s value chain.

In drafting your response to this question, these are some of the considerations that you
would need to make. Please be aware that this is a suggested response based on conditions
prevailing in an industry at a particular point in time. Consider a large telecommunications
provider. In addition to providing fixed line, mobile and internet services, the organisation owns
and operates most of the country’s telecommunications infrastructure. These two parts of the
organisation’s business are subject to very different forces and follow different strategies. A five
forces analysis would need to focus on these strategic business units separately.

The organisation was for many years a monopoly provider of telecommunications services and
was owned by the government. Today, it is a private organisation and faces competition from
major and minor telecommunications providers, as well as significant regulatory challenges.
Regulatory issues include the cost of the provision of its network to other telecommunications
organisations, the provision of services to unattractive markets (e.g. regional, less populated
areas) and the introduction of a national broadband network. All of these issues also have
significant CSR implications.

• New entrants—Experience has shown that the retail segment of the telecommunications
industry value chain is easy to enter. Other aspects of the organisation’s business have high
barriers to entry due to the massive investment required to build a network.

• Existing competitors—No significant competitors for the organisation exist in the provision
of telecommunications infrastructure. In the retail area, competitors are active in the
regulatory process and, as a result, are likely to have significant power through this route.

• Alternative or substitute products—Substitute products are not generally provided by direct


competitors but by some industry organisations that have adopted alternative technologies,
or by organisations operating in other industries. The organisation operates a copper or wire
network. Other network technologies exist, like optical fibre and wireless communications,
and these provide a threat to its infrastructure business. Other communications technologies,
such as Skype (computer-to-computer telephony over the internet), are also relevant in the
retail sector. Other substitutes for telephone services include mail, email and texts.

• Customers—Buyers of the organisation’s retail services would have little power if each
makes a relatively small purchase. Customers for the organisation’s infrastructure—other
telecommunications retailers—are likely to have more power due to the regulatory issues
noted above. Large-scale customers like governments and large corporations have more than
insignificant power because switching providers is an option.

• Suppliers—Due to the organisation’s size, buying power, and the existence of a number
of competing suppliers, supplier power is a moderate threat. It is not low because the
main suppliers include some other very large organisations. Due to the complexity of the
organisation’s business and the number of different suppliers involved, an analysis of supplier
power needs to take into account the differential importance of various suppliers in the
organisation’s value chain.

Note: We have chosen a hypothetical organisation in the telecommunications industry, as it provides

a ready basis for illustrating the competitive forces at work and information is easily sourced in the
public arena.
Suggested answers | 223

Question 2.12
Table SA2.9

Strengths Established market share, production facility, product range and distribution network
Quality reputation
Unused factory capacity

Weaknesses High relative labour cost/low level of automation

Low level of profitability to support new equipment
Insufficient capacity to satisfy current customer demand and the BayMart contract

Opportunities Growing bicycle market

Consumer preference for Australian products
BayMart contract—potentially offers increased factory utilisation, increased market
share and stable demand

Threats High Australian dollar/Low cost imported bicycles
Buyer power (large chain stores like BayMart)

(b) Strengths
(i) From the suggested answer to Question 2.4, unused capacity is currently 25 000 bicycles.
For the unused capacity of 25 000 bicycles, the total contribution available is $2 million.
(ii) The ‘Australian made’ differentiator is clearly sustainable.

The current low level of profit ($0) prohibits new investment in the machinery required to reduce
unit cost (i.e. by reducing labour costs) and improve the company’s competitive position.

Bicycle market growth will support the existing strategy and exploit the unused factory
capacity. Unused capacity is currently 25 000 bicycles. See Strength 1 for a calculation of the
profit potential. The increased profitability would permit investment in the new machinery
required to improve the company’s manufacturing cost profile.

(i) The Australian industry is increasingly based on imported products and the consolidation
of retailers. An Australian manufacturer selling through independent retailers does not fit
the industry trend.
(ii) BikeCo’s quality reputation will be increasingly difficult to sustain in the face of cheaper
imports. Prices of comparable (equal quality) bikes will continue to decline as Australian
wages rise and competitors mechanise their production processes.

(c) Strengths
(i) The new strategy builds on 40 years’ experience of building quality bikes in Australia.
(ii) Unused capacity—the factory is operating at 80 per cent capacity, implying a full capacity
of 125 000 units (i.e. 100 000 bicycles / 80% = 125 000).

(i) Assuming retention of existing customer demand, the new strategy requires expansion
(or outsourcing) of capacity: existing demand 100 000 + BayMart demand 40 000 =
140 000 bikes per annum versus 100 per cent capacity of 125 000 bikes. If BikeCo pursues
a cost-leadership strategy, investment in machinery will be required and the company’s
profitability is not adequate for this purpose.
(ii) Additional warehouse capacity may be required as per the BayMart contract terms.
The company’s current profitability is not adequate to support this investment.

(i) BikeCo is responding to the emergence of powerful buyers and competing more
effectively with foreign imports through price reductions based on economies of scale
(lower per unit fixed costs).
(ii) The BayMart contract (also a strength relating to unused capacity). Accepting the BayMart
contract would mean capacity of 125 000 bicycles could be achieved, with 40 000 sold
to BayMart and 85 000 to existing customers. This would mean a profit contribution
of 40 000 × $60 = $2.4 million per annum from BayMart, in addition to 85 000 × $80 =
$6.8 million from existing customers; a total contribution of $9.2 million. Assuming the
$4 million fixed manufacturing costs and the $4 million selling and administration
expenses are fixed over the relevant time frame, this increased contribution would
improve BikeCo’s net margin by $1.2 million (i.e. $9.2m – $8.0m); from 0 to 5 per cent
(i.e. $1.2 million / (40 000 × $180 + 85 000 × $200)). The increased profitability would
permit investment in new machinery required to improve the company’s manufacturing
cost profile.
(iii) BikeCo could consider outsourcing bicycles from other manufacturers in the short
(or long) term in order to provide the additional capacity required. This would mean

BikeCo could continue selling 100 000 bikes to existing customers, plus the 40 000 bikes
to BayMart, increasing total sales to 140 000 bikes. Such an outsourcing arrangement
would provide for an additional 15 000 units (i.e. 140 000 total sales – 125 000 factory
capacity) at a contribution of up to $80 per unit, depending on the cost of outsourcing
(potentially adding $1.2 million).
(iv) The new strategy provides a new distribution channel accessing consumers who prefer
Australian manufactured products as well as low prices.

(i) BikeCo’s entry into the BayMart distribution network is a direct threat to its existing
customers. The company may increase its low margin business at the expense of its high
margin business.
(ii) The strategy is not sustainable unless major economies of scale are achieved through
market expansion (exporting) or increasing market share.

Question 2.13
(a) CPA Australia functions, like other professional organisations, to train, accredit and monitor
its members. These activities provide a social benefit, as consumers or employers who hire
a CPA have confidence that a CPA will be both technically competent and ethical. This also
reduces transaction costs in the labour market (the cost of employment and training for
employers), and reduces any losses that might be caused by incompetent or unethical
people providing accounting services.

