Monitoring Test MT2C

Performance
Management
F5PM-MT2C-Z17-A

Answers & Marking Scheme

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®
1 Y AND Z

(a) Return on investment

The calculation of return on investment has been prepared by taking controllable divisional
income as the performance measure. This is considered to be a more true reflection of the
performance of the divisions and the divisional managers. Central, apportioned costs are not
controllable by divisional managers, so it is unfair to include these in the calculation of their
performance.
Y Z
$000 $000
Controllable income 155 101
Divisional net assets 9,760 1,260
–––––– ––––––
Monthly ROI 1.6% 8.0%
Annualised (× 12) 19.2% 96%

Both divisions have exceeded the target 12% return on capital. However, there is a large
discrepancy between the results of the two divisions, with division Z achieving an impressive
96%, while division Y achieves a relatively small 19.2%.

The main reason for this would appear to be a large difference in the value of divisional net
assets. It is possible that division Z may be using very old assets, which have a very low net
book value, while division Y is using new assets. This suggestion would seem to be
supported to some extent by the fixed costs. Since the net assets of division Y are nearly 8
times larger than division z, we would expect depreciation to be 8 times larger if both
divisions’ assets are of a similar age. In fact the fixed costs of division Y are only three times
greater than division Z. It would be useful to have more information about the amount of
depreciation included in the fixed costs, and about the age of the assets of the two divisions to
make a more valid comparison.

In terms of profit margins, division Y generates more contribution per $ of revenue; it

returned a contribution margin of 61.67% while division Z generated 43.78%. We are told
that the two divisions operate in similar markets, so the difference may be due to better
control of variable costs in division Y. If we look at net controllable profit margins, division
Z is performing marginally better than division Y, with a margin of 18.2%, compared to Y’s
17.22%.

In conclusion, it appears that division Z is performing better than division Y, particularly

when considering returns on investment. However, further investigation about the age of the
assets is required, as this may explain the large difference.

WORKINGS
Y Z
1. Contribution profit margin
Contribution 555 243
= × 100 × 100 × 100
revenue 900 555

61.67% 43.78%
2. Controllable profit margin
Controllableincome 155 101
= × 100 × 100 × 100
revenue 900 555

17.22% 18.2%

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(b) Residual income

Y Z
$000 $000
Monthly controllable income 155 101
––––– –––––
Annualised controllable income 1,860 1,212
Imputed interest:
(9,760 × 12%) 1,171
(1,260 × 12%) 151
––––– –––––
Residual income 689 1,061
––––– –––––

Both divisions are making a positive residual income. This means that the profits they
generate exceed the required return on the assets that were used to generate those profits.

In the case of division Y, the cost of capital can increase to 19% before the residual income
becomes negative, and in the case of division Z, the controllable income is 96% of the net
assets of the division, implying that even if the cost of capital is 96%, division Z will make a
positive residual income.

Comparing the two divisions, division Z generates the higher amount. However, comparison
of residual income in absolute terms does not provide useful information, since absolute
comparison does not take into account the size of the investment. A more meaningful
comparison would be residual income as a percentage of net assets; if this is the case, then
division Z definitely did perform better.

As mentioned in part (a) of the question, the better performance of Z may be due to using old
assets with a very low net book value. If this were the case, at some point, division Z would
need to replace those assets, which may reduce the reported residual income.

Alternative measures of performance evaluation for investment centres include:

 Net present values/internal rates of return (outside of the syllabus for paper F5!)
 Increase in sales revenues/profits over time.
 Sales/cost variances
 Non-financial measures such as new products developed, number of defects.

Tutorial note: Any reasonable alternative measures would be considered.

