ACCA

Performance Management (PM)

Practice & Revision Notes
For exams in September 2019,
December 2019, March 2020 and
June 2020
ISBN: 9781509780501
 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted, in any
form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written
permission of BPP Learning Media Ltd.

The contents of this book are intended as a guide and not professional advice. Although every effort has been made to
ensure that the contents of this book are correct at the time of going to press, BPP Learning Media makes no warranty
that the information in this book is accurate or complete and accept no liability for any loss or damage suffered by any
person acting or refraining from acting as a result of the material in this book.

2
Contents

Page

Introduction

How to use the Practice & Revision material 4

The examination and syllabus capabilities 5

Skills bank 7

Knowledge bank 13

Appendices 109

3
 INTRODUCTION

Introduction
How to use the Practice & Revision material

Step 1 Learn
Until now you have been introduced to the core skills needed to pass this exam. You must now focus on developing
these new skills to address the ultimate test – the exam itself.

Step 2 Practise
Your revision course material will help you to apply this knowledge to the context of the exam-style questions. Using
real exam questions written by the examining team you'll learn the unique exam skills required to achieve success in
each exam. Your revision material consists of:

 Skills bank (in these notes)

This illustrates the main skills needed to pass this exam. We will teach you how to:
– Use your planning time effectively
– Tackling objective test case questions
– Tackling constructed response questions
– Good knowledge of the whole syllabus

 Knowledge bank (in these notes)

During the Step 1 phase of your studies (Learning phase) you have already gained the knowledge required to
pass the exam. During this phase reinforcement of this knowledge is critical.
To help this reinforcement you will find that the same diagrams contained in your taught course notes are used
here with additional information added if we feel it is necessary.

 Question and answer bank

The Practice & Revision Kit contains:
– Questions that will be covered in class
– Questions you will do during home study following guidance provided by your tutor
– Additional questions for further practice

Step 3 Rehearse
All your skills need to be applied on the day of the exam to deal with a complete exam.
This can be developed through use of mock exams within the Practice & Revision Kit, attending a question day at BPP
where a final mock exam is sat in full and feedback provided, or through purchasing a mock exam and online debrief.
Please see our website for further details www.bpp.com.

4
 INTRODUCTION

The examination and syllabus capabilities

The examination
The examination lasts for 3 hours and consists of three sections.

40% Numerical 60% Discussion

40% Knowledge 60% Application

Computer-based exams
It will only be possible from exams in June 2019 for candidates to sit Applied Skills exams as a computer-based exam
(CBE). Paper-based exams will no longer be run in parallel.

Exam duration
The syllabus is assessed by a computer-based exam (CBE) format. With effect from June 2019 for TX and
September 2019 for all Applied Skills exams, seeded questions have been removed from CBE exams and the exam
duration is 3 hours for 100 marks. Prior to the start of each exam there will be time allocated for students to be informed
of the exam instructions.

Format of the exam

The exam comprises three exam sections

Section Style of question type Description Proportion of exam, %

A Objective test (OT)  15 questions  2 marks 30
B Objective test (OT) case  3 questions  10 marks 30
 Each question will
contain 5 subparts each
worth 2 marks

C Constructed Response  2 questions  20 marks 40

(Long questions)
Total 100

Section A and B questions will be selected from the entire syllabus. These will be a variety of objective test questions.
The responses to each question or subpart in the case of OT cases are marked automatically as either correct or
incorrect by a computer.

Section C questions will mainly focus on the following syllabus areas but a minority of marks can be drawn from any
other area of the syllabus
 Information, technology and systems for organisational performance (A)
 Decision-making techniques (syllabus area C)
 Budgeting and control (syllabus area D)
 Performance management and control (syllabus area E)
The responses to these questions are human marked.

5
 INTRODUCTION

Main capabilities
The syllabus aims to test the student's ability to:
 Identify and discuss the information, systems and developments in technology required for organisations to
manage and measure performance
 Explain and apply cost accounting techniques
 Select and appropriately apply decision-making techniques to facilitate business decisions and promote efficient
and effective use of scarce business resources, appreciating the risks and uncertainty inherent in business and
controlling those risks
 Identify and apply appropriate budgeting techniques and methods for planning and control and use standard
costing systems to measure and control business performance and identify remedial action
 Assess the performance of an organisation from both a financial and non-financial viewpoint, appreciating the
problems of controlling divisionalised businesses and the importance of allowing for external aspects.
PM requires you to be able to apply techniques and think about their impact on the organisation. It seeks to examine
candidates' understanding of how to manage the performance of a business.

6
 Skills bank

This section explains and demonstrates the key skills

required to enable you to maximise your chance of
exam success. Knowledge of the syllabus is insufficient
on its own. Through question practice you will develop a
set of skills that will enable you to pass this exam.

7
8
 SKILLS BANK

Key skills required to pass

Our analysis of the examining team's comments on past exams, together with our experience of preparing students
for this type of exam, suggests that to pass PM you will need to develop a number of key skills.

1 Effective reading
and planning at the
5 Good knowledge of start of the exam
the whole syllabus

B C
2 Tackling multiple
4 Tackling constructed choice questions.
response questions Specific skills are
Good technique is needed in section A
essential in section C of the exam

3 Tackling objective A ...... ……

B ...... ……
test case questions. C
D
...... ……
...... ……
Good technique is
essential in section B

Each of these key skills is analysed on the following pages. Example(s) from past exam questions have been
included to illustrate the importance of these skills and how these skills should be applied.

9
 SKILLS BANK

Skill 1 – Effective reading and planning time at the start of the

exam
We recommend that you spend time at the beginning of your exam to carefully read your exam, specifically looking
through the requirements in sections B and C. Once you feel familiar with your exam we then recommend that you
attempt Section C, ensuring that you spend adequate time reading and planning before you begin to write up your
answer. Comments from examining teams across all exams regularly suggest that students appear less time-
pressured if they do larger section C style questions first.
Focus on the requirement first, underlining key verbs such as prepare, comment, explain, discuss etc to ensure
you answer the question properly. You should make good use of the time you have to read the rest of the question,
underlining and annotating important and relevant information, and making notes of any relevant technical
information you think you will need. Answers plans for written questions can help consolidate your thoughts before
you start writing.
However, our recommendations are not inflexible. If you would prefer to start on section A or B questions, then do
those first, but DON'T run over time on them. Advice on tackling each of the question types is given below.

A ...... ……
B
C
...... ……
...... …… Skill 2 – Tackling multiple choice question
D ...... ……

Section A and B of the exam will include some 2 mark multiple choice questions. Time allocation is important
here to ensure you tackle the questions in the allotted time. There is no negative marking on multiple choice
questions, so if you are unsure you should make sure that you guess rather than leaving the question out!
Having a selection of answers to choose from does not make multiple choice questions easier. The wrong options
will often be very plausible. You need to think carefully before selecting an option and ensure you practice lots of
questions so that you can spot red-herrings and potential pitfalls.

Skill 3 – Tackling objective test case questions

Read through the whole case first and then skim the five questions. Identify the easier or less time consuming
questions quickly as these should be attempted first. The questions are independent of each meaning they can be
answered in any order.

B C Skill 4 – Tackling constructed response questions

Approach is very important in section C. Professional presentation of answers is an area that students often don't do
well. It is vital that you do not throw marks away purely because the examining team cannot follow what you have
done. Ensure that you are happy with the basic formulae to save time when performing calculations in the
spreadsheet software.
Numbers should be well referenced and in discussion questions you need to avoid waffle. It is important that you
make and explain your point fully without going overboard.
You also need to ensure that you stick to the requirements in the question. This may sound obvious but many
candidates appear to get side tracked in the exam and therefore waste precious time on answers that don't score any
marks.
Candidates are required to not just make a point but need to apply it to the scenario given. Whenever you think you
have finished your answer always go back and re-read that requirement before moving on.

