Answers

Part 3 Examination – Paper 3.3

Performance Management June 2005 Answers

1 (a) Quicklink Ltd

Budgeted Profit and Loss Account for the year ending 31 May 2006
Quicklink Ltd Celer Transport Combined
£ £ £
Revenue:
Contract clients:
Mail 1,769,040 237,600 2,006,640
Parcels 1,474,200 247,500 1,721,700
Machinery/processed food 6,747,300 2,700,000 9,447,300
–––––––––– –––––––––– –––––––––––
9,990,540 3,185,100 13,175,640
Non-contract clients:
Mail 1,651,104 776,160 2,427,264
Parcels 1,179,360 693,000 1,872,360
Machinery/processed food 1,124,550 – 1,124,550
–––––––––– –––––––––– –––––––––––
3,955,014 1,469,160 5,424,174
Total revenue 13,945,554 4,654,260 18,599,814
Operating costs:
Fuel 1,989,000 1,615,680 3,604,680
Salaries 1,921,920 1,098,240 3,020,160
Sundry operating costs 3,120,000 1,990,340 5,110,340
–––––––––– –––––––––– –––––––––––
Total operating costs 7,030,920 4,704,260 11,735,180
–––––––––– –––––––––– –––––––––––
Net profit 6,914,634 (50,000) 6,864,634
–––––––––– –––––––––– –––––––––––
Workings
(1) Sales Revenue:
Quicklink Ltd
Contract Total number Contract Number of Fee per Total (£)
clients: of deliveries deliveries contract delivery
(%) deliveries
Mail 468,000 60 280,800 £6·30 1,769,040
(£6 x 1·05)
Parcels 234,000 60 140,400 £8·40 1,474,200
(£10 x 1·05)
Machinery 35,700 90 32,130 £210 6,747,300
(£200 x 1·05)
Non-contract Total number Non-contract Number of Fee per Total (£)
clients: of deliveries deliveries non-contract delivery
(%) deliveries
Mail 468,000 40 187,200 £8·82 1,651,104
(£6 x 1·05 x 140%)
Parcels 234,000 40 93,600 £12·60 1,179,360
(£10 x 1·05 x 120%)
Machinery 35,700 10 3,570 £315 1,124,500
(£200 x 1·05 x 150%)
Celer Transport
Contract Total number Contract Number of Fee per Total (£)
clients: of deliveries deliveries contract delivery
(%) deliveries
Mail 132,000 30 39,600 £6 237,600
(120,000 x 110%)
Parcels 82,500 30 24,750 £10 247,500
(75,000 x 110%)
Processed food 32,500 100 32,500 2,700,000

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 Non-contract Total number Non-contract Number of Fee per Total (£)
clients: of deliveries deliveries non-contract delivery
(%) deliveries
Mail 132,000 70 92,400 £8·40 776,160
(120,000 x 110%) (£6 x 140%)
Parcels 82,500 70 57,750 £12·00 693,000
(75,000 x 110%) (£10 x 120%)
(2) Fuel costs:
Quicklink Ltd Number of vehicles Days in use Average Cost per Cost (£)
kilometres per kilometre
vehicle per day
Mail and parcels 55 340 300 £0·10 561,000
Machinery 21 340 400 £0·50 1,428,000
––––––––––
1,989,000
––––––––––
Celer Transport Number of vehicles Days in use Average Cost per Cost (£)
kilometres per kilometre
vehicle per day
Mail and parcels 22 340 300 £0·12 269,280
Processed food 22 340 300 £0·60 1,346,400
––––––––––
1,615,680
––––––––––
(3) Salaries:
Number of employees Salary per annum Cost (£)
Quicklink Ltd 70 £27,456 (£26,400 x 104%) 1,921,920
Celer Transport 40 £27,456 (£26,400 x 104%) 1,098,240
(4) Sundry operating costs
Cost (£)
Quicklink Ltd (£3,000,000 x 104%) 3,120,000
Celer Transport Per question 1,990,340

