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BY: Asad Ejaz

(ACCA, CISA,
CIISA)
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2

Specialist cost and management


accounting techniques

Decision-making techniques

Budgeting

D
E

Standard costing and variances


analysis
Performance measurement and
control

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3

Examiner:
Examiner: Ann
Ann Irons
Irons

Exam format (five compulsory


questions)

Mar
ks

Question
1

20

Question
2

20

Question
3

20

Question
4

20

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The June 2011 exams

Topics examined in the JUNE 2011 exam


Question 1

Maximax and Minimax

Question 2

Pricing decisions

Question 3

Basic Variances and Flexed Budgeting

Question 4

Financial and Non Financial Performance

Question 5

Costing Methods (THROUGHPUT)

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The December 2010 exam

Topics examined in the December 2010 exam


Question 1

Basic Variances

Question 2

Financial & non financial Performance

Question 3

Linear Programming

Question 4

Costing Methods (Absorption and ABC)

Question 5

Incremental, ZBB: Public Sector

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The June 2010 exam

Topics examined in the June 2010 exam


Question 1

ABC, Pricing Strategies, Marginal Costing

Question 2

Basic Variance Analysis

Question 3

Linear Programming

Question 4

Transfer Pricing

Question 5

Performance and Budget Manipulation

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The December 2009 exam

Topics examined in the December 2009 exam


Question 1 Variance Analysis (basic + Planning &
Operational)
Question 2 Target Costing with Learning Curve
Question 3 Regression and incremental budgeting
Question 4 Financial Performance & Quality of
Service
Question 5 Short-term decision making, pricing
strategies
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The June 2009 exam

Topics examined in the June 2009 exam


Question 1

Throughput accounting

Question 2

Performance management

Question 3

Variance analysis

Question 4

Decision making

Question 5

Budgeting

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The December 2008 exam

Topics examined in the December 2008 exam


Question 1

Performance measurement

Question 2

Risk

Question 3

Learning curves

Question 4

Lifecycle costing and budgeting

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The June 2008 exam

Topics examined in the June 2008 exam


Question 1

Variance analysis

Question 2

Linear programming

Question 3

Performance measurement

Question 4

Activity based costing

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Topics examined in the December 2007 exam


Question 1

Target costing

Question 2

Performance measurement

Question 3

Budgeting and variances

Question 4

Further processing decision

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Costing

All production costs (including fixed


production overheads) are included in
the cost of a unit

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A cost card shows us the cost to make one unit


$/unit
Direct materials

15.00

Direct labour

18.00

Prime cost

33.00

Variable Overheads

2.00

Fixed Overheads

3.00

Full Product cost

38.00
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Production costs

Direct

Indirect

Dept A
Dept A

Dept B

Dept C

Dept B

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OAR =

Budgeted production overhead


Budgeted activity level
Choose
Choose
basis
basis
first
first

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All production costs (including fixed


production overheads) are included in
the cost of a unit

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Overhead absorbed = OAR x actual activity


Actual overhead expenditure X
Overhead absorbed
(X)
Under / (over) absorption
X

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Variable production costs only are


included in the cost of a unit

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A cost card shows us the cost to make one unit


$/unit
Direct materials

15.00

Direct labour

18.00

Prime cost

33.00

Variable Overheads

2.00

Marginal Product cost 35.00


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Contribution = selling price per unit


less ALL variable costs per unit
4Selling price
Less: Variable production costs
Variable non-production costs
Contribution

$
X
X
X
(X)
X
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Activity based
costing

Absorption costing uses one universal OAR

based on machine/labour hours


Implication that overheads are volume related

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Traditional absorption costing


Production
set up costs
Machine oil
Supervisor
salary

Production
department
A

OAR
= machine
hrs

Machine
repairs
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Volume related
overheads
Complexity
Complexity

Diversity
Diversity

Service support functions


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Activity Based Costing (ABC)


Production
set up costs

No. of production
set ups

OAR

Machine oil &


Machine repairs

No. of machine
hours

OAR

No. of labour
hours

OAR

Supervisors Salary

Activities

Cost drivers
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27

1.
2.
3.
4.