(b) In considering the contribution of your own organisation, focus on key stakeholder groups
and the benefits they derive from the organisation.

Presented below is the ‘one-page’ strategy document of Deakin University, which clearly
illustrates its mission and vision, as well as its objectives and strategic performance measures.
Here, the vision is called the ‘Deakin Offer’ and the mission is the ‘Deakin Promise’.
Deakin University offers you a borderless and personalised relationship, creating the power and opportunities to
live the future in a new world.
Deakin will be Australia’s premier university in driving the digital frontier to enable globally connected education
for the jobs of the future, and research that makes a difference to the communities we serve.


Deakin Promise As a globally joined university, engaged locally and informed by its Australian context, Deakin promises to advance:


Offer brilliant education where you are Make a difference through world-class Enhance our enterprise, strengthen our Delight our students, our staff our alumni
– and where you want to go. innovation and research. communities and enable our partners. and our friends.

Deakin Response Deakin will achieve its Promise through integrated strategies:

1. Provide premium cloud and located learning 1. Grow research capacity, depth and quality 1. Create innovative environments both located and 1. Optimise our services and support to meet the
2. Deliver globally connected education 2. Develop targeted commercial research partnerships in the cloud prioritised needs of students
3. Welcome, support and retain committed and 3. Develop a strategic international research footprint 2. Build employee capacity, capability and productivity 2. Deliver services, resources and environments to enable
capable learners 3. Progress a sustainable and competitive enterprise an engaged, inclusive, productive and satisfied staff
4. Empower learners for the jobs and skills of the future 3. Strengthen connections with, and add value to,
governments, industry, alumni and the communities
that Deakin serves

Deakin Tracks Deakin will know it is succeeding by tracking:

• Premium enhanced courses • Research capability • Deliver ICT and Infrastructure projects • Student engagement
• Globally connected learning experiences • Innovation impact • Workforce productivity • Staff and student satisfaction
Table SA2.10: Live the future—the Deakin plan

• Student success • Research outputs • Resource utilisation • External engagement

• Graduate employment and further study

Deakin Personality Through LIVE the future Deakin will be:

• Brave • Accessible • Inspiring • Stylish • Savvy

Live the Future—The Deakin Plan’, Deakin University.

Source: McLean, P. 2015, ‘Live The Future Agenda 2020:
Suggested answers |


Question 2.14
Your answer to this question requires you to be familiar with the case facts and strategy of
HZ Electrical (HZ) (see Case Study 2.1). You need to:
• answer Hambrick and Fredrickson’s (2001) six questions; and
• evaluate HZ’s strategy.

1. Strengths (internal). Does the organisation’s strategy exploit its resources and capabilities?
All of HZ’s strengths are employed in the organisation’s strategy. HZ’s strengths are:
–– new CEO—the CEO is instrumental in forwarding the strategy;
–– licence agreements with suppliers—these provide well-known branded products;
–– growth in sales and product range—this supports the growth of the business;
–– HZ’s own product range—this also supports the growth of the business; and
–– factory outlet stores—these provide a new distribution channel to support growth.

2. Weaknesses (internal). Does the organisation have sufficient resources to pursue its strategy?
HZ’s weaknesses prevent it from pursuing a meaningful strategy. It’s weaknesses include:

–– no strategic plan—lack of a strategic plan means that HZ lacks strategic planning skills; and
–– board in conflict—this will prevent the development and implementation of any strategy.

3. Opportunities (external). Does the organisation’s business strategy fit with what’s going on
in the environment?
The lack of a coherent strategy means that HZ is failing to exploit its opportunities as
effectively as it might. HZ has opportunities to:
–– expand product range; and
–– expand retail chain.

4. Threats (external). Will the organisation’s differentiators be sustainable?

HZ does not seem to be effectively addressing its threats. The current threats for HZ are:
–– supplier dissatisfaction with HZ’s own brand products—this could lead to long-term
problems including the loss of suppliers and brands; and
–– retailer dissatisfaction with HZ’s own retail outlets—this could lead to the loss of
retail customers.

5. Fit. Are the elements of the organisation’s strategy internally consistent?

HZ’s strategy is not internally consistent. Related to point 4 above, there is:
–– conflict between continuing to sell licensed products and expanding sales of HZ’s
products—serious conflict exists between home brand and other branded products;
and conflict with selling through independent retail outlets and starting up own factory
outlets and other retail stores—serious conflict also exists between the retail distribution
chain and HZ own outlets.

6. Reality check. Is the organisation’s strategy capable of being implemented?

HZ does not really have a strategy to implement at this point. The issues identified above
need to be resolved before the company can proceed with new strategic initiatives.

Clearly, HZ’s strategy needs significant improvement.

Suggested answers | 227

Question 2.15
Please note, the letters (A or B) in the table relate to the two customer segments (A—existing
customers; B—BayMart contract). For example, in the ‘Key activities’ building block, the bike
factory is A/B. This indicates it is important to both customer segments.

Table SA2.11: Business Model canvas—BikeCo

8. Key partners 7. Key activities 2. 4. Customer 3. Channels

Present: A/B Bike factory Value relationships A Frequent
Bicycle parts A/B Working propositions A Personalised small delivery
manufacturers capital A Quality sales B Dedicated
(especially A) product B Long-term warehouse
Potentially: B Warehouse A Model range and large- and
outsourcing 6. Key resources A/B Australian scale contract distribution
new warehouse Manufacturing made system

and distribution workers wages B Low cost
channel as
well as bicycle

9. Cost structure 5. Revenue streams 1. Customer

Investment in fixed assets and working A 100 000 at $80 margin segments
capital B 40 000 at $60 margin A Independent
Payment of relatively high labour cost bike shops
B BayMart

Question 2.16
The study materials identify the following guidelines for strategy implementation. Your answer
to this question requires you to be sufficiently aware of your own organisation’s strategy
implementation process to determine whether the guidelines are followed. The following
analysis applies the guidelines to HZ (see Case Study 2.1).

1. Unite the organisation behind its agreed strategy.

HZ has no agreed strategy and conflict is evident at the board level.
2. Ensure that organisational activities lead to realisation of the strategic objectives.
Strategic objectives remain unclear at HZ.
3. Generate a commitment from all levels of the organisation to implement the agreed
Management at HZ has the expectation of serving two masters and compromising
their activities.
4. Hold managers accountable for, and reward them for, successful implementation.
There is no obvious strategically oriented compensation plan at HZ.
5. Provide regular feedback on the practicality and success of strategic plans so that
those plans can be reconfigured
The only regular reporting at HZ are the quarterly performance reports. These are not
strategically aligned.