(b) The businesses of Quicklink Ltd and Celer Transport are engaged in the same industry and are therefore broadly comparable.
Each business has its own ‘distinctive competence’ which in the case of Quicklink Ltd is the delivery of industrial machinery
whilst Celer Transport has developed a specialism in the delivery of processed food.
Relevant operating statistics are as follows:
Quicklink Ltd Quicklink Ltd Celer Transport Celer Transport
2005 2006 2005 2006
Revenue per vehicle (per annum) Actual Budget Actual Budget
Mail and parcels £105,172 £110,431 £72,679 £88,830
Machinery/processed food £357,000 £374,850 £122,727 £122,727
Vehicle in-use % 93 93 93 93
Deliveries per vehicle (per annum):
Mail and parcels 12,764 12,764 8,864 9,750
Machinery/processed food 1,700 1,700 1,477 1,477
2005 2005
Actual Target Actual Target
Delivery mix (mail/parcels):
Same day 20% 75%
Next day 80% 25%
On-time deliveries (%):
Mail and parcels 99·5% 99% 82% 95%
Machinery/processed food 100·0% 99% 97% 100%
No. of lost items 145
% of telephone calls answered within target time 99% 90%
% of telephone calls abandoned 0% 2·00%
The number of mail and parcel deliveries per vehicle, per annum, made by Quicklink Ltd during the year ended 31 May 2005
was 44% higher than those made by Celer Transport which explains the higher budgeted revenues per Quicklink vehicle
engaged in the delivery of mail and parcels for the year ending 31 May 2006. The revenue generation per vehicle shows that
the budgeted average revenue generated vehicle used in the delivery of mail and parcels in respect of the year ending 31 May
2006 amounts to £110,431 and £88,830 in respect of Quicklink Ltd and Celer Transport respectively. However, this

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difference will reduce in the year ending 31 May 2006 due to the projected growth in sales volumes of the Celer Transport
business. The average mail/parcels delivery of mail/parcels per vehicle of the Quicklink Ltd part of the business is budgeted
at 12,764 which is still 30·91% higher than that of the Celer Transport business.
As far as specialist activities are concerned, Quicklink Ltd is budgeted to generate average revenues per vehicle amounting to
£374,850 whilst Celer Transport is budgeted to earn an average of £122,727 from each of the vehicles engaged in delivery
of processed food. It is noticeable that all contracts with major food producers were renewed on 1 June 2005 and it would
appear that there were no increases in the annual value of the contracts with major food producers. This might have been
the result of a strategic decision by the management of the combined entity in order to secure the future of this part of the
business which had been built up previously by the management of Celer Transport.
Each vehicle owned by Quicklink Ltd and Celer Transport is in use for 340 days during each year, which based on a
365 day year would give an in use % of 93%. This appears acceptable given the need for routine maintenance and repairs
due to wear and tear.
During the year ended 31 May 2005 the number of on-time deliveries of mail and parcel and industrial machinery deliveries
were 99·5% and 100% respectively. This compares with ratios of 82% and 97% in respect of mail and parcel and processed
food deliveries made by Celer Transport. In this critical area it is worth noting that Quicklink Ltd achieved their higher on-time
delivery target of 99% in respect of each activity whereas Celer Transport were unable to do so. Moreover, it is worth noting
that Celer Transport missed their target time for delivery of food products on 975 occasions throughout the year 31 May 2005
and this might well cause a high level of customer dissatisfaction and even result in lost business.
It is interesting to note that whilst the businesses operate in the same industry they have a rather different delivery mix in
terms of same day/next day demands by clients. Same day deliveries only comprise 20% of the business of Quicklink Ltd
whereas they comprise 75% of the business of Celer Transport. This may explain why the delivery performance of Celer
Transport with regard to mail and parcel deliveries was not as good as that of Quicklink Ltd.
The fact that 120 items of mail and 25 parcels were lost by the Celer Transport business is most disturbing and could prove
damaging as the safe delivery of such items is the very substance of the business and would almost certainly have resulted
in a loss of customer goodwill. This is an issue which must be addressed as a matter of urgency.
The introduction of the call management system by Quicklink Ltd on 1 June 2004 is now proving its worth with 99% of calls
answered within the target time of 20 seconds. This compares favourably with the Celer Transport business in which only
90% of a much smaller volume of calls were answered within a longer target time of 30 seconds. Future performance in this
area will improve if the call management system is applied to the Celer Transport business. In particular, it is likely that the
number of abandoned calls will be reduced and enhance the ‘image’ of the Celer Transport business.
Workings
Revenue generation per vehicle:
Quicklink Ltd 2006 2005
Mail and parcels: £ £
Contract mail 1,769,040
Contract parcels 1,474,200
Non-contract mail 1,651,104
Non-contract parcels 1,179,360
––––––––––
Total 6,073,704
Number of vehicles 55
Revenue per vehicle £110,431 = £105,172 (110,431/1·05)
Machinery: £ £
Contract 6,747,300
Non-contract 1,124,550
––––––––––
Total 7,871,850
Number of vehicles 21
Revenue per vehicle £374,850 = £357,000 (374,850/1·05)
Celer Transport 2006 2005
Mail and parcels: £ £
Contract mail 237,600
Contract parcels 247,500
Non-contract mail 776,160
Non-contract parcels 693,000
––––––––––
Total 1,954,260
Number of vehicles 22
Revenue per vehicle £88,830 = £72,679 (88,830/1·10 x 90%)
Processed food: 2,700,000 2,700,000
Number of vehicles 22
Revenue per vehicle £122,757 £122,757 (no change in contract values)

