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Commentary, Marking scheme and Suggested solutions
Using a variety of ratios you are then required to compare the performance of COC against budgeted and HC and prove certain numbers in the statements from operating data provided. Section A Q1 Crown Oak Construction (COC) Part (a) of this question provides a budgeted and actual income statement for a quoted company together with selected balance sheet information and the actual figures for an unquoted competitor (HC). In part (b) you are then provided further information about the strategies of COC and HC and are then required to determine how these stated strategies help assess performance. You are also provided with a data which you must use in part (b) to create NFPI’s. Part (c) considers the problems of comparing the performance of divisions in different countries and requires little application to GA to score well. Part (a) requires some simple calculations to illustrate the problems of ROI and RI and EVA. both flexibly and in enough depth in the time allowed. Q2 Jolene Communications (JC) Part (a) is a factual definition of what is meant by the planning gap. Explanation of usefulness must relate to the critical success factors and strategies of GA. This mock examination is a realistic test of your ability towards the final stages of your preparation for the real event. Section B Q3 Glenn Associates (GA) This question considers non-financial performance indicators. In part (b) two possible pricing strategies are given for a new product and you are required to assess the remaining profit gap under each of the two strategies. Finally in part (c) you are to use Ansoff’s product matrix model to consider any other strategies that could be followed.Commentary Tutor guidance on improving performance on the exam paper The key to success in P5 is application of wide and varied syllabus knowledge. Q4 Edwards Incorporated (EI) This question concerns decision making in divisions and the opportunity for dysfunctional behaviour. Part (c) requires a discussion of the problem of short-run results and long-run results and finally part (d) requires you to consider the likely reaction of shareholders to the results that you have been working on. 3 . Part (b) requires four reasons to separate the assessment of a divisional manager from assessment of the division itself. In part (a) you are to consider why there is growing emphasis on NFPIs for service businesses such as GA.
open and closed systems and the principal controls over the preparation and distribution of internal information.Q5 Management accounting and reporting This essay covers how contingent factors affect management accounting systems. 4 . It is vital to answer the question set and not to wander from the requirements by repeating what you have learnt on these topics.
The budgeted gross profit margin for COC was similar to that of HC but the actual gross profit margin of COC is considerably lower. Chief accountant Accountant June 2008 Performance of COC and HC REPORT 5 . indicates that there has been considerable investment by COC in additional non-current assets during the year. The position is even worse when the operating profit margin is considered which is only 7.5% for HC. However. This is over 50% more than the amount that was budgeted for and considerably higher as a percentage of sales than those sub-contracting costs incurred by HC.8%) less than budget but 25% less than HC despite the fact that HC has a smaller capital base. General expenses to sales are not only higher than budgeted but also a greater percentage of sales than charged by HC indicating that COC may have a problem with the control of its other expenses. indicating significantly higher direct costs. which would indicate that these are fixed costs of support staff.SECTION A 1 Crown Oak Construction Marking scheme (a) 3 professional marks for presentation etc 1 mark for each proof of budgeted and actual figures Calculation and discussion of ratios COC HC General comments regarding short v long term Application to COC Importance of information available Importance of dividend signal Belief in long term growth 3 4 15 Max 4 4 4 4 1 2 1 8 Marks Max 20 8 (b) (c) (d) 4 40 Suggested solution (a) To: From: Date: Subject: Introduction The information in this report has been based upon the summarised budgeted and actual income statements of COC for the year ended 31 March 2008 together with some additional information and the same information provided for our direct competitor HC. If the costs are examined by category depreciation is much higher than was either budgeted for or charged by HC. This.7% compared to 19. Revenue and profitability COC’s revenue is slightly less (2. The staff costs are exactly as budgeted. the main reason for the large fall in operating profitability below budget and below that achieved by HC is the large amount of costs incurred in sub-contracting work. together with the increased loan capital.