10
 SKILLS BANK

Skill 5 – Knowledge of the syllabus

You need to have a good, broad knowledge of all of the PM syllabus. The examining team can and will test all areas
of the syllabus.
Practising objective test questions is a really effective way of testing you knowledge of technical numerical content.
For written content, you can also use a variety of memory techniques. Creating mind maps can be helpful as the
human brain is better at remembering patterns than lists. Pictures are another excellent memory too as often a
simple picture can act as aid in recalling information. Another effective memory technique is to create mnemonics as
often it is easier to recall sounds and rhymes than simple lists.

11
 SKILLS BANK

12
Knowledge
bank

13
 Contents
Page

1 Assumed Knowledge variances 15

2 Managing information 21
3 Information systems and data analytics 23
4a Activity based costing 25
4b Target costing 29
4c Life cycle costing 33
4d Throughput accounting 35
4e Environmental management accounting 39
5 Cost volume profit analysis 41
6 Limiting factor analysis 45
7 Pricing decisions 47
8 Short-term decisions 53
9 Quantitative analysis in budgeting 59
10a Risk preferences 63
10b Risk and uncertainty in decision making 69
11 Budgetary systems 75
12 Budgeting and standard costing 79
13 Mix and yield variance analysis 83
14 Planning and operational variance analysis 87
15 Performance management 91
16 Divisional performance measures 95
17 Further performance management 99
18 Answers to lecture examples 103
19 Appendix A: Formulae to learn 109
20 Appendix B: Formulae given in the exam 112
21 Appendix C: Verbs used in question requirements 113

14
Assumed Knowledge variances

Basic variance analysis is assumed knowledge in PM. You should ensure that you have a good knowledge of the basic
calculations in preparation for the exam.

15
 Basic variances Operating Statements

 Materials  Marginal costing

 Labour  Absorption costing
 Variable overhead
 Fixed overhead
 Sales

Variance
analysis

Interpretation

Consider:
 Cause
 Controllable or uncontrollable
 Correct standard
 Measurement
 Interdependencies of variances

16
1 Basic variances
Material Variances
$
Price:
'Should' Actual purchases should cost X
'Did' Actual purchases did cost (X)
X

Kgs
Usage:
'Should' Actual production should use X
'Did' Actual production did use (X)
X
Difference valued at standard cost $X

Labour variances
$
Rate:
'Should' Actual hours paid should cost X
'Did' Actual hours paid did cost (X)
X

Idle time: (when none budgeted) Hrs

'Should' Hours worked X
'Did' Hours paid (X)
X
Difference valued at standard rate per hour $X

Efficiency: Hrs
'Should' Actual production should take X
'Did' Actual production did take (X)
X
Difference valued at standard rate per hour $X

17
 Variable overhead variances
$
Expenditure:
'Should' Actual hours worked should cost X
'Did' Actual hours worked did cost (X)
X

Efficiency: Hrs
'Should' Actual production should take X
'Did' Actual production did take (X)
X
Difference valued at standard rate per hour $X

Fixed overhead variances

Under marginal costing, the only variance is the fixed overhead expenditure variance.
Under absorption costing, the fixed overhead variance can be further subdivided as follows:
Total variance (over/under absorption)

Expenditure variance Volume variance

$ Units
'Should' Budget expenditure X 'Should' Budgeted units X
'Did' Actual expenditure (X) 'Did' Actual units (X)
X X
Difference valued at OAR
per unit $X

Efficiency Capacity
Hours Hours
'Should' X 'Should' X
Actual production should take Budgeted hours worked
'Did' (X) 'Did' (X)
Actual production did take Actual hours worked
X X
Difference valued at OAR $X Difference valued at OAR $X
rate per hr rate per hour

18
 Sales variances
$
Price:
'Should' Actual units sold should sell for X
'Did' Actual units sold did sell for (X)
X

Volume: Units
'Should' Budgeted sales units X
'Did' Actual sales units (X)
X
Difference valued at standard contribution/unit $X
Under absorption costing this variance will be valued at standard profit/unit.

2 Operating statement proformas

Marginal costing operating statement

$
Budgeted contribution
Sales volume contribution variance
Sales price variance

Cost variances: $(F) $(A)

Materials Price
Usage

Labour Rate
Idle
Efficiency

Variable o/h Expenditure

Efficiency

Actual contribution
Fixed overheads
Budgeted
Expenditure variance
Actual
Actual profit

19
 Absorption costing operating statement

$
Budgeted profit
Sales volume profit variance
Sales price variance

Cost variances: $(F) $(A)

Materials Price
Usage
Labour Rate
Idle
Efficiency
Variable o/h Expenditure
Efficiency
Fixed o/h Expenditure
Efficiency
Capacity

Actual profit

20
Managing information

How have the syllabus learning outcomes been examined?

Syllabus learning outcomes Exam past exam questions
Identify the principal internal and external sources of
management accounting information.
Demonstrate how these principal sources of management
information might be used for control purposes.
Identify and discuss the direct data capture and process Q8 Section A – September 2016
costs of management accounting information.
Identify and discuss the indirect costs of producing Q11 Section A – Specimen exam
information.
Discuss the limitations of using externally generated
information.
Discuss the principal controls required in generating and
distributing internal information.
Discuss the procedures that may be necessary to ensure Q10 Section A – December 2016
security of highly confidential information that is not for
external consumption.

21
 Managing information

Information Communication of Internal/external Control

systems information

Improved when computers Cost v benefits distribution

are joined together.
Security and confidential
Benefits Costs Methods include: Costs Uses information
 Networks
 Intranets
 Wireless technology
 Internet
 Extranet
Sources

Primary Secondary
 Collected by  Obtained from
organisation existing information
 Expensive  Cheaper
 Bespoke

22
Information systems and data
analytics

How have the syllabus learning outcomes been examined?

Syllabus learning outcomes Example past exam questions

Identify the accounting information requirements and

describe the different types of information systems used
for strategic planning, management control and
operational control and decision making
Define and identify the main characteristics of transaction Q10 Section A – specimen exam
processing systems; management information systems; Q4 Section A – September 2016
executive information systems; and enterprise resource
planning systems
Define and discuss the merits of, and potential problems Q4 Section A – December 2016
with, open and closed systems with regard to the needs of
performance management

23
 Information systems and
data analytics

Information Management Big

Levels Information Data
systems

Characteristics:
Strategic Long term  TPS Transaction  Volume
processing system  Velocity
 MIS Management  Variety
Tactical Medium term information systems
 EIS Executive information
systems
Operational Day to day  ERP Enterprise resource
planning systems

24
Activity based costing

How have the syllabus learning outcomes been examined?

Syllabus learning outcomes Example past exam questions
Identify appropriate cost drivers under ABC.
Calculate costs per driver and per unit using ABC. Q1 Section A – Specimen exam
Q15 Section A – September 2016
Q11 Section A – December 2016
Compare ABC and traditional methods of overhead
absorption based on production units, labour hours or
machine hours.

25

Calculation of cost/unit
Cost pools
Cost drivers
 Overheads are grouped
into activities (cost pools)
 Identify the item which
causes cost to be incurred
(cost driver)
 Calculate a cost per unit
for each cost driver
 Absorb costs into
production based on
actual usage of cost
drivers
26
Activity based
costing
Comparison with Absorption Implications of ABC
Costing
Costs are more closely linked
to the causes of overhead this
makes activity based costing
more appropriate in today's
environment where:
 Overheads are high
compared with prime costs
 Product ranges are Benefits
diverse
 Resources are not merely Criticisms
driven by volume Implications
Better analysis of costs leads
to better:
 Cost control
 Production decisions
 Pricing decisions
 Profitability analysis
Criticisms:
 Time consuming
 Costly
 Some arbitrary
apportionment may still
exist
 Limited benefit if products
have similar cost
structures
1 Formula summary
Learn
Cost pool ($)
OAR =
Cost driver

27
28
Target costing

How have the syllabus learning outcomes been examined?

