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Professional Level Options Module

Advanced Performance Management


Thursday 8 December 2011

Time allowed Reading and planning: Writing:

15 minutes 3 hours

This paper is divided into two sections: Section A BOTH questions are compulsory and MUST be attempted Section B TWO questions ONLY to be attempted Present Value and Annuity Tables are on pages 11 and 12. Do NOT open this paper until instructed by the supervisor. During reading and planning time only the question paper may be annotated. You must NOT write in your answer booklet until instructed by the supervisor. This question paper must not be removed from the examination hall.

The Association of Chartered Certified Accountants

Paper P5

Section A BOTH questions are compulsory and MUST be attempted 1 Mackerel Contracting (Mackerel) is a listed defence contractor working mainly for its domestic government in Zedland. At present, Mackerel is considering tendering for a contract to design and develop a new armoured personnel vehicle (APV) for the army to protect its soldiers during transport around a battlefield. The invitation to tender from the government specifies that the APV should take two years to develop and test, and be delivered for a full cost to Mackerel of no more than $70,000 per unit at current prices before Mackerels profit element. Normally, government contracts are approximately priced on a cost plus basis with Mackerel aiming to make a 19% mark-up. At the last briefing meeting, the institutional shareholders of Mackerel expressed concern about the volatility of the companys earnings (currently a $204m operating profit per annum) especially during the economic downturn which is affecting Zedland at present. They are also concerned by cuts in government expenditure resulting from this recession. The Zedland minister for procurement has declared In the current difficult economic conditions, we are preparing a wide ranging review of all defence contracts with a view to deciding on what is desirable within the overall priorities for Zedland and what is possible within our budget. The government procurement manager has indicated that the government would be willing to commit to purchase 500 APVs within the price limit set but with the possibility of increasing this to 750 or 1,000 depending on defence commitments. In the invitation to tender document, the government has stated it will pay a fixed sum of $75m towards development and then a 19% mark-up on budgeted variable costs. Mackerels risk management committee (RMC) is considering how much to spend on design and development. It has three proposals from the engineering team: a basic design package (Type 1) and two other improved design packages (Type 2 and Type 3). The design packages will have different total fixed costs but are structured to give the same variable cost per unit. The basic design package will cost $75m to develop which will satisfy the contract specification. It is believed that the improved design packages will increase the chances of gaining a larger government order but it has been very difficult to ascertain the relevant probabilities of different order volumes. The RMC need a full appraisal of the situation using all suitable methods. The risk manager has gathered information on the APV contract which is contained in appendix A. She has identified that a major uncertainty in pricing the vehicle is the price of steel, as each APV requires 94 tonnes of steel. However, she has been successful in negotiating a fixed price contract for all the steel that might be required at $1,214 per tonne. The risk manager has tried to estimate the effect of choosing different design packages but is unsure of how to proceed to evaluate the different options. You are a consultant brought in to advise Mackerel on the new contract. The RMC need a report which outlines the external factors affecting the profitability of the project and how these factors can be built into the choice of the design budget which is ultimately set. Appendix A Budgeted cost for APV Variable cost per unit Steel Engine/transmission Electronics Other Labour Design and development (fixed total) Package Type 1 Type 2 Type 3 $ 11,412 9,500 8,450 4,810 13,800 $ 7,500,000 8,750,000 10,000,000 94 tonnes at contracted prices

Risk managers assessment of likely government order: Demand 500 750 1,000 Required: Write a report to the risk management committee to: (i) Analyse the risks facing the management of Mackerel and discuss how the management teams attitude to risk might affect their response; (9 marks) Type 1 85% 10% 5% Probability Type 2 25% 50% 25% Type 3 20% 50% 30%

(ii) Evaluate the APV project using metrics and methods for decision-making under risk and uncertainty and assess the suitability of the different methods used; (19 marks) (iii) Recommend an appropriate choice of method of assessing the project and, therefore, a course of action for the APV contract. (3 marks) Professional marks will be awarded for the format, style and structure of the discussion of your answer. (4 marks) (35 marks)