0%. This dividend was partly paid out of previously retained profits.This reduction in profitability is a large part of the cause of a return on capital employed of only 6.5% and the return achieved by HC of 23. which means that the management of COC has lower expectations of their effective and efficient use of the resources available to them. is lower than the budgeted figure and both the budgeted and actual asset turnovers are much lower than that of HC. 6 .4 times as budgeted to 3. In a quoted company dividends are considered to be very significant and a reduction over what is expected may have a detrimental effect on share price. the lack of debt capacity or possibly the tax position of directors or shareholders. It is a concern that something as important as additional loan capital at this level had not been budgeted for. However it should be noted that either the interest rate for the new loans is lower than the budgeted amount of 10% per annum of that the loans were only taken out part way through the year. however.7% to 29.000 employees which would have resulted in a budgeted profit per employee of $28. part of the reason for the lower asset turnover is that investments in new non-current assets in COC may not have been fully utilised for the whole of the accounting period. all other budgeted figures are lower. The actual results of COC are considerably worse than budgeted. Although budgeted gross profit margin is similar to that of HC.500. The dividend of $30 million is as budgeted despite profits of only $16 million.5%). By comparison HC has almost insignificant gearing (20/444 = 4.667 compared to $31. is clearly very different as with a much higher profit level of $78 million after tax only $15 million was paid out as dividend with the remainder retained in the company. The budgeted figure was for 2. However the other reason for the low level of return on capital employed is that the asset turnover. If this is a long term trend for COC then there must be serious concerns about the management of the business. However as there has been a large reduction in profitability in COC as well as a 20% increase in employees above those budgeted for then the profitability per employee has fallen to a miserable $6.1 times. However. HC may have other reasons for making not making distributions: the objectives of shareholders. thereby indicating a similar performance level. The policy of HC. This is why the dividend was maintained at prior period levels despite the lack of profits to support it. which may indicate the difficulties of raising finance for an unquoted company or the lack of desire for debt by the business.4% compared to a budgeted figure of 16. Conclusion From the information available there should be some concern about the financial and operating performance and management of COC.1% as an additional $40 million of loan capital has been taken out reducing the interest cover from 10. Other financial indicators The gearing level of COC has increased from 18. As an unquoted company.200 achieved by HC. Finally in terms of profitability there is a worrying concern about the number of employees in COC. This indicates that HC is using its capital more intensively and effectively than COC.
05) Other (6.54 33.72 85.660 x 1.660 6.193 5.87 217.560 Materials cost $m 46.00 272.80 54.970 16.000 x 26%) Other (41.437 18.82 Barns (41.000 6.10 50.970 16.04 Cost of sales $m 76.76 12.000 12.62 22.46 438.67 26.193 5.47 25.155 11.31 135.46 201.810 x 1.73 Barns (6.19 274.53 121.08) Car ports (10.96 Labour cost $m 30.000 x 17%) Garages (41.36 23.000 8.970 x 78%) Garages (16.560 Price $ 18.11 42.71 Labour cost $m 26.000 12.86 89.000 x 41%) Car ports (41.36 451.810 10.000 Revenue $m 125.42 78.48 Cost of sales $m 62.03 10.576 Materials cost $m 36.155 11.437 18.21 84.86 9.000 Revenue $m 97.000 x 16%) Actual revenue Actual volume Units 5.97 27.660 6.92 7 .Appendix – proof of budgeted and actual revenue and cost of sales Budgeted revenue Budgeted volume Units 6.000 8.810 10.83 26.560 x 85%) Budgeted cost of sales Budgeted units Barns Garages Car ports Other 6.03 Actual cost of sales Actual units Barns Garages Car ports Other 5.44 14.28 39.03 49.576 Price $ 18.000 6.
500 $6.5 c 8.5 5.0% 0.4% 23. A selection of suitable ratios should be included in the answer.90 0.2 c 18.5% 6.8% Operating profit margin 83/452 x 100 34/439 x 100 107/550 x 100 General expenses : sales 22/452 x 100 28/439 x 100 23/550 x 100 Subcontractor costs : sales 34/452 x 100 52/439 x 100 39/550 x 100 Return on capital employed 83/(424 + 80) 34/(413 + 120) 107/(444 + 20) Asset turnover 452/(424 + 80) 439/(413 + 120) 550/(444 + 20) Profit per employee $57m/2. COC COC HC Budget Actual Gross profit margin 180/452 x 100 39.2 28.5% 4.9% 6.9 0.5% 11.4 3.1% 16.2% 7. A full schedule of ratios is included here for completeness.5 1.8% 164/439 x 100 37.Workings – financial performance indicators Note: Not all these figures are required to answer this question.0 c 31.8% 7.4% 219/550 x 100 39.5% 8 .667 $31.82 1.7% 29.1 53.400 $78m/2.7% 19.1% 4.500 Interest cover 83/8 34/11 107/2 Dividend cover 57/30 16/30 78/15 Earnings per share $57/200 $16/200 $78/250 Gearing (Loans/Shareholders’ Funds) 80/424 120/413 20/444 18.19 $28.200 10.000 $16m/2.3% 7.4% 4.