Syllabus learning outcomes Example past exam questions
Derive a target cost in manufacturing and service Q2 Section A – Specimen exam
industries. Q27 Section B – September 2016
Explain the difficulties of using target costing in service Q7 Section A – September 2016
industries. Q30 Section B – September 2016
Suggest how a target cost gap might be closed. Q28 & 29 Section B – September 2016

29

Deriving a
target cost
Externally focused
approach.
A selling price is set with
reference to the market.
The desired profit margin
is then deducted leaving
a target cost.
30
Target
costing
Closing a target
cost gap
Target cost – estimated
cost = cost gap
Any cost gap needs to be
closed through product
design and processing
improvements.
Implications
 Turns traditional pricing on
its head
 Cost control is considered
upfront as part of the
product development
 Performance management
focuses on:
– Sales targets and
selling price
– Improving processes
/development to drive
down cost
 Target costing is suitable
in today's environment as
short product life cycles
mean it is essential to
consider costs upfront.
Target costing in
service industries
Implementation of target
costing is more difficult in
service businesses:
 Cost measurement is
more difficult.
 Price set is based upon
qualitative information
 Characteristics of
service industry:
- Simultaneity
- Heterogeneity
- Intangibility
- Perishability
1 Formula summary
Learn
Target cost = Selling price – desired profit margin
Cost gap = Target cost – estimated cost

31
32
Life cycle costing

How have the syllabus learning outcomes been examined?

Syllabus learning outcomes Example past exam questions
Identify the costs involved at different stages of the life Q12 Section A – specimen exam
cycle.

Derive a life cycle cost in manufacturing and service Q1 Section A – September 2016
industries. Q7 Section A – December 2016
Identify the benefits of life cycle costing. Q26 Section B – September 2016

33
 Life cycle
costing

Stages of the product life Costs at the different stages Benefits of life cycle costing
cycle of the life cycle

Consider all costs and revenues

throughout a products life. Costs associated with stages of
 Promotes maximisation of
the life cycle include:
The five stages in the product life return over the product life
cycle are:  Development – research and cycle
development  Considers all costs leading to
 Development cost reduction
 Introduction – high fixed
 Introduction costs  Suitable for modern
 Growth  Growth – increase in variable environment with short
 Maturity costs life cycles
 Decline  Maturity – primarily variable  Considers external factors
costs throughout product's life
 Decline – primarily variable
costs

34
Throughput accounting

How have the syllabus learning outcomes been examined?

Syllabus learning outcomes Example past exam questions
Calculate and interpret a throughput accounting ratio Q13 Section A – Specimen exam
(TPAR). Q16–Q20 Section B – Specimen exam
Q26 Section B – December 2016
Suggest how a TPAR could be improved. Q11 Section A – September 2016
Q3 Section A – December 2016
Q28–Q30 Section B – December 2016
Apply throughput accounting to a multi-product decision- Q27 Section B – December 2016
making problem.

35
 Theory of constraints Goldratt's 5 steps Throughput accounting

Focuses on bottlenecks in 1. Identify Based on theory of constraints

production that stop throughput 2. Exploit  Material is the only variable cost
maximisation. 3. Subordinate  Operates in a JIT environment
4. Elevate  Only inventory is a small buffer
In short term all production 5. Return to step 1 stock before the bottleneck
should be at pace of bottleneck.
 WIP valued at material cost only

Throughput
accounting

Throughput accounting ratios Throughput accounting and

decision making

Viable products / divisions

should have a TPAR >1

Return/hour Products
Cost/hour Divisions
TPAR Limiting factor scenarios

Sales – material purchases  Products within same

Return/hour =
Time on key resource factory ranked on return/hr
Total factory costs  Divisions ranked on TPAR
Cost/hour =  If a limiting factor exists
Time on key resource
rank products based on
Return/hour their return/limiting factor
TPAR =
Cost/hour

36
1 Comparison of traditional and throughput accounting
Traditional Costing Throughput accounting
Labour costs and variable overheads are All costs other than materials are seen as fixed
treated as variable costs. in the short term.
Inventory is valued at total production cost. Inventory is valued at material cost only.
Value is added when an item is produced. Value is added when an item is sold.
Product profitability can be determined by Profitability is determined by the rate at which
deducting a product cost from selling price. money is earned.

2 Formula summary
Learn
Sales  material purchases
Return / hour =
Time on key resource

Total factory costs

Cost / hour =
Time on key resource

Return / hour
TPAR =
Cost / hour

37
38
Environmental management accounting
How have the syllabus learning outcomes been examined?
Syllabus learning outcomes
Discuss the issues business face in the management of
environmental issues.
Describe the different methods a business may use to
account for its environmental costs.
Example past exam questions
Q4 Section A – Specimen exam
Q5 Section A – September 2016
Q13 Section A – December 2016
39
 Environmental management
accounting

Principles Methods to account for

 Historically environmental costs
were treated as production
overheads and effectively
hidden.
 A carbon footprint is a
measure of the environmental
impact of an organisation,
event or product.
environmental costs
Defining environmental costs  Input/output flow analysis
 Flow cost accounting
 Activity-based costing
 Environmental prevention costs  Life cycle costing
 Environmental detection costs
 Environmental internal failure
costs
 Environmental external failure
costs

Managing environmental
costs

 Identifying, controlling and

reducing environmental costs
 Increasing worldwide regulation
and regulatory reporting
 Ethical issues
 Improving brand image
 Impact of management of
environmental costs on product
pricing and profitability

40
Cost volume profit analysis

How have the syllabus learning outcomes been examined?

Syllabus learning outcomes Example past exam questions
Explain the nature of CVP analysis.
Calculate and interpret breakeven point and margin of Q3 Section A – specimen exam
safety. Q3 Section A – December 2016
Q16 Section B – December 2016
Calculate the contribution to sales ration, in single and
multi-product situations, and demonstrate an
understanding of its use.
Calculate target profit or revenue in single and multi- Q2 Section A – September 2016
product situations, and demonstrate an understanding of Q17–19 Section B – December 2016
its use.
Prepare break even charts and profit volume charts and
interpret the information contained within each, including
multi-product situations.
Discuss the limitations of CVP analysis for planning and Q20 Section B – December 2016
decision making.

41
 CVP analysis

Single product Multi-product

 Only possible if constant

product sales mix is assumed

Breakeven point = Fixed costs

Contribution / unit
Output required for target profit =
Fixed costs + target profit
Contribution / unit
 Breakeven point Breakeven point =
 Margin of safety Fixed costs
Measure of amount sales must Weighted average contribution/unit
fall by before a loss is made
 C/S ratio
Alternative method of finding the
breakeven point giving the
amount of contribution earned
per dollar of sales
 Target profit
 Breakeven chart
Graphical representation of
breakeven point
 Profit volume chart
Variation of breakeven chart
emphasising the impact of  All costs can be split into fixed and
volume changes on profit variable elements
 Limitations  Fixed costs are constant
 Variable cost per unit is constant
 Selling price is constant
 Inventory levels are constant

42
1 Formula summary
Learn
Single-product breakeven analysis
Fixed costs
Breakeven point =
Unit contribution

Contribution / unit
Contribution/Sales ratio =
Selling price / unit

Fixed costs
Breakeven revenue =
C/S ratio

Budgetedsales – Breakevensales
Margin of safety (%) =
Budgetedsales
Fixed costs  target profit
Output required for target profit =
Unit contribution
Contribution = Sales – all variable costs

Multi-product breakeven analysis

Fixed costs
Breakeven point =
Weighted average unit contribution

Fixed costs
Breakeven revenue =
Weighted average C/S ratio

43
44
Limiting factor analysis

How have the syllabus learning outcomes been examined?