Case Study 2.1

Table SA2.12: Evaluating strategic planning at HZ

Evaluating statements Poor Fair Good

1. The directors and senior management understand and agree on: 

– mission and vision;
– goals and objectives;
– strategic issues;
– core strategies; and
– major initiatives to implement these strategies

2. Strategic planning tools and frameworks are effectively employed 

3. The board has high-level strategic skills 

4. The board and senior management are actively involved in strategy 


5. An appropriate balance in strategy development is maintained between the 

board and senior management

6. The board is always involved early in the strategy development process 

7. Strategic planning meetings are always supplied with detailed 

environmental and organisational data

8. Sufficient board time and resources are made available for strategic 
planning and review

9. Reports of senior management to the board are strongly linked to strategy 

10. Strategic planning is built into the board’s meeting agenda 

11. Strategic issues and updates receive strong coverage at board meetings 
and meetings of the board with management

12. Proposals considered by the board and senior management are linked back 
to an agreed mission, goals and objectives

13. The board and senior management monitor a broad range of financial and 
non-financial KPIs relevant to the strategy

14. Evaluation of senior management is strongly linked to strategy 

15. Risk assessment is carried out for every strategic proposal considered by 
the board

16. Directors and managers routinely engage in informal dialogue about 

strategic issues
Suggested answers | 229

How did you rate the strategic planning process employed by HZ? Hopefully, you have allocated
mostly ‘Poor’ to each of the evaluation criteria.

The broad conclusion that can be drawn from the case study is that the members of HZ’s board
of directors and the senior executives do not have a clear and strongly shared view about the
organisation’s business model. Furthermore, there is some confusion among the directors and
senior executives about the strategic initiatives the organisation should employ to maintain a
competitive position in the Australasian consumer-products industry.

Specifically, HZ uses few relevant tools in its strategic planning process and the board is poorly
equipped to carry out this function. In spite of this, the board dominates the process and
excludes management from its discussions. Little relevant information is provided to the board
to support its discussions. No strategic planning framework is agreed, strategic KPIs are not
tracked, and no risk assessment takes place. As a consequence, it is not possible to connect
senior management rewards to strategic goals.

HZ must start the strategic management process by carrying out a strategic analysis of the

organisation and its operating environment. Following this, they should draw on the strategic
analysis to develop a corporate vision and mission to guide the development of organisational
objectives, and then develop strategies to accomplish those objectives.

In developing the strategies, the board and management must create a shared understanding of
how HZ creates value for its stakeholders (e.g. shareholders, creditors, employees, customers and
suppliers). Without this understanding, the future for HZ is bleak.
References | 231


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Hambrick, D. C. & Fredrickson, J. W. 2001, ‘Are you sure you have a strategy?’, The Academy of
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Howarth, C. S., Gillin, M. L. & Bailey, J. 1995, Strategic Alliances: Resource Sharing Strategies for
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pp. 5–19.

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Module 3

* Updated by Rahat Munir.


Preview 237
Teaching materials

Part A: The role of performance measurement 240

Introducing ‘performance’ and ‘performance measurement’
Financial performance measurement
Non-financial performance measurement
The measurability of performance
The multiple roles of performance measurement 246
Performance: A process of value creation
Performance and sustainability
Integrated reporting
Governance, risk management and performance
Ethics and performance measurement
Theories related to performance measurement

Part B: Strategy, management control and

performance measurement 266
Strategy and performance measurement
Limitations of traditional controls
Models of performance measurement 274
Operational and strategic performance
Leading and lagging measures
Frameworks for performance measurement

The balanced scorecard

Designing a balanced scorecard
Public sector and not-for-profit performance measurement
Strategy mapping and performance measurement
Cascading performance measures
The role of information systems in performance measurement
The role of performance measurement in implementing and monitoring strategy

Part C: Determining performance measures and

setting performance targets 297
Designing performance measures
Measuring efficiency, effectiveness and equity
Designing performance targets
Characteristics of performance measures and targets
Costs and benefits of performance measurement
Performance measurement, power and culture
Improving performance 308
Organisational learning and knowledge management
Behavioural consequences of performance measurement
Performance measures and performance targets
Reward systems

Review 320

Appendix 321
Appendix 3.1 321

Suggested answers 329

References 351
Study guide | 237

Module 3:
Performance measurement
Study guide


The Strategic Management Accounting subject promotes ‘the CPA as a value driver’. It emphasises
the role of the professional accountant in engaging with the organisation’s senior management
team to contribute to strategy development and implementation. The aim is to create customer
value and a strong competitive position for the organisation. This subject focuses on developing,
implementing and monitoring strategies in order to enhance value for the organisation. Such a
focus would not be possible without understanding the key role that performance measurement
plays in strategy and value creation.

The need for sound design and an understanding of the use and implications of strategic
performance measurement and control systems is gaining increasing importance in all
organisations. This module sets the context for performance measurement and control
including the:
• characteristics of effective performance measures and control systems;
• use of performance measures; and
• application of performance measurement to motivate and reward.

Module 3 is concerned with how performance measurement helps to achieve goals and
objectives through setting targets and measuring performance against those targets through
control and feedback systems.

Module 3 builds on Module 1 and emphasises the role of the management accountant in
supporting the management team in their strategic role. In particular this module looks
at performance measurement in the context of value creation and the sustainability of
performance over time, as well as sustainability in the sense of corporate social responsibility.

This module also builds on Module 2 by discussing the role of the management accountant
in generating and interpreting information about value chain performance. The links between
strategy, management control systems and performance measurement, and the limitations of
some traditional accounting-based controls are considered. The various models of performance
measurement, emphasising the balanced scorecard and the strategy mapping process, as well as
cascading performance measures and the important role of information systems in performance
measurement will be highlighted.

Modules 4 and 5 will be previewed by discussing the role of performance measurement in the
creation and management of value and in project management. How performance measures
and their associated targets are designed and the characteristics that make performance
measures useful, including the need to compare the costs and benefits of performance
measurement will be discussed. This module focuses on improving performance through
targets, trends and benchmarking, and the importance of continuous improvement through
organisational learning and knowledge management processes.

This module illustrates concepts with examples from manufacturing, service and retail
organisations and the public and not-for-profit sectors.

Figure 3.1: Subject map highlighting Module 3

n n
v v
i i
r r
o o

n n
m m
e Vision / Mission e
n n
t Goals and objectives t
a a
l Strategy—Creation l
a a
n Strategy—Implementation n
l l
y Strategy—Implementation y
i i
s Control and feedback systems s

Goals and objectives: Developing appropriate performance measures for objectives.

Control and feedback systems: Performance measures, variance analysis and

balanced scorecard reporting

Source: CPA Australia 2015.

Study guide | 239

After completing this module you should be able to:
• explain performance and performance measurement;
• examine the role of performance measurement in value creation and sustainability;
• discuss the role of performance measurement in implementing and monitoring strategy;
• design alternative frameworks for performance measurement;
• evaluate the characteristics of different types of performance measures;
• analyse techniques for performance improvement; and
• explain the behavioural effects of performance measurement and reward systems.

Teaching materials
• Learning task
A learning task for this module is available in ‘My Online Learning’.

