MANAGEMENT ACCOUNTING SUMMARY

| 1. MANAGEMENT ACCOUNTING |

Management Accounting = processes and techniques that focus on effective and efficient use of organisational
resources to support managers in their tasks of enhancing both customer value and shareholder value

1. Resources = financial and non-financial, organisational capabilities and competencies

2. Shareholders Value = key focus of managers - Involves improving worth of business from shareholders’ or
owners’ perspective
3. Customer Value = Value that customer places on particular features of a product

Role of Management Accountant in decision making:

● Responsible for collecting data

● Involved in Developing Decision Model

Management ACCG Processes and Techniques:

○ Support formulation and implementation of strategy

○ Support strategic and operational decision
○ Contribute to identifying and improving competitive advantage
○ Manage resources through planning and control systems
○ Define and manage costs

Management Accounting Financial Accounting

Users of information Management External users and company

management

Sources of data ● Both Financial and non- ● Financial data

Financial ● Drawn from organisation’s core
● Drawn from many sources - transaction-based accg system
core accg system, physical and
operational data from
production systems

Nature of information ● Past and Future-oriented ● Past oriented

● Timely ● Reliable
● Subjective ● Verifiable
● Relevant ● Highly aggregated

Regulations ● No ACCG standards or rules ● Prepared according to ACCG

standards

Vision = desired future state or aspiration of an organisation

Mission Statement = statement that defines purpose and boundaries of organisation

Objectives (or goals) = specific statements of what the organisation aims to achieve (often quantified and relating to
specific period of time)

Strategies = direction that the company intends to take over long term to meet its mission and achieve it objective

Corporate Strategy = decisions about types of business which to operate, which business to acquire and divest, and
how best to structure and finance the organisation
Business (or competitive) strategy = the way a business competes within its chosen market

Strategy Implementation = Putting plans into place to implement and support chosen business strategy

Competitive advantage = advantages that business may have over another that are difficult to imitate

Components of Traditional Systems Modern Systems

Management Accg Systems

Costing Systems ● Focus on costs of departments and ● Focus on costs of activities,

products products, customers and suppliers
● Assume production volume is the ● Recognise a range of factors that
only factor that can cause costs to can cause costs to vary
vary

Budgeting (Planning) ● Built around departments ● Built around departments and

Systems activities

Performance measurement ● Past and Future-oriented ● Past oriented

systems ● Timely ● Reliable
● Subjective ● Verifiable
● Relevant ● Highly aggregated

Regulations ● No ACCG standards or rules ● Prepared according to ACCG

standards

Cost Types:

Cost = Resources given up/used to achieve particular objective (measured in $) - focuses on Asset & Expenses

Cost object = item which management wants to identify as a separate measure of costs

Direct Costs (DC) = traced to particular cost object

Indirect Costs (IDC) = cannot be traced to cost object

Controllable Costs (CC) = can be controlled by manager

Uncontrollable Costs (UCC) = cannot be controlled by manager

Product Costs = costs incurred to produce goods

Period Costs = NOT product costs - expensed in the period they incurred in

Common Cost : Behaviour, Traceability, Controllability, Manufacturing, Timing of Expense

Value Chain:

Product Cost

Prime Costs = DM + DL
Conversion Costs = DL + MOH
Product Costs:
For Manufacturing = DM + DL + MOH
For Retailer & Wholesaler = Cost of Purchase + Cost of Delivery to supplier
Note: MOH = indirect costs

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| 2. COST BEHAVIOUR |

Cost Behaviour = relationship between cost and level of activity or cost driver

Cost Estimation = determining cost behaviour of particular cost item

Cost Prediction = using knowledge of cost behaviour to forecast level of cost at particular level of activity

● Traditional approaches:
○ Assumed costs driven by volume of production (volume cost drivers)
○ E.g. Unit produced, DL hours worked, DL costs, Machine Hours worked
● Contemporary approaches:
○ Recognise a range of possible drivers (non-volume cost drivers)
○ E.g. No. of batches, No. of shops/customers/deliveries, Distance covered

Cost Behaviour Pattern:

Relevant Range = range of activity over a particular cost behaviour pattern (FC remains unchanged in that range of
activity)

Variable Costs = cost that changes in total in direct proportion to change in level of activity

Fixed Cost = costs that remain the same in total dollar amount as activity level changes

Step Costs = remain fixed over a range of activity level but change outside that range

Semi-variable Costs = has both fixed and variable components

Curvilinear Cost = has a curved cost line

Engineered Costs = have defined physical relationship to level of output - if level of activity is known, total cost can
be predicted

Committed Costs = cost of organisation’s basic structure and facilities

Discretionary Costs = Result from management decision to spend money for a specific purpose and can be changed
easily

Cost Estimation:
● 3 approaches to cost estimation
1. Managerial Judgement = managers use judgement to classify costs as fixed, variable or semi-
variable costs
2. Engineering Method = study of processes result in incurrence of a cost
3. Qualitative Analysis = analysis of past data to identify relationships between costs and activities

Qualitative Analysis:
High-Low Method:
Variable Cost per unit = Difference in total Costs (highest - lowest cost) .
Difference in unit produced (corresponding units)
Fixed Cost = Total costs - Total variable costs

Simple Regression:
Y = a + bX
Y = Total Cost
a = FC (intercept on vertical axis)
b = VC (slope of the line)
X = level of activity

Multiple Regression:
Y = a + b1X1 + b2X2

Problems with Cost estimation:

● Data collection problems: i.e. missing data
● Accuracy of cost functions in business: E.g.Limited time and knowledge
● All costs functions based on simplifying assumptions
● Cost of producing more accurate cost estimates need to be assessed against likely benefits

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| PRODUCT COSTING |

Product costs = costs incurred during production process

Product Costing System = accumulates product-related costs and uses procedures to assign them to organisation’s
final products (Aim: provide managers with information about the way which resources have been used)

Raw Material Inventory (RM) = records cost of major material will be used in production

Work in Process Inventory (WIP) = records cost of product that are partially complete at balance date

Finished Goods Inventory (FG) = records cost of manufactured goods that are completed and ready for sale

Cost of Goods Sold Expense (COGS) = cost of product transferred from inventory account when sold, matched
against revenue to determine gross margin

Profit and Loss account (P&L) = summary of all expenses and revenues, include COGS

Determining OH Rate:
Product Cost = Actual DM + Actual DL + Applied OH
Predetermined OH rate (POR) = Estimated total MOH .
Estimated total unit in allocation based
Overhead Applied = POR x Actual Activity
 Prorate Amount = Under or Over-applied x POR

If applied MOH is 1. Close COGS 2. Prorate COGS, WIP & FG

Actual > Applied = Underapplied + COGS (CR MOH) + COGS, WIP & FG

Actual < Applied = Overapplied - COGS (Dr MOH) - COGS, WIP & FG
*Over or under-applied - occurs due to error in estimating POR

Job Costing:

Job costing = assigns manufacturing (or product-related) costs to individual jobs

Job cost sheet = record of all costs relate to particular job (include DM, DL and MOH) - managers use for making
pricing decision, assess product profitability, control product costs, and estimate inventory values

Bill of Materials = list of all materials required for a job

Material requisition form = authorises movements of RM from ware to production department

Source document = basic document used to initiate an accounting entry

Purchase of RM

DR Raw Material

CR Account Payable

RM (Begin) + RM Purchased - RM (End) = RM Used

Transferring DM to Job

DR WIP

CR Raw Material

Charging DL to Jobs

Direct Labour Indirect Labour

DR WIP DR MOH
CR Wages Payable DR Wages Payable
Actual MOH Incurred

DR MOH

CR Prepaid rent

CR Accum depreciation: equipment

CR Account Payable

CR Prepaid insurance

Applied MOH

DR WIP

CR MOH
Under or Over-applied MOH

Under-applied (Actual > Applied) +ve Over-applied (Actual < Applied) -ve
DR COGS DR MOH

CR MOH CR COGS

Completion and Sale of a production job

Completion of Goods Completion of Goods

DR Finished Goods DR Account Receivable

CR Work in Process CR Sales Revenue

DR COGS

CR Finished Goods

COGS = FG (Begin) + COGM - FG (End)

Process Costing:
Process Costing = assigns all production costs to process/departments, and averages tham across all units produced

Average Unit Cost = Total cost of process for time period .