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 Marks
2 SUPERELECTRIC

(a) Expected cumulative direct labour hours based on the learning rate of 80%

The learning curve states that as cumulative output doubles, cumulative average time per unit
falls to a given percentage (the learning rate) of the previous cumulative average time. The
approach to calculating cumulative direct labour hours therefore is to start by calculating
cumulative average time per unit. In this case, the learning rate is only expected to last for the
first 4 batches.
Cumulative Cumulative average
number of time per batch
batches hours
1 28,000 ½
80%
2 22,400 ½
80% ½
4 17,900
100% ½
8 17,900

Having calculated the cumulative average time for each level of output, the total cumulative
time can be calculated by multiplying the cumulative number of batches by the cumulative
average time per batch:
Cumulative Cumulative average Cumulative total
number of time per batch labour hours
batches hours
1 28,000 28,000 ½
2 22,400 44,800 ½
4 17,900 71,700 ½
8 17,900 143,400 ½

(b) Learning rate exhibited

The approach to this part of the question is the reverse of the approach to part (a). Here we
know what the actual direct labour hours are at each level of output, and are asked to calculate
the actual learning rate. The first step therefore is to calculate the cumulative average labour
hours by dividing the cumulative hours at each level by the cumulative number of batches:
Cumulative Cumulative total Cumulative average
number of labour hours labour hours
batches
1 28,000 28,000 ½
2 47,600 23,800 ½
4 80,900 20,200 ½
8 137,600 17,200 ½

As cumulative output rises from 1 to 2 batches, cumulative average time per batch falls from
28,000 to 23,800 hours (i.e. it falls to 85% of the batch 1 level). This is repeated each time
cumulative output doubles. So the actual learning rate is 85%. This does not just occur until
the fourth batch is complete however, but continues up to the eighth batch. Since there is no
information about production after the eighth batch, it is not possible to know if the learning
rate continues after this.

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(c) Direct labour cost for the 8th batch

Hours
Direct labour hours for first 8 batches 137,600 1
Direct labour cost of first 7 batches (working) 124,309
–––––––
Direct labour hours for 8th batch 13,291 2
–––––––
Therefore the direct labour cost of the 8th batch is $132,910 (13,291 hours @ $10 per hour).

WORKING

Cumulative average time taken for the first 7 batches using the formula provided:

y = axb

Where y = cumulative average time per unit (or in this case batch)
a = time taken for the first batch
x = total number of batches produced = 7
b = learning factor (log LR/log 2) = log 0.85/log 2, = -0.07058/0.30103 = -0.234

y = 28,000 × 7-0.234 = 17,758.45. 2

This y value gives the cumulative average time per batch for the first 7 batches. The total
time for the first seven batches is therefore 7 × 17,758.45 = 124,309.15. 1

3 STANDARD SELLING PRICE

(a) Sales price and sales volume variances

Standard contribution using original forecast selling price = 12·48 – 4·20 = $8·28
Selling price variance = (12·48 – 12·36) × 32,000 = $3,840 (A) 1
Sales volume variance = (30,000 – 32,000) × 8·28 = $16,560 (F) 1

(b) Sales price planning and operating variances

Revised standard selling price using actual inflation = 12·00 × 1·015 = $12·18
Planning selling price variance = (12·48 – 12·18) × 32,000 = $9,600 (A) 1
Operational selling price variance = (12·18 – 12·36) × 32,000 = $5,760 (F) 1

Whether this analysis provides the finance director with useful information will depend on the
way in which the company uses responsibility accounting and whether reward systems are
linked to performance against budget. In terms of operational responsibility, an adverse
selling price variance of $3,840 has become a favourable selling price variance of $5,760 and
thus may be an occasion for praise or reward for the manager concerned. The planning
selling price variance shows the effect on sales revenue of the mistake in forecasting the
selling price and if the cause of the mistake can be identified, improved forecasting may
become possible.

Tutorial note: A planning selling price variance using the budgeted sales volume of 30,000
units would also gain credit. The method used above is the method preferred by the
examiner.

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4 BEDCO

(a) Material usage planning variance

Bed sheets Pillowcases

Actual output (units) 120,000 180,000
Original standard quantity for actual output (m2) 240,000 90,000
Revised standard quantity for actual output (m2) 240,000 99,000 1
––––––– –––––––
Difference 0 9,000
× original standard cost per m2 5 5
––––––– –––––––
Material usage planning variance 0 45,000 adverse 2

Workings

Bed sheets Pillowcases

Original standard usage per unit (m2) 2 0.5
Revised standard usage per unit (m2) 2 0.55
Output 120,000 180,000
⇒ Standard usage for actual output –original 240,000 90,000
⇒ Standard usage for actual output – revised 240,000 99,000