• APES 110 Code of Ethics for Professional Accountants


Part A: The role of performance

In Part A the concepts of performance and performance measurement are introduced.
Both financial and non-financial performance are considered, and the measurability of
performance. The multiple roles of performance measurement, including its role in value
creation and sustainability are explained. Corporate governance in terms of the links between
risk management and performance measurement, and the role of ethics in performance
measurement are reviewed. Part A concludes with two theories that help explain differences
in how accountants affect and are affected by performance measurement.

Introducing ‘performance’ and ‘performance measurement’

When we refer to ‘performance’ or ‘performance measurement’, we need to be clear about what
we mean, as these terms can mean different things to different people. Performance may be a
discrete event, as in achieving a certain level of profit or customer satisfaction. Performance may
be considered quantitatively (i.e. a numeric value)—for example, that profit is $10 million, or that
85 per cent of customers are satisfied. It may also be considered qualitatively (and typically more
subjectively)—for example, the quality of a service or an organisation’s reputation. There may be
a trade-off between quantitative and qualitative aspects of performance, for example between
achieving a certain level of profitability, and the organisation’s reputation. Similarly, there can
be a trade-off between short-term performance and longer term sustainable performance,
whether that be financial, societal, environmental or reputational.

Performance may be understood at the level of the whole organisation, or different business
units, products or services, geographic areas, or customer segments within the organisation.
At each level of analysis, performance may be interpreted differently. For example, if you
follow the news reports about the Australian airline Qantas, you will know that the results the
organisation achieves are quite different between its international, domestic, and low-cost
subsidiary (JetStar) business segments, and different strategies and measures of performance
may apply across each of these different segments.

Further, different stakeholders (e.g. investors, lenders, customers, suppliers, employees,

local communities) may interpret performance in very different (and sometimes competing)
ways. For example, if you are a customer of Qantas, you may see Qantas’ performance in terms
of on-time departures or the comfort of the cabin seating. If you are an investor, you may be
more interested in its financial performance. If you are a member of the public living near an
airport, you may be more interested in the airline’s environmental performance.

Performance measurement implies a scientific technique involving comparison to a specific

scale (e.g. a metre in length, a tonne of weight, one thousand dollars). A performance measure
is therefore quite specific in nature. Financial performance, such as profit or return on investment,
can often be readily measured because it is clearly defined and based on a clear application of
rules (such as accounting standards or generally accepted accounting principles).

A performance indicator is less specific in nature—it is more like a signal (like a traffic light)
indicating a general direction or trend rather than an exact comparison against a scale.
For example, judging customer satisfaction would be more of an indicator because it can
mean different things to different people and can be judged in different ways (e.g. sales
to returning customers, a survey of a sample of customers). Performance indicators are
often presented as a trend or as ‘traffic lights’: green for acceptable, red for unacceptable,
and amber for borderline performance.
Study guide | 241

There are many other functions relevant to the concept of performance:

• Performance monitoring involves surveillance over performance.
• Performance management involves taking deliberate action.
• Performance improvement implies an absolute or relative target that needs to be
achieved (such as a return on investment of 12 per cent, or a market share that is greater
than a particular competitor).
• Performance reporting involves the publication of information about performance to
those inside and/or outside the organisation.

An understanding of performance therefore must include a clear definition of what the

organisation means by performance (i.e. what it is trying to achieve) and also include processes
for its measurement, monitoring, management, improvement and reporting. Performance
can be seen as a method of value creation (‘If we aren’t creating value what are we doing?’)
in terms of process or the results of a process. Performance is usually interpreted relative to a
target, a trend over time, or by comparison to a benchmark. Targets, trends and benchmarks
are discussed later in this module.

An organisation’s performance should not be viewed from one dimension only (i.e. only from a
financial point of view). Performance should be seen more holistically through:
• financial dimensions—via a combination of financial measures (e.g. profit before tax,
return on investment);
• non-financial dimensions—in non-financial but quantitative terms (e.g. market share (%),
net promoter score, quality pass rate, patent registrations (number));
• quantitative dimensions—via combinations of financial and non-financial quantitative terms
(e.g. dollar sales per square metre of floor space, earnings per share); and
• qualitative dimensions—via subjective judgments and opinions (e.g. employee satisfaction,

reputation or environmental awareness).

Organisations use different terms for their performance measures such as key performance
indicators (KPIs) or critical success factors (CSF). Organisations may call their performance
measurement system a ‘dashboard’ (picture the dials in an aircraft cockpit) or a ‘scorecard’.
These differences in terminology matter less than understanding what an organisation is
trying to measure and how that measurement takes place.

Example 3.1: Performance reporting by Qantas

Performance needs to be understood relative to an organisation’s strategy and the particular industry
in which it operates. Qantas, the company, has a two-brand strategy. Qantas is the premium airline
targeting the time-conscious business market while Jetstar is the low fares airline which targets the
more cost-conscious holiday market. As a company, Qantas has safety as a first priority, with efficiency
being achieved through having the right aircraft on the right routes with optimum capacity utilisation
(i.e. seats filled with passengers).

Financial performance is highlighted in the annual report to shareholders. Qantas draws particular
attention in its annual reports to profit before tax, revenue, operating cash flow, and cash held at year
end. Qantas reports its results for its major business segments, where it focuses on underlying earnings
before income tax (before interest costs). These segments are:
• Qantas domestic;
• Qantas international;
• Qantas loyalty (Frequent Flyers);
• Qantas freight;
• Jetstar; and
• corporate/unallocated.

While you would expect that financial performance through the financial statements would be a
central part of the annual report, Qantas also includes a broad range of measures of performance in
its annual report.

➤➤Question 3.1
The Qantas Annual Report 2014 is available online at:
investors-annual-reports/global/en. Click the ‘Annual Report’ link for 2014.
Search the 2014 Qantas annual report and identify as many performance measures as you can.

Financial performance measurement

Accountants are familiar with measuring, monitoring, managing, improving and reporting
financial performance through the income statement (or statement of profit or loss and other
comprehensive income), statement of financial position (balance sheet), and statement of cash
flows. Accountants can interpret financial performance through the use of ratio analysis to
discover trends and opportunities from the five perspectives provided by ratios:
• profitability;
• liquidity;
• gearing;
• activity or efficiency; and
• shareholder returns.

Various approaches to measuring shareholder value from an investor’s perspective are also
available. The study of the impact of reported financial performance on capital markets is an
important one in order to understand stock market expectations and how reported performance
influences share price movements over time.

Financial performance is also reported internally by organisations. While financial statements

produced for external parties are governed (in Australia) by the Corporations Act 2001 (Cwlth),

International Financial Reporting Standards (IFRS) and the requirements of external audit,
these have limited usefulness to managers who are interested in understanding organisational
performance at the more detailed level necessary for planning, decision-making and controlling
operations. Strategic management accounting, however, provides a more detailed analysis of
performance as shown in Table 3.1.