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 Deliveries per vehicle:
Quicklink Ltd Celer Transport
2005 2006 2005 2006
Actual Budget Actual Budget
Mail and parcel deliveries:
Number of deliveries 702,000 702,000 195,000 214,500
(468,000 + 234,000) (195,000 x 110%)
Number of vehicles 55 55 22 22
Deliveries per vehicle 12,764 12,764 8,864 9,750
Machinery/processed food deliveries:
Number of deliveries 35,700 35,700 32,500 32,500
Number of vehicles 21 21 22 22
Deliveries per vehicle 1,700 1,700 1,477 1,477

(c) The managing director of Quicklink Ltd might consider ‘the acquisition of the Celer Transport business to be a good strategic
move’ for the following reasons:
– The acquisition of the Celer Transport business would enable a rapid expansion of the business, whereas to grow
organically in a competitive industry requires a much longer timescale and be more difficult to achieve.
– Since the business operates both mail/parcel deliveries there is the potential for synergies to be taken advantage of in
terms of route scheduling as well as the opportunities to take advantage of the complementary mix of same day/next
day business that are distinctive features of the separate businesses.
– The fact that each of the Quicklink Ltd and Celer Transport businesses has a distinctive competence in terms of the
delivery of machinery and food products respectively helps to reduce the threat to future income streams.
– The combination of the Quicklink Ltd and Celer Transport business might well present opportunities to take advantage
of economies of scale. There would undoubtedly be scope for savings in establishment costs, staff costs, communication
costs etc.
– It is quite possible that the fuel costs per kilometre of the Celer Transport business during the year ending 31 May 2006,
which are budgeted to be 20% higher than those of Quicklink Ltd, may reduce profitability by up to £269,280. Hence
the Celer Transport business would have been budgeted to make a profit of £219,280 as opposed to a loss of £50,000
(note 1), had its fuel been provided under the terms of the contract with the supplier of fuel to Quicklink Ltd.
Note (1):
£ £
Loss per part 1(a) (50,000)
Potential saving in fuel costs:
Actual expenditure by Celer Transport business:
340 x 300 x 22 x (£0·12 + £0·60)= 1,615,680
Expenditure at contract rates:
340 x 300 x 22 x (£0·10 + £0·50) = 1,346,400
––––––––––
Potential saving in fuel costs 269,280
–––––––––
Potential net profit 219,280
–––––––––
NB: The above calculation assumes that the cost per kilometre of a vehicle used in the delivery of processed food would be
the same as that of a vehicle used in the delivery of industrial machinery.