# output during that period

Job Costing Process Costing

Production Many jobs are worked during the Single product is product for long period
period (Small #, Distinct Batches, of time (Mass production)
Customisation)

Cost Accumulated by Individual jobs Departments/process

Key Document Job cost sheet Department production

Unit costs calculated by Job Department

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| ABSORPTION AND VARIABLE COSTING |

Absorption Costing = all manufacturing costs are assigned to products: DM, DL, variable and fixed MOH
Variable Costing = only variable costs are assigned to products: DM, DL and variable MOH
Variable Manufacturing Overhead Costs (VMO) = indirect manufacturing costs that vary in proportion to level of
production or volume of cost driver
Fixed Manufacturing Overhead Costs (FMO) = indirect manufacturing costs that do not vary with level of production
Absorption Costing Variable Costing

Product Costs ● DM ● DM
● DL ● DL
● VMO ● VMO
● FMO

Period Costs ● SG&A Exp ● FMO

● SG&A Exp
*AC Method usually > CM Method in Net profit (Unit produced carried forward as FG)

Relationship between production Effect on inventory Relationship between Variable

and sales and Absorption Costing

Unit Produced = Unit Sold No change inventory Absorption = Variable

Unit Produced > Unit Sold Inventory ↑ Absorption > Variable

Unit Produced < Unit Sold Inventory ↓ Absorption < Variable

Short Cut Method (Reconcile):

Difference in Net Profit = Change in Inventory (units) x Fixed Manufacturing Cost per unit
Change in Inventory (units) = Unit produced - Unit Sold
Fixed Manufacturing Cost per unit = FMOH / Unit Produced

CVP Analysis:
Cost Volume Profit (CVP) analysis = estimates how changes in costs (both variable and fixed), sales volume, and
price affect company’s profit

Contribution Margin (CM) Ratio = Total CM ($) or Unit CM (Units) . or

Total Sales Revenue Unit Selling Price
CM ($) = CM Ratio x Sales
Break-even Sales (units) = FC .
Unit CM ---------> SP-VC

Break-even Sales ($) = FC .

CM Ratio

Sales Revenue - Variable Costs - Fixed Costs = Profit

At Break-even: Sales Revenue - Variable Costs - Fixed Costs = 0

Target Profit:
Sales Revenue - Variable Costs - Fixed Costs = Target Profit (Before Tax)

Target Sales Volume = Fixed Costs + Target Profit (before tax)

Contribution Margin per unit

Target Sales in Dollars = Fixed Costs + Target Profit (before tax) .

Contribution Margin Ratio

Sales volume required to earn a target after-tax profit = Fixed Costs + [Target Profit (after tax)/(1-t)] .
Contribution Margin per unit
Margin of Safety = Budgeted Sales Revenue - Break-even profit

Operating Leverage:
Operating Leverage = Contribution Margin .
Net Income
 % increase in net profit = % increase in sales revenue x Operating leverage factor

If Operating leverage is: High Low

% profit ↑ with sales ↑ Large Small

% loss ↓ with sales ↓ Large Small

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| ACTIVITY BASED COSTING (ABC)|

Traditional Product Costing = traces DM and DL to products, and allocates MOH to products using POR
● DM and DL → Traced to products
● MOH → Allocated to product using predetermined OH rate (POR) at department level
POR = Budgeted OH / Budgeted DL Hrs

Activity-Based Costing (ABC) = used to measure both cost of cost objects and performance of activities (2 stage
process of assigning costs to products)
● Limitations:
○ Facility level costs being randomly generated to products
○ Use of average costs in decision making:
○ Complexity and costly
● When to Use
○ Diverse product range, diverse batch size and product complexity
○ Setup are costly
● Objective: understand the causes of OH costs and to identify profitability of products or customers
1. Stage 1 - Identification of Activities: OH costs → traced to more than 1 activity