One way to reduce costs. then HC’s higher ROCE and earnings may not be maintained indefinitely as assets reach the end of their useful lives and have to be replaced. especially if they are also the directors of the business and may be more focussed on internal control than on strategic planning initiatives. The pre-assembled parts for the houses are imported from Sweden which may partially account for the increased direct costs and lower gross profit margin. including depreciation. This new line of business may also have required additional employees which were not envisaged when the budget was set. This accounts. 9 . For this new line of business there has been significant investment in new non-current assets which will explain the increased gearing level and the increased depreciation charge over the amount budgeted. It is possible that this strategy emerged during the year when results were seen to be diverting from budget. There is probably a large learning curve for the company in carrying out such new work. in terms of their employment and remuneration. which indicates that this new line may be taking time to gain market acceptance and that other product sales are also deviating significantly from budget. Revenue here is below budget. unless this was a very late decision on the part of the management of COC.(b) Crown Oak Construction COC has changed its strategic direction. The level of dividend has only been maintained by payment form retained profits of prior years. It can also be argued that the directors of a company need to produce results in the short-term in order satisfy the requirements of the investors in terms of earnings per share each year At only 8. Finally. one would have expected these figures to have been included within the budget. However as COC is quoted. This will have affected profits which may well revert to more healthy figures once the business is fully established and COC has more experience in this area. whereas the equity investors have a longer-term interest as they have made an investment in the shares in order to secure a return over time. and harvest stronger results from business is to maintain older assets which are held at lower net book values. for improved ROCE figures. HC also has a lower asset base than COC. Pressure to remove non-value added costs and activities will be a key part of this strategy and would appear to be the reason why all levels of costs for HC are lower than those budgeted for COC and profit levels higher. However. If COC can control its costs in the way that HC clearly does and works through the learning curve of its new line of business then it is possible that results may improve in future periods. in part.0 cents per share for COC compared to a budgeted figure of 27 cents the COC shareholders may well have reasons to be concerned over short-term performance. This product development will help to explain the performance of COC. A worrying feature of COC’s income statement is the large amount of sub-contractors costs which were very much higher than those budgeted for. particularly the additional loan capital. If sales are suffering from recession this could indicate that COC is wise to look for cheaper product lines. (c) It could be argued that in general terms the directors of a company have a short-term interest in their company. Henderson Construction HC has a completely different strategy to COC which centres upon increasing profitability by constant monitoring of costs in the current line of business but no growth by new market or new product development. Revenue of this new product line should be included in other revenue. moving into a different product. the lower average rate of interest this indicates that the loans and capital investment took place part way through the year and therefore this new line of business may not have been fully operational for the entire year. HC’s shareholders may be risk averse. although the price they realise for the shares may well have fallen from previous levels. building houses from pre-assembled imported parts. shareholders always have the opportunity to liquidate their investment if they are not happy with the returns they are receiving from their investment. It is entirely possible that the management of COC underestimated the amount of additional work that the house assembly would require and this has resulted in the increased number of employees and increased sub-contracting costs. If this is the case.