Group overheads into activities cost pools


Identify significant factors driving the costs
cost drivers
Calculate a cost per unit of cost driver
Absorb activity costs based on usage of
drivers

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Activity Based Costing


A

10
5
15

10
5
15

Product cost ($):


Direct materials
Direct labour
Prime cost
Overheads
Product cost

5
10
15

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Step 1: Group overheads into activities


Step 2: Identify cost drivers

Cost driver

Machining

55,000

Machine hours

QC & Setup

90,000

Production runs

Receiving

30,000

Component receipts

Packing

15,000

Customer orders
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Step 3: Calculate a cost per unit of cost dri


OAR working machining costs
A

Production

20,000

25,000

2,000

Total mach hrs

40,000

50,000

4,000

Mach hrs per unit

Total

94,000

OAR = $55,000 94,000 = $0.585/hr


Mach costs total $23,404
$0.585 x 40,000

$29,255

$2,341
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Machining
QC & set-up
Receiving
Packing

A
$23,404

B
$29,255

C
$2,341

Total
Units

20,000

25,000

2,000
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A
Machining $23,404
QC & set-up $36,000
Receiving
$13,636
Packing
$5,000

B
$29,255
$46,800
$13,636
$5,000

C
$2,341
$7,200
$2,728
$5,000

Total

$78,040

$94,691

$17,269

Units

20,000

25,000

2,000

$3.90

$3.79

$8.63

OAR / unit

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Step 4: Absorb activity costs based on


usage of drivers
A

Profit/unit ($):
Prime cost
Overheads
Product cost

15.00
3.90
18.90

15.00
3.79
18.79

15.00
8.63
23.63

Sales price

20.00

20.00

20.00

1.10

1.21

(3.63)

Profit

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Target costing

Traditionally:
The focus
is internal

mark-up
(2nd)

Cost
(1st)

selling
price
(3rd)

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Target costing:
The focus is
external

Profit
(2nd)

target
cost
(3rd)

selling
price
(1st)

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$/unit
Target price
Target profit (w)

Target cost

67.50
37.50

30.00

(w)Target total profit = 30% x $5,000,000


= $1,500,000
Target profit per unit = $1,500,000 / 40,000
= $37.50
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Estimated
Estimated
cost
cost

Target
Targetcost
cost

Cost
Cost Gap
Gap

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Lifecycle
costing

volumes

Maturity
Growth
Introduce
Develop

Decline

Sales
revenue
Profit

time
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Consider the stages of the lifecycle and


the associated volumes and costs

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Throughput
accounting

Key concept
Throughput sales revenue less material
cost
All costs other than materials are deemed
to be fixed in the short term

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Sales

100 units
per hr

50 units
per hr

100 units
per hr

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Return per factory hr


= sales revenue material purchases
time on key resource
i.e. all
Cost per factory hr
production costs
= Conversion costs
excluding
time on key resource
materials
TPA ratio
= return per factory hour
.
Conversion cost per factory hour

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TPA ratio should be greater than 1


Products / divisions will be ranked by
TPA ratio

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Environmental
Management
Accounting

Savings through waste


Poor environmental performance means

increased cost of capital


Energy and environmental taxes
Cost of processing which becomes waste
Pressure Groups campaigns

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Environmental costs
Internal costs directly
impact on the income
statement of a company.

External Costs are imposed


on society at large but not
borne by the company that
generates the cost in the
first instance

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Input / Output Analysis


Flow Cost Accounting
Activity Based Costing
Life-Cycle Costing

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Limiting factor
analysis

Yes
Is there just
one
constraint?
No

Determine
optimum
production
using
contribution /
limiting factor
Determine
optimum
production
using linear
programming
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Identify limiting Factor


Calculate Contribution / Unit
Calculate Contribution / limiting factor
Ranking
Production Plan

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Formulate the model


a) Define variables
b) Formulate objective function
c) Formulate constraints
Solve the Problem
d) Plot constraints on a graph
e) Identify feasible space
f) Plot slope of objective function and slide to optimal
point
g) Calculate value of objective function
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Key term - Shadow price


The additional contribution from
having 1 more unit of scarce
resource
This is the maximum extra you would
pay for 1 more unit
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Pricing
decisions

Response of demand to changes in price


PED = % change in Q
% change in P

If PED >1 = elastic


demand

If PED <1 = inelastic


demand

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a)
b)
c)
d)
e)

Price of other goods


Incomes
Tastes or fashions
Expectations
Obsolescence

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Downward sloping relationship between price and quantity

demanded
If using equations need to assume straight line in exam questions

P=a-bQ

a
b

Theoretical
maximum
price
Q

Change in P
Change in Q
(ie gradient
always -ve)
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Optimum price is when MC = MR