(d) The benefits that might accrue from the successful implementation of a Total quality management programme by the
management of the combined entity include the following:
– There will be an increased awareness of all personnel within Quicklink Ltd of the need to establish a ‘quality culture’
within the company which will provide a basis of improved performance throughout the organisation.
– The successful adoption of a TQM philosophy would ensure that there is a real commitment to ‘continuous improvement’
in all processes.
– It would place a greater focus on customer satisfaction since at the heart of any TQM programme is a deep-seated
commitment to the satisfaction of every customer.
– There would be a greater emphasis upon teamwork which would be used in a number of forms e.g. quality circles which
could be established with a view to improving performance within every area of the business. The fostering of team spirit
will also improve communication within Quicklink Ltd.
– A major characteristic of a TQM programme is process-redesign which is used to simplify processes, systems,
procedures and the organisation itself. In this respect the adoption of a TQM philosophy will be invaluable since the
integration of the Quicklink Ltd and Celer Transport businesses will require, of necessity, a detailed review of those
processes currently employed.

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 – The adoption of a TQM philosophy will necessitate the monitoring of quality costs in order to measure whether the
objective of continuous improvement is being achieved. In this respect the aim will be to eliminate internal failure costs
such as late deliveries and lost items which are clearly detrimental to a business which operates in the transport and
haulage industry.

2 (a) Project North East South

Year 1 Cashflow 6,000·0 11,500·0 12,000·0
Depreciation (6,000·0) (8,000·0) (6,000·0)
––––––––– ––––––––– –––––––––
Profit/(loss) nil 3,500·0 6,000·0
Average invested capital 21,000·0 20,000·0 21,000·0
Return on Investment (ROI) nil 17·50% 28·57%
Year 2 Cashflow 8,000·0 11,500·0 10,000·0
Depreciation (6,000·0) (8,000·0) (6,000·0)
––––––––– ––––––––– –––––––––
Profit 2,000·0 3,500·0 4,000·0
Average invested capital 15,000·0 12,000·0 15,000·0
Return on Investment (ROI) 13·33% 29·17% 26·67%
The management of the IOA Division is likely to prefer to invest in the South project as the projected return on investment is
much higher than the projected returns from the North and East projects. Their choice of project would be influenced by the
fact that under the terms of the management incentive plan they are eligible to receive annual bonus payments which are
calculated by reference to the overall year 1 and 2 return on investment (ROI). Thus the management incentive plan is
causing divisional management to adopt a short-term focus which is detrimental to the organisation as a whole. The
inappropriate performance-rewards linkage can therefore be said to be precipitating dysfunctional behaviour on the part of
the management of the IOA Division. It would be interesting to know for how long ROI had formed the basis of payment under
the management incentive plan. We know that in recent years the IOA Division has been one of the more profitable divisions
within NCL plc, however, one must question to what extent the fortunes of NCL plc have been adversely affected by the
dysfunctional behaviour of not only the management of the IOA Division, but also all the other divisional management teams.
On the other hand, the board of directors of NCL plc could adopt a much longer-term view and also have as an objective the
maximisation of shareholders’ wealth. They are likely to assess the three projects on a whole-life basis and consequently will
choose the project which yields the largest discounted cash flow. In this case that is the North project. Much will of course
depend upon the attitude to risk of the board of NCL. The fact that the life of the East investment is only three years might
well mean that there is less uncertainty in the estimate of future cashflows than there is in the estimates of the North and
South projects which are forecasted to have a life of four years.

(b) The use of residual income as a basis for the management incentive plan operated by NCL plc would have the following
advantages:
Divisional management would be more willing to accept a project with a positive residual income and this would contribute
to the improved performance of NCL plc. Also, the disincentive to accept a project with a positive residual income but a return
on investment regarded by divisional management as not being in their best interests would be removed, because divisional
management would be rewarded.
The use of annuity depreciation may improve performance appraisal by removing the effect of straight-line depreciation which
tends to distort project returns especially in the early years of a project’s life when invested capital remains relatively high due
to the constant depreciation charge. The residual income approach using annuity depreciation will only match the NPV if the
annual cashflows of a project are constant. Hence the method when applied to the North or South projects would produce
an NPV which does not exactly match that previously calculated. By way of contrast it is forecast that the East project will
have constant cashflows and in this instance the NPV and residual income based approach when discounted, will produce
the same result.