Table 3.1: C
 omparison of approaches to performance between financial accounting
and strategic management accounting

Financial accounting Strategic management accounting

Annual figures in external financial statements Monthly figures (or in some cases weekly or even
daily—e.g. retail sales) reporting

Consolidated data (even segmental reporting in Reporting for individual business units and
financial statements is highly aggregated) responsibility centres

Highly aggregated data on income and expenses Detailed analysis of individual income and expense
line items

Comparison to prior year Comparison to prior year, budget and external


Source: CPA Australia 2015.

Study guide | 243

Strategic management accounting also provides comparisons to budgets and standard costs,

and enables variance analysis, product/service profitability analysis, customer and distribution
channel profitability analysis, activity-based cost analysis and a variety of other tools and

Strategic management accounting information increasingly links the information in the

general ledger with other sources of data such as inventory records, labour routings, bills of
materials, and standard costs.

Strategic management accounting techniques may move beyond the:

• financial year to encompass a multi-period, life cycle approach to understand performance;
• hierarchical organisational structure of reporting to the analysis of its organisational value
chain and business processes; and
• organisation to assess the whole supply chain (industry value chain) of which the
organisation is a part, and to provide comparisons with competitor organisations and
competitor supply chains.

Increasingly, strategic management accounting can provide managers with increased information
about markets, customers, competitors, supply arrangements and production processes,
based on formal and informal sources.

Non-financial performance measurement

Strategic management accounting increasingly links financial data with non-financial
data and reports them together to managers. Applying the Qantas example (Example 3.1
and Question 3.1 above), it is clear that managers within Qantas interpret performance, plan,

make decisions and exercise control by reference to:
• financial data;
• business operating data (e.g. passenger numbers, seat utilisations, available seat kilometres
(ASK), revenue passenger kilometres (RPK)); and
• performance measures for the safety and health, environment, customer, people and
community perspectives.

Individual managers of business units will be responsible for various measures of performance
within their areas of responsibility. The Qantas Remuneration Report discloses how many of these
measures are incorporated into executive and director remuneration packages.

Most organisations maintain comprehensive statistical data to support planning, decision-making

and control. This information may come from:
• data captured as a by-product of the accounting process (e.g. quantities of product
purchased and sold, labour hours worked);
• data captured by the organisation from non-accounting systems (e.g. on-time delivery,
product quality);
• external surveys (e.g. customer satisfaction);
• published data (e.g. Australian Bureau of Statistics, or industry associations); or
• stock exchange data (e.g. market capitalisation).

Performance, whether it is financial or non-financial, needs to be interpreted in the context of

the industry, and the organisation’s competitive strategy and business model. While ‘sales per
square metre’ is a useful performance measure in retail stores, it is fairly meaningless in airlines.
Equally, ‘available seat kilometres’ will have no relevance to retail stores. A measure for capacity
performance is just as important in a hotel (where it is called ‘room occupancy’) as it is in an
airline (where it is called ‘seat utilisation’).

In the Qantas example, its two-brand strategy means that performance measures across
the organisation are unlikely to be applied in the same way. Qantas may have performance
measures for onboard sales of duty-free items on international flights, but does not sell food and
alcohol for onboard consumption as it is built into the ticket price. Jetstar by contrast emphasises
onboard sales of food and drink as an important source of additional revenue, as these are not
always built into the ticket price. While on-time arrivals and departures are important measures
for both Qantas and Jetstar, the actual turnaround time between arrivals and departures is
likely to be very different for the two airlines. On the other hand, safety would have the same
importance for both airlines (because the detrimental reputational impact of poor safety
practices is very high). Qantas and Jetstar have different ‘business models’. The model defines
the assumptions that managers use about how the business achieves success.

The measurability of performance

A favourite saying in performance measurement is ‘what gets measured, gets done’. This is
because measuring something focuses people’s minds on what is measured, especially if the
performance is reported, compared to some target, and where rewards are linked to achieving
the desired performance level (e.g. sales representatives may receive a commission on the value
of sales, or managers may receive a bonus on the reported profit). Those things that are not
measured are often deemed to be unimportant. Unfortunately, organisations tend to measure
what is easy to measure, rather than what is important to measure (Denton 2005). This raises the
issue of whether all performance is measurable.

Some people believe that performance must be ‘measurable’ to be useful. But not everything
that is important can be objectively measured. Qantas has long held a reputation for safety.
However, during the period 2011–13 Qantas experienced a range of aircraft faults and moved

to offshore maintenance, which may have damaged its reputation. But how is this measured?

Example 3.2: Safety Index

There are rankings of airlines around the world based on aircraft loss accidents and serious incidents
as a percentage of revenue per passenger kilometre (RPK). The Germany-based Jet Airliner Crash
Data Evaluation Center, or JACDEC (, calculates
its Safety Index and annual rankings based on aircraft loss accidents and serious incidents where an
accident nearly occurred over the past 30 years. The Safety Index relates the accidents to the RPK.

In 2013, Fairfax reported that Qantas had dropped in place to 13th in the world, despite the fact
that it has had a clean record (defined as no aircraft loss or serious incident) since 1983. The Center
director explained that this was because Qantas ‘had experienced multiple incidents where a serious
accident had nearly occurred in recent years.’ Qantas has since improved its position and was listed
at 7th in the 2015 rankings.

Source: Adapted from Mace W. & Olivieri N. 2013, ‘Qantas downgraded on Safety Index’
Sydney Morning Herald, 12 January, accessed September 2015,

The Safety Index is a good example of a performance indicator rather than a performance
measure because there is no objective way of measuring Qantas’ actual safety or its reputation
for safety. Any trend in passenger numbers or results of surveys of customers may indicate a
reputational effect, but could equally be a consequence of other factors including economic
conditions, cost, service or comfort. So Qantas’ performance in terms of safety or reputation
is difficult, if not impossible to objectively measure. But it remains an important element
of performance.

Similar difficulties exist with attempts to measure brand image, customer satisfaction or employee
morale, where surveys, a common method of evaluating performance in relation to these issues,
may provide limited, ambiguous or even biased information.
Study guide | 245

One development to improve the measurability of customer satisfaction is the Net Promoter
Score (NPS). NPS measures the loyalty that exists between an organisation providing goods or
services (the provider) and a consumer. The focus of the score is the question: ‘How likely is it that
you would recommend our company/product/service to a friend or colleague?’, which can be
answered on a scale of one to 10. Responses range from customers being complete detractors
of the provider to complete promoters of the provider. The measure has been adopted by many
Australian companies, including Qantas (Bradley & Hatherall 2013).

The importance of NPS is that it provides a measure of sustainable customer satisfaction

necessary for future financial performance, not only in terms of repeat business for existing
customers but extends to referrals to new customers. This helps the business to focus on keeping
profitable customers happy, and continuous improvement in customer satisfaction.

In the public sector, where the primary focus is not on financial results, organisations also
communicate the success of their activities by reporting on their performance through a range
of non-financial measures.