Activity Cost Activity Driver Cost per Unit of Activity Driver

2. Stage 2 - Identification of Cost Drivers: Each activity is analysed to find what best drives cost of activity
Activity Product 1 Product 2

Activity 1
Activity 2

Total
Cost per Unit Total / unit produced

Activity-Based Costing Traditional Product Costing

● Shift OH cost: high-volume, large batches → low- ● Assumes costs are unit level and with output
volume, small batches ● Assumes product costs driven by volume-based
● Insight into cost structures for diverse range cost drivers
 ● More accurate product cost info ● Ignores batch level costs - units product in large
● More detailed info on cost of activities and drivers batches (low per unit batch costs)
of those costs ●
● Avoid under/over-pricing (which causes ↓ sales &
profits)

Unit Level Costs (E.g. Depn, Repairs, Maintenance, Cost if indirect materials)
● Cost incurred each time a unit of product or service is produced
● Cost Driver: cost ↑ as # unit produced ↑

Batch Level Costs (E.g. Salaries, Quality control costs, processing, Setup cost)
● Cost incurred for batches of goods produced
● Cost Driver: varied with # batched produced - independent of # units in batch

Product Sustaining Costs (E.g. Maintaining/Prep , Designing cost for product, Cost of handling and warranty service)
● Cost incurred for each type of product produced
● Activities performed to enable production of individual products (or services) to occur
● Cost Driver: varies with # of product lines

Facility Level Costs (E.g. General admin, Rent, Building Security, Wages for factory maintenance)
● Cost incurred to Sustaining facility - not related to production)
● Cost Driver: necessary to operate plant/organisation but DOES NOT vary with units/ batches/ services or
customers

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| 6. BUDGETING |

Budget = Used to evaluate performance by comparing actual vs budget results

○ Detailed plan for future operating activities
○ Financial model
○ Core component of planning and control systems
○ Short term (< 1 year)
● Purposes
1. Planning - Expresses plan of actions in financial terms
2. Control of profits and operations - budget can be a benchmark
3. Communication and Coordination
4. Allocation of limited resources among competing users
5. Performance management and evaluation - Budget v Actual; Achievement of targets; Setting
incentives
Strategic Planning = focuses on company’s long-term objectives and goals (Involves: Corporate Strategy - overall
company & Business (or competitive) strategy - business units)
Annual Budget (Master Budget) = comprehensive set of budgets that covers all of firm’s activities
○ Include: 1. Financial 2. Operation 3. Sequential nature of sub-budgets: budgets are linked
together and impact on each other
○ 1 year (can be 3 months or a month)
Operating Budget = sales and various cost budgets - directly associated with operating asisitives of company
○ Sales Budgets - shows estimated sales in unit & $ of organisation’s products
○ Manufacturing firms (Production budgets) - shows # units needed to be made to meet sales and to
satisfy inventory requirements
■ Production budget = DM + DL + MOH Budget
○ Retailers and Wholesalers (Purchases budgets) - set out qty and COG need to be purchased
○ Service firms - show how expected demand for services will be met

Financial Budget = budgeted IS, BS, cash budget and capital expenditure
 ○
Cash budget - include cash receipts, cash payments (disbursements)
○
Capital Expenditure budget - plan for acquisition of long-term assets / may involve CF over many
years
○ Budgeted Income Statement - shows expetect Revenues & planned expenses
○ Budgeted Balance Sheet - shows expected A & L at end of budget period
Rolling Budget = budget continually updated by adding a new period and dropping period just completed (quarter)
Cash Flow Budget = important as it forecast possible cash shortages & surplus and a way to manage cash receipts
and disbursement

Behavioural Consequences of Budgeting:

Padding the budget = managers intentionally underestimate revenues or overestimates costs
Top-Down budgeting = senior managers impose budget targets
Bottom-Up budgeting = lower managerial & operations level sets their own budget
1. Participative Budgeting - Managers develop their own initial budget estimates for their own areas of
operations
○ Benefits:
■ Encourages coordination and communication between managers and wider organisation
■ More accurate budget estimates
■ Individuals identifying more closely with budget targets
○ Drawbacks:
■ Costly and time-consuming
■ Can cause delays and indecisiveness
■ May cause differences and disagreements
■ Provides opportunities for padding the budget
2. Budgetary Slack - differences between (padded) estimated revenue or cost projection and realistic estimate
or revenue or costs
○ Reasons for padding the budget:
■ Performance looks better (exceed their budget)
■ Way of coping with uncertainty
■ To guard against initial budget request being cut back by SM
3. Budget difficulty - budgets should be realistic and provides challenges and stretch (but not unachievable)
○ Budget acceptance occurs when
■ Targets are developed with employees’ participation
■ Targets are considered achievable
■ Frequent feedback on performance
■ Individuals are held responsible for activities within their control
■ Achievement of targets accompanied by rewards
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| 7. STANDARD COSTING |

Control = when operations go according to plan and objectives are achieved

Standard costing = part of budgetary control system
Standard unit cost = budget for production of one unit or more goods or service
Standard cost variances = to evaluate performance and control costs

Setting cost standards (both methods may be used together in practice)

1. Analysis of Historical Data (less expensive than engineering) - Provide indicator of future costs
2. Engineering Methods - Analysis of a production process to determine what it should costs to produce a
product
Types of Standards:
1. Perfection - minimum attainable costs under NEARLY PERFECT operating conditions (peak efficiency, lowest
material and labour costs, no production disruption) - Motivation to achieve lowest cost possible
2. Practical - minimum attainable costs under NORMAL operating conditions (allow downtime and wastage) -
Encourage more positive attitudes towards target
Price Variance = calculated on the entire quantity purchased
Quantity Variance = calculated only on quantity used
 ● Variance Analysis Cycle
1. Prepare Standard cost performance report
2. Variance Analysis
3. Identify questions
4. Receive explanations
5. Take corrective actions
6. Conduct next period’s operations

Direct Materials Variances:

Direct Material Price Variance (DMPV) = AQp (AP - SP) AQp = actual quantity purchased
SP = Standard Price
Direct Material Quantity Variance (DMQV) = SP (AQu - SQa)
AQu = actual quantity used
SQa = std unit x actual output

Direct Labour Variances:

Direct Labour Rate Variance (DLRV) = AH (AR - SR) AH = actual hours

AR = actual rate
SR = standard rate

Direct Labour Efficiency Variance (DLEV) = SR (AH - SHa) SHa = std unit x actual output

Flexible Budgets:

Static Budget = based on one specific planned level of activity

Flexible Budget = budget prepared for a range of levels of activity (activity measure of OH allocation - varies similarly
to VOH varies)

Total Budgeted Cost = (Budgeted VOH cost per unit of activity x Total activity units*) + Budgeted FOH costs
*Planning Budget → Budget units
*Flexible Budget → Actual units
Activity Variance = Flexible - Planning
Spending Variance = Actual Results - Flexible Budget
VOH Rate = Variable OH / Machine Hrs
FOH Rate = Fixed OH / Machine Hrs
Total POR = Var OR + Fixed OR

Variance OH Cost Variances:

Variable OH Spending (Rate) VaR = Actual Variable OH - (AH x SVR) or AH (AVR - SVR)
Variable OH Efficiency VaR = SVR (AH - SHa) SVR = Budgeted MOH Variable $/ Budgeted DL
hr
SHa = Standard hours allowed for actual output

Fixed OH Cost Variances:

Fixed OH Budget Variance = Actual Fixed OH - Budgeted Fixed OH

Fixed OH Volume Variance = Budgeted Fixed OH - Applied Fixed OH
Applied Fixed OH = SHa x (Budget FOR / Std Mhrs)
SHa = Standard hours allowed for actual output
Cost Control = accomplished throughout the efforts of individual managers and employees
(Managers can control outcomes, and set standards for cost)
○ Material Price Variance = Purchasing manager
○ Material Quantity Variance = Manufacturing Production Manager
○ Labour Rate Variance = Manufacturing Production Manager
○ Labour Efficiency Variance = Manufacturing Production Manager
Unfavourable = variances are equivalent to underapplied OH (Over budget) Actual > Budget
Favourable = variances are equivalent to overapplied OH (Under budget) Actual < Budget