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Cod Electrical Motors (Cod) manufactures electrical motors for some of the 24 different European domestic appliance manufacturers. Their motors are used in appliances such as washing machines and refrigerators. Cod has been in business for over 50 years and has obtained a reputation for producing reliable, low cost motors. Cod has recently rewritten its mission statement, which now reads: Cod Electrical Motors is committed to providing competitively priced, high quality products, with service exceeding customer expectations. We will add value to our business relationships by investing in product development and highly trained personnel. The board have recognised that their existing key performance indicators (KPIs) do not capture the features of the corporate mission. They are worried that the staff see the mission statement as a public relations exercise rather than the communication of Cods vision. The monthly board papers contain a simple performance summary which is used as the key performance measurement system at that level. Example of board papers for November 2011: Cod Electrical Motors Key performance indicators for November 2011 Profit ($m) Free cashflow ($m) Return on capital employed (%) Notes: (a) (b) (c) (d) The year end is 31 December. The comparative figure is for the same month in the previous year. ROCE is an annualised figure. YTD means year to date. This month 21 34 124 YTD 256 176 117 Comparative 19 16 118

There are additional performance indicators not available to the board that line management use for a more detailed picture. Additional performance information: Note 1 Activity No of orders No of deliveries Staff No of staff (FTE basis) No of staff training days No of vacant posts Customers No of orders with a complaint late delivery product quality customer service other Preferential supplier status Production New products begun in year to date in development at month end launched in year to date Quality internal failure costs ($'000) external failure costs ($'000) 2011 2010

2,560 1,588 2 3 4 26 39 21 52 14 1,229 2,286 11

2,449 1,660 1,226 1,762 17

25 31 24 43 12

2 4 1 3,480 872 4

1 3 1 2,766 693

Notes: 1 Figures are year to date with comparatives from the previous year quoted on the same basis. 2 FTE = Full-time equivalent staff numbers. 3 Post is considered vacant if unfilled for more than four months. 4 Complaints are logged and classified into the four categories given when received. 5 Number of customers where Cod holds preferred supplier status. Required: (a) Assess whether the current key performance indicators (KPIs) meet the expected features of a modern performance measurement system. (7 marks) (b) Explain how the performance pyramid (Lynch and Cross) can help Cods board to reach its goal of a coherent set of performance measures. (6 marks) (c) Evaluate the current system using the performance pyramid and apply the performance pyramid to Cod in order to suggest additional KPIs and a set of operational performance measures for Cod. (12 marks) (25 marks)

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Section B TWO questions ONLY to be attempted 3 Bluefin School (Bluefin) is a school for 12 to 17-year-old pupils. It currently has 1,000 pupils attending drawn from its local area. The school is run by an executive group comprising the head of school and two deputy head teachers. This group reports to a board of governors who are part-time and selected from the local community and parents. The school is wholly funded by the government. The schools ethos is to promote learning, citizenship and self-confidence among the pupils. This is developed from a consensus, led by the board of governors and the head of school and informed by the views of the pupils parents. The school information systems are highly decentralised. Each department keeps its own records on a stand-alone PC using basic word processing and spreadsheet packages. The schools administrative department has a small network in its own offices with compatible applications and also a database and financial recording and reporting package for use in schools (provided by the government). The school is broken down into 11 academic departments such as mathematics, science and history. Each department head must prepare information for reporting to the board by inputting and processing the data. They obtain some help from an administrator who visits each department to spend a few hours per week helping in the recording and preparation of the departmental information. The department heads have different approaches to reporting their performance, with some using average marks in the annual exams for each class and some using pass rates of the annual exams. Some department heads present graphs of their data while most use tables of figures. The information is passed from each department to the school administration office on a memory stick (USB flash drive). The school administration office prints out the information for each department and adds it to a financial report creating a governors pack of usually about 13 pages for the annual review board meeting. The financial report is a detailed income and expenditure statement for the period under review (usually a two page print-out from the reporting package). An example of one of the 11 departments report is given in the Appendix. The board of governors meets every quarter and reviews the governors pack once a year. The board are concerned that the information that they are receiving is not meeting their needs and that there are a number of problems with the control and security of some of the data. It has been suggested that the school should consider improving its information systems by installing a network across the school to link the departmental computers and the administration department. A single database would be created to store all the performance information. The computers would then be linked to the internet in order to facilitate data transfer to other schools in the region and to the government.