Syllabus learning outcomes Example past exam questions
Identify limiting factors in a scarce resource situation and
select an appropriate technique.
Determine the optimal production plan where an Q8 Section A – Specimen exam
organisation is restricted by a single limiting factor, Q32 (a) Section C – September 2016
including within the context of 'make' or 'buy' decisions
Formulate and solve a multiple scarce resource problem
both graphically and using simultaneous equations as
appropriate.
Explain and calculate shadow prices (dual prices) and
discuss their implications on decision-making and
performance management.
Calculate slack and explain the implications of the Q9 Section A – September 2016
existence of slack for decision-making and performance Q32 (c) Section C – September 2016
management.

45
 Shadow prices Limiting factor Slack / Surplus
analysis

The extra contribution from 1 Slack is when the maximum

more unit of scarce resource amount of a resource has not
It is the maximum extra amount been used.
you would pay for 1 more unit Surplus is when more output
than the minimum requirement is
made.

Single limiting factors Multiple limiting factors

Prioritise production based on

contribution/limiting factor

Linear programming
 Graphical
 Simultaneous equations

Formulate the model:

 Define variables
 Establish constraints
 Formulate objective function

Solve Graphically Solve using Simultaneous Equations

 Plot constraints
 Identify feasible region
 Find optimal point (using
iso-contribution line)
 Calculate objective function
at optimal point
(not if asked to draw graph)
 Plot constraints
 Identify feasible region
 Find optimal point (using
simultaneous equations)
 Calculate objective function at
optimal point

46
Pricing decisions

How have the syllabus learning outcomes been examined?

Syllabus learning outcomes Example past exam questions
Explain the factors that influence the pricing of a product
or service.
Explain the price elasticity of demand.
Derive and manipulate a straight line demand equation. Q31 Section C – September/December 2017
Derive an equation for the total cost function (including
volume-based discounts).
Calculate the optimum selling price and quantity for an Q31 Section C – September/December 2017
organization equating marginal cost and marginal
revenue.
Evaluate a decision to increase production and sales
levels, considering incremental costs, incremental
revenues and other factors.
Determine prices and output levels for profit maximisation Q31 Section C – September/December 2017
using the demand based approach to pricing both tabular
and algebraic methods.
Explain different pricing strategies. Q24 Section B – Specimen exam
Q14 Section A – December 2016
Calculate a price from a given strategy using cost-plus
pricing and relevant costing.

47

Demand
Price elasticity
% Q
% P
PED >1 = elastic demand
(Small change in price
leads to large change in
quantity demanded)
PED <1 = inelastic
(Large changes in price
do not lead to large
P
changes in demand)
48
Pricing
decisions
Total cost function
Y = a + bx
Demand function Optimal pricing
P = a – bQ MR = MC
P = selling price The output level to
Q = quantity demanded at that price maximise profit is found
a = theoretical maximum price. when MR = MC.
The output level to
change in price
b = maximise revenue is
change in quantity
where MR = 0.
Prices at these output
levels can then be
determined from the
demand function.
Pricing strategies
 Cost plus
o Full cost
o Marginal cost
o Relevant cost
o Standard cost
 Market penetration
 Market skimming
 Premium pricing
 Price discrimination
 Product bundling
 Psychological pricing
 Product line pricing
 Complementary products
 Loss leaders
 Controlled pricing
 Volume discounting
1 Pricing strategies

Cost plus strategies

Cost plus: Ignores demand and competitors; not profit maximising; easily calculated
Full/Absorption May result in too high a price
Marginal May not be enough to cover fixed costs
Relevant cost Appropriate for one-offs or when have spare capacity
Standard cost Standards may be out of date; encourages cost control

New product pricing strategies

Market penetration Low price when product is first launched to obtain volume
Market skimming High price when product is first launched; try to recover development
costs quickly

Other strategies
Premium pricing Imply product is different in some way, typically quality, enabling high
price to be charged
Price discrimination Same product is sold in different markets at different prices.
Discrimination may be by:
 Age
 Location
 Time
Product bundling A group of products sold together at a lower price than if bought
individually
Psychological pricing Setting prices at $9.99 instead of $10
Product line pricing Assess profitability of product range rather than individual products within
it
Complementary products One good sold relatively cheaply, stimulates demand for the other good it
is used with
Loss leaders One item sold at a loss, encourage sales of additional products in the
range
Controlled pricing If only one supplier they can set high prices
Volume discounting Increase volumes without permanently reducing prices

49
 Lecture Example 1
When the price of a product is $48 demand is 70,000 units each week. When the price is $78, only 40,000 units are
demanded each week.
Required
What is the demand function?

Solution

Lecture Example 2
Required
Assuming units demanded in Lecture Example 1 to be purely price dependent, what should the selling price be
to ensure maximum demand of 54,500 units?

Solution

50
2 Optimal pricing
Step 1 – Determine the demand function.
Step 2 – Make the MR equation given equal to the value of MC.
Step 3 – Substitute the values found for a and b in step 1 into the MR formulae and solve.
Step 4 – Take the quantity found in step 3 and put this into the demand function to find the price that
should be charged.

3 Formula summary
Formula given in exam
Demand function: P = a – bQ
Where:
P = selling price
Q = quantity demanded at that price
a = theoretical maximum price
change in price
b =
change in quantity

The marginal revenue will be MR = a – 2bQ

Formula to learn
% change in Q
Price elasticity of demand (PED) =
% change in P

Profit is maximised where marginal revenue = marginal cost

51
52
Short-term decisions

How have the syllabus learning outcomes been examined?

Syllabus learning outcomes Example past exam questions
Explain the concept of relevant costing.
Identify and calculate relevant costs for a specific decision Q26–30 Section B – Specimen exam
from given data.
Explain and apply the concept of opportunity costs.
Explain the issues surrounding make vs. buy and
outsourcing decisions.
Calculate and compare 'make' costs with 'buy-in' costs.
Compare in-house costs and outsource costs of
completing tasks and consider other issues surrounding
this decision.
Apply relevant costing principles in situations involving Q32 Section C (part c) – September 2016
shut down, one-off contracts and the further processing of Q6 Section A – December 2016
joint products.

53
 54

Short-term
decisions

Relevant costs Decisions

 Future  Accept or reject
 Cash flow  Make or buy
 Incremental (Specific to  Outsourcing
decision)  Shut down
 Opportunity cost  Minimum price
 Further processing
Costs that are not relevant include:
 Sunk costs Relevant costs should be used when
 Committed costs making any of these decisions
 Apportioned costs
 General overheads
 Joint costs

54
1 Relevant cost of materials

55
 56

2 Relevant cost of labour

56
3 Decision types
Relevant costing principles should be applied regardless of type of decision

Minimum price Accept or reject Make or buy

Accept projects with positive Buy in if cost effective.

Common pitfalls:
return. Reject those which are Other key considerations:
Relevant cost only – don't include: negative
 Quality of bought in product
 Apportionment of overheads However, negative projects may be  Reliability of supplier
 Mark up accepted in order to:  Become dependent on supplier
 Undercut a competitor  Likelihood of future price
Key problems with technique:
 Gain market share increases
 Fine for one off decisions but  Attract a new customer  How to use spare capacity
does not cover fixed costs or  Confidentiality issues
contribute to profit
 How will repeat orders be
priced? – If you charge more,
customer will expect better
quality etc

Further processing Shutdown

Consider lost contribution and

Joint costs are not relevant specific fixed costs (avoidable
SP now vs NRV (ie SP later less costs)
further costs) However, consider non financial
Does market exist before & after aspects:
further processing?  Impact on customers
 Impact on other products
 Competitor reactions
 Impact on employees
 Impact on supplier negotiations
Viability of common process

Joint costs are relevant

57
 58

58
Quantitative analysis in budgeting

How have the syllabus learning outcomes been examined?