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| 8. TACTICAL DECISIONS |

Tactical Decisions = Do not require changes capacity-related resources, Changed/reversed quickly, Short-term, Focus
on incremental revenues and costs resulting from alternative decisions
Long-term (Strategic) Decisions = Involve change in capacity, More difficult to reverse, Long-Term, Recognise time
value of money
Relevant Information:
○ Different under competing courses of action
○ Costs and benefits relate to future: relevant
○ ‘Sunk costs’ are ignored: irrelevant
○ Timeliness VS Accuracy: Only value if available in time in decision making process
Incremental Revenues = additional revenue gained as a result of choosing one alternative over another
Incremental Costs = additional costs arise from choosing one course of action over another
Out of pocket Costs = incremental costs incurred if a particular course of action is selected
Suck Costs = Costs that have already been incurred (Irrelevant)
Opportunity Costs = potential benefit given up when the choice of one action prevents a different action
Avoidable Costs = Costs will not be incurred in the future if a particular decision is made
Unavoidable Costs = costs that will continue to be incurred no matter which decisions alternative is chosen;
(irrelevant)
**Incremental revenue > Incremental Cost - to ACCEPT**
Differential Analysis (Incremental Analysis):
● Changes in Revenue, costs and profits result from business decision for each alternative
● Difference between costs & benefits if the alternatives

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| 9. PERFORMANCE MEASUREMENT |

Purpose:

1. Communicates business strategies and plans (aim to achieve goal congruence)

2. Tracks management performance against targets
3. Evaluates and reward subordinates’ performance
4. Guides future development of business strategies & operations
Decentralisation = structuring an organisation → smaller sub-units such as divisions or departments
● Managers of these units → assigned particular operational & decision-making responsibility/authority
● Benefits: Decisions made by manager most familiar with the problem
Goal Congruence = consistency between individual goals with company goals
● Difficult to achieve:
○ Managers unaware of their decisions on other sub-units
○ Managers more concerned on their own achievements than achievements of overall organisation
Responsibility Centres:
Responsibility accounting = involves identifying responsibility centers and their objectives, developing performance
measurement schemes, and preparing & analysing performance reports of the responsibility centers
Cost Centre = Responsible for costs only (E.g. IT, Finance)
● Performance Reports - differences between budgeted and actual costs using variance analysis
● Measure: cost variance, staff turnover
Revenue Centre = Responsible for revenue only (E.g. Marketing, Sales)
● Performances Reports - sales price variances
● Measure: Sales variances, Achievement of target revenue
Profit Centre = Responsible for costs & revenue (E.g. Branch of Big Company)
● Performances Reports - income measures, such as overall flexible budget variance or sub-unit’s margin
● Measure: Profit generation - CM, Controllable Net profit & Gross Profit)
Investment Centre (Strategic Business Units SBUs) = Separate business with its own value chain (E.g. Corporate HQ,
Branch of Global Company)
● Measure: ROI, RI
Shared Services = concentration of support services across decentralised company, into separate unit to service
multiple internal customers
● Aim: Reduce cost and Improve quality of services
● Set up as Profit centres
● Core business focus on non-strategic areas (Finance, AP, Payroll, IT)
Team Based structures = teams with wide responsibilities to manage all aspects of particular process
● Self managed work teams
● Flatter structures
● Set up as Cost centres
Transfer Pricing:
Transfer Pricing = internal selling price when G&S are transferred between profit centres in divisionalised
organisation (Company’s perspective - money moves out of one pocket and into another)
● Market-Based Prices (Price obtained in external market)
○ No excess capacity
■ TP = Outlay Cost (VC) + OC (MP - Outlay)
○ Excess capacity
■ TP = Outlay Cost (VC)
● Cost-Plus Prices (Used for intermediate product where there is no competitive external market OR External
MP exists but supplying unit has excess capacity)
● Negotiated Prices (Units managers negotiate prices based on External MP OR if no external MP exists, costs
recovery may be the basis for negotiation)