Example 3.3: Performance reporting by Victoria Police

The annual reports of police services contain a large number of performance measures. The Victoria
Police Annual Report for 2013–2014 has five key areas of focus:
1. Effective police service delivery.
2. Improving community safety.
3. Working with stakeholders.
4. Achieving through people.
5. Developing our business.

The quantity, quality, timeliness and cost of the delivery of policing services are measured through
18 key performance measures (as published in the Victoria Police Annual Report 2013–14 and Victorian
Government’s Budget Paper 3). The measures comprise for example:
• Quantity measures: reduction in property crime and crimes against the person; number of
responses to events (calls to police); crime prevention checks;
• Quality measures: the proportion of the community who are satisfied with police services and
confident in police; the proportion of drivers who comply with alcohol limits and speed limits;
and successful prosecution outcomes;
• Timeliness measures: the proportion of crimes against the person and property crimes resolved
within 30 days; and
• Cost: measured by total output cost of policing services.

The Victoria Police annual report also provides:

• a summary of crime statistics, by both recorded crime numbers and the offence rate per 100 000
• statistics on family violence incidents, road traffic fatalities and serious injuries, alcohol and drug
testing results, etc.; and
• a large number of performance measures addressing the health and safety of police officers.

Source: Adapted from Victoria Police 2014, Victoria Police Annual Report 2013–2014, accessed July

Appendix 3.1 contains a case study of Western Water, located in Victoria, Australia, which reports
its performance in both financial and non-financial terms. This is an interesting case study because
Western Water is a government-owned corporation, yet it has local residents (both individuals
and organisations) as its customers, and operates in a highly regulated market. The case study is
intended as an aid to learning as it provides a detailed example of the concepts included in this
Study Guide. Read the Western Water case now.

Note: The concepts covered in this appendix (not the specific details of the case) are examinable.

The multiple roles of performance measurement

Performance measurement has multiple roles which include providing information:
• for managers to aid in planning, decision-making and control in pursuit of value creation;
• on environmental and social sustainability for integrated reporting purposes; and
• for signalling to investors and other stakeholders.

Each of these roles is described below.

Performance: A process of value creation

Value creation is a process of turning one thing into something else, with the ‘something else’
having more value than the original. Value adding may be seen as increasing shareholder value
to an investor or, at the level of the business, through results (products/services) or processes that
improve efficiency. Value creation was discussed in detail in Module 2.

A value creation process in production may involve turning wood into paper and paper into a
printed book. A value creation process in services may be using knowledge and skill to construct
a contract between two parties that will enable them to carry on business together. Value creation
may also take place through improved efficiencies (e.g. reducing the distance travelled in making
a delivery, or the time taken to carry out a service).

Performance measurement can therefore be seen in terms of the value creation process. Porter’s
(1985) ‘value chain’ (as discussed in Module 2) shows the primary and support activities that add
value to a customer, and the margin that can be achieved as the difference between the cost
of providing those value-adding activities and the price the customer is willing to pay. Hence,

the value added for which the customer is willing to pay must exceed the cost of performing the
activities that lead to the added value, or else the activities should be eliminated.

This idea of value creation is particularly important when we consider for-profit organisations
whose purpose is to increase shareholder value. Shareholder value can be increased through a
combination of dividends and capital gains over time.

There are many ways value creation can be achieved. One is through technological innovation
that leads to products that customers want—as the example of Apple Inc. demonstrates.

Example 3.4: Value creation at Apple Inc.

At 31 March 2015, the Financial Times Global 500 placed Apple Inc. as the largest company in the
world as measured by stock market capitalisation, followed by Exxon Mobil, Microsoft and Google
(Financial Times 2015). In September 2013, advertising agency giant Omnicom claimed that Apple
had surpassed Coca Cola as the world’s most valuable brand.

Prior to 2003, Apple had sluggish growth and achieved mediocre financial performance and shareholder
returns. Some argued at the time that it faced collapse. However, under Steve Jobs (now deceased),
the company implemented a strategy of giving customers what they wanted by investing in innovation
that added value to customers and building intellectual property within Apple. This led to vastly
improved financial returns.

Apple has been successful by manufacturing in relatively low-cost countries such as China which has
enabled it to improve its profits far more than if manufacturing had taken place in the US. However,
this  strategy has required focused management attention on sourcing, supply chain logistics,
and quality control. As a result, the company has faced criticism for the poor labour practices of some
of its subcontractors, and for Apple’s own environmental and business practices. It is undergoing long
running law suits with South Korean electronics giant Samsung and other companies over alleged
patent infringements.
Study guide | 247

Apple’s focus would be on continually expanding market share by introducing new products.
Although the information is not publicly available, Apple’s internal performance measures would likely
include new patents, new product launches, new store openings and market share, as well as the more
usual financial measures such as sales growth and profitability.

However, value creation does not need to come only from innovation. It can also come from
more conventional businesses, as the example of Woolworths demonstrates.

Example 3.5: Value creation at Woolworths

Although there are many ways that market share can be measured (and different methods are supported
or disputed by different interest groups), it is reasonably clear that Woolworths and Coles dominate
the grocery market in Australia. While Coles is owned by the Wesfarmers group, Woolworths is listed
on the Australian Securities Exchange (ASX) in its own right.

Woolworths is best known for its supermarket chain, its Big W department stores and its partnership
with Caltex in fuel retailing, but it also owns the home improvement retailer Masters, liquor retailers
Dan Murphy and BWS, and the ALH leisure and hospitality group which owns restaurants, hotels and
gaming venues. Woolworths’ strategy for value creation has been to diversify from supermarkets into
related retail fields, and to expand its range of stores geographically (including online shopping).

Because of the tightly held market share of Woolworths and its competitors, a key strategy is to
increase spending by existing customers. Woolworths has consequently expanded its product range,
introducing its own-brand products, from the less expensive to the more expensive Woolworths ‘Select’
brand. Woolworths’ supermarket advertising slogan, ‘The fresh food people’, has been successful
in creating value for the company, as has its ‘Everyday Rewards’ loyalty cards system (with nearly
8 million members in Australia) that is linked to Qantas Frequent Flyer points, and reward points that

provide discounts on fuel purchases. One of Woolworths’ strategies is to use the large amount of data
gathered on customer buying habits that is available to them through the ‘Everyday Rewards’ card.
It uses this to target customers with specific promotional campaigns. Woolworths is also expanding
its multi-channel strategy including online and social networking channels. Woolworths has also
expanded to New Zealand.

In its 2014 Annual Report, Woolworths identified some performance measures, mainly financial (sales,
gross margin, and ‘cost of doing business’—the largely fixed costs of their stores) as well as closing
inventory days (a measure of inventory holding). The limited disclosure of non-financial performance
measures is no doubt because of the advantage this could give to its competitors, notably Coles.

Woolworths’ value creation strategy is to improve its value to shareholders, rather than out of any
altruistic motivation towards its customers. Nevertheless, if customers are dissatisfied with store
locations, product range, quality or price, they will go to its competitors. The consequence will be
reduced shareholder value, as lower market share and profits will lead to lower dividends and a lower
share price.