Syllabus learning outcomes Example past exam questions
Analyse fixed and variable cost elements from total cost
data using high/low and regression methods.
Estimate the learning effect and apply the learning curve Q21 Section B – Specimen exam
to a budgetary problem, including calculations on the
steady state.
Discuss the reservations with the learning curve. Q22 – 23 Section B – Specimen exam

59
 High-low method

Use to calculate amount of variable

Theory:
and fixed cost within a semi variable
As cumulative output doubles the
cost
average time to produce a unit falls
by a given rate Step 1 – Take the highest and lowest
output levels
Step 2 – Find the difference
Step 3 – Calculate the variable cost/
unit
Formula
Step 4 – Calculate the fixed cost
Y = axb

Quantitative analysis
in budgeting

Learning
curves

Conditions Steady state Experience effect Problems

 Significant
Reached when no Applies to other costs Some of the problems with
manual element
further improvements which may also reduce as the theory include:
 Repetitive task
can be made the workforce gains  How to calculate the
 Early stage of
experience rate?
production
The time taken per  Materials  Is the rate really
 Consistent units is constant
workforce  Variable overhead constant?
 No breaks in  Fixed overhead  When will production
production reach the steady
 Motivated state?
workforce

60
1 Formula summary
Formula given in exam
Y= aXb
where Y is the cumulative average time per unit taken to produce X units
a is the time taken to produce the first unit
X is the cumulative number of units
log r
b is the index of learning (calculated as where r is the learning rate)
log 2

61
62
Risk preferences

How have the syllabus learning outcomes been examined?

Syllabus learning outcomes Example past exam questions
Suggest research techniques to reduce uncertainty eg
Focus groups, market research.
Apply the techniques of maximax, maximin, and minimax Q16–18 Section B – September 2016
regret to decision-making problems including the
production of profit tables.
Calculate the value of perfect information. Q14 Section A – December 2016
Q19 Section B – September 2016

63

Risk vs Uncertainty
Risk = past experience
Can estimate probabilities
Uncertainty = no past experience
Cannot predict probabilities
Decision methods
 Maximax
Risk preference  Maximin
 Risk seeker  Minimax regret
 Risk averse
 Risk neutral
Maximax = Risk seeker
 Maximise maximum return
 Risk seeker = optimist Maximin = risk averse
 Risk averse = pessimist  Maximise minimum possible return
 Risk neutral = most likely outcome Minimax regret
 Minimise maximum opportunity cost

Risk preferences

Expected values (EV) Perfect information

 px

p = probability Perfect information (PI) removes risk

x = outcome Value of perfect information =
 Long term average EV with PI – EV without PI
 Takes no account of risk
 May not represent a possible
outcome

Limitations:
 Long term average
 Ignores risk
 May not represent a
possible outcome
 Inappropriate for one off
decisions

64
 Lecture Example 1
Data table
Kiss Ltd must buy in stocks of a fashion product for distribution to retail outlets before quarterly demand is known.
Trouble is that demand is unpredictable and Kiss's supplier will only give Kiss batches of 500, 750, 1,000 or 1,250.
For order sizes below 1,000, the unit cost is $42. Order sizes of 1,000 and above will cost $40 per unit.
The retail price is $80 per unit and units unsold at the end of a quarter will be sold to a market trader for $30 per unit.
Kiss reckons that each unit of unsatisfied demand will lead to an opportunity cost of $4.
An initial estimate of demand is as follows:
Units Probability
500 0.2
750 0.3
1,000 0.35
1,250 0.15
Required
What order quantity will maximise profits in the long term?

Solution

65
 Lecture Example 2
Maximin
Required
Using the information from Lecture Example 1, what decision would be taken using the maximin decision rule?

Solution

Lecture Example 3
Maximax
Required
Using the information from Lecture Example 1, what decision would be taken using the maximax decision rule?

Solution

66
 Lecture Example 4
Minimax regret
Required
Using the information in Lecture Example 1, what decision would be taken using the minimax regret decision
rule?

Solution

67
 1 Formula summary
Learn
Expected value =  px
Where p = probability
x = outcomes

Value of perfect information (VOPI)

EV (with perfect information) X
EV (no perfect information) (X)
VOPI X

68
Risk and uncertainty in
decision making

How have the syllabus learning outcomes been examined?

Syllabus learning outcomes Example past exam questions
Explain the use of simulation, expected values and .
sensitivity.
Apply expected values and sensitivity to decision-making Q20 Section B – September 2016
problems.
Draw a decision tree and use it to solve a multi-stage Q7 Section A – Specimen exam
decision problem.

69
 Risk and
Uncertainty in decision making

Expected values (EV) Techniques

 px

p = probability  Data tables  Sensitivity Analysis

x = outcome
 Long term average
 Takes no account of risk
 May not represent a possible
outcome
Limitations:
 Long term average
 Ignores risk
 May not represent a
possible outcome
 Inappropriate for one off
decisions
 Joint probabilities  Simulation
 Decision trees
Sensitivity analysis – assess %
change in a variable before it
would change the decision
One variable Two variables Simulation – using software
assesses the probability when
Prepare pay off table Construct two way data
there are several uncertain
Decision as columns table
variables
Variable and probability Then a joint probability table
as rows
Sequence of interrelated
decisions and their
expected outcomes
Lastly calculate expected value Prepare a decision tree

70
 Lecture Example 1
Two way data table
The following data table records budgeted profit for a company that is uncertain about demand and inflation in the
forthcoming budget year.
Inflation factor
1.04 1.06 1.08 1.10
Demand 30,000 –32,000 –23,000 –14,000 –5,000
(units) 31,000 –16,400 –7,100 2,200 11,500
32,000 –800 8,800 18,400 28,000
33,000 14,800 24,700 34,600 44,500
Probabilities
The following (independent) probabilities apply to the above data table:
Demand Inflation
Units Prob. Rate Prob.
30,000 0.2 4% 0.15
31,000 0.3 6% 0.35
32,000 0.3 8% 0.35
33,000 0.2 10% 0.15
Required
Interpret the information.

Solution

71
 Lecture Example 2
Decision Tree
The RS group owns a large store in Ludborough. The store is old-fashioned and profits are declining. Management is
considering what to do – there appear to be four possibilities.
(a) Shut down and sell the site for $15m.
(b) Continue as before with profits of $17m.
(c) A deluxe upgrade to the store.
(d) A standard upgrade to the store.

The group has had similar problems in the past and experience suggests that when stores are upgraded, 60% achieve
good results and 40% poor results.

Because of the doubts, management is considering whether to contract a leading market research company to carry out
consumer research in Ludborough for $1m.

There is 55% probability of positive feedback, and 45% probability of negative feedback. However the survey is not
100% reliable. The probability of a good outcome after positive feedback is 93%, whereas the probability of a poor
outcome after negative feedback is 80%.

If the research indicates a positive attitude, management will consider either deluxe upgrading which will generate more
profit but will cost $12m or standard upgrading costing $6m.

If the research indicates a negative attitude, then management will consider either standard upgrading or shutting down
and selling the site.

Cash flows generated from deluxe upgrading

Good results $40m
Poor results $20m

Cash flows generated from standard upgrading

Good results $25m
Poor results $10m

Required
Draw up a decision tree and use this to evaluate the decision using expected values.

72
Solution

73
 1 Formula summary
Learn

Value of perfect information (VOPI)

EV (with perfect information) X
EV (no perfect information) (X)
VOPI X

74
Budgetary systems

How have the syllabus learning outcomes been examined?