Transfer Pricing (TP) = Outslay Cost + Opportunity Cost Outlay = Variable prdn cost per unit
OC = MP - Outlay

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|10. FINANCIAL & NON-FINANCIAL MEASURES |

Return on Investment (ROI) **FC - ignored if comparing incremental rev or costs**

Return on Investment (ROI) = to evaluate the financial performance of investment centres

Invested Capital (Operating Asset) = assets needed to generate revenue (E.g. Cash, Prepaid expenses, AR, Inventory,
P&E)
ROI = Profit (Earnings before interest & tax EBIT) .
Invested Capital (Cash, AR, Inventory, PPE, & other productive assets) --> Operating Asset

Return on Sales = Profit . Investment Turnover = Sales Revenue .

Sales Revenue Invested Capital (Operating Asset)
 ● Improving ROI:
○ ↑ Return on Sales (ROS) → ↑ Sales Revenue/↓ Selling price → ↓ Expenses
○ ↑ Investment Turnover → ↑ Sales Revenue → ↓ Invested capital
● Advantages
○ Widely used
○ Focus on both Profit & Assets required to generate profits
○ Discourage excessive investment
○ Evaluate investment centres performances (which differ in sizes)
● Limitations
○ Short-term focus
○ Defer asset replacement - maintain high ROI
○ Reject Projects that ↓ division’s ROI
■ E.g. ROI: Company = 20%, Divn = 30%, Invest = 25% → ROI Co = 22.5%, Divn = 27.5%
○ Accept Projects that ↓ Company’s ROI
■ E.g. ROI: Company = 20%, Divn = 10%, Invest = 15% → ROI Co = 17.5%, Divn = 12.5%

Residual Income
Residual Income = Profit - (Invested Capital x Min Rate of Return)
Invested capital = average Total Assets (Operating Asset)
Min Rate of Return = Imputed interest rate based on required rate of return that firm expects from its investments
which is based on organisation’s cost of capital
● Advantages
○ Promote goal congruence (compared to ROI)
○ Consider company’s RR in measuring performance
● Limitations
○ Cannot compare between different sized business units
○ Biased towards larger business
○ Short-term focus (Like ROI)

Non-Financial Measures
● Advantages:
○ Emphasise strategy
○ Drivers of future financial performance
○ More actionable, timely, easier to understand
● Limitations:
○ Wide choice of measures
○ Dd hoc & undirected
○ Must take trade-offs
○ Not easily translate into financial outcomes

Du Pont Chart
Du Pont Chart = linkage between KPI, KPD and financial measures

Ratio of Outputs produced per unit of input:

Labour Productivity = # of Units produced
# of DL hours

Total factory Productivity = # of Units produced .

Cost of all inputs to production

Balanced Scorecard (BSC) = tool that translates organisation’s mission, objectives & strategies into performance
measures for each key strategic area of business
● Implement strategy, monitor & manage organisation performance
●
4 Perspectives of BSC
1. Financial Perspective = To succeed financially, how should we appear to our shareholders
2. Customer Perspective = To achieve our vision, how should we appear to our customers
 3. Learning and Growth = To achieve our vision, how will we sustain our ability to change & improve
4. Internal Business Processes = To satisfy our shareholders & customers, what business processes should we
excel at (Customer & financial objectives)

Performance Measures

Objectives Lag Indicators (KPI) Lead Indicators (KPD)

1. Financial ● Return on Equity ● Sales mix

● Improve return for shareholders ● Economic Value added ● Cost per product
● ↑ profits ● Product profitability ● Market Shares

2. Customer ● Customer satisfaction ● # product returns

● ↑ customer satisfaction ● Market share ● On-time delivery
● Expand customer base ● # of new customers ● # product variations available
● # of customers retained ● # customer complaints
● # completed goods

3. Internal Business Processes ● # completed goods ● Product defect

● Improve quality of products ● # products under development ● # product returns
● Create new, innovative products ● Product development time
● Improve production processes ● Production cycle time
● # machine breakdowns