Woolworths would be focused both on geographic and product expansion, by opening new stores,
improving existing stores, and growing its ‘Everyday Rewards’ program to identify customer purchasing
habits to increase the spend per customer. Internal performance measures would probably focus on
new store openings, sales per employee, sales per square metre and market share (especially market
share relative to Coles). Measures of Woolworths own ‘Select’ brand sales compared with other
branded products would also be likely.

➤➤Question 3.2
Please access the Annual Report 2014 of JB Hi-Fi (an Australian consumer electronics and
entertainment retailer), available online at:
(a) Who in the company is responsible for shareholder value creation?
(b) What is the company’s strategy to increase shareholder value?
(c) What performance measures does JB Hi-Fi use to measure the success of its shareholder
value creation activities?

The key issue for performance measurement is to understand the organisation’s strategy for
value creation and to measure the success of its value creation activities. As the JB Hi-Fi example
illustrates, we can look at value creation from the shareholder perspective, or from the internal
business perspective, although the two are clearly interrelated.

The idea of value creation over time is important, because the measurement of value creation
should not be seen solely in terms of short-term gains such as current year profits or customer
satisfaction in a single survey. This highlights the importance of sustainable performance.

➤➤Question 3.3
Mega Markets Ltd (Mega Markets) is an ASX listed chain of retail stores with branches in all the
major shopping centres in Australia. Mega Markets sells clothing, homewares and toys. Much of
Mega Markets’ product range is sourced from South East Asia, enabling it to offer low prices for
a wide range of products. Over many years Mega Markets has become a popular department
store for families on a budget with young children.

However, over the last two years, Mega Markets has faced a flattening of sales. Mega Markets
has faced out-of-stock situations where customers have asked for a particular style/colour/size
combination, which is not always available in every store. Market research has revealed that
customers are increasingly going online to source similar products from an overseas competitor
at even lower prices than Mega Markets can offer. The purchased goods are posted to their
home address from a large warehouse in South-East Asia.
Mega Markets has complained in the press that this competition is unfair as the overseas suppliers
do not have the high rental costs charged by the large shopping centre owners, nor the high
wage and on-costs that Australian retailers have to pay.
The sales director of Mega Markets said:
Our customers can go to our competitor online, choose the product they want, in the
colour they like, in any size, and have it delivered to their home within a week, all at a
price that is typically 10 to 20 per cent lower than our retail store prices and customers
can return or exchange their products if they are dissatisfied. No wonder our sales
are suffering.
Mega Markets has suffered from a deteriorating financial position as a consequence of its flat
sales, tighter margins and increased overhead costs. The company now faces considerable
pressure from investment analysts and institutional investors to improve its sales and earnings.
The board of Mega Markets has put pressure on senior management to develop strategies to
overcome competition from online sales.
(a) Explain the value creation process for Mega Markets.
(b) Why is its value creation process now facing competition from online sales?
(c) Can the company do anything in the face of online competition?
Study guide | 249

Performance and sustainability

When we use the term ‘sustainability’ in relation to performance, we mean two things.

1. The performance, whether measured in financial, non-financial, quantitative, or qualitative

terms, must be considered over time. Customer satisfaction must be sustained. Product/
service quality must be sustained. Financial performance must also be sustained.
Performance that is achieved in one year, but cannot be achieved in the following year,
is not sustainable. To achieve true value creation, an organisation must be capable of—
at the very least—sustaining value, and ideally improving value over time.

2. Meeting the needs of today without compromising the ability of future generations to
meet their own needs. This longer-term perspective has arisen for example, in relation
to over-fishing, deforestation and global oil supplies. It is also relevant to pollution of the
environment through carbon emissions and waste disposal.

Most companies listed on the ASX now produce a corporate social responsibility (CSR)
or sustainability report in which they address issues including sustainability and pollution
reduction, and often include performance measures of their effectiveness. This is the so-
called ‘triple bottom line’ reporting of economic, environmental and social performance.

Sustainability reporting tends to be distinct from other elements of (mainly financial) reporting
and is often addressed in a supplementary statement, rather than being integrated with financial
reports or other elements in the annual report. While some stakeholders (including ethical
investors) are interested in sustainability reporting, others have little or no interest. Boards of
directors often see their responsibility, as it is prescribed in the Corporations Act (for Australian
companies), to the company and its shareholders, not to broader stakeholder groups. Hence,

short-term financial motives often drive out longer-term aspirations for sustainability. The problem
is how to convert the long-term benefits of sustainability into current period measures of
performance and how to balance these long-term needs with the current financial need to
satisfy shareholders.

Consequently, performance measures for financial issues and sustainability issues do not always
gain the same exposure and are not always accorded similar importance in annual reports,
despite the importance of sustainability, in both its meanings. However, reputational issues
have increased the importance, not just of reporting sustainability performance, but of actually
engaging in sustainable practices. Importantly, many organisations now see engaging in
sustainable practices as necessary for long-term shareholder value, and sustainability reporting
as a means for enhancing their reputation.

Further detail on CSR is presented in the ‘Ethics and Governance’ subject of the CPA Program.

Returning to Appendix 3.1, we see that Western Water reports its performance against both
financial and environmental criteria. Western Water recognises that its success comes from satisfying
regulators, customers and government, yet it must operate in a sustainable way in order to ensure
water quality and the health of the population it services.

While one can be cynical and consider that companies engage in sustainability reporting for
purely reputational reasons, there can be sound business reasons for engaging in sustainable
practices as long-term value creation opportunities can be affected. The mining industry is a
good example.

Example 3.6: Sustainability at Newcrest Mining

Newcrest Mining is the largest gold producer listed on the Australian Securities Exchange and
one of the world’s largest gold mining companies by gold reserves and market capitalisation
(Newcrest 2015a).

Newcrest has strong technical capabilities in deep underground block caving, shallow targeted
underground mines, large open pits and a variety of metallurgical processing skills. The company’s
mines are located in Australia, Papua New Guinea, Indonesia, and in West Africa.

In its Sustainability Report 2014 (the 13th consecutive report produced by the company), Newcrest Mining
describes the importance it attaches to sustainability:
Over the coming years, Newcrest aims to remain focused on our key priorities of safety and
operating discipline, cash generation and profitable growth within a culture of accountability
and personal ownership. For sustainability, this means maintaining a strong focus on the
safety and health of our employees; regularly engaging with our stakeholders, including
neighbouring communities, to maintain our social licence to operate; applying robust
environmental management through application of our policies and standards to meet
regulatory requirements and manage risks; and managing all-in sustaining costs of the business
to be able to respond to changes in market conditions and progress growth opportunities
(Newcrest 2015b, p. 1).

The report covers the company’s practices and performance under the headings of economic,
environmental, social and employee performance. The sustainability report is supplemented
by a comprehensive set of data tables and a separate set of performance measures under the
Global Reporting Initiative (GRI) G3 Guidelines (the GRI for sustainability reporting is explained below).