Appendix Bluefin School Mathematics department Year 2010/2011 Class A B C D A B C D A B C D A B C D A B C Average marks Current yr % 63 60 51 47 61 58 49 45 67 61 50 42 62 59 50 46 57 51 47 54 Previous yr % 59 61 55 44 70 62 47 43 67 57 50 41 58 59 54 47 58 49 48 53

Year 1

Year 2

Year 3

Year 4

Year 5

Year 6

Notes: Each year contains pupils of the same age. Annual national exams are set in years 4, 5 and 6. Each year group is divided into different classes in order to ensure that classes do not exceed 35 pupils. (Not all pupils take every subject each year.) Average marks are for the annual examinations. Required: (a) With reference to the current situation at Bluefin School, discuss the controls and security procedures that are necessary for management information. (9 marks) (b) Using the limited information available, evaluate the usefulness of the pack that is provided to the board of governors. (6 marks) (c) Evaluate the improvements suggested to the information systems at Bluefin. (5 marks) (20 marks)

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Albacore Chess Stores (Albacore) is a chain of 12 shops specialising in selling items associated with the game of chess: boards, pieces, clocks, software and books. Three years ago, the company was the subject of a venture capital buyout from a larger group. A new senior management team was put in place after the buyout. They have the aim of running the business in order to maximise profits. The Chief Financial Officer (CFO), along with the other members of senior management, sets the annual budget and uses a standard costing approach with variance analysis in order to control individual shop performance. The head office handles all capital purchases and brand marketing. All inventory purchasing is done centrally and the shop opening times are set as standard across the company. As an illustration of senior management attitude, the CFO had set the budget for 2011 staff costs at $7 per hour for part-time staff and this was rigorously observed in the period. Each shop is run by a manager who reports their financial results to head office. The shop managers recruit and manage the staffing of their shop. They have some autonomy in setting prices locally and have been given authority to vary prices by up to 10% from a master list produced by the CFO. They also have a local marketing budget agreed each year by the shops manager and the marketing director as part of the annual appraisal process. The shop managers have approached the Chairman of Albacore to complain about the way that they are managed and their remuneration. They feel that their efforts are unrecognised by senior management. One manager commented, I have had a successful year in hard economic circumstances. I have run a number of promotions in the shop that have been well received by the customers. However, the budgets that are set are impossible to achieve and as a result I have not been paid any bonus although I feel that I have done everything in my power to bring in good profits. The shop managers at Albacore are paid a basic salary of $27,000 with bonuses of up to 30% of basic salary dependent on two factors: performance above budget and the operational directors performance assessment. The budget for the next year is prepared by the CFO and presented at the shop managers annual appraisal. The Chairman has come to you to ask if you can consider the system of performance assessment for the shop managers and give an independent perspective on the reward systems at Albacore. She has provided the following illustrative information from the previous year for one shop: Albacore Chess Stores Tunny Branch Year to Sept 2011 Budget $ 266,000 106,400 159,600 12,000 27,000 38,000 26,600 56,000 Actual $ 237,100 94,840 142,260 11,500 27,000 34,000 26,600 43,160 Variance $ 28,900 11,560 17,340 500 0 4,000 0 12,840

Sales Cost of sales Gross profit Marketing Staff costs Manager Part-time staff Property costs Shop profit

Notes: Property costs includes heating, lighting and rental. Positive variances are favourable. The manager of this shop commented at the appraisal meeting that she felt that the assessment was unfair since her failure to make budget was due to general economic conditions. The industry as a whole saw a 12% fall in revenues during the period and the budget for the period was set to be the same as the previous period. She was not paid a bonus for the period.