Syllabus learning outcomes Example past exam questions
Explain how budgetary systems fit within the performance
hierarchy.
Identify the factors which influence behavior.
Discuss the issues surrounding setting the difficulty level
for a budget.
Explain the benefits and difficulties of the participation of
employees in the negotiation of targets.
Select and explain appropriate budgetary systems for an Q6 Section A – Specimen exam
organisation, including rolling, zero-based, activity-based, Q2 Section A – December 2016
incremental, bottom up and feed-forward control.
Describe the information used in budget systems and the
sources of the information needed.
Explain the difficulties of changing a budgetary system.
Explain how budget systems can deal with uncertainty in
the environment.
Indicate the usefulness and problems with different budget Q31 (b) Section C – December 2016
types (zero-based, activity-based, incremental, master,
functional and flexible).
Explain the difficulties of changing the type of budget Q31 (c) Section C – December 2016
used.
Prepare rolling budgets and activity based budgets Q21–22 Section B – September 2016
Q31 (a) Section C – December 2016
Explain the importance of flexing budgets in performance Q23–24 Section B – September 2016
management.
Apply expected values and explain the problems and
benefits.
Explain the benefits and dangers inherent in using Q25 Section B – September 2016
spreadsheets in budgeting.

75
 Budgetary
control

Planning and control cycle

Determine objectives

Control Planning
Compare actual with budget Set budget

Operate in line
with objectives

 Planning
 Responsibility
 Integration
 Motivation
 Evaluation

Controllable vs uncontrollable expenditure Budgetary control Behavioural aspects

Feedback & feedforward control

Managers should be evaluated only Single or double feedback loop

on those items within their control Elements of system include:
Feedback control involves taking  Target General
action after the event  Sensor Motivation
Feedforward involves taking action  Comparator Participation
during the event
 Effector
Consider:
Level of standard – attainable best
level to motivate

Participation:
 Top Down
 Bottom Up
 Negotiated

76
 Fixed Flexible Flexed

Budget set in advance
Does not change
Budget set for several activity Restate budget based on actual
levels volumes
Good planning tool enabling Useful for control
'what if' scenarios Like for like comparison and
meaningful variances

Incremental Activity based

Build up budgets by activity

Based on current year
rather than by department
Builds in slack &
inefficiencies Budgetary
systems

Zero based Rolling

Always look at 12 months of budget

Build up budgets from scratch
Complete 1st quarter, remove from
Allocates resources effectively budget and add another quarter on
Suitable for discretionary the end
spend Useful in times of uncertainty

Changing budgetary systems Budgeting and uncertainty

Has various implications:

Budgets are estimates and
 Resistance therefore subject to risk and
 Costly uncertainty. Suitable tools may be:
 Training needs  Flexible budgets
 Learning curve  Rolling budgets
 Probabilistic budgeting
 Sensitivity analysis
 Spreadsheets

77
78
Budgeting and standard costing

How have the syllabus learning outcomes been examined?

Syllabus learning outcomes Example past exam questions
Explain the use of standard costs. Q1 Section A – Specimen exam
Outline the methods used to derive standard costs and
discuss the different types of cost possible.
Explain and apply the principle of controllability in the
performance management system.
Discuss the dysfunctional nature of some variances in the
modern environments of JIT and TQM
Discuss the behavioural problems resulting from using
standard costs in rapidly changing environments
Discuss the effect that variances have on staff motivation
and action.

79
 Purpose of standards Calculation of standards Bases of standard

 Decision making Based on expected prices and  Ideal

 Budgeting expected usage or time and  Attainable
 Control wastage  Current
 Performance evaluation  Basic
 Inventory valuation

Budgeting and standard

costing

Controllability Standards and budgets

Managers should only be held Standards Budgets

accountable for those items that By unit In total
they can control, ie variable or Areas of repetition All areas
discretionary fixed costs. Financial and non financial Financial targets
targets

80
 Behavioural aspects of
Standard Costing

Criticisms of standard Behavioural impacts of

costing Standard costing in the
modern environment

 Needs a stable environment Modern environment Impacts of standard

 Needs regular revision costing
 No incentive to do better than standard High overhead Overhead variances
 Less appropriate for customised do not have enough
products detail to aid
performance
measurement
Rapidly changing Regular revision of
environment/ standards can be
products demotivating
Customised product Differences between
products make
developing a standard
difficult; resulting
variances may not be
meaningful
Focus on quality Desired quality may
drive adverse price
variances
JIT philosophy Inventory may be built
up in an effort to
improve efficiency
variances

81
82
Mix and yield variance analysis

How have the syllabus learning outcomes been examined?

Syllabus learning outcomes Example past exam questions
Calculate, identify the cause of and explain mix and yield Q5 Section A – Specimen exam
variances. Q3 Section A – December 2016
Q21–23 Section B – December 2016
Q32 Section C – Sept/Dec 2018
Explain the wider issues involved in changing mix eg cost,
quality and performance measurement issues.
Identify and explain the interrelationship between price,
mix and yield.
Suggest and justify alternative methods of controlling
production processes.
Calculate, identify the cause of, and explain sales mix and Q24–25 Section B – December 2016
quantity variances.
Identify and explain the relationship of the sales volume
variances with the sales mix and quantity variances.

83
 Mix and yield variance
analysis

Mix and yield variances Additional production

control methods

Mix variance represents the financial These might include:

impact of using a different proportion  Quality control measures
of raw materials to standard.  Customer satisfaction scores
Yield variance represents the  Wastage rates
financial impact of the input yielding  Number of late deliveries
a different level of output to the
standard.

84
1 Materials mix and yield variances
Mix variance
Actual Qty Actual Qty
Std Mix Actual Mix Difference Std cost Variance
$ $
Material A X X X X X
Material B X X X X X
X X X

Yield Variance
Std Qty Actual Qty
Std mix Std mix Difference Std cost Variance
$ $
Material A X X X X X
Material B X X X X X
X X X

Alternative yield calculation

Batches
Actual input should yield X
Actual input did yield (X)
X
Valued at standard cost per batch $X

Sales mix and quantity variances

Mix variance
Actual Qty Actual Qty Std
Std Mix Actual Mix Difference margin Variance
$ $
Product A X X X x X
Product B X X X x X
X X X

Quantity Variance
Std Qty Actual Qty Std
Std mix Std mix Difference margin Variance
$ $
Product A X X X x X
Product B X X X x X
X X X

85
86
Planning and operational variance
analysis

How have the syllabus learning outcomes been examined?

Syllabus learning outcomes Example past exam questions
Calculate a revised budget.
Identify and explain those factors that could and could not
be allowed to revise an original budget.
Calculate planning and operational variances for sales, Q31 Section C – Specimen exam
including market size and market share, materials and Q12 Section A – September 2016
labour.
Q8 Section A – December 2016
Q31 Section C – March/June 2017
Explain the manipulation issues in revising budgets. Q31 Section C – Specimen exam

87
 Planning and operational
variance analysis

Planning and Revised budgets

operational variances

Planning variances are those A budget should only be revised for

variances driven by a wrong items beyond the control of an
standard. organisation, not for operational
Operational variances are those issues.
variances that were within a
manager's control.

88
1 Planning and Operating variances
Total Planning variance (Materials)
$
'Should' Actual production should cost @ original standard kg and original $ X
'Should now' Actual production should cost @ revised standard kg and revised $ (X)
(X)

Total Operational Variance (Materials)

$
'Should now' Actual production should cost @ revised standard kg and revised $ X
'Did' Actual production did cost (X)
(X)
Planning Price variance (Materials)
$
'Should' actual quantity @ should cost X
'Should now' actual quantity @ should now cost (X)
(X)

Planning Usage Variance (Materials)

kg
'Should' Actual production should use @ original standard kg X
'Should now' Actual production should now use @ revised standard kg (X)
X
Difference valued at original standard cost $X

Operating Price variance (Materials)

$
'Should now' Actual purchases @ should now cost X
'Did' Actual purchases did cost (X)
X

Operating Usage Variance (Materials)

kg
'Should now' Actual production should now use @ revised standard kg X
'Did' Actual production did use (X)
X
Difference valued at original standard cost $X

89
 Sales volume – Planning variance (market size)
Units
'Should' Original budgeted sales volume X
'Should now' Revised budgeted sales volume (X)
X
Valued at original contribution or profit $X

Sales volume – Operating variance (market share)

Units
'Should now' Revised budgeted sales volume X
'Did' Actual sales volume (X)
X
Valued at original contribution or profit $X

90
Performance management

How have the syllabus learning outcomes been examined?