Source: Newcrest Mining 2015b, Sustainability Report 2014, accessed September 2015,

Research in Australia by Ferreira Moulang et al. (2010) pointed out that environmental strategies
are often poorly integrated with overall business strategy. This results (among other things)
in failure to incorporate environmental impact assessments into capital investments which
leads to problems with managing future cost structures. Over half the organisations surveyed
had no performance measures addressing environment-related matters. The Newcrest case
study suggests that companies do consider environmental issues in their strategy; however,
there remains only a small amount of research concerning the integration of environmental
concerns into overall business strategy formulation or implementation. The Global Reporting
Initiative (GRI) G4 Guidelines (discussed below) address the need to adopt a more holistic
approach to reporting performance.

The GRI ( is a multi-stakeholder process aimed at developing

and disseminating globally applicable sustainability reporting. The GRI G4 Sustainability
Reporting Guidelines offer Reporting Principles, Standard Disclosures and an Implementation
Manual for the preparation of sustainability reports by organisations, regardless of their size,
sector or location.

The GRI argues that sustainability reporting helps organisations to set goals, measure
performance, and manage change in order to make their operations more sustainable.
A sustainability report conveys disclosures on an organisation’s impacts—be they positive or
negative—on the environment, society and the economy. GRI Sustainability Reports under
G4 include the disclosure of the governance approach and the environmental, social and
economic performance and effects of organisations. Importantly, the economic dimension
of sustainability concerns the effects of the organisation’s activities on the economic conditions
of its stakeholders and on economic systems at local, national, and global levels rather than on
the financial condition of the organisation.
Study guide | 251

There are seven general standard disclosures in G4:

1. strategy and analysis;
2. organisation profile;
3. material aspects and boundaries;
4. stakeholder engagement;
5. report profile;
6. governance; and
7. ethics and integrity.

In addition, there are specific standard disclosures on management approach and performance
indicators (note: ‘indicators’ rather than ‘measures’ is the term used in the GRI). There are three
categories of specific standard disclosures with the social category being subdivided into four
1. economic;
2. environmental; and
3. social:
(a) labour practices;
(b) human rights;
(c) society; and
(d) product responsibility.

A full set of the disclosures can be viewed at:


However, not all of these have to be disclosed, only those where the organisation deems them
to be material.

Although the G4 Guidelines have only recently been released, Australia has become one of the
fastest growing countries in the world for sustainability reporting. The Global Reporting Initiative
reports that:
Australia saw a remarkable 25 percent increase in sustainability reporting, between 2011 and 2013
with 82 percent of the top 100 companies now disclosing sustainability impacts and performance.
This makes Australia the fourth fastest climber internationally when it comes to growth in sustainability
reporting, rising from the 23rd to 12th most prolific reporting country in just two years (GRI 2014, p. 4).

An earlier GRI G3 version adopted by Newcrest Mining Limited is available in a separate document.
Candidates may wish to consult this document following their review of Example 3.6. See:

Successful companies in the future will need an integrated strategy to achieve strong financial
results and create lasting value for the company, its stakeholders and society. The value created
by companies in the future cannot be expressed by an isolated financial and a sustainability
report, with no clear links between the ‘single bottom line’ and the sustainability impacts caused
or the value created in order to generate its financial results. Consequently, the Global Reporting
Initiative co-founded the International Integrated Reporting Council (IIRC) because it believed
the future of corporate reporting is the integration of financial and sustainability strategy and
reporting. Understanding the links between financial results and sustainability impacts is critical
for business managers, and is increasingly connected to long- and short-term business success.

The move towards integrated reporting has important implications for accountants in terms of
performance information.

Integrated reporting
Integrated reporting is an emerging and evolving trend in corporate reporting. It offers providers
of financial capital to an organisation with an integrated representation of the key factors that are
material to that organisation’s present and future value creation.
Integrated reports build on sustainability reporting foundations and disclosures. Through the
integrated report, an organisation provides a concise communication about how its strategy,
governance, performance and prospects lead to the creation of value over time.
Therefore, the integrated report is not intended to be an extract of the traditional annual report,
nor a combination of the annual financial statements and the sustainability report. The integrated
report interacts with other reports and communications by making reference to additional detailed
information that is provided separately.

Source: Global Reporting Initiative 2013, G4 Sustainability Reporting Guidelines, p. 85,

accessed October 2015,

The International Integrated Reporting (IR) Framework document (‘the Framework’) was issued
by the International Integrated Reporting Council in 2013 (please see http://integratedreporting.
In relation to performance measurement:
The Framework takes a principles-based approach… It does not prescribe specific key performance
indicators, measurement methods, or the disclosure of individual matters, but does include a small
number of requirements that are to be applied before an integrated report can be said to be in
accordance with the Framework (IIRC 2013, p. 4).

The Framework refers to a collection of ‘capitals’. ‘The capitals are stocks of value that are

increased, decreased or transformed through the activities and outputs’ (IIRC 2013, para. 2.11)
of the organisation:
• financial capital (funds for use in the business);
• manufactured capital (machines);
• natural capital (air, water and land);
• human capital (skill, experience and motivation);
• intellectual capital (the intangibles); and
• social and relationship capital (community stakeholders).

The ability of an organisation to create value for itself enables financial returns to shareholders.
This is interrelated with the value the organisation creates for stakeholders and society at large
through the resources and relationships that are used by, and affected by, an organisation.

More information is available online at:

While the initial focus of the IIRC is on reporting by larger companies and on the needs of
their investors, it may have important implications for organisations and accountants in the
longer term.

CPA Australia believes that bringing together all the strands of corporate reporting will help
satisfy the growing demands of investors for information about performance beyond the
bottom line.

Integrated reporting is also discussed in the ‘Advanced Audit and Assurance’, ‘Contemporary
Business Issues’ and ‘Ethics and Governance’ subjects of the CPA Program.
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Integrated reporting takes advantage of new and emerging technologies such as eXtensible
Business Reporting Language (XBRL) to link information within the primary report and to facilitate
access to further detail online where that is appropriate.

XBRL (a language for the electronic communication of business and financial data) is becoming a
standard means of communicating information between businesses and on the internet. Instead
of treating financial information as a block of text (as in a standard internet page or a printed
document) it provides a unique computer-readable identifying tag for each individual item of
data (e.g. net profit after tax). Computers can treat XBRL data intelligently. They can recognise
the information in an XBRL document, select it, analyse it, store it, exchange it with other
computers and present it automatically in a variety of ways for users.

Further information about XBRL is available online at:

XBRL is also discussed in the ‘Advanced Audit and Assurance’ subject of the CPA Program.

While governance is concerned with conformance and performance, and with making value
adding decisions, signalling is aimed at trying to influence someone else’s decisions. Signalling
occurs when a measure is used to communicate information (either a forward goal or an
actual achievement). One of the key roles of senior management is to communicate with
stakeholder groups. Financial statements, for example, are a signal, prepared by directors for
shareholders, about the performance of directors and managers in carr