(b) Material usage operational variance

Bed sheets Pillowcases

Actual quantity used (m2) 248,000 95,000
Revised standard quantity for actual output (m2) 240,000 99,000
––––––– –––––––
Difference 8,000 (4,000) 2
× original standard cost per m2 5 5
––––––– –––––––
Material usage planning variance 40,000 adverse 20,000 favourable 1

Tutorial note: The sum of the planning and operational variances calculated this way equals
the traditional usage variance:

Bed sheets Pillowcases

2
Actual quantity used (m ) 248,000 95,000
Original standard quantity for actual output (m2) 240,000 90,000
––––––– –––––––
Difference 8,000 5,000
× original standard cost per m2 5 5
––––––– –––––––
Material usage variance 40,000 adverse 25,000 adverse

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5 BRACE CO

The balanced scorecard is a strategic management technique for communicating and

evaluating the achievement of the strategy and mission of an organisation. It comprises an 1
integrated framework of financial and non-financial performance measures that aim to 1
clarify, communicate and manage strategy implementation. It translates an organisation’s
½
strategy into objectives and performance measurements for the following four perspectives:

Financial perspective ½

The financial perspective considers how the organisation appears to shareholders. How
can it create value for its shareholders? Kaplan and Norton, who developed the balanced ½
scorecard, identified three core financial themes that will drive the business strategy:
revenue growth and mix, cost reduction and asset utilisation. ½ each
theme
Customer perspective ½

The customer perspective considers how the organisation appears to customers. The
organisation should ask: “to achieve our vision, how should we appear to our customers?” ½

The customer perspective should identify the customer and market segments in which the ½
business units will compete. There is a strong link between the customer perspective and
the revenue objectives in the financial perspective. If customer objectives are achieved, ½
revenue objectives should be too.

Internal perspective ½

The internal perspective requires the organisation to ask: “what must we excel at to achieve
our financial and customer objectives?” It must identify the internal business processes ½
that are critical to the implementation of the organisation’s strategy. Kaplan and Norton
identify a generic process value chain consisting of three processes; the innovation process,
½ each
the operations process and the u process.
process
Learning and growth perspective ½

The learning and growth perspective requires the organisation to ask whether it can
continue to improve and create value. ½

If an organisation is to continue having loyal, satisfied customers and make good use of its
resources, it must keep learning and developing. It is critical that an organisation continues max 1½
to invest in its infrastructure (i.e. people, systems and organisational procedures) in order ————
to provide the capabilities that will help the other three perspectives to be accomplished. max 10
————

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 Marking Scheme

Marks Marks
1 Y AND Z

(a) Calculation of return on investment (2 marks each) 4

Comparison of performance – up to 2 marks per point
Provided that possible reasons are discussed max 5 4
––– 8

(b) Calculation of residual income 3

Comments – 1 per point 3
––– 6
–––
15
–––

2 SUPERELECTRIC

(a) Calculation of cumulative average direct labour hours per

batch for each of the four levels of output (½ each) 2
Calculation of cumulative total direct labour hours for each
of the four levels of output (½ each) 2
––– 4

(b) Calculation of actual cumulative average direct labour hours

per batch for each of the four levels (½ each) 2
Calculation of learning rate – at each level (½ each) 2
––– 4

(c) Correct approach (calculating cumulative total for 8 batches

less cumulative total for 7) 2
Calculate cumulative average hours per unit for 7 batches
using formula 2
Calculate total direct labour hours for 7 units 1
Use correct total direct labour hours for 8 units 1
––– 6
–––
14
–––
3 STANDARD SELLING PRICE

(a) Sales price variance 1

Sales volume variance 1
––– 2

(b) Planning variance 1

Operating variance 1
Discussion – 1 mark per comment max 2
––– 4
–––
6
–––

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4 BEDCO

(a) Compare revised standard quantity with original standard quantity,

either on a per unit basis or total (for actual output):
1 mark for each product 2
Variance ½ for each product 1
––– 3

(b) Compare actual quantity with revised standard quantity,

either on a per unit basis, or in total (for actual output):
1 mark for each product 2
Variance ½ for each product 1
––– 3
–––
6
–––
5 BRACE CO

Up to 2 marks for overall description of the scorecard 2

Up to 2 marks for description of each perspective:
Financial perspective 2
Customer perspective 2
Internal perspective 2
Learning and growth 2
–––
–––
10
–––

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