(c) The net present value of the West project is dependent upon the level of environmental expenditure that will be incurred by
Division IOA at the conclusion of the project. The potential NPV of the West project can be calculated using a discount rate
of 12% per annum which assumes that the West project has similar characteristics to the North, East and South projects.
Net cash inflows for each of years 1–4 = £5 million
Cumulative discount factor at 12% per annum = 3·037
Therefore the present value of cashflows is £5 million x 3·037 = £15,185 million and the net cash flow after the initial
outlay of £12 million is £3,185,000.
There is now the strategic consideration regarding whether to spend £2 million which will restore the river to its original colour
and also clear 90% of the pollution caused as a result of the mining activities of the IOA Division, or to incur expenditure of
a further £2 million which will completely redress any damage done to the environment by the activities of the IOA Division.

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 The net present value of the potential outcomes is as follows:
Environmental expenditure £2 Million £4 million
£000 £000
Net cash flow before environmental expenditure £3,185 £3,185
Year 4 expenditure (discounted at 12%)
£2m * 0·636 (1,272)
£4m * 0·636 (2,544)
–––––– ––––––
Net present value 1,913 641
–––––– ––––––
If only £2 million of expenditure was incurred in respect of making good the local environment, the NPV of the West project
would be nearly three times greater than it would be if £4 million were to be spent. However, much will depend upon the
extent of that the board of directors of NCL plc is socially responsible, which in turn is dependent upon their concern for the
environment in which they operate. The board of directors should acknowledge that the activities it undertakes will invariably
be of concern to those communities in which it operates. With regard to the West project the board of directors of NCL plc
should be mindful that the fact that the river would be polluted for up to four years constitutes a significant reputational risk
because a polluted river will inevitably precipitate much negative public opinion.
Moreover the board of directors of NCL plc need to be aware of the fact that whilst profits and cashflows may be reduced as
a consequence of pursuing socially responsible policies their image as a socially responsible organisation will be enhanced
and this may well create goodwill from which longer-term benefits may arise.

3 (a) The weaknesses of traditional budgeting processes include the following:

– many commentators, including Hope and Fraser, contend that budgets prepared under traditional processes add little
value and require far too much valuable management time which would be better spent elsewhere.
– too heavy a reliance on the ‘agreed’ budget has an adverse impact on management behaviour which can become
dysfunctional having regard to the objectives of the organisation as a whole.
– the use of budgeting as base for communicating corporate goals, setting objectives, continuous improvement, etc is seen
as contrary to the original purpose of budgeting as a financial control mechanism.
– most budgets are not based on a rational causal model of resource consumption but are often the result of protracted
internal bargaining processes.
– conformance to budget is not seen as compatible with a drive towards continuous improvement.
– budgeting has an insufficient external focus.

(b) Benchmarking
Benchmarks enable goals to be set that may be based on either external measures of ‘best practice’ organisations or internal
cross-functional comparisons which exhibit ‘best practice’. A primary aim of the traditional budgeting process is the setting of
realistic targets that can be achieved within the budget period. The setting of realistic targets means that the extent of
underperformance against ‘best practice’ standards loses visibility, and thus short-term financial targets remain the
predominant focus of the traditional budgeting process. It is arguable that because the budgetary reporting system purports
to give managers ‘control’, there is very little real incentive to seek out benchmarks which may be used to raise budgeted
performance targets. Much depends upon the prevailing organisational culture since benchmarking may be viewed as an
attempt by top management to impose impossible targets upon operational managers. The situation is further exacerbated
where organisations do not measure their success relative to their competition.
Balanced scorecard
The Balanced scorecard is often misunderstood as a consequence of the failure by top management to ensure that it is
implemented effectively within the organisation. Thus it may be viewed as the addition of a few non-financial measures to
the conventional budget. In an attempt to overcome this misperception many management teams now establish a
performance-rewards linkage based upon the achievement of Scorecard targets for the forthcoming budget period.
Unfortunately this can precipitate dysfunctional behaviour at every level within the organisation.
Even in situations where the Scorecard has been well-designed and well-implemented it is difficult for it to gain widespread
acceptance. This is because all too often there exists a culture which places a very high value upon the achievement of the
fixed annual targets in order to avoid the loss of status, recognition and rewards.
A well-constructed Scorecard contains a mix of long-term and short-term measures and therefore drives the company in the
direction of medium-term strategic goals which are supported by cross-functional initiatives. On the other hand, the budgeting
process focuses the organisation on the achievement of short-term financial goals supported by the initiatives of individual
departments. Budgets can also act as an impediment to the acceptance of responsibility by local managers for the
achievement of the Scorecard targets. This is often the case in situations where a continued emphasis exists on meeting short-
term e.g. quarterly targets.
Activity-based models
Traditional budgets show the costs of functions and departments (e.g. staff costs and establishment costs) instead of the costs
of those activities that are performed by people (e.g. receipt of goods inwards, processing and dispatch of orders etc). Thus