Required: (a) Assess the suitability of the branch information given as a means of assessing the shop managers performance for this store, providing suitable additional calculations. (8 marks) (b) Analyse the performance management style and evaluate the performance appraisal system at Albacore. Suggest suitable improvements to its reward system for the shop managers. (12 marks) (20 marks)

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Tench Cars (Tench) is large national car manufacturing business. It is based in Essland, a country that has recently turned from state communism to democratic capitalism. The car industry had been heavily supported and controlled by the bureaucracy of the old regime. The government had stipulated production and employment targets for the business but had ignored profit as a performance measure. Tench is now run by a new generation of capitalist business people intent on rejuvenating the companys fortunes. The company has a strong position within Essland, which has a population of 200 million and forms the majority of Tenchs market. However, the company has also traditionally achieved a good market share in six neighbouring countries due to historic links and shared culture between them and Essland. All of these markets are experiencing growing car ownership as political and market reforms lead to greater wealth in a large proportion of the population. Additionally, the new government in Essland is deregulating markets and opening the country to imports of foreign vehicles. Tenchs management recognises that it needs to make fundamental changes to its production approach in order to combat increased competition from foreign manufacturers. Tenchs cars are now being seen as ugly, pollutive and with poor safety features in comparison to the foreign competition. Management plans to address this by improving the quality of its cars through the use of quality management techniques. It plans to improve financial performance through the use of Kaizen costing and just-in-time purchasing and production. Tenchs existing performance reporting system uses standard costing and budgetary variance analysis in order to monitor and control production activities. The Chief Financial Officer (CFO) of Tench has commented that he is confused by the terminology associated with quality management and needs a clearer understanding of the different costs associated with quality management. The CFO also wants to know the impact of including quality costs and using the Kaizen costing approach on the traditional standard costing approach at Tench. Required: Write to the CFO to: (a) Discuss the impact of collection and use of quality costs on the current costing systems at Tench. (6 marks) (b) Discuss and evaluate the impact of the Kaizen costing approach on the costing systems and employee management at Tench. (8 marks) (c) Briefly evaluate the effect of moving to just-in-time purchasing and production, noting the impact on performance measures at Tench. (6 marks) (20 marks)

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Present Value Table Present value of 1 i.e. (1 + r)n Where r = discount rate n = number of periods until payment Discount rate (r) Periods (n) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 1% 0990 0980 0971 0961 0951 0942 0933 0923 0941 0905 0896 0887 0879 0870 0861 2% 0980 0961 0942 0924 0906 0888 0871 0853 0837 0820 0804 0788 0773 0758 0743 3% 0971 0943 0915 0888 0863 0837 0813 0789 0766 0744 0722 0701 0681 0661 0642 4% 0962 0925 0889 0855 0822 0790 0760 0731 0703 0676 0650 0625 0601 0577 0555 5% 0952 0907 0864 0823 0784 0746 0711 0677 0645 0614 0585 0557 0530 0505 0481 6% 0943 0890 0840 0792 0747 0705 0665 0627 0592 0558 0527 0497 0469 0442 0417 7% 0935 0873 0816 0763 0713 0666 0623 0582 0544 0508 0475 0444 0415 0388 0362 8% 0926 0857 0794 0735 0681 0630 0583 0540 0500 0463 0429 0397 0368 0340 0315 9% 0917 0842 0772 0708 0650 0596 0547 0502 0460 0422 0388 0356 0326 0299 0275 10% 0909 0826 0751 0683 0621 0564 0513 0467 0424 0386 0305 0319 0290 0263 0239 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