MC = Variable Cost/unit
MR = a 2bQ

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Penetration

Skimming

Cost Plus
Premium
Volume
discounts
Pricing Strategies

Discrimination

Controlled
Bundling
Loss leaders
Complementary
product

Psychological
Product line

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Short-term
decisions

Relevant costs are:


Future

Cash

They may also be:


Opportunity Costs

Incremental

Relevant costs are not:

Sunk

Committed

Apportioned

Approach
Calculate the variable cost to make each of the
units
Then calculate the difference between the cost
of buying and making per unit
Multiply this by the production volume
Compare this cost with the fixed cost savings to
determine whether the company should make
or buy
Consider non financial factors

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Shutdown decisions should focus on:


Variable costs
Avoidable costs
Directly attributable costs (and revenues) if
the closure is made
Timing

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A joint product should be processed further if:

sales value further processing costs > sales value at spl

Joint costs are sunk.


They are not relevant when
considering whether to process further

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Risk and
uncertainty

Does the decision maker have


past experience in this area?
Yes

Risk

No

Uncertainty

Risk Seeker

Best outcome

Risk averse

Worst outcome

Risk neutral

Most likely outcome

Special contract
Demand

800

700

500

300

400

Prob
0.2 (800x$3)+
$4,400
(400x$5)

(700x$3)+
$4,100
(400x$5)

$3,500

$2,900

500

0.3

As$4,400
above

(700x$3)+
$4,600
(500x$5)

$4,000

$3,400

700

0.4

$4,400

As$4,600
above

$5,000

$4,400

900

0.1

$4,400

$4,600

$5,000

$5,400
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Key formula
Expected value = px

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Maximin
Risk averse decision makers
Maximise the minimum return that the decision
maker could get

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Maximax

Risk seeking decision makers


Maximise the maximum return that the decision
maker could get

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Minimax Regret

Regret is based on opportunity cost


Minimise the maximum opportunity cost from
making the wrong decision

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Minimax Regret example


Special contract
Demand

800

400

500

700

500

300

$300

$900

$1500

$200

$600

$1200

700

$600

$400

$600

900

$1000

$800

$400

Max regret

$1000

$800

$900

$1500

A special contract of 700 units


minimises regret

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Complex Expected value problem the construct


decision Tree
Possible Outcome
Decision Point
Construct Decision Tree from Left to Right
Solve Decision Tree from Right to Left

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Technique to assess risk


Calculates the maximum % change in a
variable before the decision would change
b) Assesses whether a decision would change
if a variable changed by x%
a)

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Objectives of
budgetary control

Mission
Corp.
Objectives
Business
Objectives
Operational
Objectives
Individual
Objectives
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Control

Revise
objectives

Compare actual
with budget

Planning

Revise budget
Operate in line
with new
objectives
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P-

Planning

R - Responsibility
I -

Integration and co-ordination

M - Motivation
E - Evaluation

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Comparing actual (historical) results against a

plan
Taking necessary control action

Past
events

Corrective
action for
future

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Comparing planned results against a current

forecast
Taking necessary control action

Forecast

Corrective
action for
future

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Planned
results

Control Action

Forecast

Current date

Time
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General considerations
Motivation
Challenging yet achievable
Goal congruence

Participation
Top-down
Bottom-up

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Budgeting is part of planning & control


Managers should only be assessed on those

items they can control


Feedback control is reactive, feed forward
proactive
The level of budget set and the amount of
participation will impact on motivation

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Budgetary
systems

Fixed budget
prepared before beginning of budget period
budget volumes and $

Flexible budget
changes as volume of activity changes
used to ascertain the budget cost allowance, or

flexed budget

To cope with different activity levels


Useful at planning stage
Necessary for control

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Base on current year


Advantages:
Easy to prepare

Disadvantages:
x Inefficient
x Budgetary slack

Start with a clean


sheet
Advantages:
identifies inefficiencies
close examination
more efficient resource
allocation

Disadvantages:
x emphasis on short
term benefits
x needs skills
x resistance
x time and effort
x limited resources

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93

Always have 12 months of budget


Advantages:
reduce uncertainty
regularly reassess
planning & control
extend into future

Disadvantages:
x effort &
expense
x demotivational

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94

ABB

Uses activities that drive cost to set the budget

Advantages:
Looks at activity in its
entirety
Reflects strategy

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95

You
You should
should now
now be
be able
able to
to attempt
attempt the
the following
following key
key
questions
questions from
from the
the BPP
BPP Learning
Learning Media
Media Practice
Practice
and
andRevision
RevisionKit.
Kit.