24
 managers have no visibility of the real ‘cost drivers’ of their business. In addition, it is probable that a traditional budget
contains a significant amount of non-value-added costs that are not visible to the managers. The annual budget also tends
to fix capacity for the forthcoming budget period thereby undermining the potential of Activity-based management (ABM)
analysis to determine required capacity from a customer demand perspective. Those experienced in the use of ABM
techniques are used to dealing with such problems, however their tasks would be much easier to perform and their results
made more reliable if these problems were removed.

4 (a) Dental Health Partnership

Summary Profit and Loss Account for the year ended 31 May 2005
£
Fees received 1,226,880 (Note 1)
Other Operating Income 20,800
––––––––––
Total Income 1,247,680
Less: variable costs
Material and consumables 446,400
Less: fixed costs
Salaries 538,880
Establishment costs 85,000
Other operating costs 75,775
––––––––––
Total costs 1,146,055
––––––––––
Net profit for the period 101,625
––––––––––
Calculation of % of total capacity required to break-even during the year ended 31 May 2005.
Fees received £1,226,880
Less: variable costs £446,400
–––––––––––
Contribution £780,480
–––––––––––
Total number of consultations 28,800
Weighted average contribution per patient visit = £780,480/28,800
= £27·10
Total fixed costs: £
Salaries 538,880
Establishment costs 85,000
Other operating costs 75,775
––––––––
699,655
Less: fixed income 20,800
––––––––
Total fixed costs less fixed income 678,855
––––––––
Divide by weighted average contribution per patient visit £678,855/£27·10 = 25,050 consultations.
Total capacity for patient visits= 28,800/0·8333 = 34,560 per annum
Therefore percentage of maximum capacity required in order to break-even is 25,050/34,560 = 72·5%
Note 1. Fees received:
Adult fees = Payment plus Government refund
Children/Senior Citizens = Government refund
Adjusted patient mix is as follows:
Adults 50% x 2 = 100%
Children 40%
Senior Citizens 10%
––––––
Total 150%
––––––
The weighted average fee per patient is as follows:
Type of patient treatment: £
None 0·70 x £12 = 8·40
Minor 0·20 x £50 = 10·00
Major 0·10 x £100 = 10·00
––––––
Total 28·40
––––––
Therefore fees received during the year ended 31 May 2005 = 28,800 x 1·5 x £28·40 = £1,226,880.

25
 Note 2. Capacity:
Each dentist had a maximum of 24 patients per day but on average treated 20 patients per day which equates to 83·333%
of maximum capacity.

(b) The major characteristics of services which distinguish services from manufacturing are as follows:
– Intangibility.
When a dentist provides a service to a client there are many intangible factors involved such as for example the
appearance of the surgery, the personality of the dentist, the manner and efficiency of the dental assistant. The output
of the service is ‘performance’ by the dentist as opposed to tangible goods.
– Simultaneity.
The service provided by the dentist to the patient is created by the dentist at the same time as the patient consumed it
thus preventing any advance verification of quality.
– Heterogeneity.
Many service organisations face the problem of achieving consistency in the quality of its output. Whilst each of the
dentists within the Dental Health Partnership will have similar professional qualifications there will be differences in the
manner they provide services to clients.
– Perishability.
Many services are perishable. The services of a dentist are purchased only for the duration of an appointment.