although it does not attempt to control costs as strictly as HC. 10 .Therefore there is likely to have been much debate at COC over the investment in the new house assembly business. the expectations of management were that profitability would not be too far behind that of HC. then there should be little effect on the share price of COC. However if the shareholders are not informed or do not believe in the return to profitability levels then these results may lead to a fall in the share price of COC. This should indicate to the shareholders that the directors of COC have confidence in the long term future of the company despite the short-term downturn in results. It is often advisable for the chief executive of a company to meet with key shareholders. (d) The likely reaction of the shareholders in COC will depend upon the amount of information that is available to them. The budgeted figures for COC show that. It is also considerably lower than that of a direct competitor in the form of HC. This should have satisfied shareholders in the short-term and the directors themselves who would have continued to be run a profitable and stable company. particularly institutional shareholders on a regular basis. backed up by the dividend payment. Clearly there has been a downturn in results and their earnings per share is lower than budgeted and probably than previous years. Therefore the decision to invest for the longer term growth of the company rather than short-term continuation of profits was a brave one. in order to keep them informed of major developments such as this move into a new line of business. However the decision was taken to turn to a relatively new product with initial capital costs and other learning factors. However the directors of COC have taken the decision to keep the dividend in total and dividend per share at the same amount as that which was budgeted despite the reduced profitability. If the shareholders are informed of what is going on in COC and believe the directors assertions of future levels of profitability. Inevitably this has led to depressed short-term results although the directors firmly believe that the long term prospects are good especially given the likely future economic conditions.
00 (20. The Mobsat is a key part of this strategy to achieve the objective of this increase in sales. Therefore this performance planning gap can be determined by comparing the strategic target for the forecast period (be it revenue. new strategies may need to be implemented.10 $133. Failing this. If the performance planning gap analysis indicates that the profits from the Mobsat will not meet this objective then decisions will need to be made to reduce the costs of the Mobsat.000 x $100) Contribution Less: fixed costs Forecast profit Planning gap ($133.10 x 1.98 m $m 106.1 million $m 80. (b) Required profit level by 31 March 2011 = = $100 million x 1. to increase its selling price or to a follow a different pricing policy in order to ensure that the overall objective of this increase in profits is achieved. profit etc) and the forecast performance if the company continues with its current strategies.000 x $160) Less: variable cost (500. the Board of Directors of JC have set an objective of increasing profits by 10% per annum for the next three years.12 If Mobstat priced using strategy of marginal cost plus pricing Current profits ($100 x 1.2 Jolene Communications Marking scheme (a) (b) Correct definition / explanatory diagram Why concerned Required profit Marginal cost price Marginal cost profit gap Use of demand function for price and quantity Optimal price profit gap Definition of matrix 1 mark for each strategy as applied to JC ( max 5 strategies) Combinations to fill gap 2 2 1 1 1 5 2 10 (c) 1 5 1 max Marks 4 6 20 Suggested solution (a) The performance planning gap is the difference between the forecast position according to the expected performance from the current activities of the organisation and the desired forecast position from the perspective of the strategic planners.00) 116.00 (50.10 x 1.00) 30. If the current strategies are not sufficient to meet the desired strategic position then new strategies must be developed to close the planning gap.12) 11 .12 $16. market share.02 x 1.1 – 116.02 x 1.02) Sales of Mobsat (500. As part of their strategic planning process.
12 .02 x 1.000 x $250) Less: variable cost (300.02 x 1.0005 x 300.0005q 400q – 0.00 (20. This gives four combinations which may lead to new strategies for the business.0005q2 400 – 0.0005 a – (0.If Mobstat priced using strategy of optimal pricing Optimal price for Mobsat Use demand function where P = a – bq P = selling price at which q units can be sold a = price at which zero units are sold b = change in unit price/change in quantity demanded q = quantity demanded b = $10/20.001q q At this quantity = = = = P P P 100 400 – 100 300 300.12 $1.0005 x 400.000) $400 .000 = = = 400 – (0.12 (c) Ansoff’s product matrix model considers the various combinations of products and markets to determine strategies that may be available to an organisation that is seeking growth. JC currently operates in in-car satellite navigation systems and would look to gaining share by competitive pricing or advertising and promotions.00) 45.001q 0.001q So.001q 0. demand function Total revenue function Marginal revenue function To maximise profits.00 (30. JC’s products are not likely to have extended lifetimes as they are quickly superseded by new technologies.12) 75.$200 $400 P Pq = = = 400 – 0.000 $200 $200 a = = = = 0.98m Therefore optimal quantity to be sold to maximise profit is 300.00) 131. Profits might also be increased by withdrawing from areas (products in particular) that are in decline as they near the end of the life cycle.000 units $m 106.000) a .1 – 131.$150 $250 $m Current profits ($100 x 1. the optimal quantity to sell can be established by setting marginal revenue equal to marginal cost 400 – 0.02) Sales of Mobsat (300. Current product and current market This includes strategy of market penetration where the organisation seeks to increase its share of the current markets with the current products.000 x $100) Contribution Less: fixed costs Forecast profit Planning gap ($133.