Syllabus learning outcomes Example past exam questions
Describe, calculate and interpret financial performance Q32 Section C – Specimen exam
indicators for profitability, liquidity and risk in both Q31 Section C – September 2016
manufacturing and service businesses. Suggest methods
Q32 Section C – March/June 2017
to improve these measures.
Describe, calculate and interpret non-financial
performance indicators (NFPIs) and suggest method to
improve the performance indicated.
Explain the causes and problems created by short-
termism and financial manipulation of results and suggest
methods to encourage a long-term view.
Explain and interpret the Balanced Scorecard, and the Q15 Section A – Specimen exam
Building Block model proposed by Fitzgerald and Moon. Q32 Section C – March/June 2017
A31 Section C – September/December 2018
Discuss the difficulties of target setting in qualitative
areas.

91
 Financial performance Non financial performance
indicators indicators
 Profitability
 Liquidity
 Gearing  Can measure anything
 Quantitative and qualitative
 Gather information on key areas eg
 Compare with prior years or other quality, customers, employees
companies in same industry  Good indicator of future prospects
 Focus on past  Can provide too much information
 Only part of the picture  Can forget overall goal
 Short-term measure

Performance
management

Short termism Balanced scorecard Performance measurement in

service businesses

Focus on short term goals at Enables focus on both internal

the expense of long term goals and external factors and on  Simultaneity
key elements of business  Heterogeneity
strategy  Intangibility
 Perishability
Four dimensions are:
 Customer
 Internal Building block model
 Financial
 Innovation and learning

92
1 Formulae summary
Formulae to learn

Profitability Ratios
PBIT
ROCE =  100 %
Capital employed

Net profit
Net profit margin =  100 %
Sales
Gross profit
Gross profit margin =  100 %
Sales
Sales
Asset turnover =
Capital employed

Liquidity/working capital ratios

Current assets
Current ratio =
Current liabilities
Current assets – inventories
Quick ratio =
Current liabilities

1 Receivables period Average receivables  365 = days

Credit sales

2 Inventory period Average finished goods  365 = days

Cost of sales

3 Payables period Average payables  365 = days

Credit purchases

Gearing ratios
long term debt
Gearing ratio =
Long term debt  equity (shareholders' funds)

Contribution
Operating gearing =
Profit before interest and tax (PBIT)

93
94
Divisional performance measures

How have the syllabus learning outcomes been examined?

Syllabus learning outcomes Example past exam questions
Explain the basis for setting a transfer price using variable Q14 Section A – Specimen exam
cost, full cost and the principles behind allowing for Q5 Section A – December 2016
intermediate markets.
Explain how transfer prices can distort the performance
assessment of divisions and decisions made.
Explain the meaning of, and calculate, Return on Q10 Section A – September 2016
Investment (ROI) and Residual Income (RI), and discuss Q32 Section C – December 2016
their shortcomings.
Q32 Section C – March/June 2017
Compare divisional performance and recognise the Q13 Section A – September 2016
problems of doing so. Q15 Section A – December 2016
Q32 Section C – March/June 2017

95
 Divisional performance
measures

Responsibility accounting Investment centre Transfer pricing

performance appraisal
methods
Performance measurement in
decentralised units

ROI RI

Divisional Profit Residual income = Divisional profit

ROI =  100 less: imputed interest
Divisional Investment (Investment  cost of capital)
Only projects which increase the existing Projects with a positive residual income
ROI should be undertaken should be undertaken
Avoids dysfunctional behaviour
Problems with ROI
 Dysfunctional behaviour Problems with RI
 The ratio will be distorted by the age of  The ratio will be distorted by the age of
the assets the assets
 Profit can be manipulated  Profit can be manipulated
 Gives an absolute number

ROI is used more frequently than RI

 Dysfunctional behaviour is not material
 ROI is consistent with ROCE
 Percentages are more easily understood
 RI requires a cost of capital

96
 Divisional performance
measures

Aims Transfer pricing

 Goal congruence
 Equitable performance measurement
 Retain divisional autonomy
 Motivate divisional managers
 Optimum resource allocation Approaches

Market-based Cost-based Opportunity cost

Selling division gets same profit on

internal and external sales Minimum Maximum
acceptable payable by
Buying division pays a commercial to Seller Buyer
price (possibly less savings in selling
Marginal cost External market
and distribution)
price
Equitable performance measurement +
for both divisions Opportunity cost
Will result in goal congruent behaviour
Actual Standard

Unlikely to result in goal congruent Should result in goal congruent

behaviour
 Inefficiencies passed on to buying
division
 No cost control in selling division
 Buyer does not know what price
he will pay
behaviour
 Selling division measure on
performance vs standard
 Buying division's profitability not
impacted by internal transfer price

Full cost plus Variable cost plus

May lead to dysfunctional behaviour May lead to dysfunctional behaviour

 Covers all costs  Selling division does not cover all costs
 Seller encouraged to make transfer  Buyer encouraged to make transfer
 Buyer may wish to buy externally

97
 1 Formula summary
Formula to learn
Divisional Profit
ROI =  100
Divisional Investment
Residual income = Divisional profit X
Less: imputed interest
(investment  cost of capital) (X)
Residual income X

98
Further performance management

How have the syllabus learning outcomes been examined?

Syllabus learning outcomes Example past exam questions
Comment on the problems of having non-quantifiable
objectives in performance management.
Explain how performance could be measured in this Q6 Section A – September 2016
sector (NFPOs and the public sector). Q12 Section A – December 2016
Comment on the problems of having multiple objectives in
this sector.
Outline Value for Money (VFM) as a public sector Q9 Section A – Specimen exam
objective.
Explain the need to allow for external considerations in
performance management, including stakeholders, market
conditions and allowance for competitors.
Suggest ways in which external considerations could be
allowed for in performance management.
Interpret performance in the light of external
considerations.
Identify and explain the behaviour aspects of performance
management.
Describe, calculate and interpret non-financial
performance indicators (NFPIs) and suggest methods to
improve the performance indicated.
Explain the causes and problems created by short-
termism and financial manipulation of results and suggest
methods to encourage a long term view.
Discuss the difficulties of target setting in qualitative
areas.
Analyse past performance and suggest ways for
improving financial and non-financial performance.

99
 Objectives Evaluation of performance

Profit seeking organisations =

maximise shareholder wealth Difficult in Public sector/NFPOs due to:
Public sector/NFPOs have
multiple objectives  Lack of financial measure
 Multiple objectives
 Difficulty in measuring output
Focus on value for money and use of 3 Es
 Economy
 Effective
 Efficiency

Further performance
management

External factors Behavioural aspects

 Stakeholders Targets should consider:

o Internal
o Connected  Company objectives
o External  Controllability
 Economic environment  Long term vs short term
 Competition  Level of standard
 Motivation
 Financial and non-financial measures

100
 Answers to
lecture examples

101
102
Chapters 1 - 6
No Lecture Examples

Chapter 7

Answer to Lecture Example 1

Price – £30
b= = = –0.001
Quantity  30,000
$78 = a – (0.001  40,000)
$78 = a – 40
 a = $118
P = 118 – 0.001Q

Answer to Lecture Example 2

P = 118 – (0.001  54,500)
P = $63.50

Chapters 8 and 9
No Lecture Examples

Chapter 10a

Answer to Lecture Example 1

500 750 1,000 1,250
Demand p x x x x
500 0.2 19,000 *16,000 **15,000 **12,500
750 0.3 18,000 28,500 27,500 25,000
1,000 0.35 17,000 27,500 40,000 37,500
1,250 0.15 16,000 26,500 39,000 50,000

px 17,550 25,350 31,100 30,625

* (500  80) + (250  30) – (750  42)