(c) In order to assess the quality of patient care provided by the Dental Health Partnership the following performance measures
might be used:
– The percentage of ‘on time’ treatment of those patients who arrived prior to their appointment time would provide an
indication regarding the effectiveness of the scheduling of appointments by the Dental Health Partnership.
– the percentage of patient appointments which were re-arranged at the request of the Dental Health Partnership.
Rearranged appointments represent the provision of a lower level of service provision to clients who may, as a result,
switch to an alternative dental practice.
– the percentage of patients who return for treatment after their first appointment would provide an indication that they
were satisfied with the service they received.
– the percentage of patients who were able to gain an appointment at their preferred date and time is an indication of the
availability of the service to clients.
Note: Candidates were only required to discuss three measures.

5 (a) The overall performance of Taliesin Ltd during the year ended 31 May 2005 can be measured by its Return on Capital
Employed (ROCE) as follows:
2005 2004
Profit Before Interest = 5,000 4,000
––––––––––––––––––––––––––––– ––––––– –––––––
Total Assets less Current Liabilities 66,000 52,000
= 7·58% 7·69%
A figure of 7·58% is not good especially when Taliesin Ltd has borrowed money at 10% in order to develop further. 7·58%
is a slight fall from 2004. Since this information was available at the start of the 2005 financial year the directors should
have reconsidered their objective of growth.
Sales have increased by 20% over the previous year. There is a considerable variation in the sales achieved by Taliesin Ltd
in the different halves of their accounting year. This variation in seasonal demand required the hiring of a secondary core work
force for the period 1 June – 30 November during each financial year. Most of the growth in sales revenue occurred during
the first half of the year ended 31 May 2005.
Cost of sales has remained constant at 60% of sales. It is interesting to note that the composition of cost of sales has changed
during the year and management attention should be focussed on this in order to ascertain the reasons for this change. The
material percentage content of cost of sales has remained constant whereas labour has decreased. Manufacturing overheads
comprise the majority of cost of sales in 2005 (51·5%). This is an increase of 1·5% over 2004.
2005 2004
% of cost of sales: % of cost of sales:
Materials 32·5 32·5
Labour 16·0 17·5
Overheads 51·5 50·0
–––––– ––––––
100·0 100·0
–––––– ––––––

26
 Whilst the gross profit percentage has remained constant at 40% the net profit percentage has reduced from 10% to 8·33%.
In absolute terms, Taliesin Ltd has earned the same profit during the year ended 31 May 2005 as it did in the previous year.
Operating costs have risen by 27·5% over the previous year’s level. The company has also paid £1 million in interest on a
loan which was taken out during the year presumably to finance the plant and equipment required in order to manufacture
the six new products.
Details of the composition of net current assets are required in order to ascertain the liquidity position of Taliesin plc and
thereby gain a fuller picture of the financial position of Taliesin Ltd.
From the information provided it would appear that although sales increased by 20% over the previous year’s level, Taliesin
Ltd has lost a customer during the year ended 31 May 2005. It is quite conceivable that this only happened towards the end
of the year and thus the profit and loss account might not fully reflect financial consequences of the lost customer. The loss
of the customer could well be highly significant since the company had only six customers at the start of the year. It is highly
probable, therefore, that each of the six customers, being supermarkets, purchased in relatively large volumes and thus
significant turnover may have been lost. This will only become apparent during the next year but Taliesin Ltd should attempt
to find a new customer to replace the lost customer as soon as possible.
Growth may only have been achieved by introducing new products. There may be a limit to the number of times that this
can be done effectively. It has already been noted that the six new products have led to a loan, the cost of which exceeds the
return generated by Taliesin Ltd.

(b) The major benefits of pursuing a policy of internal development that may accrue to Taliesin Ltd are as follows:
– By confining their activities to its internal environment the company avoids the need to manage the integration of
businesses which is necessitated by an acquisition. Management teams, when considering the acquisition of another
organisation, very often underestimate the costs of integration.
– There is no need for the board of directors of Taliesin Ltd to familiarise itself with different organisational and national
cultures, values etc, thereby avoiding many potential problems.
– The board of directors of Taliesin Ltd is better able to control the activities of the business and the need for more complex
supply chains and strategic alliances with foreign organisations is rendered unnecessary.
– All investments are made at market price whereas if the board of directors was to attempt to grow the business
acquisition then significant outlays would probably be made in respect of purchased goodwill.
– As the organisation develops and expands, staff are provided with development and learning activities that may
precipitate an increase in the level of their commitment to the organisation.