4. Learning Growth ● Employee satisfaction survey ● Improvements made to

● Improve employees’ satisfaction ● # employees participating in employee facilities
● Develop employees’ technical skills training programs ● Time spent developing
employee programs

Strategy Map = visual representation that explains cause and effect relationship linking objectives of perspectives of
the organisations
Lag Indicators = help monitor progress towards objectives - Key Performance Indicators KPIs
Lead Indicators = Drive outcomes and provide actionable info - Key Performance Driver KPDs
Benchmarking = Compares products, functions and activities in organisation against external businesses by
identifying areas for improvement and to implement continuous improvement
Steps to Benchmarking
1. Identify functions/activities to be benchmarked and appropriate performance measures
2. Select benchmarking partners
3. Data collection & analysis - performance gaps
4. Establish performance goals
5. Implementing plans
Forms of Benchmarking
● Internal benchmarking
○ Between business units within same company
● Competitive benchmarking
○ Identifying weaknesses and strengths of competitors
● Industry benchmarking
○ Comparing performance against companies with similar interests and technologies
● Best-in-class or Process benchmarking
○ Benchmarking against industry best practices
○ Businesses may try to normalise to be comparable

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|11. INTEGRATED REPORTING |

Corporate Sustainability = Focus on achieving a sustainable economy, sustainable environment & sustainable society
Sustainability Reports = measure and communicate the economic, environmental and social (ESS) impacts of an
organisation’s activities
● Common names of sustainability reports
○ Triple Bottom lim Reports
○ Corporate Social Responsibility Reports (CSR)
○ Corporate Responsibility Reports
○ Social Audits
○ Social & Environmental reports
Global Reporting Initiative GRI Framework (G4) - aims to improve organisational transparency and accountability
(widely recognised as global standards)
1. Economic
2. Environmental (includes product and services)
3. Social
Integrated report = communication about how organisation's strategy, governance, performance and prospects lead
to the creation of value over the short, medium and long term
● Purpose = explain to providers of financial capital how an organisation creates value over time
● 6 capitals of integrated reporting
1. Financial Capital - funds to produce G/S - obtained through financing or through operations or
investments
2. Manufactured Capital - physical objects available for use in production of G&S (E.g. Buildings &
Equip)
3. Intellectual Capital - Includes intellectual property (E.g. Patents & licenses), Organisational capital
(E.g. knowledge, systems & equip)
4. Human Capital - Employees’ competences & experiences
5. Social and relationship Capital - the institutions & relationships within and between communities,
groups of stakeholders & other networks, and ability to share information and enhance individual
and collective wellbeing
6. Natural Capital - all renewable & non-renewable environmental resources & processes that provide
G/S that support past, current or future prosperity of an organisation (Includes air, water, land,
minerals, forests, biodiversity and ecosystem health)
Executive support system (ESS) = presents summarised information used by executives to come up with best
● Economic and Social impacts - difficult to identify and measure but may be important
Environmental Management Accounting (EMA) = system in place to manage environmental performance (includes
Life cycle costing, Environmental cost accounting, Environmental performance measures, Assessment of
environmental benefits, Strategic planning for environmental management)
Environmental Costs = costs incurred to prevent, monitor and report environmental impacts and costs of non-
compliance with environmental regulations
Private Costs = directly affect profit of organisation or are costs the company can be held legally accountable
● 5 Tiers of Environmental Costs
1. Conventional Costs - Direct costs associated with Capex, RM and other Operating and maintenance
costs
2. Hidden Costs - Costs from activities such as monitoring and reporting of environmental activities and
emissions, costs of searching of environmentally and cost of cleaning up contaminated land
3. Contingent Costs - contingent liabilities from failure to clean up contaminated sites, and fines and
penalties for non-compliance with regulations
4. Relationship and Image Costs - Less tangible costs and benefits that relate to consumer perceptions
and employee and community relations
5. Societal Costs - costs that organisations impose on others - environmental and society - may not be
held legally responsible and cannot be compensated for in legal system