Q25

Q26

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96

Quantitative
analysis in
budgeting

Simple average growth models


Linear regression
Moving averages

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98

Sales in 2000 x (1+g)3 = Sales in 2003


(1+g)3 = Sales in 2003
Sales in 2000
(1+g)3 =

260,000
200,000

(1+g)3 = 1.3
3
1 + g = 1.3
g

= 1.09

0.09 = 9%
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99

Find the trend line:


$

y = a + bx

(y)
dependent
variable

(x)

output
independent
variable

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100

y = a + bx
b = nxy - xy
nx2 - (x)2

a=

y - b x
n
n

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XY

X2

Y2

22
15
7
44
29
18
10
37

11
12
7
20
14
11
11
22

484
225
49
1,936
841
324
100
1,369

121
144
49
400
196
121
121
484

182
x

108
y

242
180
49
880
406
198
110
814
2,879
xy

5,328
x2

1,636
y2
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102

n=8
b = 8 x 2,879 - (182 x 108)
8 x 5,328 - 1822

= 3,376
9,500

= 0.3554
a = 108
8

- 0.3554 x

182
8

= 5.415

y = 5.415 + 0.3554x
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103

Components of a time series:


Trend (T)
Seasonal variation (S)
Cyclical variation

time series
trend

Random variation
time

Additive model: Y = T

+
S
Proportional model: Y = T
S

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104

Step 1: use moving averages to get trend


& seasonal variations
Centred MA
Period

Yr1 Q1
Q2
Q3
Q4
Yr2 Q1
Q2
Q3
Q4
Yr3 Q1
Q2
Q3
Q4

Sales (S)
18
60
90
102
30
72
99
120
36
90
114
135

4 period MA

67.50
70.50
73.50
75.75
80.25
81.75
86.25
90.00
93.75

(T)

Seasonal
Variation (SV)
A/T
90 / 69

69.00
72.00
74.63
78.00

1.304
1.417
0.402
0.923

81.00
84.00
88.13
91.88

1.222
1.429
0.409
0.981
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105

Step 2: average seasonal variations


Q1

Q2

Yr1

Q3

Q4

1.304

1.417

1.222

1.429

Yr2

0.402

0.923

Yr3

0.409

0.981

Average

0.406

0.952

1.263

1.423

Rounded SV

0.4

0.9

1.3

1.4

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106

Step 3: average trend increase


Trend has increased from 69.0 to 91.88 over
7

quarters.

Quarterly inc in trend = 91.88 69.0


7
= 3

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107

Step 4: forecast Year 4 sales


Trend
(T)

Seasonal
variation
(S)

Forecast sales
(Y)

Q1 91.88 + (3 3) 101

0.4

40.4

Q2 101 + 3

104

0.9

93.6

Q3

107

1.3

139.1

Q4

110

1.4

154.0
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108

General idea

The more you do


something the
faster you
become at it

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109

Requirements

Large manual element


Repetitive
Early stage of production
Consistency in workforce
No breaks in production
Motivated workforce

As cumulative output doubles,


cumulative average time per unit
falls to a given % of the previous
average time per unit

Example
Output
1

Total Time
(hrs)

Cum avg time


(hrs)

100

100
75%

150

75
75%

225

56.25
75%

337.5

42.1875

Cum.
average
time per
unit

Learning effect

Y = axb

Steady state

Cumulative output

y = axb
Where:
b = index of learning (log r/ log 2)
a = time taken for 1st
x = cumulative output
y = cumulative average time per unit

Learning curve effect ceases when


Machine efficiency restricts

improvements
Physical limits reached
Workforce go-slow

further

Budgeting and
standard costing

Decision making
Budgeting
Control
Performance evaluation

Inventory valuation

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117

Ideal standard

perfect operating
conditions

Attainable standard

possible
improvements

Current standard

current efficiency

Basic standard

leave unaltered
over long period
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118

When in production does wastage


occur?
Before
Adjust
purchases
budget

During
Adjust
materials
usage
budget
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119

Idle time

Build into an
attainable
labour hours
standard

Adjust
labour
budget

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120

Key concept
Managers should only be held
accountable for those items they can
control.
This is known as the principle of
controllability.