(c) The usefulness of activity-based techniques is accentuated in situations where overheads comprise a significant proportion of
product costs. Manufacturing overheads comprise 30·9% of turnover during the year ended 31 May 2005. Traditional
methods of allocating overheads to products might result in product cost information which is misleading and detrimental to
managerial decision-making. Calculations of product costs are more prone to error in situations where higher levels of
overhead exist. The consequences can prove disastrous as, for example, in the under-pricing or over-pricing of products.
Since Taliesin Ltd is going to confine its activities to its home country it must be prepared to face increased competition and
this increases the need for greater visibility and more accurate product cost information.
At present, Taliesin Ltd offers a range of products which is increasing in number and this may lead to the need for a more
detailed costing system. Traditional absorption systems might well be inadequate as the number of product variants increases.
One would expect that each new product developed is more complex than its predecessors. The company would probably
start with simple Vanilla, then a few basic flavours but as Taliesin Ltd has expanded one would expect it to take longer to
originate and test new products until they are ready to be introduced. It will probably take longer to mix the ingredients for a
run of each product.
These two, development and mixing ingredients, are examples of activities which arise when new products are considered.
If traditional absorption costing and budgeting are used based on machine-time in production then the effect of these activities
would be ignored.
In order to gain a full appreciation of the impact of new product introduction activity-based techniques should be used to
guide Taliesin Ltd into the easiest way to maintain its policy of growth. It may be a better decision to expand abroad or into
new markets at home with the existing products than pursue growth by introducing new products to a dwindling number of
customers.
We are not told of the composition of the customer base of Taliesin Ltd. However, one thing we do know is that the scope of
activity-based techniques extends beyond products and services. For example, the application of activity-based costing can
provide vital information that enables management to undertake customer profitability analysis, thereby further improving
management decision-making and operating performance.

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Part 3 Examination – Paper 3.3
Performance Management June 2005 Marking Scheme

Marks Marks
1 (a) Sales revenue 11
Fuel 4
Salaries 1
Sundry operating costs 1
Presentation (including profit/loss) 2
––– Maximum 16

(b) Revenue generation per vehicle 8

Vehicle utilisation and delivery mix 6·5
Service quality 6
––– Maximum 14

(c) Comments (on merit) – four required up to 1·5 marks each Maximum 5

(d) Link to: Improved performance 1

Continuous improvement 1
Customer satisfaction 1
Team spirit 1
Process-redesign 1
Quality costs 1
Other relevant comments 2
––– Maximum 5
–––
Total 40
–––

2 (a) Relevant calculations 6

Comments (on merit) 4 10
–––

(b) Comments (on merit)

Residual income 2
Annuity depreciation 3
––– Maximum 4

(c) Revenue 1
Expenditure 1
Net cash flow 1
Comments (on merit) 3 6
––– –––
Total 20
–––

3 (a) Comments (on merit):

Inherent disadvantages (five required) Up to 2 marks each Maximum 8

(b) Benchmarking 4
Balanced scorecard 4
Activity-based models 4 12
––– –––
Total 20
–––

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 Marks Marks
4 (a) Fee income 4
Materials and consumables 0·5
Salaries 1
Establishment and other operating costs 0·5
Other operating income/profit 1
Calculation of break even capacity utilisation 5
––– 12

(b) Comments (on merit):

Intangibility Up to 1·5
Simultaneity each
Heterogeneity
Perishability
––– Maximum 5

(c) One mark per performance measure 3 3

–––
Total 20
–––

5 (a) Comments (on merit):

Return on Capital Employed (ROCE) 2
Sales revenue 2
Cost of sales 2
Operating costs 1
Interest payable 1
Net profit 1
New product introduction 1
Lost customer 2
Net current assets 1
Other relevant comments 2
––– Maximum 11

(b) Comments (on merit):

Avoidance of problems re:
Integration of different businesses
Different cultures
Control
Purchased goodwill
Other relevant comments Maximum 4

(c) Comments (on merit):

High overhead content
More accurate product cost information
Extension to customer profitability analysis
Other relevant comments Maximum 5
–––
Total 20
–––

30