JC could approach retailers that it not currently using. so will increase risk. This type of strategy usually requires acquisition of another business so will only be possible if suitable surplus funds are available. or could look to using the internet as a sales channel. provided resources are available. 13 . It is possible to use a combination of these strategies in order to reduce the profit gap. which for JC could include retailing or manufacture of components that it currently buys from third parties. New product and new market This is a strategy of diversification which could lead to growth provided that the products and markets chosen offer better prospects for growth than the current product/market combination. Related diversification concerns activities that are complementary to the current business. Unrelated diversification involves moving into products or markets with no known connection to the current business.Current product and new market This is a strategy of market development which could be moving into new geographical markets such as the export market or finding new distribution channels in order to attract new customers. New product and current market This is a strategy of product development which is the one that JC has currently chosen with the development of the Mobsat. There may be more new products in the research and development pipeline which JC could develop.
reliability. Increase in number of contracts: Service (18. The break down between service and installation contracts provides management with information about which section of the business is more competitive. 14 . non-financial performance indicators are of very great importance as the reputation of their business relies upon not only the reliability of the product that they supply.635 – 8. For GA. after sales service and customer satisfaction are vital to continued success of any business.SECTION B 3 Glenn Associates Marking scheme (a) Weakness of traditional measures Importance of other areas of performance Widen managers focus Application to service industry 3 marks per NFPI plus explanation Max 1 1 1 1 4 16 20 Marks (b) Suggested solution (a) It is now fairly widely recognised that concentration on financial performance indicators alone is too narrow a focus for businesses and means that important goals and factors may be ignored.510/1.840) 71. the security system.9% 18. In the current business environment factors such as quality. but also the service that they provide in terms of their speed and quality of installation and emergency response and their reliability in terms of servicing of the security systems.0% 82.890 – 15.005/4.890)/15.7% This gives an indication of growth in the business rather than simply considering growth in turnover. In particular.120 18. delivery. so GA should see the service percentage rise in future periods. (b) Competitiveness Percentage of enquiries turned into contracts New business (3. Non-financial performance indicators will tend to make managers consider external factors such as customers and competitors. the percentage of new business is a useful indicator due to strategic objective of increasing the customer base.1% This indicates how well GA turns enquiries about business into contracts and is therefore an indication as to how competitive they are at winning new contracts from both new business customers and existing customers.120)/8. This is particularly true of service industries such as that of GA where the quality and flexibility of service that they provide to their customers is of extreme importance in a competitive market. Such elements of a business cannot be quantified and reported using the traditional financial performance indicators such as profit margins and return on capital employed. The increase in installations contracts is of particular importance as it is recognised that new installations lead to an increase in service contracts thereafter.890 Installations (9. Further. managers are more likely to narrow their focus if only financial performance indicators are considered.230) Repeat business (1. This in turn can result in managers thinking more strategically about the business and making decisions to improve service rather than increase short run profit or profitability.
7% 6. These are the indicators that may suffer if too much pressure is applied to resource utilisation.790/213. 15 .320/95) 150. Care must be taken when setting standards in this area. quality of both the product and the service provided is of vital importance in retaining customers and the directors of GA recognise this as part of their overall strategy. Again as above this ties in with the strategic objective of providing the highest quality of service. Time to reach client Time between enquiry and installation 3. As above the greater the productivity of the engineers the lower will be the cost per installation and cost per service.7 per engineer This indicates the productivity of the service engineers. In a service industry such as this.Resource utilisation Number of service call outs per engineer (14.6% This shows the level of customer satisfaction with the work carried out and indicates the quality of the work of the engineers. The more service callouts made by each engineer will reduce the salary costs per call out and increase profit per call out.750) 92.0% 78.300) Service (166. Percentage of chargeable hours to total hours Installations (62.0% Again this indicates the productivity of each type of engineer.2 hours on average 5 days on average Both of these indicators are important factors as customers will assess GA not only on the quality of their product and their engineers but also on the speed of dealing with problems and getting a new installation in place.635) Service contracts (1. Productivity is an important aspect of cost control as the salaries of the engineers will be fixed costs of the business. Given the need for emergency cover and to maintain flexibility.250/18. GA will need to accept some spare capacity.830/68.890) 9. Quality Customer complaints as percentage of contracts Installations (934/9.