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121

Variance
analysis

$
1560
78 F
121 F
1759

Budgeted profit
Sales volume variance
Sales price variance
Cost variances:
Materials - price
- usage
Labour
- rate
- idle
- efficiency
Variable o/h - expenditure
- efficiency
Fixed o/h - expenditure
- volume

F
10
18

150
40
100
35
25
37
190

Actual profit

225

35 A
1725
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123

Variances may affect each other:

Cheaper materials

Favourable price
variance

Inferior quality
Adverse usage variance
(& efficiency?)
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124

Consider:
Size
Controllability
Cost
Interrelationships
Standard
Trend

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125

Materials
Total variance
Price variance

Usage variance
Mix
variance

Yield
variance
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126

Materials mix variance


Actual qty
std mix
Onions 5kg
Toms

750
750

5kg
10kg 1,500
should mix

Actual qty
actual mix

600
900
1,500

$/kg

Variance
$

150 F 2.00
150 A 4.00

300 F
600 A

Diff
(kg)

300 A

did mix

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127

Materials yield variance

Onions 5kg
Toms

Std qty
std mix

Actual qty
std mix

500
500

750
750

5kg
10kg 1,000
should qty

1,500

$/kg

Variance
$

250 A 2.00
250 A 4.00

500 A
1,000 A

Diff
(kg)

1,500 A

did qty

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128

Mix and Quantityvariances


Sales
Total variance
Price variance

Volume variance
Mix
variance

Quantity
variance
Slide
Slide 129129

Behavioural
aspects of
standard costing

Standard
Standard
cost
cost
card
card

Original
budgets

Revised
Revised
standar
standar
ds
ds
Revised
budgets

Planni
ng
Total
variances

Actual
Actual
Performan
Performan
ce
ce
Actual
results

Operatio
nal
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131

Planning variances represent the difference

between original and revised budget. They are


due to inaccurate planning or faulty standards
Operational variances are the difference
between revised budget and actual. These
are within a managers control

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132

Performance
measurement

Profitability

Liquidity

Gearing

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134

Key formula
ROCE = Profit before Interest and tax
Capital Employed

Total Assets less Current Liabilities


OR Equity + Long term Debt
How efficiently generate profit from capital investment
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135

PBIT
Sales
Net Profit
Margin

How efficiently turn


sales into profit

Sales
Capital Employed
Asset
Turnover

How efficiently
generate sales
from investment
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136

Learn the ratios


Interpret against prior years +/or other

businesses
Consider how to improve them

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137

Financial
Gearing

Operating
Gearing

Long term debt

Contribution

Long term debt & equity

PBIT

Measure of
financial risk

Measure of
business risk
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138

Provide key information about key business

areas

Imagine your financial and


non-financial indicators
provide conflicting results.
Which would be more
reliable and why?
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139

Customer

Internal

Innovation &
Learning

Financial

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140

Dimensions
Profit
Competitiveness
Quality
Resource utilisation
Flexibility
Innovation
Standards
Ownership
Achievability
Equity

Rewards
Clarity
Motivation
Controllability

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141

Financial indicators focus on short term and

the past
Non financial indicators also therefore vital
Balanced scorecard looks at all key areas of
the business
Building block model focuses on performance
measurement in service industries

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142

Divisional
performance
measures

Conditions for a good performance measure


Goal congruence
Accountability
Recognition of

long term and


short term
objectives

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144

Key formula
ROI =

Divisional profit

100

Divisional Investment

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145

$
Controllable divisional profit
X
Less: imputed interest
(X)
(= divisional investment x cost of capital)

Residual income
X

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146

ROI is better for making inter-division


comparisons & is easier to
understand
RI is less likely to lead to
dysfunctional behaviour and is more
flexible
Neither is as good as NPV for
appraising investments

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147

What price should be set when goods


are transferred from one part of the
business to another?

Transfer pricing problems:


Maintaining the right level of divisional
autonomy
Ensuring divisional performance is
measured fairly
Ensuring corporate profits are
maximised

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Minimum
transfer price

= Marginal cost +
Opportunity cost

Maximum
transfer price

= External purchase price

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149

Further
performance
management

Not-for-profit organisations have


multiple objectives which are difficult to define
Problems with performance
measurement:
Multiple objectives
Measuring outputs
Lack of profit measure
Nature of service provided
Financial constraints
Political, social and legal considerations

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151

Economy

Effectiveness

Efficiency

Sourcing inputs at
minimum cost while
maintaining standards of
quality
Success in achieving
objectives
Achieving better
productivity (output) from
resources input/consumed

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152

Stakeholders
Internal

External
Connected

Economic Environment
Competition

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153

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154