** (500  80) + (500  30) – (1,000  40)
*** (500  80) + (750  30) – (1,250  40)
Highest EV with order size 1,000 units

Answer to Lecture Example 2

Maximin

Decision 500 750 1,000 1,250

Minimum return 16,000 16,000 15,000 12,500
Maximum of minimum returns @ decision = 500 units or 750 units (500 has the lower variability or risk)

103
 Answer to Lecture Example 3
Maximax
Highest possible profit if 1,250 units ordered

Answer to Lecture Example 4

Opportunity cost table
Order size
500 750 1,00 1,250
Demand
500 0 (W1) (3,000) (W2) (4,000) (6,500)
750 (10,500) 0 (1,000) (3,500)
1,000 (23,000) (12,500) 0 (2,500)
1,250 (34,000) (23,500) (11,000) 0
Maximum regret (34,000) (23,500) (11,000) *(6,500)
W1 If demand was 500 units, from data table the best decision would have been to place an order of 500 units
giving a profit of $19,000. There would be no opportunity cost if an order size of 500 units had been chosen.
W2 If an order size of 750 units had been selected and demand was 500 units, this gives a profit of only
$16,000, representing a loss of $3,000 (difference between maximum potential profit of $19,000 and
profit achieved $16,000).
* Minimise maximum regret with an order size of $1,250 units.

Chapter 10b
Answer to Lecture Example 1
Interpretation of 2 way data table
 In 7 outcomes from 16, there will be a loss.
 The highest profit could be $44,500, the highest loss, $32,000.
 Inflation is not as critical a factor as demand. If demand is low, there will definitely be a loss
whereas losses might arise at any level of inflation.
Joint probability table
Inflation
1.04 1.06 1.08 1.10
Demand p 0.15 0.35 0.35 0.15
30,000 0.2 0.03 0.07 0.07 0.03
31,000 0.3 0.045 0.105 0.105 0.045
32,000 0.3 0.045 0.105 0.105 0.045
33,000 0.2 0.03 0.07 0.07 0.03
 There is a 39.5% chance of making a loss, a 60.5% chance of making a profit.
Expected value table
Inflation
1.04 1.06 1.08 1.10
Demand p 0.15 0.35 0.35 0.15
30,000 0.2 –960 –1,610 –980 –150
31,000 0.3 –738 –745 231 517
32,000 0.3 –36 924 1,932 1,260
33,000 0.2 444 1,729 2,422 1,335
 Expected value of profit is $5,575.

104
Answer to Lecture Example 2
Shutdown
£15m
Continue as before
£17m
Good (0.6)
No research Upgrade – Deluxe £40m
B F Poor (0.4)
(£12m) £20m
Good (0.6)
Upgrade – Standard £25m
G Poor (0.4)
(£6m) £10m
Good (0.93)
A Upgrade – Deluxe £40m
H
(£12m) Poor (0.07)
£20m
Positive
D Good (0.93)
0.55 £25m
(£6m)
I
Upgrade – Standard Poor (0.07)
£10m
C
Research Good (0.2)
£25m
(£1m) Upgrade – Standard
J Poor (0.8)
Negative (£6m) £10m
E
0.45
£15m
Shutdown
Expected value (EV)
Shutdown – 100% certain to receive $15m
Continue as before – $17m
F (0.6  40) + (0.4  20) = $32m
G (0.6  25) + (0.4  10) = $19m
H (0.93  40) + (0.07  20) = $38.6m
I (0.93  25) + (0.07  10) = $23.95m
J (0.2  25) + (0.8  10) = $13m
Decision at B:
Shutdown $15m
Continue as before $17m
(F) Deluxe upgrade $32m – $12m = $20m
(G) Standard upgrade $19m – $6m = $13m
Therefore choose Deluxe upgrade

Decision at D:
(H) Deluxe upgrade $38.6m – $12m = $26.6m
(I) Standard upgrade $23.95m – $6m = $17.95m
Therefore choose Deluxe upgrade

Decision at E:
(J) Standard upgrade $13m – $6m = $7m
Shutdown $15m
Therefore choose to shutdown
Expected value at C (0.55  26.6) + (0.45  15) = $21.38

Decision at A:
No research – deluxe upgrade $20m
Research £21.38m – £1m $20.38m
Therefore it is marginally preferable to conduct research

105
 Chapters 11– 17
No Lecture Examples

106
Appendices

107
108
 SKILLS BANK

Appendix A: Formulae to learn

Formulae to learn

Costing
Overhead Absorption rate
Budgeted overhead
OAR =
Budgeted activity

Under/(over) absorption = Actual Overhead – Overhead Absorbed

Contribution = Sales – all variable costs

Target Costing
Target Cost = Selling price – desired profit margin
Cost gap = Target cost – estimated cost

Throughput accounting
Sales  material purchases
Return / hour =
Time on key resource

Total factory costs

Cost / hour =
Time on key resource

Return / hour
TPAR =
Cost / hour

Cost volume profit analysis – single product

Fixed costs
Breakeven point =
Unit contribution
Contribution / unit
Contribution / Sales ratio =
Selling price / unit

Budgeted sales – break even sales

Margin of safety (%) =
Budgeted sales
Fixed costs  target profit
Output required for target profit =
Unit contribution

109
 SKILLS BANK

Cost volume profit analysis – multi product

Fixed costs
Breakeven point =
Weighted average unit contribution

Pricing
% change in Q
Price elasticity of demand (PED) =
% change in P

Risk & Uncertainty

Expected value =  px
Where p = probability
x = outcomes

Quantitative analysis
y = a + bx

Performance measurement

Profitability Ratios
PBIT
ROCE =  100 %
Capital employed

Net profit
Net profit margin =  100 %
Sales
Gross profit
Gross profit margin =  100 %
Sales
Sales
Asset turnover =
Capital employed

110
 SKILLS BANK

Liquidity/working capital ratios

Current assets
Current ratio =
Current liabilities
Current assets – inventories
Quick ratio =
Current liabilities

Receivables period Average receivables  365 = days

Credit sales

Inventory period Average finished goods  365 = days

Cost of sales

Payables period Average payables  365 = days

Credit purchases

Gearing ratios
Long term debt
Gearing ratio =
Long term debt  equity (shareholders funds)

Contribution
Operating gearing =
Profit before interest and tax (PBIT)

Divisional Performance Measures

Divisional Profit
ROI =  100
Divisional Investment
Residual income = Divisional profit X
Less: imputed interest
(investment  cost of capital) (X)
Residual Income X

111
 SKILLS BANK

Appendix B: Formulae given in the exam

List of formulae given in the exam

Learning curve:
Y= aXb
where Y is the cumulative average time/cost per unit taken to produce X units
a is the time/cost taken to produce the first unit
X is the cumulative number of units
log LR
b is the index of learning (calculated as where r is the learning rate)
log 2
LR is the learning rate as a decimal

Demand curve:
P = a – bQ
a = price when Q = 0
change in price
b =
change in quantity

Mr = a – 2bQ

112
 SKILLS BANK

Appendix C: Verbs used in question requirements

Intellectual
level
1 Define Give the meaning of

1 Explain Make clear

1 Identify Recognise or select

1 Describe Give the key features of

2 Contrast Make a comparison between things on the basis of the

differences between them

2 Analyse Give reasons for the current situation or what has

happened

3 Assess Determine the strengths/weaknesses/importance/

significance/ability to contribute

3 Discuss Examine in detail by using arguments for and against

3 Construct the case Present the arguments in favour, supported by evidence

3 Evaluate Determine the value of

3 Recommend Advise the appropriate actions to pursue in terms the

recipient will understand

113
 SKILLS BANK

114