35 million and has a positive residual income in this first year of $32.000 ($1.000)/2 $875. 1 for explanation) 1 mark per valid issue Max 2 2 2 2 3 1 12 4 4 20 Marks (b) (c) Suggested solution (a) (i) Return on investment = Profit before interest and tax Average capital investment = = = = $120.000 $875. Both of these measures mean that the investment would be suitable for the company overall and therefore the Board of directors of EI would want TT to invest in this project. Therefore the manager of TT is unlikely to invest in this project as it will reduce his division’s return on investment in the short term and therefore affect the amount of bonus which he will be paid for this year.000 16 .500.000 x ¾) Average capital investment Return on investment = = 13.500 $32.000 Opening capital investment Closing capital investment (1.7% which is lower than the current return on investment for TT of 15.8%.000 x 10% $120.000 $750.000 x 100 $1.4 Edwards Incorporated Marking scheme (a) ROI RI Explanation of manager’s reaction Board reaction EVA calculation EVA commentary 2 marks per reason (1 for identification.500 The return on investment of the project in the first year is only 13.000 $87. However the project has an overall positive net present value of $0.000.000 + 750.000. (iii) Economic value added EVA = Net operating profit after tax – capital charge Capital charge = Weighted average cost of capital x economic value of net assets Net operating profit after tax Profit after tax per question Add back advertising cost NOPAT Value of net assets at start of period At 10% charge EVA $000 90 40 130 100 30 1.000.7% Residual income Profit before interest and tax Interest cost on average investment Residual income $875.
Some costs may be under the control of a senior manager but not a junior manager. minimum wages. A manager should be assessed on the value added to a division rather than on reported profits. the state of the economic cycle in the country. consumer protection. pollution control and waste disposal. Legal factors Different countries may have different laws and regulations in areas such as health and safety. Strategic decisions may not always be available if capital budgets are set by head office. Some costs may be under joint control of two or more managers.Managerial ability will require separate measurement. Costs and revenues will be created by a system of transfer prices. Economic factors may include different inflation rates. Many divisions are also charged with costs from head office. changing exchange rates. All of these are likely to affect the performance of a division. Funding The availability of funds for investment from country to country may differ and this is likely to affect the ability to invest and also the cost of investment if the funds are available. which may have been determined by higher levels of management rather than the manager being assessed. in a manner that the divisional manger cannot control. The manager of a division should only be held accountable for costs over which he has some influence. • In a divisionalised business such as EI some costs are controlled by a manager in another division. • • • • (note: only FOUR reasons required) (c) The problems of comparing divisional performance when divisions are in different countries include: Market conditions The economic climate in different countries will affect the reported performance of divisions within those countries. interest rates and local taxation policy. 17 . incentives or grants which may be allowed. (b) The performance of a division must be assessed separately from that of a manger for the following reasons: • An astute manager may have been put in charge of a poorly performing division. Managers may not have control over all costs. Many strategic decisions take time to affect results. effects on competition or regulations and controls in that particular industry. Political climate Political factors that may affect performance include the attitude of the local government to that particular industry. However it is not always easy to determine controllable and non-controllable costs in practice. Managers have skills and attributes that cannot be assessed by considering divisional returns .As the economic value added of the investment is positive the manager of TT concluded that the investment will add to the wealth of the shareholders and therefore should be undertaken. He may have improved the division’s performance due to his own ability but if the division is still performing poorly then divisional measurements will not reflect the performance of the manager. These may be apportioned to divisions irrespective of use.