(n) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

11% 0901 0812 0731 0659 0593 0535 0482 0434 0391 0352 0317 0286 0258 0232 0209

12% 0893 0797 0712 0636 0567 0507 0452 0404 0361 0322 0287 0257 0229 0205 0183

13% 0885 0783 0693 0613 0543 0480 0425 0376 0333 0295 0261 0231 0204 0181 0160

14% 0877 0769 0675 0592 0519 0456 0400 0351 0308 0270 0237 0208 0182 0160 0140

15% 0870 0756 0658 0572 0497 0432 0376 0327 0284 0247 0215 0187 0163 0141 0123

16% 0862 0743 0641 0552 0476 0410 0354 0305 0263 0227 0195 0168 0145 0125 0108

17% 0855 0731 0624 0534 0456 0390 0333 0285 0243 0208 0178 0152 0130 0111 0095

18% 0847 0718 0609 0516 0437 0370 0314 0266 0225 0191 0162 0137 0116 0099 0084

19% 0840 0706 0593 0499 0419 0352 0296 0249 0209 0176 0148 0124 0104 0088 0074

20% 0833 0694 0579 0482 0402 0335 0279 0233 0194 0162 0135 0112 0093 0078 0065 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

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Annuity Table
n Present value of an annuity of 1 i.e. 1 (1 + r) r

Where

r = discount rate n = number of periods Discount rate (r)

Periods (n) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 (n) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

1% 0990 1970 2941 3902 4853 5795 6728 7652 8566 9471 1037 1126 1213 1300 1387 11% 0901 1713 2444 3102 3696 4231 4712 5146 5537 5889 6207 6492 6750 6982 7191

2% 0980 1942 2884 3808 4713 5601 6472 7325 8162 8983 9787 1058 1135 1211 1285 12% 0893 1690 2402 3037 3605 4111 4564 4968 5328 5650 5938 6194 6424 6628 6811

3% 0971 1913 2829 3717 4580 5417 6230 7020 7786 8530 9253 9954 1063 1130 1194 13% 0885 1668 2361 2974 3517 3998 4423 4799 5132 5426 5687 5918 6122 6302 6462

4% 0962 1886 2775 3630 4452 5242 6002 6733 7435 8111 8760 9385 9986 1056 1112 14% 0877 1647 2322 2914 3433 3889 4288 4639 4946 5216 5453 5660 5842 6002 6142

5% 0952 1859 2723 3546 4329 5076 5786 6463 7108 7722 8306 8863 9394 9899 1038 15% 0870 1626 2283 2855 3352 3784 4160 4487 4772 5019 5234 5421 5583 5724 5847

6% 0943 1833 2673 3465 4212 4917 5582 6210 6802 7360 7887 8384 8853 9295 9712 16% 0862 1605 2246 2798 3274 3685 4039 4344 4607 4833 5029 5197 5342 5468 5575

7% 0935 1808 2624 3387 4100 4767 5389 5971 6515 7024 7499 7943 8358 8745 9108 17% 0855 1585 2210 2743 3199 3589 3922 4207 4451 4659 4836 4988 5118 5229 5324

8% 0926 1783 2577 3312 3993 4623 5206 5747 6247 6710 7139 7536 7904 8244 8559 18% 0847 1566 2174 2690 3127 3498 3812 4078 4303 4494 4656 4793 4910 5008 5092

9% 0917 1759 2531 3240 3890 4486 5033 5535 5995 6418 6805 7161 7487 7786 8061 19% 0840 1547 2140 2639 3058 3410 3706 3954 4163 4339 4486 4611 4715 4802 4876

10% 0909 1736 2487 3170 3791 4355 4868 5335 5759 6145 6495 6814 7103 7367 7606 20% 0833 1528 2106 2589 2991 3326 3605 3837 4031 4192 4327 4439 4533 4611 4675 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

End of Question Paper

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