Equally if there is a major change in the circumstances in which a business operates such as expansion overseas then this will inevitably require changes in the management accounting system. costs. As competition from other firms becomes more severe then there will be a necessity for more complex management accounting information to be prepared including non-financial information. The fact that there is this element of uncertainty is a major factor which affects the design of management accounting systems and this is often known as contingency theory. In an extreme case where a business has no form of competition for the sale of its products then the requirements of the management accounting system will be very simple. Contingent factors can be classified as relating to environment. However if there are competitors in the market then this will necessarily mean that more management accounting information is required about prices. The amount of change in a business will also be an important element in the management accounting system that is required. market share and any information that can be found about those competitors. Environment One of the key external factors which will affect the design of a management accounting system is the element of competition in which the business operates. Management accounting systems must not only be specifically tailored to the business but be capable of change as changes occur in the business environment. Therefore there can be no universally accepted model for a management accounting system as this must be tailored to the situation of each individual business. market size. technology and organisation. 18 . If the business operates in a dynamic environment which is constantly changing then more frequent reporting will be required under the management accounting system.5 Management accounting and reporting Marking scheme (a) No “correct” model Environmental factors Technological factors Organisation factors Open systems Closed systems Controls over generation (max 1 per point) Controls over distribution 1 5 2 2 2 3 3 3 10 5 Max 5 20 Marks (b) (c) Suggested solution (a) In all but the most simple of business situations there will always be an element of uncertainty and different factors will affect different businesses.
including business situations as they are unable to react to environmental influences. • It must be clear that the preparation of the report is worthwhile. Organisation The size. It also does not influence the environment in which it operates. as a result they have few merits for business and performance management. If a manufacturing process is complex. Closed systems are seldom found in naturally occurring situations. interacts with it. then more things could go wrong and a more complex system of accounting will be needed. The most common example of closed system which tends to be cited is that of a chemical reaction which takes place in a laboratory environment. 19 . In contrast an open system is one which is connected to its environment. New outputs may need to be generated to cope with disturbances and thus new input will need to be collected and processed. Typically an open system will accept input from its environment.Technology Quite clearly the nature of the production process in an organisation will dictate to a large extent the type of management accounting system that is required. A more complex business structure with many divisions. However where the organisation expands into different products and different markets then it is likely to take on a divisional structure requiring completely different forms of management information. and with transfer prices involved will necessarily require a more complex management accounting system. employees. the government and society. If the nature of a business changes due to acquisition by another organisation then it is likely the acquiring company will impose its systems on the acquiree. is influenced by it and in turn affects the environment in which it operates. but a system to consolidate this will be required. This also applies to service industries with high overheads which will require a different type of management accounting system to that of a manufacturing organisation. The management accounting system must be in line with the culture of the organisation and with the power structure and must be adaptable enough to change where there are changes in these factors. This will particularly apply to operational units within an organisation. There must be some form of cost/benefit analysis to ensure that the usefulness of the report is worth the time that it will take to prepare. The same information supplied for the simple business can be re-produced for the individual divisions. (b) A closed system is a system which is isolated from outside influences and external factors and is unaffected by the environment in which it operates. competitors. The inputs and outputs of a business are affected by suppliers. customers. some of whom service other divisions. Generation: Information will include both routine reports and ad hoc reports but the principles regarding their generation will be very similar. The management accounting system will also be affected by the organisational structure of the business A simple manufacturing business will be organised on a functional basis and management reporting will also be on that basis. A management accounting system needs to be an open system. (c) It is vital that controls are in place over both the generation and distribution of this information. process the input in some way and produce an output. nature and culture of an organisation will have an effect on its management accounting system. Both inputs and outputs may be either predicted or unforeseen.
• If a report is to be used regularly then it should firstly be given a trial run by preparing a prototype to ensure that the correct information is being provided in a useful format. In particular any payroll and personnel information is highly confidential and should be kept either physically locked away or if kept on computer protected by password access. ie shredded. Confidentiality is a key issue. thrown away or filed. to whom these reports should be sent and the format of the report. In general all employees should have signed contracts in which they agree not to divulge confidential information. Often a company will also have as house style for such reports. The principles and procedures regarding distribution of internal information should be set out in a procedures manual. Standard reports should be prepared on a consistent basis with the same format and definitions each time it is produced. • • Distribution: • • • • (Note: only 3 points required in either section) 20 . The procedures manual should also make clear what information should be regarded as confidential and how to dispose of reports. Amongst other matters this will include details of which standard reports should be produced and when. The usefulness of the report for information provision should also be reassessed on a regular basis. Most reports will require some form of action from someone therefore the originator of the report must be clearly identified in case of any queries and the report should set out clearly limits to the action that should be taken as a result of the report.